A sell signal for the S&P 500 is coming from U.S. Treasuries, but this is still a “buy weakness” market until something changes.
Monsanto – positive trends expected to continue
McCormick – downside risk
Greenbrier – upside risk
As we’ve discussed frequently so far in 2013, our basic view of the market right now is based on the Federal Reserve’s support of the markets through U.S. Treasury and mortgage-backed security purchases, which combine to be the greatest amount of liquidity the Fed has ever given and is expected to continue through 2013 and perhaps even longer. Somewhat tied to this view is the “Great Rotation” view among so many that money is going to come out of bonds and Treasuries and go into U.S. stocks. This would naturally lead to a rise in interest rates and that’s exactly what we’ve seen for much of 2013 – U.S. Treasury yields have gone higher even though the Fed has been buying U.S. Treasuries. These means more money has come out of Treasuries than the Fed was able to put in, and much of that money has gone into U.S. stocks.
However, during the past three weeks we’ve seen U.S. Treasuries rally and yields decline. This shouldn’t be too much of a concern given the Fed’s action, but it does go against the “Great Rotation” theory and in the past has coincided with stock market selling. For nearly 10 years now, whenever yields have rolled over from an overbought level based on the stochastics to the point they are now, the S&P 500 has sold off with it or was about to, but also, by this time, it was at or near the end of the selling.
The S&P 500 closed last week at a high, so we haven’t seen such selling yet… and given the liquidity added to the market in April – four out of five trading days each week during the month – we’re not confident we are going to see any real selling. Still, this is the first real sell signal we’ve gotten in 2013 other than just some simple seasonality and it is worth watching closely. We are still buyers of weakness though so we will view any such selling as a buying opportunity. Or, more accurately, we are focused on trading long around earnings and looking to hold some of our successful trades for an extended period and that’s the strategy we want to continue to have while the Fed is adding so much liquidity to the markets. But during periods of selling, we well take profits more quickly on our long trades and will give a little more weight to trading short.
For much of the past couple of weeks, the S&P 500 has pushed against the 1,563 area and then sold off the next day. Each selling day saw a higher low, but the S&P 500 couldn’t make it through until Thursday. To be confident the market isn’t selling off like, we need the S&P 500 to remain above this 1,563 area. There is still more support below, so we will still have a bullish bias as long as these support areas hold, but we’ll lighten up and be less aggressive below 1,563.
The biggest downside risks to Monsanto (MON) going into its earnings release are probably weather and comparability. The fiscal second quarter is the strongest seasonal period for the company as seeds are shipped ahead of planting. During the fiscal second quarter last year we experienced an unusually warm winter and mild spring, which puled forward sales from future periods into the second quarter. That means comparisons to the same quarter last year will be tougher since this year has been much cooler – to the point that the Economist recently published an article Jason Hansen, the scientist most commonly credited for first brining awareness to global warming, admitted that their global warming models have been wrong and unless temperatures rise over the next couple of years, the whole global warming theory will have been proven wrong.
But while the pull forward last year makes for tough comparisons this quarter, it makes it easier during the second-half of the year. In fact, even though the company soundly beat estimates last year, it also said that earnings during the second-half of its fiscal year would be essentially flat. That put the near-term growth behind it and the stock sold off over the next six weeks before bottoming. That could very well be the positive this quarter as the company should see stronger growth in the second-half of the year compared to last year. That suggests stronger earnings releases are still ahead and puts our bias on the long side with the upward trend in earnings estimates.
Still, when it comes to trading shares of Monsanto after earnings, there are also important factors such as guidance, but those items tend to affect the stock more on the gap. From there, the stock has traded based whether it beat or missed the MyRollingStocks® number. For example, when Monsanto has provided negative guidance in the past but reported earnings that were above the MyRollingStocks® number, the stock gapped lower by 3.59% on average, but then gained an average of 5.23% throughout the day and a month later it was up an average of 9.01%. The one time the company provided positive guidance but reported earnings below the MyRollingStocks® number, it just marginally ticked higher at the open, but was down 0.82% by the end of the first day and an additional 2.0% on the second trading day.
The consensus earnings estimate is $2.55 per share and the MyRollingStocks® number is $2.63 per share. The company is scheduled to report earnings before the market opens on Wednesday, April 3, 2013 with a conference call at 9:30 AM ET.
Technically, the stock gapped higher last quarter after it beat the MyRollingStocks® number and was an after-the-news play where we pointed out that the price pattern gave us upside room in the stock to just under $103, which it hit about two weeks later. We generally shoot for a greater return for our short-term trades, but this still calculates to a 95% annualized return before commission. Still, from the gap higher in January, the stock has formed a similar pattern just on a longer time scale, where as long as the stock remains above $105 it has upside room to $112.
McCormick & Co
Last quarter McCormick & Co (MKC) missed estimates and lowered guidance. The stock sold off on the news with heavy volume, which has turned out to confirm $61 as a strong support area that we see little evidence is going to be broken. The stock is a long way from $61 at the moment though and when you consider the company has historically traded at 16.8 times forward estimates but is currently trading at 20.7 times 2014 estimates, there is plenty of room for the stock to trade lower from Thursday’s close of $73.55.
The stock has also spent the entire month of March technically overbought based on the 14-day Relative Strength Index (RSI). The general rule is that when a stock exits the overbought condition it pulls back to the area it was when it first entered the overbought condition. For example, back on June 18, the stock entered the overbought condition at $57.83 and traded its way up to $59.24, but by June 25, it had traded back below $57.83. The stock opened on June 29 at $59.40 and the RSI pushed above 70, and by July 24, the stock was back below $59.40. The same move came after the overbought conditions in September and November.
There is support at $67 based on the prices just before the company’s negative earnings in January, and that happens to be the open where the stock pushed its way into its current overbought condition. A pullback to this level would be reasonable, but we see $68.40 as a better target to either look to take profits on a short sale or to consider going long after the news.
McCormick is scheduled to report earnings before the market opens on Tuesday, April 2, 2013 with a conference call at 8:00 AM ET. Statistically, the best trade for McCormick has come when the company beat the consensus earnings estimate but missed the MyRollingStocks® number and then opened lower on the news. This quarter, the consensus earnings estimate is $0.56 per share and the MyRollingStocks® number is $0.58 per share.
The railroad companies we generally follow are either right around their all-time highs or looking to break out to all-time highs. They’ve been able to do so without multiple expansion too as nearly all are trading right in-line with their average forward PE multiple over the past 15 years, which means the move has come with rising earnings estimates. The growing earnings provide the railroad companies with the ability to pay for new freight car equipment. We haven’t seen much of that growth trickle down to Greenbrier Companies (GBX), but that appears to be at the cusp of changing.
The data on the previous page for Greenbrier shows earnings estimates for 2014, which bottomed basically in February. The company had revamped one of its production lines to add capacity and that was resulting in flat earnings growth expectations for 2013 while the rail industry expanded and its railcar peers outperformed. Now the new production is beginning to come online and, in the meantime, the company has been gaining new orders and increasing its backlog. That’s why you see the increase in 2014 earnings estimates begin to move higher in March and that appears to be the beginning of a trend that should continue for several more months and quarters as the more recent orders bring the backlog to more than a full year’s production rate. About half of the recent orders have been for the higher-margin tank cars, which is part of the reason why Michael Baudendistel at Stifel Nicolaus recommended owning shares of Greenbrier ahead of its earnings release.
Greenbrier’s peer that has led the group has been Wabtec (WAB), and it is currently trading fairly close to its historical forward PE multiple of 15.8. Greenbrier has not commanded the same multiple as Wabtec in the past since it has historically traded at just 13.9 times forward estimates. But the stock still needs to get to $34 to trade at this historical multiple using current estimates – estimates that are expected to trend higher for the next several months and quarters – and that means the stock will need to increase by approximately 50%.
For the quarter, the consensus earnings estimate is $0.37 per share and the MyRollingStocks® number is $0.42 per share. Greenbrier is scheduled to report earnings before the market opens on Thursday, April 4, 2014 with a conference call at 11:00 AM ET.
Below is a list of upcoming earnings releases of Russell 2,000 companies that missed earnings estimates last quarter and traded down on the news. Buy the stock at the open after it reports earnings if it beats the consensus estimate and reports positive earnings (does not report a quarterly loss). Sell at the close of the next trading day.
A strategy of buying a Russell Reversal at the open following the earnings announcement and holding until the close on the second trading day would have averaged approximately a 58% annual return over the past 11 years. A loss was made just under 40% of the time with an average decline of 4.15%, but there were more gains than losses and the gains were greater than the losses.
|CALM||Cal-Maine Foods Inc.||4/1/2013||Before||$1.15||$42.56|
|HNR||Harvest Natural Resources Inc.||4/1/2013||Before||$0.40||$3.50|
|PNX||Phoenix Cos. Inc.||4/1/2013||Before||$2.05||$30.82|
|EGLE||Eagle Bulk Shipping Inc.||4/1/2013||After||($1.97)||$3.52|
|SCVL||Shoe Carnival Inc.||4/1/2013||After||$0.58||$20.44|
|OXM||Oxford Industries Inc.||4/2/2013||After||$0.69||$53.12|
|PBY||Pep Boys-Manny Moe & Jack||4/2/2013||After||$0.05||$11.79|
|SCLN||SciClone Pharmaceuticals Inc.||4/2/2013||After||$0.12||$4.60|
|AYI||Acuity Brands Inc.||4/3/2013||Before||$0.62||$69.41|
|JOSB||Jos. A. Bank Clothiers Inc.||4/3/2013||Before||$1.35||$39.90|
|OMN||Omnova Solutions Inc.||4/3/2013||Before||$0.12||$7.66|
|MIND||Mitcham Industries Inc.||4/3/2013||After||$0.39||$16.92|
|RELL||Richardson Electronics Ltd.||4/10/2013||After||$0.06||$11.86|
|ESBF||ESB Financial Corporation||4/16/2013||After||$0.27||$13.69|
|OKSB||Southwest Bancorp Inc.||4/17/2013||Before||$0.17||$12.56|
|SCSS||Select Comfort Corporation||4/17/2013||After||$0.46||$19.77|
|UFPI||Universal Forest Products Inc.||4/17/2013||After||$0.17||$39.81|
|HAFC||Hanmi Financial Corporation||4/18/2013||Before||$0.30||$16.00|
|MYE||Myers Industries Inc.||4/18/2013||Before||$0.28||$13.96|