Earnings Season

10/4/15

After a very disappointing jobs number on Friday morning, it looked as if the market was headed for the August 24^th lows, with the S&P falling as much as 1.5% shortly after the open, only to spend the rest of the day rallying back to close UP 1.4%. So with a jobs number so bad, why did equities actually rally instead of continuing to sell off? The answer is simple…look no further than the bond market, and you will see that the market now does not expect the Fed to begin raising rates until next year…at the earliest. On Friday, the rate on the 10-year Treasury note closed below its August 24^th rate at 1.989%. At the same time, the Fed Funds rate predicts a 5% chance that the Fed will raise rates in October and only a 30% chance the Fed acts in December. There’s now talk that the Fed may even have to do another round of QE, something that I find to be a little ridiculous. My take is that while the September jobs number was a letdown and the downward revision for August was also bad to see, it’s just one indicator and a blip in the otherwise pretty strong US economic data.  

Looking ahead to this week, earnings season begins on Tuesday with reports from PepsiCo (PEP) and Yum Brands (YUM). I don’t really like either stock, as PepsiCo’s stock has gone literally nowhere in the last 12 months. It’s in a struggling industry and although it sports a 3% yield, there’s no catalyst to really move the stock. As for Yum, there are also better options in the food service industry, but with such a big presence in China, I am listening to what they say about the Chinese consumer going into the end of the year, which I think is stronger than most economists expect.

On Wednesday, one of my favorites, Constellation Brands (STZ) reports before the bell. This is a stock that I recommended weeks ago and has held up very well during the recent market volatility. Constellation has two of the best imported beer brands in the world, Modelo and Corona, and I think they will report another strong quarter. Constellation is sitting just 2% off all-time highs that it hit a couple weeks ago, but I still think you can buy it before they report and after if the stock sells off.

On Thursday, we’ll hear from pizza chain, Dominos (DPZ). Despite the recent market turmoil, Dominos is still up 13.5% YTD, vastly outperforming the S&P and most other restaurant stocks. I think the pizza is still terrible, but I do like the stock. Mobile ordering, much like Starbucks, has been the key driver of strong sales and will continue to do so in the future. Dominos has held the $103 (61.8% Fibonacci retracement) level since gapping up on earnings back in April, and bounced off that level on Friday to close at $106.88. The stock isn’t cheap, trading at about 27x FY16 earnings, but when compared to Starbucks, Yum Brands, Darden Restaurants and many others, it’s actually relatively cheap. However, with EPS expected to grow 21% this year and 15% next year, it’s priced to perfection and I would wait until after they report to hear what they say. If the report is strong and the guidance is good, but the stock goes lower on the back of a bad equities tape, look to be a buyer against $103.

Despite the strong rally into the close on Friday, I think the selling is far from over. Markets hate uncertainty, and the only certainty in this market is uncertainty.  Some members of the Fed say they want to raise rates, some say they don’t. Some say they are data dependent, some say they are concerned about the global economy. I am of the opinion that until they finally raise rates, the stock market absolutely will stay in this pattern of flat to lower price movements.

Hopefully by now, you have some cash on the sidelines, ready to put to work. It’s important to be patient in this market. It’s too easy to chase stocks as they rally like they did on Friday. The levels in the S&P to watch are 1970, which is the 38.2% Fibonacci retracement and 1931, the 23.6% retracement. The market has not closed above 1970 for three straight days since dropping below that level on August 24^th. I would rather see you be a buyer at 1931 or lower, which will likely get tested again this week. As for where we go from here, I think we’ve seen the lows for the year. The market tested those lows again last Tuesday and failed to break down, which shows very strong support at 1867. During earnings season, it’s especially important to not rush and chase stocks. Read through the conference calls and buy stocks of companies that report strong revenues, strong earnings, and offer better-than-expected guidance. Don’t mistake strong earnings for strong sales. You want to look for both. I think earnings overall will be very strong this quarter, but the true sign of economic and company strength is in their revenues.

Last week, I took advantage of the overselling in biotechs and bought more Amgen and Allergan. The entire biotech and healthcare sector has been overly beaten up, and should continue to be bought. The biotech EFT (IBB) saw its largest volume day in years on Monday, however what’s important to note is that it held major support at $283.55 and rallied 11% from there. I like the big cap biotechs, which at these levels are all oversold.

My current positions: Long Gilead Sciences (GILD), Starbucks (SBUX), Facebook (FB), Time Warner (TWX), NXP Semiconductors (NXPI), Darden Restaurants (DRI), Celgene (CELG), Mobileye (MBLY), Jack In The Box (JACK), Under Armour (UA), United Rentals (URI), Regeneron (REGN), Apple (AAPL), Southwest Airlines (LUV), Dow Chemical (DOW), L Brands (LB), Costco (COST), Amgen (AMGN), Home Depot (HD), Allergan (AGN), FireEye (FEYE), Humana (HUM), Skyworks Solutions (SWKS), Disney (DIS), Lockheed Martin (LMT), TJX Companies.

Jeff Lewison