Market Shadows'  Instablog

Glimpse into Future

In this issue of the Market Shadows Newsletter, we index previous educational articles by Paul Price for easy access and review recent moves in the virtual portfolios. Lee Adler provides an update on current market conditions.

Read the whole newsletter: Sea of Money: Market Shadows Newsletter 5-7-13

Excerpt from Glimpse into Future

Lee Adler of the Wall Street Examiner reported on May 1 that the Federal Government is "rolling in cash" due to higher-than-predicted tax collections and possibly reduced spending due to the sequester cuts. In Wildly Bullish Liquidity Flows Should Benefit Stocks More Than Treasuries (subscription required), Lee noted,

"Overall, the TBAC sees a net paydown of $21 billion from now through the end of the second quarter. That's a far more bullish forecast than they had in February for this period when they were expecting that the Treasury would need to raise cash from net new supply of $83 billion from now until the end of the quarter. That's a positive swing of $104 billion from the last quarterly TBAC update until the one just released at the beginning of May."

Thus, the Treasury's revised projection that it will pay off $21 billion in net borrowing by the end of June resulted from higher than expected tax revenues and the much maligned sequester cuts. This is equivalent to a family being able to reduce their credit card's monthly balance by paying more to the bank in a given period than they incur in new charges.

Reduced federal borrowing will free up $21 billion investor money that would have been soaked up by new T-bond issuance. A good part of that sum will likely find its way into the stock market, providing fuel for a stock market melt-up. This excess liquidity is bullish for stocks, as Lee Adler explains in the following excerpt from The Irony Of The Fed's Manipulation - Professional Edition (subscription required):

The only change in today's FOMC statement was the addition of some words to the effect that the Fed would consider increasing quantitative easing (QE, colloquially known as 'money printing'). Apparently its strategy of jawboning and manipulating commodity prices worked too well, so now instead of threatening to end or taper QE, it now must resort to threatening to add to it to keep commodities from continuing the decline that the Fed seemed to want.

It would seem that too little inflation is a worse fate than too much.

Regardless of all the words, the policy remains the same. Print mass quantities of money and jam it into the accounts of the Primary Dealers every month. Today (May 1) there's some profit taking as traders and algos digest weak economic data, but I'm sure that once they've had a chance to consider and recalibrate the implications of the Fed continuing to increase the size of the numerator that goes into the pricing equation, they'll be back at the table shortly.

The composite liquidity indicator rose last week, mostly from the Fed's weekly Treasury purchases.

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Gains in most indicators were slight. April, the period of the strongest liquidity flows of the year from the massive paydowns of Treasury debt, has now ended. Liquidity will slack off a little in May as the Treasury returns to being a net borrower, but river of cash will continue until the Fed ends QE. The Bank of Japan's (BoJ) massive new QE program will also add to US market liquidity."

The biggest surges of cash come after the Fed settles its MBS purchases around mid month. That pattern will go on until the Fed ends this round of QE. News flow will cause stock and bond prices to continue to fluctuate around the liquidity trend. Buyers will get fatigue from time to time, as they did today. No doubt there will be more efforts to manipulate commodity prices, particularly gold and silver, but now that the Fed sees that it may have been too successful in scaring speculators away from commodities, they'll probably try to say stuff that gets them buying again. Fed policy is nothing if not ironic...

Some of the money that the BoJ prints not only can but does move into US paper, whether Treasuries or stocks. It will show up in the Foreign Central Bank measure and in banking measures. There's a strong correlation between the BoJ balance sheet and US stock prices, both over the long term, and in intermediate swings."

The correlation between the direction of stock prices and the size of these central bank balance sheets is remarkable.

Fed Cash to Primary Dealers measures the flow of cash into Primary Dealer accounts from Fed securities purchases. This indicator has the heaviest weighting in the composite. The current growth under QE3/4 is the fastest in history. It will be bullish until the Fed ends QE. Stocks will stall or pull back from time to time, hemmed in by resistance and news flow, but the Fed's cash will find its way into equities sooner or later.

*****

Read the whole newsletter: Sea of Money: Market Shadows Newsletter 5-7-13

Get regular updates the machinations of the Fed, Treasury, Primary Dealers and foreign central banks in the US market, in the Fed Report in the Professional Edition, Money Liquidity, and Real Estate Package. Click this link to try WSE's Professional Edition risk free for 30 days!

Courtesy of Paul Price

Tiffany (TIF), Coach (COH) and Michael Kors (KORS) are major players in the luxury segment of retailing. KORS has only been publicly traded since December of 2011. TIF and COH have long, very successful track records.

You might expect that the performance of these three stocks would parallel each other. In fact, the present valuations are widely disparate. For smart shoppers, this may spell opportunity.

Comparing these companies is complicated because they each use different fiscal years. Tiffany's FY ends around Jan. 31 of the following year. Coach closes its books on the Saturday nearest June 30. Kors totals up near March 31 of the next calendar year. For clarity in this discussion, I'm going to use my best guess in making apples-to-apples comparisons for the 12-month period ended around January 31, 2013.

As of Jan. 31, 2013, Tiffany had earned about $3.25 per share, Coach's EPS were about $3.62 and KORS came in at around $1.83 per share. Market pricing placed their current valuations as follows…

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Traders are paying up for KORS while getting no dividends. Investors are shunning Coach even though it has a modest multiple and a decent yield. TIF falls between those two extremes. The long-term results from the two companies which have been trading long enough to have them suggests that investors have gotten things mixed up.

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Coach shareholders benefited from the huge profit surge.

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It seems odd that today's investors prefer TIF to COH and award it a 54% higher P/E. Michael Kors premium valuation is easier to understand. KORS' pro forma EPS were $0.40 in fiscal 2010. Profits almost doubled to $0.78 in 2011. Earnings are expected to be $1.86 when FY 2012 is reported for the period ending March 30, 2013. A further 59% increase is now forecast for FY 2013.

True believers in KORS feel the shares are not overpriced at 23.1x next year's projection of $2.45 per share. Bargain seekers should logically be more attracted to Coach than Tiffany & Co.

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The only time Coach traded cheaper than today, valuation wise, was near the exact nadir in 2009. It paid no dividend back then. Shareholders were about to embark on an almost 600%, three-year move up. Today's 2.4% yield is unprecedented. The trailing P/E of 13.8x is a lower starting point than those that launched huge rallies in 2003, 2006, 2010 and 2011.

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All three of these companies are financially sound and highly profitable. Michael Kors is the fastest grower of the three companies but that fact is already reflected in its lofty valuation. Tiffany had a down 2012, yet is priced for growth. Coach had an all-time record fiscal year but is currently out of favor.

I bought both TIF and COH last summer when they sold off. I'm satisfied with my Tiffany gain and am planning to let TIF go via covered calls that expire on April 19. If Coach remains around $49 - $50, I'll be using those proceeds to increase my position.

A lower than historically typical P/E on the FY 2014 consensus projection of $4.14 could support a 12-month target price of $65 - $75. That's 30% - 50% above the current quote yet lower than was actually achieved early in 2012.

Paul's Disclosure: Long COH, Long TIF, short TIF covered calls.

Courtesy of Paul Price

Shares of drive-in restaurant operator Sonic (SONC) have been on a roll (pun intended). The stock rallied from a 52-week low of $6.84 to close at $12.88 on Wednesday, 3/27. Adjusted earnings for the end of the February quarter came in at 5-cents versus 3-cents a year earlier in the seasonally weakest (winter) quarter for this open-air eatery. Same store sales were flattish although 2012 was a leap year with one extra selling day.

Should we be savoring Sonic's positive momentum or digesting its gains?

Quick service restaurants in general face some major headwinds: minimum wage increases, Obamacare-related costs, and the FICA tax holiday reversion. These factors conspire against profitability. Sonic, in particular, has not shown very good results since FY 2008 (ended Aug. 31, 2008).

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From FY 2008 through FY 2012, total sales dropped 32.2%. EPS declined by 40%. The share price plunged from a peak of $26.20 in 2007, bottomed and bounced multiple times in 2008, 2009, 2010, 2011 and 2012 to annual highs of $10.90 - $13.10. Each advance proved to be a false start. I wouldn't bet that this time will be different.

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Company officers have chosen to sell at prices below today's. Director Federico Pena exited almost $290,000 worth at an average price of $11.58 just days ago. The last insider buy was relatively small and took place more than eight months ago.

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Sonic has a weak balance sheet and no dividend to support its price.

Value Line uses a financial strength rank of 'C' as their lowest other than outright default.

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Wall Street research has been busy cheerleading to explain Sonics recent share price action. Barrons just endorsed it as a good buy, while noting it was no longer cheap.

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Why pay 18.4 times the FY 2013 estimate of $0.70 for a serial disappointer in an industry with unfavorable forces working against its success?

If long SONC, I'd take profits.

Disclosure: No position