Thursday, July 31, 2014

The Long-Term Bullish Bias of the Equities Market

Twenty-Two Years of Massive Outperformance - What Can We Learn?

By Dr Van Tharp Trading Education Institute

A recent CNBC interview with hedge fund honcho Leon Cooperman, founder of Omega Overseas Partners, caught my attention for several reasons. The first was a genuine curiosity as to how this guy has been able to continually outperform the market with a huge account for so many years. Second, I wanted to see if there are any lessons that we could learn from him. And third, my business partner had run money for Cooperman for a number of years and had told many Cooperman stories already but I couldn’t wait to ask him a few more questions about this maven.

One Maven Talks About Another

My business partner, Christopher Castroviejo, is a 35+ year Wall Street veteran who worked both the sell side (brokerage) and buy side (hedge fund, money management). In the mid-1990s, Christopher and his firm were well known as one of the few hedge funds who successfully ran a short book. Cooperman had heard this and sent his right-hand man, Doug Kass, over to check out the operation. Kass and Cooperman were impressed enough to give Christopher’s firm $50 million to run on the short side as a hedge for the rest of their book. And for the next five years, Christopher and Cooperman had frequent discussions about how this chunk of money was being managed.

I asked Christopher what stood out about those interactions, and here’s a list of Christopher’s thoughts on Leon Cooperman in no particular order:

One thing that stood out plainly was that Cooperman was (and remains!) a superb fundamental analyst. He took nothing at face value and always dug deeper into the information in order to form his own opinions.

Christopher was impressed by his intense discipline – he believed hard work always paid off.

He always advocated “love what you do”.

Cooperman played the game in line with what he believed and where he saw his strengths. He was not going to play an institutional-style game with low volatility returns.

When Christopher ran Cooperman’s short book, he noted Cooperman’s great courage in his convictions. Even with the courage to stay the course, however, he always challenged his positions to make sure that nothing fundamental to the trade had changed. He asked Christopher three words countless times, “Are you sure?” and that refrain still rings in Christopher’s ears. Even with his constant checking and curiosity he would stick with many (though not all) positions that were well-reasoned.

Cooperman would frequently call and ask for a review of the position, and he wasn’t shy about changing course with his whole book, even if he liked individual positions. He realized how important — as well as how difficult— hedging was on the short side and he would insist on long periods of holding his short account totally in cash or mostly in cash.

As you can tell from these comments, he was very hands on — very on top of what was happening, and thanks to his work ethic, he really knew the details.

Like Christopher’s grandfather, Bernard Smith — Cooperman believed that you always had to be bullish on something. This is undoubtedly why he cashed in recoveries better than anyone in the business (see his return figures below).

One of his main edges is a thorough knowledge of the fundamentals that he matched so well to his ability to foresee upcoming business cycle trends.

Now for That Head-Spinning Track Record:

Here is Cooperman’s Omega Partners’ track record that was included in the CNBC interview:

Click the Image Below for a Larger View

Cooperman averaged an annual return of 14.6% compounded vs. 9.3% for the S&P 500 during the same period. If that isn’t impressive enough, note that his figures are net of fees — meaning that the actual returns were significantly higher!

Here are some observations:

He does have down years, but knows who he is & what his strengths are.

He can have significant drawdowns, but his returns on rebounds (1993, 2003 and 2009) are nothing short of stunning.

Looking at his current top holdings (none more than 3.2% of capital): Sprint, SandRidge Energy, AIG, Sirius XM, Citigroup, Tribune, Tetragon Financial, Telenet Group, Dish Network and Chimera Investment, you can tell that he is a stock picker (and a value guy) and not one to jump on the same bandwagon just because other managers are.

What Can We Learn From Mr. Cooperman?

The first thing that leaps out after talking to Christopher and digging into the CNBC interview is that Cooperman is a guy who trades his beliefs. He believes in the long-term bullish bias of the equities market and is quick to capitalize on upturns after down periods. In addition, specialization works — his specialty is fundamental analysis. Lastly, when you have edge, have the courage to stick to your convictions; don’t get shaken out after a few rough trades. Let the law of large numbers and the confidence in your plan carry you through.

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Tuesday, July 29, 2014

How to Start a Financial Crisis Part 3

Click Here to Read Part 1

Click Here to Read Part 2

First, in the last three decades, low interest rates and increases in productivity are mostly responsible for record amounts of corporate balance sheet cash. That cash needs to go somewhere.

Second, banks devised a pawn-like scheme to take corporate balance sheet cash and use it to finance the purchase of higher-yielding securities, earning the difference in what they pay to borrow and what they earn on the purchase.

Third, the borrowed cash needed to be backed by AAA-rated collateral. To fulfill this need, Wall Street securitized packages of loans, thereby creating a new form of AAA-rated collateral.

This spawned the “shadow banking system”: corporations would lend money to banks through repo and commercial paper markets in exchange for a low interest rate and the banks would back these loans with securitized products. Even after Dodd-Frank, this system still remains largely unregulated.

Today, I’ll explain how the whole process led to higher asset prices through the creation of more credit.

Think of it like this: banks enter a pawn shop with a gold chain. The pawnbroker lends the banker $1000 at a 1% interest rate and keeps the gold chain as collateral. Banks take the $1000 and purchase another gold chain, and promptly return to the pawn shop to borrow another $1000. This process is repeated ad infinitum until all the cash on corporate balance sheets has been lent to finance the available supply of gold chains.

Suppose these gold chains weren’t your average run-of-the-mill gold chains. These gold chains have Mr T-like mystical powers and pay a 6% dividend to the owner. For every $1000 that the bank borrowed from the pawn shop at 1%, they earn a 5% return (the difference between what the bank borrows and what it receives). Each time the bank is due to pay the pawnbroker back the original $1000, he tells him to keep the gold chain and renews the agreement on the funds for 1%. Thus, borrowing money from the pawn shop to finance the purchase of higher yielding gold chains is a very lucrative endeavor.

So what happens to the market in gold chains? Well, if banks are using borrowed money to purchase gold chains, the price of gold chains is going to increase rapidly as demand outpaces supply. And the bankers can now take these gold chains with inflated valuations and use them to extract even more money from lenders.

However, the value of gold chains is increasing not as a function of buyers’ incomes, but through the introduction of more leverage from corporate balance sheets. As the leverage in the pawn system increases, so does the ratio between price and incomes. At some point, buyers’ incomes can no longer support the price of gold chains.

And this is precisely what happened to the housing markets in the early aughts as the price to income ratio of homes was boosted by the shadow banking market.

However, as the available supply of gold chains dissipated, bankers would sometimes deposit fool’s gold (subprime). The pawnbrokers started to worry about phony loans in early 2007, and began requiring more collateral to back their loans. Instead of lending at 100% of the collateral deposited, pawnbrokers would only issue funds equal to 90% of the value of the collateral. Slowly, this started to drain leverage from the system.

And as leverage fell, so did the value of the gold chains, which further arrested the flow of cash from corporate balance sheets. This vicious cycle repeated itself until the pawnbrokers decided that all gold chains were worthless and wanted their money back. Since the banks didn’t have the cash on hand, they needed to immediately liquidate gold chains into a market where there were no buyers. Lehman failed overnight, and the government was forced to respond by providing the banks with $1 trillion in capital.

The 2008 financial crisis was a run on the shadow banking market caused by a loss of confidence in the debt owed by banks. There were similarities to the bank runs of the 19th century, however, this time it was institutions that were lining up to retrieve their cash and not retail depositors.

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Monday, July 28, 2014

Investing in High End Jewelry Sales Earnings Growth

2014 has been an interesting year for retailers to say the least. Several clothing stores have had horrendous first half results as changing tastes have hit many companies hard. Meanwhile, in the restaurant side of the retail space, a similar trend has taken place as ‘higher quality’ companies are leaving their value-oriented counterparts in the dust.

This trend of high end outperforming lower end or value in the retail world is one of the bigger stories in this sector so far this year. And for a classic stock example of this that may still have more room to run as we close out the year, investors have to look no further than Tiffany & Co (TIF).

TIF in Focus

Tiffany & Co is a New York City-based jewelry retailer, specializing in fine and solitary jewelry, though the company also sells watches, perfumes, and accessories as well. The company is obviously operating in the high end corner of the market, and like many of its high end peers across the retail world (no matter the industry), it is really turning up the heat as of late in terms of stock price appreciation, including a 20% move higher in the past six months alone.

A big reason for this jump is the recent earnings picture for the company, and TIF’s beats at earnings season. TIF posted EPS of 97 cents, easily crushing the consensus estimate of 77 cents a share.

The beat was thanks to strong sales, which were up 13% from the year ago quarter, while comparable-store sales also saw a double digit increase as well. And perhaps the best news from the sales beat was the strength across geographic divisions, as Asia-Pacific saw 17% growth, while Japan saw 20% growth, showcasing the strong demand for TIF products across global markets.

Earnings Outlook

Given the strong trend in the luxury and high end corners of the retail world, and TIF’s continued dominance of the space, it shouldn’t be too surprising to note that earnings estimates have been rising for Tiffany stock.

Estimates have risen for both the current year and the next year time frames, with not a single estimate going lower for either period. Now, TIF is projected to see double digit EPS growth for both this year and next, suggesting a strong, durable trend for the company.

And though higher expectations can be difficult to match, investors should take comfort in TIF’s recent history at earnings season. The company has beaten estimates in three of the last four reports, with an average surprise of roughly 15%, so raised expectations shouldn’t be too hard to hit this time around either.

Thanks to these factors, TIF has earned itself a Zacks Rank #1 (Strong Buy). This means that we are looking for more outperformance in the months ahead, and that we expect the positive momentum in TIF shares to continue into the fall.

Bottom Line

Not only is TIF in a great position, but there is strength in the industry too. In fact, the retail-jewelry industry is ranked in the top 2% of all industries (at time of writing), so investors can rest assured that a rising tide is lifting all boats in this space.

But while this industry is looking solid overall, TIF is really the pick that is shining bright. The company has seen solid sales growth and earnings beats, while it remains well-positioned to take advantage of the focus on high end retailers and the great trends that are underpinning the space.

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Tuesday, July 22, 2014

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Monday, July 21, 2014

Investing in Semiconductor Earnings Growth

The PC industry isn't dead yet.

Intel (INTC - Trend Report) recently posted strong second quarter results, driven in part by strong demand in its core server and PC markets.

Following the Q2 report, analysts revised their estimates significantly higher for both 2014 and 2015. This sent the stock to a Zacks Rank #1 (Strong Buy).

Intel is the world's largest supplier of microprocessors with over 75% of worldwide market share among traditional PCs and servers.

Second Quarter Results

Intel delivered strong second quarter results on July 15. Earnings per share came in at 55 cents, beating the Zacks Consensus Estimate of 52 cents. It was a 41% increase over the same quarter last year.

Net revenue grew 8% year-over-year to $13.831 billion, well ahead of the consensus of $13.622 billion. This was driven by solid demand in its core server and PC markets. Intel's Data Center (server) group saw top-line growth of 19% year-over-year, while its PC Client Group saw revenue growth of 6%.

Gross profit as a percentage of total revenue improved greatly. The gross margin rose from 58.3% to 64.5%. Meanwhile, marketing, general and administrative expenses declined 5% and fell from 16.9% to 14.9% of revenue.

These factors led to a whopping 41% surge in operating income as the operating margin expanded 21.2% to 27.8%.

Earnings Outlook

Following the strong Q2 results, analysts have unanimously raised their estimates for both 2014 and 2015. This has sent the stock to a Zacks Rank #1 (Strong Buy).

Part of the catalyst for the upward revisions was encouraging guidance from management, which stated in the Q2 report that it expects about 5% revenue growth in 2014. That is slightly higher than its previous guidance.

The Zacks Consensus Estimate for 2014 is now $2.14, up from $2.04 before the report. The 2015 consensus is now $2.31, up from $2.18 over the same period.

Intel still faces long-term challenges as it struggles to gain traction in the growing tablet and smartphone markets. But the near-term outlook looks bright for the stock as the PC industry appears to be stabilizing after two years of contraction.


Shares of Intel soared after the Q2 report and have been on a tear this year, rising more than +32%. But the valuation picture still looks reasonable. Shares trade around 16x 12-month forward earnings and about 9x cash flow.

In addition, the company pays a dividend that yields a solid 2.7%.

The Bottom Line

Intel has a dominant position in the microprocessor industry for traditional PCs and servers. And thanks to recent strength in these end markets, along with solid cost controls from the company, earnings growth - and earnings estimates - are soaring for Intel.

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Friday, July 18, 2014

How to Start a Financial Crisis Part 2

How Financial Crises Start, Part 2 by Market Authority

Click Here to Review Part 1

Yesterday, I highlighted the financial panics of the 19th Century (aka bank runs), how they start, and the government’s response to prevent future runs (the Fed and FDIC). As noted, regulators and economists are only able to locate the problems with the engine after the car breaks down.

Today, let’s take a look under the hood of our current financial system to better understand how the economic machine overheated and was left stranded by the side of the road.

Businesses are more profitable than ever with record amounts of cash on balance sheets. The following chart depicts the rise of corporate cash as a % of GDP:

Since this cash must be invested somewhere (usually short-term), Wall Street created the repo and commercial paper markets. This allowed Wall Street to borrow cash from Main Street on a short-term basis. Just like a pawn shop, lenders of cash need some type of collateral that they can liquidate if the borrower doesn’t pay back the cash on time. Wall Street took the borrowed money to finance higher-yielding assets, profiting on the spread between what they paid on the corporate cash versus what they received on the higher-yielding assets.

Historically, the collateral that Wall Street pledged in order to borrow short-term corporate cash was AAA-rated US Treasuries. However, the government surplus of the late 90s mopped up too much Treasury supply. Wall Street needed another asset to use as collateral. And then Wall Street developed a game changer: securitization.

This process moves long-term bank loans off balance sheets by packaging them together and selling them to the capital markets. Securitized loans, also knowns as Asset-Backed Securities (ABS), are backed by mortgages, auto loans, credit card loans, or student loans and now comprise one of the largest markets in the world. A market large enough to provide collateral for the enormous amount of short-term borrowing.

Technology made securitization possible. Software programs can easily package millions of similar loans, something impossible to do by hand. Furthermore, easy-to-obtain credit scores allow lenders to assess the likelihood of default of each individual loan.

Here’s a brief primer on how these loans work:

Let’s say you live in a town called Springfield where 10,000 residents own houses with $200,000 mortgages that are held at the local Citibank. The average resident is paying a 10% rate on their mortgage and they all have 20 years to maturity. Since the bank can expect interest payments totaling $200mm per year (10,000 x $200,000 x 10%), they can create a new special purpose vehicle which separates these payments into different buckets. Because the bank can guarantee that the first $50mm of interest payments will go to the first bucket, the rating agencies give this a higher rating (even though the underlying collateral may be lower rated).

Securitization provided the necessary AAA collateral for Wall Street to borrow from the rest of the private sector.

Now think of this operation like the world’s largest pawn shop. The corporations (with the cash) are the pawnbrokers willing to lend cash to the banks as long as they provide adequate collateral. Typically, the corporations would lend cash at a rate of 1 to 1. So if Wall Street brought in a gold chain (or a AAA ABS) that was valued at $1000, the pawnbroker would lend them $1000 and hold onto the gold chain until Wall Street paid them back.

Wall Street would then take this cash and use it to securitize more loans, which could then be used as more collateral. This process drove the credit super-cycle in a very pyramid-scheme like way.

Tomorrow, I’ll discuss how the system began to crack when the pawnbrokers began requiring more collateral.

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Wednesday, July 16, 2014

How to Start a Financial Crisis

How Financial Crises Start, Part 1 by Market Authority

Today is the start of a multi-part series on the financial crisis: what was the cause and what have we learned.

When I lived overseas, I was the proud owner of a 1982 Toyota FJ40. Designed as an offroad vehicle, this 4-cylinder diesel could climb just about anything. I’m no gearhead, so once the truck started experiencing problems, fixing it was quite the learning experience. Some issues were easy to fix, such as replacing cheap glow plugs with a higher quality set or a worn down hose with a newer one. While I’m still not an expert on diesel engines, I’m now more familiar with how they operate and can diagnose simple problems when they arrive. The universal truth is that nobody really wonders how the engine works until it fails to start in the morning.

And the same principle applies to financial markets. Only when a crisis happens, do we pop open the hood and take a look at the problems with the system. We discover issues that a previous mechanic may have installed incorrectly or parts that need to be entirely replaced due to overuse. Some of these may be quick fixes while others may require a complete rebuild.

Every financial crisis starts with a complete loss of confidence in what’s under the hood. When fear is prevalent, investors sell assets and raise cash. Because of this action, the economy loses the financing necessary to grow and output falls.

The financial crisis of 2008 allowed us to diagnose the problems in our financial system and propose solutions to avoid similar events in the future. This is how economic systems evolve, through a crisis/recovery process leading to a better understanding of how the entire system operates.

For instance, before the Federal Reserve was created in 1914, bank runs were a national pastime. At every peak in the business cycle, depositors would worry that their local bank had underwritten too many bad loans. Fearing their cash was no longer safe, they would line up outside the local bank demanding their money back. This was a powerful signal. If you were walking through town and witnessed your neighbors waiting anxiously (and sometimes angrily) in line, you were likely to inquire what all the fuss was about. When you were told your money was at risk, you would likely join the line, reinforcing the signal. The risk of losing all of your deposit was much greater than the reward earned from keeping it in the bank.

In a fractional reserve banking system, banks never keep enough deposits on hand to pay everyone back at the same time. They don’t need to, unless a crisis occurs and all depositors are suddenly fearful of what might happen to their deposits. The bank run became a self-fulfilling prophecy, with the bank usually closing down, halting withdrawals, and declaring a “bank holiday” while it went about selling assets (in a fire sale) to raise the cash needed to satisfy withdrawals. As a result, the bank would usually close and it would take years for a new bank to repair relations with depositors and get the economy moving again.

This is essentially why the Fed and FDIC insurance were created: to stop bank runs and smooth out the business cycle. The Fed will provide the needed liquidity for the bank (they can borrow at the discount window) and the FDIC gives depositors the peace of mind that their cash will always be protected. If a crisis occurs, there’s no longer a need to withdraw your cash and bury it in the backyard. Thus, the bank runs of the 19th Century are all but extinct.

The Federal reserve as a backstop and FDIC insurance led to what Yale economist Gary Gorton describes as “the Quiet Period” in our economy: the period from 1934 to 2007 when “properly designed bank regulations prevented financial crisis for a significant period of time, until innovation and change necessitated their redesign”. Crisis brought about an evolution in understanding, which allowed for the development of regulatory systems targeted at preventing future crises.

And things got really quiet towards the end of the quiet period during the “great moderation”. Between the mid-1980s and 2007, economic volatility declined dramatically. The Fed had seemingly smoothed out the business cycle.

While economists understood some of the factors causing the great moderation (central bank independence and counter-cyclical economic stabilization), they didn’t foresee the problems under the hood until the 2008 financial crisis occurred.

Tomorrow, we’ll take a look under the hood and discuss the shadow banking system. This will allow us to understand how bank runs can still occur in the 21st Century.

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Monday, July 14, 2014

Investing in Industrial Energy Solutions Earnings Growth

EnerSys (ENS) has powered through the last several quarters producing 11 straight beats of the Zacks Consensus Estimate. Today, ENS is a Zacks Rank #1 (Strong Buy), and it is the Bull of the Day.

Powerful Earnings

Aggressive growth investors appreciate beats. They love them on the bottom line, but they really want to see them on top too. ENS has recorded six straight quarters where the company beat on top and bottom.

Another key metric that aggressive growth investors look for is larger and larger beats of the bottom line. ENS has that too. Over the last three quarts, the positive earnings surprise has increased from 3.5% to 3.9% to 7.3%.

Company Description

EnerSys makes industrial batteries and backup power systems and power related equipment and accessories. EnerSys was founded in 1999 and is headquartered in Reading, Pennsylvania.

Most Recent Quarter

ENS reported a strong 1Q14 beating the Zacks Consensus Estimate of $1.10 by eight cents. The company reported revenues of $665M when the street was calling for $657M in the quarter. The $8M top line beat translated into a 1.2% revenue surprise.

The stock moved higher by 2.5% in the session following the earnings announcement.

Prior To That Beat

Prior to the most recent beat, ENS not only provided a solid beat, they also gave positive guidance. A big beat on the top line drove the company to guide Wall Street to earnings per share between $1.08 and $1.12 for the next quarter when the consensus was calling for $1.05.

Guiding above consensus is a surefire way to please investors, and as a result of the positive guidance, the stock was bid up more than 9% in the session following that release.

ENS Sees Estimates Moving Higher

The Zacks Consensus Estimate for 2014 for ENS has been increasing all year. Starting at $4.00 in October of last year, we saw a nice move higher to $4.24 in November. By February, the estimate had kicked higher to $4.38 and now the Zacks Consensus Estimate is at $4.48.

The 2015 Zacks Consensus Estimate has only been around for a few months. The estimate remains where it started out at $4.84 as analysts have limited visibility at this point, but should release full year 2015 estimates following the next quarter.


The valuation for ENS is very attractive, as the stock trades at a discount the industry average for all the major metrics investors tend to look at. The trailing PE of 17x comes in under the 19x industry average as the the more attractive forward PE of 15x compared to 18x industry average. The price to book shows a healthy discount as well (2.5x vs 3.9x) as does the price to sales multiple (1.4x vs 1.8x).

The company is expected to produce revenue growth of 9% in Fiscal 2015, while the industry average is calling for a decrease of 1% on the top line. Earnings growth of 13% for ENS is above the 8% industry expectation.

In looking for a reason that this stock trades at a discount, the only thing that I could come up with is a lower net margin of 6.1% compared to a 6.8% and a lower pre-tax margin of 6.6% compared to 9.7% for the industry.

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Thursday, July 10, 2014

Short-Term Pullbacks and Long-Term Gains Explained

Why CNBC Wants You To Be Concerned About Your Money by Market Authority

In the days before financial news media broadcasted market information around-the-clock with scrolling pre-market quotes and endless “Breaking News” segments;

In the days before online brokerages marked your net worth up or down with every tick in the S&P 500 while simultaneously pitching products designed to squelch those worries;

In the days before 100s of virtual and real analysts dissected, projected, and connected every data point from presidential poll data to Chinese PMI’s;

In the days before every word, facial tic, hand gesture, and suit color worn by Janet Yellen was scrutinized, humanized, and hypothesized;

In these oft-forgotten days, there was one man and one show that investors turned on and tuned in for their financial news: “Wall $treet Week with Louis Rukeyser”.

This original financial news show aired on PBS from 1970-2002, and hit peak popularity in the mid-80s. Some would argue its appeal led to the launch of CNBC. Rukeyser is best known for his pun-filled humor and attempts to shift investor’s focus from the short-term market gyrations to the long-term. Along with countless awards and recognitions for outstanding journalism, People magazine once named him the “sex symbol of economics”.

Rukeyser sadly departed in 2006 at the age of 73, but many of his broadcasting memories are still alive on YouTube. Here’s a clip from shortly after the October 1987 crash (fast forward to 1:40 mark for Rukeyser’s monologue):

And the money quote:

“Ok, let’s start with what’s really important tonight… It’s just your money, not your life. Everybody who really loved you a week ago still loves you tonight. And that’s a heckuva lot more important than the numbers on a brokerage statement. The robins will sing, the crocuses will bloom, babies will gurgle, and puppies will curl up in your lap and drift happily to sleep- even when the stock market goes temporarily insane! And now that that’s all fully in perspective, let me say Ouch! … and Eeek! … and Medic! Tonight we’re going to try to make sense of mass hysteria, to look behind the crash of ‘87, and most perilously but most important of all, to look ahead.”

If you listened to Rukeyser in 1987 and held on to your stocks, you’ve witnessed a 10-fold increase in the Dow Jones Industrial Average in the past 3 decades. This return outperforms every major asset group. Note, his calmness during the crash contrasts the current state of financial news. While Rukeyser helped investors focus on the long-term, modern financial news wants investors to focus on the short-term.

In the short-term, every piece of news is “Breaking”, significant, meaningful, and market moving. In the long-term, none of these events individually matter. They’re merely noise.

Financial news networks (CNBC, CNNfn, Fox Business, Bloomberg TV) focus on the short-term to create the narrative that you should always be concerned about your money. This narrative is essential for their business model: Concern drives viewership, and viewership sells advertising time- the veritable raison d’ĂȘtre of financial news.

Without concern that a grand piano tethered to a loose string is looming over the market, people would stop watching and the ad dollars would migrate to other channels. Exciting program titles such as “Squawk Box”, “Mad Money”, “Fast Money”, and “Power Lunch”, emphasize your need to be concerned.

Take a look at CNBC’s viewership numbers over the past 17 years:

Viewership spiked at times when investors were concerned: the tech bubble and the financial crisis. Fully cognizant of these numbers, CNBC creates the illusory narrative that a market moving event is lurking around the corner. An event that needs to be closely watched because this event could wreck your portfolio. If CNBC anchors are talking about an upcoming event, the risk is likely priced into the stock market.

Known risks don’t cause unexpected selloffs. Known risks mean that investors are making contingency plans through hedging or selling stocks. Known risks mean that the market is braced for the event and its impact should be muted. Known risks mean that the market is more likely to be higher after the event passes.

For instance, have a look at the 43% rally in the SPY over the past 2 years:

Every little dip along the uptrend represents events that might have derailed the markets, but eventually turned out to be inconsequential. Remember these negative narratives from the past 2 years:

The Fiscal Cliff
Government Shutdown
Debt Ceiling Negotiations
Russia Invades Ukraine
China – Japan Tensions

While each caused short-term pullbacks, none of these events changed the current drivers of stocks: low interest rates, buybacks, strong earnings growth, and a gradually improving economy. These are long-term drivers that are resistant to change once set in motion. If Louis Rukeyser were still around today, he would be humorously highlighting these positive long-term themes, not the negative short-term narratives.

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Monday, July 07, 2014

Investing in Luxury Fashion Earnings Growth

Michael Kors (KORS) is continuing its fabulous run as the leading luxury fashion brand displacing peers like Coach (COH). The company delivered yet another stellar quarterly performance in late May when it reported Q4 EPS of $0.78, beating the consensus by 15% while rising 56% year over year.

Revenues of $917 million beat the consensus by 12% and grew 54% year over year. Further, the company's strong comps gain of 26% made it their 32nd straight quarter of positive same-store sales. In Europe, revenue skyrocketed 125%, with comps launching 63% higher. That's powerful growth for an $18 billion clothier.

And analysts responded across the board by raising earnings estimates and price targets. The current year EPS consensus estimate moved to $3.94 from $3.82, representing 22.5% growth. Next year was lifted to $4.70 from $4.56 indicating potential year over year growth of 19%.

Most price targets were moved slightly higher into a range of $105 to $115. Reportedly, Goldman Sachs was the outlier with a bump from $120 to $134, but I have not seen that report.

But investor reaction has been mixed as Wall Street digested information about declining gross margins. It seems there were questions about the available runway for this growth story and if investors were willing to pay more than 20X for EPS growth that might be leveling off to 20%.

A Long Bias for KORS

I think the KORS craze and market penetration globally is far from over. Especially when they work so hard to have so many fashion accessories at so many price points. Their "accessible luxury" strategy speaks to, and opens the wallets and purses of, more than the affluent.

I have traded KORS stock twice in the past year for my FTM portfolio, first buying last July at $63 and bagging 25%. Then we bought again in December in anticipation of a great holiday quarter. We were not disappointed as we caught the big February pop to new highs above $90 and grabbed 12% gains.

Though I am a big fan of the Michael Kors company, its products, and its marketing strategies and global growth opportunities, I rely on the retail analysts who focus on the industry to sort out the real potential of the stock as an investment.

What Do the Analysts See in KORS?

What made me buy the stock again in June, besides the core growth story still being strong, is that I liked the commentary from several analysts. Here's a sampling...

JPMorgan analysts revisited KORS in last June after British handbag retailer Mulberry reported dismal sales efforts in high-end bags. They raised estimates, even introducing their FY16 EPS number of $4.80 (we are currently in Q2 of KORS FY15 which ends next March). They also raised their PT from $100 to $104 based on 25-26X their FY15 estimate of $4.00, or 21-22X their FY16.

Europe, Men's, and jewelry markets/categories are considered "$1 billion opportunities" for the company by the JPM analysts and these areas will drive growth beyond women's handbags. Though the bears here could still force a test of $86 and lower, I am confident this stock will be approaching $100 again in the next six months.

Deutsche Bank analysts raised their price target from $105 to $110 and had this to say in response to the gross margin concerns...

"While there are many moving parts to this increasingly complex global company, the bottom line we believe is that Kors once again delivered on both results & guidance. Though FY15 plan came in at least in-line with expectation, even so, we believe management is being conservative. Primarily, we note that plan calls for gross margin normalization, but management made it clear that hasn’t happened yet (and we don't think that back-half of 1Q compares get more difficult)."

Piper Jaffray analyst Erinn Murphy met with management recently and had many good things to say about their plans and solid execution. She reiterated her Overweight rating and $115 price target.

"Management was bullish not only on near-term trends but also on the multi-category opportunity for further market share gains over time. We believe Q1 comps are tracking above 20% globally. The company is investing behind e-com, product, supply chain, stores and people as sales continue to grow in the range of $1B/year. We expect operating margins in the 29% range for the next two years. Our recent European checks confirm that the brand is taking significant 'white space' that exists below high-end luxury."

The big take away for me was that these analysts and others are as bullish on KORS for the longer-term as I am. They see the international opportunity as still being in the early innings and they view the handbag wars (which KORS is still winning) as only one battlefield they excel on.

The Global Opportunity

The $75 billion accessories category of the global luxury goods markets is the fastest-growing sub-sector of apparel. And this is 85% of KORS current sales.

Management sees the potential for 700 stores internationally, including 400 in North America (currently 288), 200 in Europe (80), and 100 in Japan (37), with potential to eventually acquire licensed Asian geographies. KORS plans to add 110 stores in F2015, including 45 in North America, 55 in Europe, and 10 in Japan.

According to, "KORS opened 7 stores in the Asia-Pacific region, bringing the total count to 94 stores, including a new flagship store in China. Management expects around 200 retail locations in the Asia-Pacific region. Kors also opened two stores in Brazil, expanding its presence in Latin America. The company currently has seven locations in Latin America and expects it can support 40 retail locations over the next several years."

To solidify their Asia strategy, the company created a new leadership position and filled it with some key talent. Stephane Lafay has been named to the newly created role of President of Asia, reporting to John D. Idol, the company’s Chairman and CEO. From the company's June 30 press release...

Mr. Lafay’s appointment, effective July 28th, 2014, reflects the brand’s powerful momentum in the region and its sustained focus on growth. "This is a pivotal moment for the brand as we continue to invest and work to build a strategic roadmap for the Asia region," says Mr. Idol. "Stephane has a long history of building luxury businesses in Asia. His skills and experience will be a tremendous asset for us going forward."

Mr. Lafay was most recently at Tiffany & Co., where he held the position of Senior Vice President, Asia Pacific and Japan. Lauded for his leadership and in-depth knowledge of the region, he led the brand to consistently strong results.

"The Asian market is an important region for us to develop as we continue to grow our global luxury brand," says Mr. Idol. "We’re excited to take advantage of the momentum our brand has recently generated. In the past two years we’ve been able to double our store count to over 100 locations in the region. Stephane’s experience and leadership will help enable us to capitalize on our momentum in the region."

"I’m delighted to be joining Michael Kors at such an exciting moment in the brand’s development," says Mr. Lafay. "Having worked in Asia for 25 years, and spent nearly two decades building brands in the region, it’s clear to me that there is enormous opportunity for Michael Kors there. I look forward to being part of the team that turns this potential into reality."

It sounds like they picked the right guy for that "enormous opportunity."

Multi-Channel Excellence

According to Baird Equity Research, "KORS utilizes several marketing avenues to project its 'jet-set' image, including print (three 40-page catalogs per year), increasingly online/social media, fashion shows, and editorial (strong relationships with press)." Baird analysts have a $114 price target on KORS.

Obviously, Michael Kors the man now carries the cache of a Ralph Lauren (RL) with global fashion consumers after his celebrity run on the hit show "Project Runway."

What makes KORS above-and-beyond the average retailer is their global reach and brand appeal, their diverse "accessible luxury" lines that attract middle class fashionistas too, and their multi-channel marketing strategies in retail and wholesale. The company strategy is not hit-or-miss like many retailers. They are going for the jugular as THE all-encompassing and innovative lifestyle brand for more than the jetset.

And that's why it was nice to see Steve Mandel of Lone Pine Capital increasing his stake in Q2 by 25% to 11.3 million shares, probably on those dips below $90 in April. He's a conservative fundamentally-driven investor with a long-term view and he's clearly not done watching the KORS growth story take his investment higher.

Neither am I. And that's why I was buying the dips below $90 in June and it's a Zacks Rank #1 (Strong Buy).

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Thursday, July 03, 2014

USA Fourth of July Independence Day Investing

The U.S. is about to celebrate its biggest secular holiday on the Fourth of July with much fanfare. Investors’ cheers will be louder since the markets have made remarkable turnaround since the country was troubled by the recession half a decade back. Countless citizens will join to celebrate the 239th birthday of the country and pay tribute to the indomitable American spirit.

That the equity market is trading at all-time highs speaks volumes about this ‘never say die’ attitude. Add to it the improvement in the labor market, rise in Consumer Confidence Index, recovery in the housing sector and continued tapering of the bond buyback plan – the pointers are clear and definite.

At this juncture, buying American stocks will offer one more opportunity to the investors to contribute handsomely to the economy. But before we guide you on which stocks to buy at this opportune moment, let us have a peek into how patriotic spending benefits economic growth.

Why Buy American Goods?

Despite arguments and counter-arguments, various studies have revealed that when American-made products are bought, it directly or indirectly creates new jobs and benefits the overall economy. According to the Boston Consulting Group, “If every builder in America used just 5% more Made-In-America products, it would create 220,000 American jobs.” Purchase of domestically manufactured products also minimizes imports, improves balance of trade and leads to trade surplus.

The Federal Transportation Administration (FTA) has utilized the “Buy America” Act to boost the job-creation potential of public funds. The Act ensures that all final assembly of the railway vehicles and buses purchased with FTA funding occurs within the U.S., while all components and sub-components have over 60% domestic content.

A research study by the University of Massachusetts indicate that on an average, at least 26% more jobs are created when manufacturers fully source the components and subcomponents of their vehicles domestically compared to manufacturers that only meet the 60% “Buy America” requirement.

Feel-Good Factors

According to private payroll processor ADP, 281,000 new jobs were created in June, which was far higher than the consensus expectations of 208,000. When the Bureau of Labor Statistics releases the data for non-farm payroll numbers, it is expected to show 213,000 job additions. Total non-farm payroll accounts for approximately 80% of the workers who produce the entire GDP of the U.S. The unemployment rate for June is also expected to be close to 6.3% recorded in May 2014 – the lowest since Sep 2008.

Higher employment opportunities will lead to improved consumer confidence, which is a key determinant for the economy’s health. A recent Conference Board data suggests that Consumer Confidence Index increased to 85.2 in June 2014 from 82.2 in May 2014. This further leads to higher consumer spending, which accounts for over two-third of the U.S. economic activity.

Despite inclement weather conditions and higher-than-expected healthcare spending, U.S. consumer spending increased 1% in the first quarter of 2014. The June PMI was recorded at 55.3% – the 13th consecutive monthly increase. A reading of above 50% generally indicates that the manufacturing economy is expanding.

The economic uptrend is more evident from the Bull Run in the equity market, which has charted new highs on many occasions since last year. The Dow Jones Industrial Average, S&P 500 and NASDAQ Composite indices gained 1.5%, 6.1% and 5.5%, respectively, in the first half of 2014. The S&P 500 has hit record highs on 23 occasions so far this year and secured the best lead over the Dow since 2009. With five consecutive monthly gains, the S&P 500 is surely on a roll.

3 American Stocks to Buy

Amid such bright macroeconomic fundamentals, there are a handful of domestic stocks with attractive valuation metrics backed by a favorable Zacks Rank. The names of these companies start with “American,” so investing in them could help you to cash in on the strong patriotic sentiments. Let’s take a closer look at these companies that appear to be well positioned to benefit from the solid sector dynamics as well.

American Airlines Group Inc. (AAL)

This Zacks Rank #2 (Buy) stock operates an average of nearly 6,700 flights per day to 339 destinations in 54 countries from its hubs in Charlotte, Chicago, Dallas/Fort Worth, Los Angeles, Miami, New York, Philadelphia, Phoenix and Washington, D.C. The earnings estimate revision for American Airlines for both the current quarter and year has moved up in the last 7 days, implying bullish long-term growth sentiments.

With a forward P/E of 8.3x and long-term earnings growth expectations of 31.4%, American Airlines is a solid pick. In addition, American Airlines belongs to the Transportation-Airline Industry that carries a Zacks Industry Rank #51. As a guideline, the outlook for industries with Zacks Industry Rank #88 and lower is 'Positive,' between #89 and #176 is 'Neutral' and #177 and higher is 'Negative.'

American Campus Communities, Inc. (ACC)

Based in Austin, TX, this company operates as an independent equity real estate investment trust (REIT). It is the largest owner, manager and developer of high-quality student housing properties in the U.S. Including its owned and third-party managed properties, the total managed portfolio of this Zacks Rank #2 (Buy) stock comprise 200 properties with approximately 128,100 beds.

American Campus has long-term earnings growth expectation of 4.9% and is currently trading at a forward PE of 16.7x. Furthermore, earnings estimate revisions for the current quarter and year have been moving up, implying bullish sentiments for the long-term growth of the company.

American Express Company (AXP)

Headquartered in New York, NY, this company offers charge and credit payment card products and travel-related services to consumers and businesses worldwide. Its products and services include charge and credit cards, business credit cards, travel services, gift cards, prepaid cards, merchant services, business travel, and corporate cards.

The earnings estimate revision for this Zacks Rank #2 (Buy) stock for the soon-to-be-reported quarter and full-year 2014 have moved up in the last month, implying bullish sentiments for the long-term growth of the company.

With a forward PE of 17.5x and long-term earnings growth expectations of 10.6%, American Express is likely to outperform the broader equity market. In addition, the company belongs to the Financial Industry that carries a Zacks Industry Rank #14.

Moving Forward

The ex-Vice President of the U.S. Hubert H. Humphrey once observed, “What we need are critical lovers of America -- patriots who express their faith in their country by working to improve it.” Perhaps the Fourth of July is the most opportune time to showcase this patriotic feeling by owning these “American” stocks.

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