I think it’s safe to say that Quantitative Easing is considered a market crutch by many. But now that we know it’s coming to an end, why aren’t stocks crashing? Could this market actually support itself without the Fed? Perhaps…
Headlines can be scary. Think about the events that took place in 2013. We went “over” the fiscal cliff, hiked taxes on Americans, and began making automatic budget cuts via the sequestration; heck, we even shutdown the government for more than two weeks!
Then the FOMC announced a reduction in monthly bond purchases (QE) sooner than later, meaning that $90 billion (now $80 billion) in monthly bond buying will just go away … and yet stocks are not only holding their ground, but moving higher.
What’s even more fascinating (and somewhat scary) is that Q4 earnings growth estimates have not only dropped to 6% from close to 12% just 3 months ago, but earnings warnings are at an all-time high.
Wall of Worry?
Yes, earnings warnings are at an all-time high. In fact, 88% of the companies on the S&P 500 that have issued an earnings outlook for the fourth quarter have been below Wall Street consensus estimates.
Prior to the start of Q4 earnings season, 108 companies had given earnings outlooks that fell below the Wall Street consensus, compared with 11 companies that gave an in-line figure and 11 companies that provided an estimate above the consensus.
Should you be concerned?
Over the last 4 years, you’ve heard many (including me) gripe about the lack of a true economic comeback … but maybe it’s better we don’t have an immediate resurgence in economic activity. Perhaps this moderate, almost pathetic recovery will keep major bubbles from forming amidst the FOMC’s cheap (free) money policies.
The truth is that earnings warnings have been on the rise, but they have helped control growth expectations to a level that the market can digest, rather than force it to have to deal with earnings report shocks that could have caused severe volatility and doubts in true sentiment.
I actually see this chart as bullish because despite the almost 100% increase in corporate warnings over the last 4 years, the S&P has managed to tack on an 80% return. Think what would happen if Wall Street just let growth expectations run amuck! If the majority of market participants were expecting record breaking growth, negative surprises would not only have dramatic negative effects on stock prices, but also on the psyche of the average investor.
So I say WARN ON! Just as the FOMC has successfully managed expectations and kept us in the loop about their progress and scaling of quantitative easing, corporate America should minimize surprises and help keep copious amounts of exuberance and gloominess controlled.
Psychological State of Things
Despite the drawbacks and reductions in estimates, the S&P 500 has managed to gain over 26% in the last year.
Why? Because there is not only value left in many stocks, but the underlying hope (bullishness) remains. Moreover is the fact that the U.S. is still the best place for global investors looking for a place to park their hard earned dollars, and investors are even looking beyond QE to see bullish potential.
More . . .
Earnings season is really heating up this week, and Zacks has briefly opened up its whisper research breakthrough to the public once more. Here’s the most exciting part: It detects positive earnings surprises just before they are reported. And with previously unthinkable accuracy.
A flurry of new signals is expected within the next few days but only a select group of investors will be able to take timely advantage of them. Important: This portfolio closes to new investors Saturday, January 18.
If markets were completely euphoric and irrational, then we should have seen a 10-15% correction without a bounce after the FOMC’s decision to taper.
There are 14 stages of investor sentiment; these variations can be fairly easy to spot at times and elusive at others. Stocks often trend depending upon the psyche of investors, not always on hard fundamental data.
Interestingly enough, there is clarity amidst the chaos. As we entered into the New Year, there was doubt and markets were cautious, but stocks still managed to charge forward.
“Hope” was the best way to describe the marketplace back in January 2013, which was fairly close to the point of maximum profitability in the market’s emotional cycle (see the chart above).
If we take a look back to mid September 2012, markets were completely euphoric running up into the elections, with the fiscal cliff just a twinkle in the eye of only the savviest investors. After the election results and woes about the cliff and future of the economy, the market quickly gave back 9%, changing the mood from elation to outright depression.
Over the last year, we have watched market sentiment go from a state of panic and then completely turn around.
Towards the end of 2013, stocks had run up into the “Thrill Zone”, but took a break, gathered some rationale and reset themselves back into what seems to be more optimism than anything.
By setting VERY realistic expectations, the market is doing an excellent job at controlling our emotional rollercoaster.
Managing Earnings Expectations
While emotions can rule the markets much of the time, there are four times a year when stocks report their results (earnings) and the objective overtakes the subjective. If the subjective mood is not “overly euphoric” than stable objective data should cause stocks to rise; this works in the opposite direction as well of course.
The good news is that markets are NOT euphoric or even overly optimistic when it comes to MOST earnings expectations. In fact, stocks are perhaps more realistic now than at any other time this year, BUT you must be able to identify those stocks that have built up such a high expectation that it may be impossible to deliver.
I’d be lying to you if I said that corporate revenues are shooting up and that the average company is making money hand over fist. But I can say that there are three things that I (still) feel very good about in the first half of 2014:
1) Corporations are lean and mean – The average American company has cut costs and economized their businesses to keep margins high and operate in a low growth environment. Margins are still expected to be on the rise year over year.
2) Hoards of cash – We are seeing many companies stockpiling cash and equivalents, preparing themselves not just for the worst, but for the turn. The turn being an improvement in the economy and post QE prosperity; that cash is utilized for expansion, M&A, share buybacks and dividends.
3) Expectations low – As I mentioned last quarter, expectations were relatively low, but more recently the average share price and growth estimates have come down even further. This makes the reaction to a positive surprise that much more significant.
These factors will help support the markets throughout the coming earnings season, as long as revenues do not fail miserably.
How Do You Trade Q4 Earnings?
Expectations are low for a reason. I wouldn’t expect the overall market to see as good a return in 2014 as we saw over the last year. Many analysts are also predicting a pullback in the near term.
This means that you have to be laser-focused and step outside the box to find alternative investment methods that capture superior returns. Defensive stocks and utilities are not in vogue and even stocks with low multiples aren’t going to necessarily be safe havens if their reports are weak. Not all stocks are rising in this bullish market.
To get the edge, I target and study analysts’ behaviors and actions ahead of a report to sniff out those companies most likely to beat earnings expectations. I compound that data with relative valuation and sector favorability to find high stocks with a high chance of not only beating estimates, but moving higher on that news.
The perfect way to add this type of diversity to your portfolio is to target companies likely to beat analysts’ estimates and keep the trades short in duration so you won’t be over-exposed to a market that is still susceptible to headlines.
The bottom line is that we will still have companies that perform extraordinarily well and top analyst expectations this coming earnings season. These companies will see their share prices break away (positively) from the market average as they attract new money looking for yield.
You will need an effective tool to do this; one that stacks the odds in your favor. Whatever method you choose, be sure to allocate your assets appropriately, reduce risk where needed and take or protect profits once you have them. This will certainly be a tough quarter for the average “long only” investor.
Listen To The Right Whispers
I am directing a service that uses Zacks research data to predict positive earnings surprises before they’re reported. It has greater than 82% accuracy in selecting companies that beat estimates. Although these “surprise” stocks don’t all turn out to be winners, listening to selected whispers obviously can give investors a substantial advantage.
So if you would like my specific stock recommendations, they are available today in the Zacks Whisper Trader.
But please note that to be fair to our current members we can’t allow too many traders to share these stocks. So the portfolio will close to new investors this Saturday, January 18.
Happy Trading (and don’t forget to hedge),
Jared A. Levy is one of the most highly sought-after traders in the world and a former member of three major stock exchanges and author of two best selling financial books. That is why you will frequently see him appear on Fox Business, CNBC and Bloomberg providing his timely insights to other investors. He directs the Zacks Whisper Trader which has an uncanny record for accurately predicting robust earnings before companies report.
Posted:Tue, 14 Jan 2014 21:40:01 GMT
Tech giant Google (GOOG) announced on January 13 that it was acquiring Internet-connected thermostat and smoke alarm maker Nest Labs for a whopping $3.2 billion in cash. Google has over $58 billion in cash and securities sitting on its balance sheet, so it can certainly afford it. But whether or not this will be a good use of shareholders’ money remains to be seen.
Businesses have several options when it comes to deploying their excess cash. They can make acquisitions like Google just did, fund organic growth, pay down debt, or return it to shareholders through dividends or stock buybacks.
Of course, a company can just let that money sit in the bank and grow its cash hoard. But with interest rates near record lows, they’re generating very low returns for their shareholders.
Ideally, a company should use its capital to maximize long-term value for their shareholders. But clearly some managers understand this concept better than others. Many corporate executives are more concerned about empire-building than producing high returns on capital and often make reckless decisions with shareholders’ money that destroys value over time.
If you own a company for the long-run, make sure you know how it is managing its cash.
Buybacks & Dividends
It’s not uncommon for companies to distribute more and more cash to shareholders as they mature. Bigger companies have less growth opportunities and compete in crowded markets, so they plow back less of their earnings into the company and more into shareholders’ wallets. And dividends, along with stock buybacks, are the quickest and surest way to return value to shareholders.
When a company actually buys back its shares, it has a direct benefit in that it reduces the number of shares outstanding. This means that earnings are divided among fewer shares. In other words, your piece of the pie just got bigger.
If a company has the excess funds and their stock is undervalued, buybacks can add tremendous value over time. But make no mistake: stock buybacks don’t always add value. In fact, history shows that companies are often bad at timing their repurchases, buying when their share price is high.
The cash allocated to their overvalued stock would have been better spent investing for growth, paying a higher dividend, or just leaving it in the bank.
So make sure the underlying business is sound and the stock is reasonably priced before investing in a company that’s buying back its own stock. Because all the buybacks in the world won’t save a company headed off a cliff.
4 Shareholder-Friendly Companies
With that in mind, here are 4 solid, shareholder-friendly companies generating strong free cash flow, raising their dividends and buying back stock:
Free Cash Flow (Trailing Twelve Months): $14,618 million (8.5% of market cap)
Share Buybacks (Trailing Twelve Months): $10,750 million (74% of FCF)
Dividends Paid (Trailing Twelve Months): $1,980 million (14% of FCF)
5-year Compound Annual Growth Rate (CAGR) in Dividends: 19%
Free Cash Flow (TTM): $1,321 million (6.4% of market cap)
Share Buybacks (TTM): $1,607 million (122% of FCF)
Dividends Paid (TTM): $345 million (26% of FCF)
5-year CAGR in Dividends: 13%
Free Cash Flow (TTM): $7,730 million (6.2% of market cap)
Share Buybacks (TTM): $4,610 million (60% of FCF)
Dividends Paid (TTM): $2,055 million (27% of FCF)
5-year CAGR in Dividends: 17%
Free Cash Flow (TTM): $3,239 million (6.3% of market cap)
Share Buybacks (TTM): $3,547 million (110% of FCF)
Dividends Paid (TTM): $723 million (22% of FCF)
5-year CAGR in Dividends: 16%
The Bottom Line
Companies have several options when it comes to deploying their excess cash. These 4 cash machines are choosing to return value to shareholders through generous dividends and big stock buybacks.
Want More of Our Best Recommendations?
Zacks Executive VP, Steve Reitmeister, knows when key trades are about to be triggered and which of our experts has the hottest hand. Then each week he hand-selects the most compelling trades and serves them up to you in a new program called Zacks Confidential.