Terry Gardner, Jr., Author at C.J. Lawrence
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19 Mar C.J. Lawrence Weekly – Tight Capacity Utilization Bodes Well for Select Machinery, Building Products, and Construction Equipment Stocks

Among the economic data released last week, both Industrial Production and Capacity Utilization came in well ahead of economists’ expectations. The Industrial Production reading, a measure of total U.S. factories, mines, and utilities output, rose 1.1% from the prior month, and 4.4% from last year’s figure. Capacity utilization reached 78.1%, the highest level since January 2015. The two metrics tend to go hand-in-glove. As manufacturing activity accelerates, idle and underutilized manufacturing capacity is re-engaged and the utilization rate climbs. Most economists believe that 80% is an important utilization hurdle. When the utilization rate climbs above that level, and available manufacturing capacity is tight, firms increase capital expenditures on new productive capacity. It appears we are closing in on that trigger level.

US Industrial Capacity Utilization versus S&P 500 Capital Expenditure Growth

US Industrial Capacity Utilization versus S&P 500 Capital Expenditure Growth Source: FactSet, S&P Global

Conversely, utilization, and corporate spending on plant, property, and equipment, falls off dramatically towards the end of, and in the aftermath of, recessions, as orders cancelled during recessions hit the books. Then, in subsequent years, utilization ramps and capital spending re-accelerates, off a lower base, and compensates for the prior spending lag and pent-up demand. Indeed, S&P 500 company capital expenditures fell 24% in 2002 and 9% in 2003 in the aftermath of the 2001 recession. It took almost three years for expenditures to return to pre-recession levels. Likewise, S&P 500 capital spending fell 19% in 2009 and took until 2011 to return to pre-crisis levels. What’s unique about the current economic cycle is that since 2012, capital spending growth, among S&P 500 constituents, has been punk. In fact, there has been no net growth in S&P 500 capital expenditures over the past four years. In 2015 and 2016 capital expenditures declined by 5.5% and 3.8%, respectively, and look to have recovered only modestly in 2017.

Thus, the strong Industrial Production and Capacity Utilization reports are welcome news for investors betting that the current economic cycle has long legs, and that the domestic economy is on the cusp of a new capital spending cycle. Healthy corporate profit growth, fiscal stimulus, and relatively low interest rates are combining with rising utilization, pent up capital spending demand, and healthy corporate balance sheets to form a potent manufacturing brew. Industrial stocks are the likely beneficiary of this convergence, and came out of the gate strong in the beginning of 2018, but have ceded ground on a relative basis over the past two months. While the stocks have largely anticipated the reacceleration in economic activity, some groups look to be discounting peak earnings and have experienced multiple compression. Those groups, including Building Products and Construction and Engineering, in addition to select Machinery and Construction Equipment names, may warrant another look, as the next capital spending cycle gets into gear.

Full Disclosure: Nothing on this site should be considered advice, research or an invitation to buy or sell securities, refer to terms and conditions page for a full disclaimer.

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12 Mar C.J. Lawrence Weekly – New S&P Sector Construct Could Create Volatility this Summer

Followers of the CJL Weekly Market Comment are familiar with our practice of looking below the broader market indices to compare the fundamentals, price performance, and valuations of the 11 different S&P Sectors, 24 Industry Groups and, 157 Sub-Industries. This style of analysis dates back to the original C.J. Lawrence. For decades, the firm published tables showing the relative sector winners and losers of market share within the S&P 500 Index. This long-term lens has provided an important perspective to investors utilizing a top-down approach in their securities analysis. Indeed, we continue to consider the changing landscape highlighted in our Sector Shifts table in our investment process.

Sector Shifts

Standard and Poor’s Corporation, (now S&P Global, Inc) was the developer of the original indices, and is still today the owner, vendor, and licensor of the index data. The indices follow the Global Industry Classification Standards (GICS), a standard developed in 1999 by S&P and MSCI, which allows for the consistent categorization of individual securities. This categorization is relevant because it determines which securities are included in funds and products that track the indices and sub-indices. Periodic index reconstitutions have become important market events as companies are added to, and removed from, the various indices, while derivative product manufacturers react to the changes. One of the larger definitional changes undertaken by S&P in recent years was the separation of the REIT stocks from the Financials sector in August of 2016. Since the split, the Financials Sector Index has delivered a 59.5% total return, while the new REIT Sector Index has produced an -5.7% return during the same period. The post-split impact has been meaningful for index trackers. In November of 2017 S&P announced another major change, to take place this year.

In September, S&P will broaden the Telecommunication Services sector index and rename it Communication Services. Importantly, S&P will remove social and interactive media companies from the Technology sector and add them to new Communications Services sector. The same shift will take place for interactive home entertainment companies. Stocks impacted by the move include the third and fifth largest market capitalization companies in the S&P 500, Alphabet (GOOGL) and Facebook (FB), as well as widely held gaming companies Activision Blizzard (ATVI) and Electronic Arts (EA), among others. Additionally, Broadcasting, Cable and Satellite, Movies and Entertainment, and Publishing stocks will be transferred out of the Consumer Discretionary Sector and will also be added to the Communications Services sector. Traditional hardware and software companies will now dominate the Technology Sector index. To help ease the transition, S&P Global is considering publishing tracking indices that mimic the new construct. But the index changes could ultimately lead to increased volatility this coming summer and fall as index trackers adjust their holdings, and index algorithm creators and traders re-write sequences and code to account for new trading patterns and conditional relationships. There is a frequently run TV and radio commercial that poses the question, “Why own single stocks when you can own the entire sector?” This realignment may be one of the reasons why.

Full Disclosure: Nothing on this site should be considered advice, research or an invitation to buy or sell securities, refer to terms and conditions page for a full disclaimer.

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05 Mar C.J. Lawrence Weekly – Bond Yield Forecasts Still Not Competitive with Earnings Yield on Stocks

Our CJL Market Monitor reading weakened in February, understandably, as interest rates rose and previously positive market technical measures reversed course. The Monitor remains narrowly in BUY territory with a +1 reading, on a scale of -6 to +6. The two components that lost ground in February include our Year/Year Long Bond Model, and our NYSE Composite Moving Average Spread Model. The Long Bond model incorporates moves in the U.S. 30-Year Treasury Benchmark Bond yield. That model had generated a BUY signal in previous months as movement at the long end of the yield curve stalled. But the 30-Year Treasury yield made a meaningful move higher in February, and nudged that component’s reading into NEUTRAL territory. The NYSE Composite Moving Average Spread model also dropped a level as equity market volatility returned and positive market momentum was broken.

The interest rate components of the Monitor highlight the importance of the rate of change in bond yields versus the direction and levels of equity earnings. But the rate sensitive components have been less useful over the past decade as record low rates tilted those component models overwhelmingly towards stocks. Those measures are now working themselves back into normal balance. As they do, the conundrum will be how to calibrate the rate of change in interest rates versus their still historically low absolute levels. The current yield on the U.S. 3-Month T-bill is ~1.65%. Many Fed watchers are forecasting that three to four 25-basis point interest rate hikes are in the cards over the next twelve months. If these forecasts prove accurate the U.S. 3-Month T-bill yield should reach ~2.65% by this time next year. The last time the T-bill yield was at this level, and rising, was in January of 2005. The T-bill rose almost 200 basis points that year. Despite rising rates being a headwind for stocks, the S&P delivered a 4.8% total return in 2005 and a 15.8% return in 2006, as rates continued to climb. Headline CPI was 3.4% and 3.2% in 2005 and 2006, respectively.

S&P 500 Industrials Earnings Yield to U.S. 3-Month T-Bill Yield

S&P 500 Industrials Earnings Yield to U.S. 3-Month T-Bill Yield

To find another period when U.S. T-bill rates were ~2.65% and rising, one must go back to 1962. In that year T-bill yields began an ascent that took them to 5.2% in November of 1966. The S&P 500 struggled in the first year of that rate cycle, posting a -8.8% return in 1962, but delivered total returns of 22.6%, 16.4%, and 12.4% in 1963, 1964, and 1965 respectively. The S&P 500 earnings profiles in both periods (1962-1966 and 2004-2006) looks similar to today’s outlook, with EPS growing, and expected to grow, at a double-digit rate for three consecutive years. Another of our Market Monitor’s components takes earnings into account by measuring the Earnings Yield (inverse of the P/E) on stocks versus the 3-Month T-bill yield. At current levels of forecasted S&P earnings, the T-bill yield would have to ise to 5.1% for that component to flip in favor of bonds. It’s likely that rising rates, from any level, will provide a sentiment headwind for stocks, and will continue to pressure the market multiple. But history suggests that in periods of rising bond yields off multi-year lows, concurrent with double digit S&P 500 earnings growth, stocks can deliver attractive absolute returns and have historically outperformed bonds on a relative basis.

Full Disclosure: Nothing on this site should be considered advice, research or an invitation to buy or sell securities, refer to terms and conditions page for a full disclaimer.

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26 Feb C.J. Lawrence Weekly – Technology Continues to Deliver

The 4Q17 earnings season for the S&P 500 is 91% complete and the results, to date, are impressive. Earnings per share for the S&P 500 are coming in 14.7% ahead of last year’s level. 72% of reporting companies have delivered earnings results that were ahead of analyst expectations, a 5-year high for positive earnings surprises. Tax reform and other GAAP related earnings adjustments have created some cloudiness and debate around the headline numbers, making pure “operating results” less clear. But revenue results, on the other hand, can provide an unadjusted view of business progress. FactSet reports that, to date, 77% of reporting companies have delivered better-than-expected revenue results for the quarter, the highest positive revenue surprise reading since FactSet began compiling the data in 2008.

To date, S&P 500 revenues are coming in 8.2% ahead of last year’s level. If that figure holds, as the remaining constituents report, it will mark the highest sales growth rate since 3Q11. Currently all eleven sectors are posting positive revenue comparisons, with leadership being provided by Energy, Materials and Technology. They are up 20.3%, 20.1%, and 13.4% respectively, versus 4Q16. A rebound in oil prices helped boost energy company top lines, while rising product prices supported major and specialty chemicals sales. Materials sector sales have also been aided by the addition of E.I. DuPont de Nemours’ revenue results to Dow Chemical’s revenue line, post-merger. Without the combination, the Materials sector top line would be up 12% from the prior year.

Once again, the Technology Sector is delivering strong top line results. It has been the most consistent producer of revenue growth among all sectors, over the past fifteen years. In fact, Technology has had only one down year for revenues (-4.0% in 2009) during the period. 2017 sector revenues will likely come in 10.2% higher than 2016. Leading the way, within the sector, are the Internet Software and Services group and the Semiconductor and Semiconductor Equipment group, which are on track to deliver 25% and 18% year/year top line growth for 4Q17. Analysts surveyed by FactSet are looking for continued outperformance from the sector with revenues forecasted to grow another 10% in 2018 and 7% in 2019. Over time, sectors, groups, and individual companies that have been successful at generating consistent and meaningful revenue growth have outperformed the broader market. The technology sector continues to exhibit these characteristics, thus warranting a meaningful overweight position in growth portfolios, in our view.

Full Disclosure: Nothing on this site should be considered advice, research or an invitation to buy or sell securities, refer to terms and conditions page for a full disclaimer.

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20 Feb C.J. Lawrence Weekly – Financials Sector is the Baby that Should be Put Back in the Bath

We made the point in a recent Weekly Market Comment that the shrinking US publicly traded company share count could be a contributing factor to the equity market’s long bull run. The same phenomenon can also contribute to stock price volatility on a short-term basis, as witnessed during the last two weeks of trading. As volatility returned to the market and sentiment shifted in both directions, the stock market’s gyrations became more pronounced. Human and electronic traders are using new tools to gain the immediate exposure they seek. When the market turns, all babies go out with the bathwater.

There are now around 4,000 publicly traded companies on major U.S. exchanges, and almost 2,000 equity ETF’s and ETN’s that own them. ETFs and ETNs now account for over 30% of daily dollar trading volume. Many of these funds own the same securities. When market sentiment shifts, as it did on February 2, with the release of better that expected average hourly earnings data (inflationary), those exchange traded products tend to be the first levers pulled. In the case of negative sentiment and selling activity, the fund sales can quickly overwhelm the markets of the individual underlying securities with sell orders, scare away natural buyers, and send the underlying share prices gapping down. As selling begets selling, corrections take shape. Several of the largest equity ETF’s experienced 2.5x-3.0x their average daily trading volumes between February 5 and February 9. Yet some of their largest holdings experienced only 1.2x-1.7x increases in average volume during the same period, suggesting that fund selling was likely dragging many underlying security stock prices along for the ride, without the corresponding increase in individual security trading volume.

For investors looking through a longer-term lens, these periods can expose attractive opportunities for long term accumulation. In the recent market downdraft, the S&P Financials Sector Index declined 11.3% from peak to trough (2/8/18). Meanwhile, 2018 earnings per share estimates for the sector have climbed 10% in just the last two months. The Index has regained 6% of its price decline but still trades at an attractive valuation. At 13.7x 2018 forecasted earnings per share, and 12.3x 2019 estimates, the S&P Financial Sector Index is priced at historically low multiples of earnings for periods of economic expansion. The low valuations come at a time when index constituents are experiencing double digit returns on equity, and improving net income margins. Inflation and interest rate related volatility is likely here to stay, and will continue to pressure P/E multiples on stocks. But at the same time, higher rates, a steepening yield curve, and an improving economy are constructive for financial shares. We continue to be overweight the sector and would be opportunistic in periods when market volatility throws out financial babies with the proverbial market bathwater.

Full Disclosure: Nothing on this site should be considered advice, research or an invitation to buy or sell securities, refer to terms and conditions page for a full disclaimer.

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12 Feb C.J. Lawrence Weekly – Volatility Returns (Chairman, James Moltz)

This week we are pleased to offer thoughts on the market from our Chairman, James Moltz.  Jim launched the Weekly Market Comment at the original CJ. Lawrence back in the early 1970s and authored the piece for several decades.  We are fortunate to have his perspectives and are grateful for his leadership in our investment process.  Please do not hesitate to reach out if you have any questions. 

The abrupt rise in stock market volatility is being driven by a growing concern that recently enacted fiscal stimulus will overheat the economy bringing with it inflation, higher interest rates and federal funding issues. The 10% correction in the major U.S. indices is testimony to the market’s penchant to discount the future. Right now, business is good. Reports from Davos confirm that global corporate leaders are very optimistic about the outlook. But recent editorials in The Wall Street Journal, The New York Times and The Economist offered varying degrees of caution. The Economist’s February 10th cover carries a speeding car describing the American economy as “running red hot”. Inside the issue it pleads for the Fed not to lose its head. While official inflation numbers are relatively benign, several companies have recently announced the need for higher prices to offset rising transportation and materials costs. Numerous businesses have offered bonuses or wage increases to be funded by lower corporate taxes. LinkedIn, which focuses on corporate hires, sees a heightened demand for workers. All this has caught the market’s eye.

In the bond market, investors cite the movement in the 10-year treasury yield as telling. Since December it has advanced from 2.4% to 2.9%. The Fed is promising three fed fund increases in 2018 and some believe it will be four. Quarterly targets have been set to retire its fixed income inventory. However, the combination of the tax cut ($1.5 trillion) and increased spending ($ 400 billion) will double the 2019 budget shortfall to $1.19 trillion. That must be financed. A spike in short rates can be costly. At the end of 2017, 50% of U.S. debt matured in three years and the average coupon was only 1.77%. The U.S. is going to be in the awkward position of the Fed selling paper or letting it mature while The Treasury is issuing record new amounts hoping foreigners and U.S. investors will be buyers. A weak dollar would not help the cause.

Using S&P 500 earnings of $153.00, the Index’s p/e has declined from a high of 18.8x to the current 17.1x. The average low p/e for the past three years is 16.1x. A 16.0 multiple produces a 2448 Index Price of 6-7% below the February 9 close of 2619. Essentially that would allow 4% inflation and results in a 6.3% earnings yield. Current estimates for 2019 income are around $155.00 – $170.00. Future price action will depend heavily on upcoming inflation and interest rate news.

Full Disclosure: Nothing on this site should be considered advice, research or an invitation to buy or sell securities, refer to terms and conditions page for a full disclaimer.

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05 Feb C.J. Lawrence Weekly – The Tug‐of‐War Between Lower Valuations and Faster Earnings Growth Still Skews Towards Growth

There are multiple reasons cited for last week’s equity market blow off. It’s difficult to know which event set the downdraft in motion but the rapid rise in interest rates, after several years of historically low rates, is a good place to start. The U.S. Benchmark 10-Year Treasury Yield finished the week at 2.85%, up 39 basis points in just one month. It’s probably fair to say that the market has been expecting higher interest rates, but has been hoping for a more gradual climb. Recently released economic data, has confirmed that both the U.S., and global, economic recoveries are accelerating and inflation is beginning to push through. The U.S. bond market is recalibrating to higher economic growth expectations.

The classical cycle of an economic recovery leading to higher inflation and interest rates looks intact. But a signal may be developing at the long end of the yield curve questioning the rate of change in inflation, versus the rate of change in growth. Yield curve disciples cite the short end of the curve as being most responsive to Fed policy, the middle-to-long portion of the curve most sensitive to economic activity, and the longest end of the curve most susceptible to changes in inflation expectations. Over the past twenty years the spread between the yields on the U.S 10-Year Treasury Bond and the U.S 30-Year Treasury Bond has averaged 63 basis points. That spread now stands at 24 basis points. The ratio bears watching as the 30-year bond is the maturity least impacted by Fed policy, and may provide the best barometer of inflation expectations. Inflation that stays lower for longer could slow an equity market valuation re-rating, precipitated by higher short rates.

Growth and inflation expectations impact the relative value of stocks versus bonds, as reflected through the market multiple. Our CJL Rule of 20 tells us that an economic environment with 2.0% inflation can accommodate an 18x price-earnings (P/E) multiple on current year earnings. Thus, should inflation climb towards 3.0%, the appropriate multiple would likely trend towards 17x current year earnings. At 17x the consensus 2018 EPS forecast of $155, the fair market value for the index would be around 2,635, or 4.5% below the current level. But that is a static calculation that does not incorporate faster earnings growth, which should be assumed if inflation trends towards 3%. For stocks to offset a potential negative re-rating, earnings will need to grow faster than the rate of decline in the market multiple. This is happening. In just the past two months, bottoms-up earnings forecasts for the S&P 500 have climbed 7% for 2018 and 8% for 2019. Estimates are likely to climb higher as the remaining 50% of S&P 500 constituents report 4Q17 earnings results and issue guidance for 2018. The race between earnings growth rates and the rate of decline in the market’s P/E multiple is on. Along the way, the 10-30 year treasury bond spread may provide insights into the appropriate market multiple to apply. The challenge for equity investors will be to find stocks with earnings growth rates that exceed the rate of decline in P/E multiples. Based on current forecasts, they can be found in the technology and financial sectors. We remain overweight in both.

Full Disclosure: Nothing on this site should be considered advice, research or an invitation to buy or sell securities, refer to terms and conditions page for a full disclaimer.

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29 Jan C.J. Lawrence Weekly – Want to Buy Stocks? Get In Line.

Positive 4Q17 earnings results, an improving economic backdrop and outlook, rising corporate profit forecasts, and increasingly bullish sentiment have added fuel to an already roaring stock market fire. The S&P 500 Index tacked on another 2.2% last week, putting the index price up 7.5% year-to-date. Hungry bears saw a meal in last week’s report that net flows into stock funds spiked in the past two weeks, and suggested that a euphoria based sell signal is building. But we would caution against reading too much into the recent fund flows results, noting that ~80% of the net new equity flows went into “global” equity funds and not into domestic funds, according to Investment Company Institute data. The return to positive equity fund inflows can also be viewed as welcome news after more than two years of net outflows. Nonetheless, the net equity inflows, and the marked increase in bullish sentiment in several widely followed investor surveys, suggest to us that the once considered “most hated bull market in history” is finally getting some love.


But for the growing number of investors looking to build new, or add to existing, stock positions, finding attractively priced, highly liquid stocks to purchase is getting more challenging and competitive. The number of public companies listed on major U.S exchanges peaked in 1998 at around 7,500. At the end of 2017 there were less than 4,000. Robust merger and acquisition activity, low cost debt-aided leveraged buy-outs, and a dearth of Initial Public Offerings (IPOs) have all contributed to the net reduction. According to private equity data provider, Prequin Ltd., in the US alone, there are now close to 7,500 private equity-owned companies, almost twice the number of public companies. Costs and risks associated with being a public company, and broader access to capital for private companies, are encouraging corporate managements to stay private longer, if not indefinitely. Corporate tax reform has also made many of them healthier, allowing for larger dividends to be paid to private equity owners, and reducing the urgency for exits. Only 47 private equity sponsored companies went public in 2017, up 42% from the decade low 33 IPOs set in 2016. On the other end, a record 770 first-time private equity funds are currently seeking capital, according to Palico, an online marketplace for funds. That is 48% more than the previous all-time high of 520 in 2008. Once raised, that money will have to be put to work, gobbling up private and public companies alike.


Exacerbating the shortage of public company shares are corporate re-purchase programs which are reducing share counts of the remaining public companies. For the average S&P 500 company, the annual buy-back pace slowed in 2017, but is likely to reaccelerate in 2018, as tax reform-freed capital is deployed for capital expenditures, but is also returned to shareholders in the form of dividends and increased share buy-backs. Meanwhile on the supply side, there were 236 U.S. IPOs priced in 2017, raising $52.2 billion, surpassing the $26.5 billion raised in 2016 (143 IPOs) and $41.0 billion raised in 2015 (217 IPOs). But the new supply of shares brought to market during the past three years, in aggregate, pales in comparison to the value removed from the market through repurchase programs in just the first three quarters of 2017. During that period, S&P 500 Index constituents executed $518 billion in share repurchases. By the time 4Q17 final results are tallied, that figure could climb well above $650 billion. Equity exchange traded funds are also contributing to the contraction in tradable shares through their creation process, which removes shares from circulation in exchange for floating the basket (ETF). Equity ETF’s now account for between 5% and 7% of most S&P 500 companies’ publicly traded float. As the ETF industry grows, those figures will continue to climb. The supply-demand equation for stocks remains tilted toward the demand side, and looks unlikely to change any time soon. So long as fundamentals stay intact, that could keep a bid under stocks for a long time.

Full Disclosure: Nothing on this site should be considered advice, research or an invitation to buy or sell securities, refer to terms and conditions page for a full disclaimer.

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22 Jan C.J. Lawrence Weekly – Inflation Counter‐Forces in the New Economy

In the previous millennium, strategists and economists would sometimes gauge inflationary pressures by measuring and comparing the prices of New York City taxi medallions versus the price of a seat on the New York Stock Exchange. The price for a NYSE seats, which allowed the limited number of holders to trade stocks on the floor of the exchange, peaked in 1999, at $2.65 million, then dropped to $975,000 in 2005. Seat prices rallied later in 2005 on the announcement that the NYSE and Archipelago would merge, become a public company, and exchange seat licenses for IPO shares and cash. But the point had been made that the value being created in stock trading was in networks and no longer in exchange floor real estate. Meanwhile, NYC taxi medallion prices peaked in 2014 near $1.3 million. Several were auctioned off last week for less than $200,000 each. The commonality between the declines of these two once prized assets is the deflationary pressures of competition and disruption. The rapid evolution of electronic trading networks doomed the on-site, in-person trading floor, while disruptors like Uber and Lyft threaten the once protected franchises of NYC taxi medallion holders.


Today’s disruptors are doing the same thing in mature industries throughout the economy. The new “gig” economy has introduced deflationary forces that some feel could challenge the traditional cycle of inflation. Economic history tells us that the correlation between labor markets and inflation is tight. For inflation watchers, that means the current set-up suggests higher prices are ahead. Labor conditions are tight, the economy is growing, monetary policy remains relatively accommodative, and the U.S. economy recently received a healthy dose of fiscal stimulus. That is a potent inflationary mix. Trade restrictions, if imposed, would further contribute to upward inflationary pressure. A confirmatory signal has been flashed by the benchmark U.S. 10-year treasury bond yield, which closed the week at 2.65%, up 25 basis points in the last month.


But the rate at which prices rise, the amplitude of the increases, and the duration of the pricing cycle, particularly in certain segments of the economy, are less clear in the modern economic era. E-commerce and the “Amazon effect” have helped to drive prices and margins of most consumer goods to historic lows. Hydraulic fracturing has revolutionized the oil and gas industry, by dramatically reducing the response time to imbalances, and constraining the industry’s ability to raise prices. Cloud computing has democratized software consumption and modularized previously one-sizefits-all product offerings. A recent announcement by a group of hospital executives suggests they will collaborate on the development of their own generic drugs to compete with established pharmaceutical companies and distributors. New technologies in agribusiness and ranching are increasing crop and herd yields and are improving the resiliency of supply lines. These are just a few examples of the deflationary forces at work in today’s economy. Many of these trends are not new, but the pace of change appears to be accelerating. Equity investors should be wary of mature companies in industries where price erosion is prevalent. Inflation certainly looks to be on the rise, and the reflation trade may still have some legs, but history suggests that long-term equity investors are well served by owning companies that innovate, possess pricing power, and grow market share in any economic environment.

Full Disclosure: Nothing on this site should be considered advice, research or an invitation to buy or sell securities, refer to terms and conditions page for a full disclaimer.

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16 Jan C.J. Lawrence Weekly – Want Blockchain Exposure? Buy a Basket “OF MAGIC”

Until last week, Kodak was an imaging company struggling to manage the transition from film and hardware to digital and software. The 130-year-old company, which emerged from bankruptcy in 2012, had lost 80+% of its market value since re-emerging as a public company. But on Tuesday, Kodak announced that it was launching a cryptocurrency called Kodak Coin and would be launching an image rights management platform, that leverages blockchain technology, called Kodak One. The stock soared on the announcement, finishing up almost 200% in a week. A similar halo was bestowed on drinks company Long Island Iced Tea Company, which changed its name to Long Blockchain Corp. only to see its stock quadruple on the announcement. Likewise, the price performance of new digital coin and token issues has been measured in multiples, rather than percentage point moves. For those who invested through the dot com boom and bust period in the late 1990’s, these stories sound eerily similar to the concept (pre-revenue) IPOs that launched in the late 1990’s in response to the market’s insatiable appetite for anything resembling an “internet company.”

Cryptocurrency and blockchain debates have dominated the business news cycle over the past few weeks. Recent moves by South Korea and China to limit cryptocurrency trading fueled volatility on exchanges already besieged by wide price swings. In an on-air interview with New York University’s expert on corporate valuations, Prof. Aswath Damodoran, highlighted the point that cryptocurrencies are currently being priced, not valued, and that the full faith and credit behind cryptocurrencies is the software code that defines them, and not any one entity, agency, or balance sheet. He also introduced the concept of crypto-commodities, versus cryptocurrencies, which some advocates consider more akin to gold than the Swiss Franc or Russian Ruble. No doubt, these instruments have their supporters. But mainstream adoption of cryptocurrencies and crypto- commodities may be evolutionary, not revolutionary. Central bankers, government officials, consumers, and consumer protection agencies world-wide, all with their own agendas, will need to agree on global protocols and processes, before cryptocurrencies become mainstream. Unlike dot com companies, which opened access to new services consumers previously did not have, cryptocurrencies seek to replace existing processes and means of exchange, that unquestionably have flaws, but which few would claim inhibit consumers’ ability to transact. Thus, for all the benefits of cryptocurrencies, the lack of a pressing unmet need may slow their adoption. Meanwhile, blockchain technology, the infrastructure behind cryptocurrencies, looks to have broad application, and may warrant more immediate investor attention.

Blockchain is a shared public ledger which tracks transactions and ensures the record of those transactions remains transparent. There are broad applications for the technology, and various initiatives are currently underway exploring the benefits of blockchain ledgers in the financial services, e-commerce, food safety, digital media, pharmaceuticals, cybersecurity, and transportation industries, among others. Leading the charge in these areas are several of the world’s most successful technology companies. Microsoft, IBM, Oracle, Alphabet (Google), and Accenture all have major initiatives underway aimed at integrating blockchain technology into current business processes. Facebook CEO, Mark Zuckerberg, has stated that blockchain and crypto currency will be one of his top personal priorities in 2018. In our view, these companies, and a few other technology leaders, possess the size, scale, engineering prowess, and balance sheets to bring blockchain technology from white board to implementation. There will no doubt be “moon shot” start-ups and disruptors that make their founders and owners rich. But for investors seeking a lower risk approach to participation in the new paradigm of blockchain technology, we suggest establishing a basket “OF MAGIC” (Oracle, Facebook, Microsoft, Accenture, Google (Alphabet), IBM Corp., and Cisco) which delivers broad exposure to this revolutionary technology.

Full Disclosure: Nothing on this site should be considered advice, research or an invitation to buy or sell securities, refer to terms and conditions page for a full disclaimer.

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08 Jan C.J. Lawrence Weekly – CJL Market Monitor Continues to Favor Stocks

As investment managers, we sleep with one eye open and the other on our Market Monitor. The C.J. Lawrence Market Monitor was created in the early 1980s to measure the attractiveness of the stock market. It calibrates the relative appeal of stocks versus fixed income and tests the internal technical health of the stock and bond markets. Over the Monitor’s 37-year history, it has been a useful asset allocation tool. While not developed as a timing model, the SELL signals generated prior to the stock market crash of 1987, and again in the period leading up to the bursting of the internet bubble in 2000, are two of the Market Monitor’s most notable measurements. The Market Monitor’s current reading is solidly in BUY territory at +3, on a scale of -6 to +6.

The Monitor consists of six components. Each is constructed to generate individual BUY, HOLD, and SELL signals. Two of the components are driven by equity fundamentals, two by the direction and rate of change in short and long interest rates, and two by technical and market breadth indicators. The interest rate signals were less useful post financial crisis, as rates fell to historically low levels and even small basis point changes had a meaningful rate of change impact. But the interest rate models are beginning to come back into balance as rates are normalized. Interestingly, in the December period, the Long Bond model generated a BUY signal, after several months in Neutral territory, as monthly average U.S. 30-Year Benchmark Treasury yields fell more than 10% below last year’s level. Normally, at the beginning of a rate tightening cycle, this component would be generating a negative signal.

C.J. Lawrence Market Monitor Chart - January 8, 2018

C.J. Lawrence Market Monitor Chart – January 8, 2018

The Market Monitor’s bullish positioning is understandable given the recent improvement in equity fundamentals and cash flow yields on stocks, versus the still relatively paltry yields on fixed income instruments. As U.S. interest rates rise, as they are expected to do in the coming year, the risk-free rate on treasuries should become more attractive. But the pace at which the economy, and corporate profits, improves may continue to tilt the relative equation towards stocks. Asset allocators, increasingly worried about the veracity and length of the current bull market, may find comfort in the CJL Market Monitor’s stance. A breakdown in equity market technical metrics and breadth would certainly weaken its conviction, but the improving fundamental backdrop will likely keep the Market Monitor favoring stocks in 2018. We continue to overweight equities in balanced portfolios.

Full Disclosure: Nothing on this site should be considered advice, research or an invitation to buy or sell securities, refer to terms and conditions page for a full disclaimer.

Terms and Conditions

02 Jan C.J. Lawrence Weekly – 2017 Scoreboard Highlights Consistent Technology Leadership

When we wrote the year-end market summary last year, we noted the high level of sector rotation that took place on a quarterly basis throughout 2016. In 2017, leadership was instead remarkably consistent. Of the major S&P 500 sectors, Technology led all others in three out of four quarters and finished the year at the top of the leader board, having generated a 39% total return. It was followed by the Materials and Consumer Discretionary sectors, which lagged the leader by wide margins, but produced attractive returns of 24% and 23% respectively.

What is also noteworthy is that the relatively high dividend, “bond proxy” sectors finished the year consistently at, or near, the bottom of the performance charts, despite historically low bond interest rates. Telecom stocks finished in the bottom position having delivered a negative return of 1.3% for the year. The Energy Sector Index also delivered a negative annual return (-1.0%) having experienced meaningful negative returns in the first half of the year, off-set by positive returns in the second half.

The broader S&P 500 Index returned 21.8% for 2017, making it the 32nd time the S&P 500 total return has eclipsed 20% in the last 90 years. The strong index performance and a proliferation of index related products may have helped to lift the prices of almost all index constituents. Only four S&P sub-index groups finished in negative territory for the year. The top performing groups for the year were Personal Products (+49.6%), anchored by the strong price performance of Estee Lauder, and Internet Retailing and Direct Marketing (+47.3%), which is driven primarily by the price performance of Amazon.com and Netflix. The worst performing groups were Energy Equipment and Services (-15.1%) and Leisure Products (-12.2%) which is comprised of Hasbro and Mattel.

Earnings per share, for the broader index, are expected to grow 11.4% in 2018 and 10.1% for 2019, according to bottoms-up forecasts provided by Factset. Interestingly, the current estimates are below the levels recorded at the beginning of 2017. Analysts appear to be waiting for company guidance before incorporating tax reform benefits into their models. Consensus forecasts suggest that the new corporate tax rate of 21% could add another 9%-10% of growth to next year’s S&P 500 Index EPS estimate. The fastest earnings growth in 2018 is expected to be generated by the Energy sector, driven by low comparisons and firming oil prices. Materials and Technology are expected to round out the top of the earnings growers list, while Telecom and Utilities are expected to lag. If earnings growth drives sector performance in 2018, the year’s leaders and laggards list could look very similar to 2017.

Full Disclosure: Nothing on this site should be considered advice, research or an invitation to buy or sell securities, refer to terms and conditions page for a full disclaimer.

Terms and Conditions

18 Dec C.J. Lawrence Weekly – Time to Rotate to Value Stocks?…Not So Fast

The likely passage of the U.S. tax reform bill, a bump up in the U.S. Fed Funds target rate, and better than expected economic data have all contributed to a reevaluation of equity investor sector and style weightings. As discussed in last week’s note, we got a glimpse of rapid sector rotation two weeks ago when the U.S. Senate announced it had the requisite votes to move on tax legislation. The shift from growth to value, or in this case, from less tax-advantaged to more tax advantaged, was fast and furious. But interestingly, much of that rotation reversed itself over the past two weeks, calling into question the permanency of the shift.

Periods of accelerating economic growth have historically been good backdrops for value stocks. The thesis holds that value stocks are more sensitive to changes in economic activity and typically trade at lower valuations, so they can be bought early-cycle at discounts, and outperform during the expansion. For “style box” allocators, the debate centers on whether now is the right time to undertake a meaningful tactical shift and overweight value stocks in equity portfolios. Rules-based investors, who continuously rebalance their portfolios according to preset asset allocation and style weight targets, have underperformed over the past several years as they sought to stay within their style guidelines while growth stocks vastly outperformed. Since 2010, the growth style, as measured by the S&P 500 Growth Index, has outperformed value, as measured by the S&P 500 Value Index, by over 50%. Mean reversion advocates suggest, therefore, that the environment is ripe for a reversal, and for the two styles to come back in balance. Technicians are echoing that call based on what they see as extended price action in many growth stock categories. But the fundamental picture paints a different story.

S&P 500 Growth / S&P 500  Value Relative P/E

S&P 500 Growth / S&P 500 Value Relative P/E

To categorize stocks as either growth or value, Standard and Poor’s uses formulas that score stocks on the following criteria: price/earnings ratio, price/book value ratio, price/sales ratio, three-year earnings growth, three-year sales growth, and price momentum. In some cases, a single stock may show up in both indices, but its weighting is often meaningfully different in each. At this stage in a bull market one might expect that growth stock valuations would far exceed those of value stocks, especially given the price differential experienced over the past several years. But interestingly, growth stocks look cheaper on a relative value basis than they have since 2013. Over the last 15 years, growth stocks have traded at a 1.21 relative P/E to value, having peaked at 1.44 and troughed at .91. That ratio now stands at 1.28 and has been declining since 2013. The same holds true for price/book value, return on equity, and price/earnings growth (PEG) relative comparisons. The technical set up may be giving a green light for a rotation from growth to value stocks, but historical fundamental valuation comparisons are telling growth weighted managers to stay put.

Full Disclosure: Nothing on this site should be considered advice, research or an invitation to buy or sell securities, refer to terms and conditions page for a full disclaimer.

Terms and Conditions

11 Dec C.J. Lawrence Weekly – Cash Can be King Even When You’re Bullish

Whether it’s the machines at work, or faster fingered traders, when the market shifts, it happens fast. The week after Thanksgiving provides a good example of how quickly sentiment can change, and how dramatically and demonstrably the market reacts to those shifts. For months, pundits have been calling for a market correction based on a variety of technical factors. While the broader market has failed to deliver that correction, the sector rotation experienced during the week after Thanksgiving was fierce. One can debate the catalyst that launched the rotation, but it seems to us that the U.S. Senate’s announcement that it had the requisite votes for tax reform, set the rotation in motion.


Within milliseconds of the headlines hitting the newswires, traders and machines bought the tax beneficiaries (domestic companies that would benefit from lower domestic corporate tax rates) and sold less tax-advantaged stocks. The rotation bid up many year-to-date price losers and sold the winners. The biggest gainers during the two-trading day period were Broadcasters, Department Stores, and Food Retailers, all of which had negative year-to-date price performance to that point. Between Friday and Monday those group indices were up 6.3%, 5.8%, and 3.9% respectively. The losers were Software, Semiconductors, and Health Care Suppliers which had all posted 30+% price gains year-to-date.

8%- 10% performance differentials between winning and losing groups were not uncommon during that two-day rotation. The broader market did not experience a correction, but many sectors and groups did.


While the market’s recovery from fundamentally driven corrections, like the recession of 1990-1991, the popping of the internet bubble and subsequent recession in 2000-2001, and the financial crisis of 2008-2009 can take months, and even years, its average response to technical moves can now be measured in days. After the “flash crash” in 2010, the S&P 500 needed only five trading days to recuperate. When Greek banks were closed in 2015 to stave off collapse, the S&P 500 needed just 11 days to recoup the 2.6% dip it experienced during that period. When the Brexit vote was tallied in 2016, the S&P 500 sold off 5.3%. It took just 10 trading days to retrace the decline. Many of the losers in the post-Thanksgiving Day rotation have now regained most or all their declines. The point is that corrections and rotations, and the reactions to them, during periods of economic stability and/or expansion, are happening within increasingly compressed durations. Investors looking opportunistically for attractive entry points to high conviction ideas now have narrow windows in which to execute their strategies. Having plenty of dry power available, and the ability to put it to work quickly, have become strategic imperatives in today’s fast-moving market.


Full Disclosure: Nothing on this site should be considered advice, research or an invitation to buy or sell securities, refer to terms and conditions page for a full disclaimer.

Terms and Conditions

04 Dec C.J. Lawrence Weekly – Improving Earnings Growth Forecasts Suggest the Bull May be Sharpening His Horns

Friday’s stock market roller coaster ride ended on a down note, but finished well off the lows of the day. Speculation about what former National Security Director, Michael Flynn, might say to the U.S. Special Prosecutor investigating his pre-inauguration activities, reversed the equity market’s previous risk-on posture, sent U.S. Treasury bond prices higher, the U.S. dollar lower, and gold higher. Then, around midday, reports circulated that the U.S. Senate had gathered the requisite votes to pass their version of tax reform legislation, and stocks quickly found a bottom and retraced their losses. The uncertainty surrounding the forthcoming Flynn testimony injects increased market risks and volatility in the coming weeks and months. But the economic and equity market backdrop remains positive, and continues to improve.


According to Tuesday’s release from the Organization for Economic Cooperation and Development (OECD) the global economy is now growing at its fastest pace since 2010, with the upturn becoming increasingly synchronized across countries. The OECD now forecasts 3.7% global economic growth in 2018. At home, the second estimate of third-quarter gross domestic product showed that the US economy grew at a 3.3% annualized rate, the strongest since Q3 2014. The New York Federal Reserve recently raised their 4Q17 GDP forecast to 3.8%, only a week after raising it to 3.2%. The globally synchronized economic expansion is intact, and that is good news for corporate profits. In the US., corporate tax reform may add additional fuel to what is already a crackling economic flame.


Forecasts now suggest that 2017 S&P 500 earnings per share (EPS) will be up over 10% from last year’s level. If that figure holds, it will be the first time that the Index has produced year-over-year double-digit earnings growth since 2011, as the economy climbed out of recession. According to estimates from FactSet, S&P 500 EPS are expected to grow 10.8% in 2018 and 10.0% in 2019. These figures do not include any benefit from corporate tax reform, as far as we can tell. If corporate tax rates are lowered to the 20%-22% range, those growth rates could potentially double. There have been only four periods, since 1960, when S&P 500 earnings grew at a double-digit clip for three consecutive years. With the exception of the 1972-1974 period, when the economy was headed into recession and investors were confounded with an inverted yield curve, stock returns averaged 14.7%, per year, during those periods. Many pundits are pointing to tax reform prospects and deregulation efforts as catalysts for the market’s 2017 rally. But accelerating GDP, at home and abroad, and corporate profit growth are the underpinnings on which durable bull markets are built. This one may be further from the top than consensus believes.


Full Disclosure: Nothing on this site should be considered advice, research or an invitation to buy or sell securities, refer to terms and conditions page for a full disclaimer.

Terms and Conditions

27 Nov C.J. Lawrence Weekly – Sector Watch: Consumer Staples’ Premium Valuation at Risk

The Consumer Staples sector has historically been viewed as a safe port in a market storm and a key component sector to diversified portfolios. The thesis has held that the consistency of sales and relatively high dividend yields of sector constituents are the defensive characteristics sought by investors in “risk-off” environments. After all, consumers don’t stop brushing their teeth or drinking beer during crisis, as the saying goes. In 1990 the S&P Consumer Staples carried the highest weighting among all sectors in the S&P 500 at 14.1%. The onset of Operation Desert Storm, and an ensuing recession, likely contributed to the sector inflows during that period. Today, the Staples sector weighting within the index stands at 8.1%, the lowest level since the 1970s.

The Staples sector consists of six sub-indices including, in descending market weight order; Beverages, Food and Staples Retailing, Household Products, Tobacco, Food Products, and Personal Care. Only the Food Products group is down year-to-date (-5.1%), with the broader sector up 6.1% on a price-only basis. Campbell Soup Company’s dismal earnings report, and subsequent stock sell off, has weighed on the group’s performance this quarter. The company reported a sales decline of 2% and stated that earnings were negatively impacted by higher carrot prices and higher transportation costs in the quarter. An important take-away from Campbell’s and other Staples’ company results may be that their top lines are not as resilient in the modern economy as they have been in the past. The Amazon affect, farm-to-table menu preferences, healthier eating habits, and the proliferation of private label goods are all trends that are chipping away at the incumbents’ once dominant franchises. That vulnerability could call into question the high multiples that investors have awarded Staples companies in the past.

The S&P Consumer Staples sector currently trades at 19.3x 2018 calendar year earnings per share estimates, according to FactSet, for an index whose constituents are expected to generate 3.5% sales growth and 7.5% earnings growth during the period. That compares to the broader S&P 500 trading at a 17.9x P/E multiple for 5% sales growth and 11% earnings growth. Over the past 15 years the S&P Staples sector has, on average, traded at a 12% premium to the S&P 500. That premium now stands at 8%, and risks compressing further as changing consumer preferences and behaviors, and the proliferation of mature industry disruptors threaten incumbent revenue streams. Staples constituent stock prices may continue to see inflows during periods of sector rotation and flights to safety, but it is hard to make a case that Consumer Staples stocks will continue to enjoy the premium valuations they have in the past.


Full Disclosure: Nothing on this site should be considered advice, research or an invitation to buy or sell securities, refer to terms and conditions page for a full disclaimer.

Terms and Conditions

20 Nov C.J. Lawrence Weekly – Talking Turkey – Deflation at Dinner

The recently released Producer Price Index (PPI) and Consumer Price Index (CPI) diverged in their October readings. The PPI rose to an annual rate of 2.8%, the highest annual rate since February of 2012. The CPI, on the other hand, barely rose for the month, and the annual rate bumped down to 2.0% from 2.2%. Most economists believe the CPI reading was more heavily influenced by the impact of fall hurricanes than was the PPI. The index readings are growing in importance as we approach the December meeting of the Federal Reserve’s Federal Open Market Committee (FOMC). Both are weighed heavily in the FOMC’s calculus of price stability and full employment, and ultimately in their monetary policy decisions. But while the direction of the data tilts towards inflation, Americans are experiencing deflation at the Thanksgiving dinner table!

This week, a vast majority of Americans will join together for the time-honored tradition of the Thanksgiving dinner. While many will disagree on politics, the appropriateness of Uncle Joe’s humor, and the dinner table seating arrangements, the overwhelming consensus is that turkey, with all the trimmings, is the mainstay of the Thanksgiving feast. The cost of that feast is projected to be down 1.5% from last year, according to the American Farm Bureau Federation survey. On average, a dinner for ten, consisting of a 16-pound bird, and all the trimmings comes in this year at $49.12. The cost of the dinner is the lowest since 2013, and the second-lowest since 2011, according the Farm Bureau’s director of market intelligence.

The big-ticket item, a 16-pound turkey, will cost American families $22.38 or $1.40 per pound. That’s a decrease of 2 cents per pound when compared to 2016. The shopping list for the Farm Bureau’s informal survey includes turkey, bread stuffing, sweet potatoes, rolls with butter, peas, cranberries, a veggie tray, pumpkin pie with whipped cream, coffee and milk, all in quantities sufficient to serve a family of 10. The Thanksgiving dinner menu has remained unchanged since 1986 to allow for consistent price comparisons. Foods showing the largest decreases this year in addition to turkey were; a gallon of milk, a dozen rolls, two nine-inch pie shells, a 3-pound bag of sweet potatoes, a 1-pound bag of peas, and a group of miscellaneous items including coffee and ingredients necessary to prepare the meal. Despite healthy supplies, prices for cranberries and cranberry sauce (a CJL favorite) rose in this year’s survey. Perhaps Amazon has not yet figured out how to disintermediate a cranberry bog! On behalf of the C.J. Lawrence team, Happy Thanksgiving to all!


Full Disclosure: Nothing on this site should be considered advice, research or an invitation to buy or sell securities, refer to terms and conditions page for a full disclaimer.

Terms and Conditions

14 Nov C.J. Lawrence Weekly – China’s and India’s Economic Growth Prospects are Good for Equity Prices

As the US House of Representatives and Senate work through the machinations of domestic tax reform, President Trump has been visiting the globe’s fastest growing region, discussing trade relations, and meeting with regional heads of state. His visit to China looks to have delivered few tangible new business opportunities for U.S. companies, but despite the challenges of operating there, many are making marked progress in the world’s most populous nation. Despite a relatively saturated smart phone market, Apple reported 40% shipment growth in iPhones to Chinese consumers in the most recent quarter. General Motors’ China business is up 2.1% year-to-date, but accelerated in October to 10%, led by a 36.1% surge in Cadillac sales. Starbucks had soft comparable store sales globally, in its recently reported quarter, but saw same store sales in China expand at an 8% clip. Revenue in the third quarter for YUM China, the spin-out from Yum Brands, grew 8% year-over-year. As expected, China domiciled firms performed even better. The grand-daddy of reports on the state of the Chinese consumer came over the week-end when Alibaba reported results from its “Singles Day.” Gross merchandise volume for the day climbed to $25.3 billion, up 39% from last year.

To be sure, China faces a new set of challenges as it attempts to manage its economy, encourage entrepreneurship and innovation, improve the living standards of a larger portion of its population, and enact reforms that protect the environment, all at once. From 1978, around the time economic reforms began, to 2011, China’s annual GDP expanded at an average rate of 9.9% per year. Between 2012 and 2016 that rate slowed to 7.2% and currently fluctuates between 6.7% and 6.9%, depending on the reporting service. But despite the deceleration in GDP growth, the Chinese consumer economy is still growing at 10% a year. According to a study conducted by the Boston Consulting Group, by 2021, China will add $1.8 trillion in new consumption. That is roughly the size of Germany’s consumer economy today, and more than one-fourth of all consumption growth of major economies.

China’s economic expansion continues despite a stubbornly high “Ease of Doing Business Index” ranking by the World Bank (released in October 2017). This year, China remains the 78th ranked country in the survey, down only eight spots in the past ten years. At the same time, China’s Asian neighbor, India, has made important strides in the rankings, improving 30 spots to rank 100 in this year’s survey. India’s rank has improved from 142 in only three years. Prime Minister Modi’s business, tax, and monetary reforms are given much of the credit for the improvement. Despite downward adjustment to near-term economic growth forecasts, as a result of the reforms, the IMF expects India’s economy to recapture its status as the world’s fastest growing economy in 2018. With a population size that is expected to surpass China’s by 2024, and a potential workforce set to climb from 885 million to 1.08 billion in the next twenty years, India’s economy represents another powerful engine of global economic growth. The prospect of both China’s and India’s economies growing simultaneously at ~7% for extended periods, alongside growing economies in the US and EU, lends considerable support to the global growth thesis, and is bullish for corporate profits and global equity prices.


Full Disclosure: Nothing on this site should be considered advice, research or an invitation to buy or sell securities, refer to terms and conditions page for a full disclaimer.

Terms and Conditions

07 Nov C.J. Lawrence Weekly – U.S. Economy is Supportive of Accelerating S&P 500 Top-Line Growth

It was not surprising that the U.S. Federal Open Market Committee decided to leave interest rates unchanged last week, but the pressure seems to be mounting for a December move. The third quarter GDP result of 3.0% was followed, last week, by an impressive ISM Non-Manufacturing Index reading of 60.1%. That was well ahead of the 58.1% reading expected by most economists. A reading above 50% indicates improvement. On Friday, the U.S. government reported that the economy added 261,000 jobs in October, despite the impact of hurricanes, and that the unemployment rate fell to 4.1%, the lowest level since December 2000. The backdrop for corporate sales and profit growth continues to improve.

For the past five years, top line growth for S&P 500 companies has averaged 2.3% while average annual GDP growth was 2.2% over the same period. Corporate managements employed a combination of debt refinance, share repurchases, and corporate efficiency initiatives to grow profit margins and earnings. Average earnings per share growth for the Index during the same period was 3.9%. With margins currently holding at high levels, and the economy increasing its pace, investor focus is returning to top line opportunities and market share growth to help identify portfolio winners.

Reported S&P 500 sales per share growth, for 3Q17, has been encouraging. With over 80% of constituents having reported results, S&P 500 sales are coming in 5.8% ahead of last year’s levels. That figure would be 4.6% if the Energy Sector was excluded. 66% of the sales reports have come in ahead of analyst expectations. That is well ahead of the five-year average of 55%. Leading in top-line growth are the Energy and Materials Sectors, both of which are coming off relatively depressed levels. Not far behind is the Technology Sector which is posting 10.2% sales growth to date. The Internet Software and Services and the Semiconductor and Semiconductor Equipment industry groups are bolstering the Index with 25% and 16% top line growth, respectively. Stocks in these sub-indices have reacted accordingly. Companies with leading edge products and services, serving large markets, and operating at attractive margins, that continue to grow their top lines at a double-digit pace are relative outperformers in any market. The Technology Sector includes companies that possess many, or all, of these characteristics, and should therefore remain a meaningful market overweight sector in growth portfolios.


Full Disclosure: Nothing on this site should be considered advice, research or an invitation to buy or sell securities, refer to terms and conditions page for a full disclaimer.

Terms and Conditions

30 Oct C.J. Lawrence Weekly – REIT Underperformance Likely to Persist

“Bond proxy” equities struggled last week as the benchmark U.S. 10-Year Treasury Bond yield climbed to 2.42% (from 2.06% in early September) reinforcing fears among bond proxy holders that rising interest rates will compete more competently for income seekers. For the week, the Telecom, Real Estate, and Consumer Staples sector indices were down 3.2%, 1.6%, and 1.5% respectively, versus the broader S&P 500 Index, which was up slightly. Sub-par earnings reports may have contributed to the declines, versus positive surprises across most other sectors. Energy stocks, typically high dividend payors, were also off for the week (-0.5%), despite oil prices that climbed 4.4% (WTI). 46% of REITs have reported 3Q17 results to date and 60% have delivered funds-from-operations (FFO) below street expectations.

Real Estate Investment Trusts were carved out of the Financials Sector Index by S&P Global in August of 2016. Investors in securities that track the Financials Sector Index have been rewarded by the split. Since separation, the total return on the S&P Financials Sector Index is 43.0%. The total return on the new S&P REIT Sector is -3.0% during the same period. Year-to-date, the total return on the Financials Index is 16.6% and the total return on the REIT Index is 7.3%.

The good news for REITs is that as the economy improves so too do real estate fundamentals. Thus, in general, REITs’ ability to grow cash flow and increase pay-outs improves as the economy ramps. The off-set is that REITs tend to be serial issuers of new debt, using leverage to grow, and their cost of capital is now on the rise. According to data provided by FactSet, the REIT Sector Index cash flow per share is expected to grow 5.1% in 2018 versus 12.3% for the S&P 500. Increasing competition from fixed income instruments, sub-market cash flow generation, and a surging sector emphasis on early cyclicals may contribute to continued REIT underperformance. We remain underweight REITs in our model portfolio.

Full Disclosure: Nothing on this site should be considered advice, research or an invitation to buy or sell securities, refer to terms and conditions page for a full disclaimer.

Terms and Conditions

23 Oct C.J. Lawrence Weekly – Goldilocks’ Porridge Made With Copper and Gold

A useful ratio in gauging global growth prospects versus global fear is the copper-to-gold price ratio. The ratio has become increasingly relevant over the past fifteen years as China, now the dominant swing factor in the global growth equation, has emerged as a massive copper consumer. At the end of 2016, China was responsible for almost 50% of global refined copper consumption, according to the World Bank. It is often said that “copper is the metal with a PhD in economics” because it is used so extensively in the industrial economy. Its uses include, but are not limited to, electrical wiring and circuit boards, plumbing, coin production, and metal alloy production. Thus, as economic activity increases, so does demand for copper. Reversals in copper price trends can be important signals for economists, as are significant price increases and decreases relative to other commodities.

Conversely, there are not many industrial uses for gold. In fact, about 78% of new gold production is used to make jewelry. The rest is added to stockpiles held by central banks, speculators, traders, and vaults containing trade collateral and bullion associated with gold-backed securities. Despite its’ limited industrial uses, ownership of the yellow metal is still widely viewed as a hedge against inflation and currency debasement, and for safety-seekers, as a safe-haven in times of geo-political and economic crisis.

At peaks and troughs, the copper-to-gold price ratio can identify important inflection points in the balance between growth and inflation, as it did at the trough in September of 1980 and at the peak in September of 2006. More recently, the ratio troughed in August of 2016, signaling a bottom in industrial commodity prices, and higher global economic growth prospects. The fact that the ratio has increased gradually suggests that the improvement in commodity prices has likely been driven by stronger unit demand, rather than broad based price inflation. Over the past forty years the ratio has averaged 5.8, and has averaged 6.3 over the past 17 years. It now stands at 5.4. Higher, but not inflated, copper prices and consumption are important underpinnings to global growth. The current ratio may be signaling that the current Goldilocks environment for stocks (low inflation and steady, moderate economic growth) may stick around.

Full Disclosure: Nothing on this site should be considered advice, research or an invitation to buy or sell securities, refer to terms and conditions page for a full disclaimer.

Terms and Conditions

16 Oct C.J. Lawrence Weekly – 2018 Earnings Estimates May Be Too Low

Third quarter earnings season kicked off last week with good reports from most of the big banks. JP Morgan Chase, Citigroup, and Bank of America all topped analysts’ top and bottom line forecasts. Despite the “beats”, the stocks of those companies experienced muted responses to their reports. It appears there may have been some selling of the news to counter the incremental enthusiasm for rising earnings and constructive outlooks. As we suggested in last week’s note, the Financials sector is projected to deliver solid double-digit earnings growth in 2018, and looks attractive on a relative valuation basis.

Earnings season provides a good opportunity to gauge corporate financial progress versus expectations and to revisit forecasts. The 3Q17 results may be a bit noisy due to the recent hurricanes but early indications suggest that corporate profits are on track. But with equity valuations close to the top of most historical ranges (discussed in our “Rule of 20” note on Sept 18, 2017) increased attention is being paid to the macro outlook and the rate of growth in corporate earnings, and what is being incorporated into those earning forecasts. The seemingly daily debate centers around whether the prospects for corporate tax reform and/or accelerating economic growth are baked into analyst projections. Our view is that neither is fully discounted, representing potential upside to current estimates.

On October 31 of 2016 the benchmark U.S 30-year treasury bond yield and the benchmark US 10-year treasury bond yield stood at 2.58% and 1.83% respectively. On Friday, they closed at 2.81% and 2.28%. While not dramatic, the upward moves in rates over the past twelve months suggest, in part, that the bond market believes there are greater prospects for inflation and growth than were expected last October. Yet, over the same period, analyst bottoms-up expectations for 2017 and 2018 S&P 500 earnings per share, as measured by FactSet, declined slightly. At the same time, our rough calculation of a move to even a 25% corporate tax rate, if achieved, could add an additional 9% to the index’s 2018 earnings per share. We’ll leave it to the policy experts to project if/when corporate tax reform becomes a reality, but if it does, and economic growth continues to accelerate, corporate earnings estimates will be revised upwards, putting a dent in the bear’s over-valued market argument.

Full Disclosure: Nothing on this site should be considered advice, research or an invitation to buy or sell securities, refer to terms and conditions page for a full disclaimer.

Terms and Conditions

09 Oct C.J. Lawrence Weekly – “Financials Add Fuel”

Financial stocks re-exerted leadership last week. After a strong 1Q17, the sector had faded into the middle of the performance pack among the broader S&P sectors. The S&P Financials Index is now up 13.1% for the year, ranking it 6 out of the 11 sectors. As we have noted in previous Weekly Comments, leadership from the financials is an essential ingredient to a meaningful equity market advance. The sector accounts for 14.7% of the weighting of the S&P 500 Index, eclipsed only by Technology, with a 23.2% weight.

The S&P 500 now has two of its top three weighted sectors leading in year-to-date performance. If Financials continue to outpace other sectors from here, and joins the top three, the trifecta could provide the broader index with added octane. Leadership from the heavyweights is important, but market participants should also note that the market’s advance has been, and continues to be, broad.

Nine of the eleven S&P sectors are in positive territory for the year, with six of them delivering double-digit gains. Only Telecom and Energy are in negative territory year-to-date, but Energy posted a positive 3Q17 return. Of the 105 S&P sub-indices, 75 are up for the year. Additionally, strength carries over into small capitalization stocks, which tend to do well when the economy gets in gear. The Russell 2000 is up 11.4% since mid-August. Leadership strength, combined with broad market participation and improving corporate fundamentals is typically a potent mixture for higher stock prices.

Full Disclosure: Nothing on this site should be considered advice, research or an invitation to buy or sell securities, refer to terms and conditions page for a full disclaimer.

Terms and Conditions

04 Oct C.J. Lawrence Weekly – “The Great Unwind Begins”

With the arrival of October comes the beginning of the Federal Reserve’s efforts to unwind its’ massive $4.5 trillion balance sheet. The Fed’s chair, Janet Yellen, has expressed her desire to keep the process running quietly in the background. The markets are hoping it plays out that way. Never in the history of the Federal Reserve has such an undertaking been attempted. The plan is for the Fed to stop reinvesting the money that current investments throw off, and then allow $6 billion in Treasury securities and $4 billion in mortgage backed securities to mature every month. At that pace, it would take over nine years to chip off 25% of the Fed’s balance sheet, following only that approach. The pace at which they sell additional securities into the open market will be closely watched for market impact.

On the other hand, household and corporate balance sheets look quite healthy. The recently released Flow of Funds data from the Fed shows household net worth up 1.8% at the end of 2Q17 versus the end of 1Q17, and up 9.3% on a year-over-year comparison. The increase has been driven primarily by higher real estate values and the appreciation in value of securities held by U.S. households. Household debt rose by 3.7% annual rate which is faster than last quarter’s annual rate but slower than the 4.4% pace in 2Q16. Importantly, the Fed’s Household Debt Service and Financial Obligations Ratio, which measures households’ ratio of interest expense to income, held at 15%. This ratio has averaged 16.5% since 1980 and has had peaks above 17.5% in 4Q86, 2Q01, and 4Q07. The current ratio suggests U.S. households are doing a good job keeping borrowing in check.

The Fed’s version of a U.S. non-financial corporate balance sheet shows that asset values of U.S. companies have risen faster than liabilities, creating a higher “net worth” for U.S. companies. Balance sheet cash levels were up 6.8% in 2Q17 from the year-ago period, and debt, as a percentage of corporate “net worth” is now calculated at 37.5%, down from 38.7% last year. While the absolute level of borrowing by U.S. corporations has risen, the interest coverage ratio of the S&P 500 is in-line with its 20-year average, suggesting that managements are doing a good job optimizing their capital structures without getting extended. With corporate and household balance sheets in relatively good shape, the market’s attention will likely stay focused on the Fed’s balance sheet unwind, keeping it in the forefront, rather than in the background, as Chair Yellen had hoped. So far, it appears that investors are optimistic that the Fed can pull it off.

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27 Sep C.J. Lawrence Weekly – “The Prospect for Corporate Tax Reform May Be Keeping Bears in Their Dens”

The Prospect for Corporate Tax Reform May Be Keeping Bears in Their Dens

Senator John McCain’s indication that he would not support the Graham-Cassidy Health Care Bill threw more sand into
Washington D.C.’s gears last week. Week-end jockeying may make the bill more palatable to hold-outs, but the machinations
highlight the fact any new legislation faces considerable challenges in making its way through the current congress. Tax
reform looks to be next on the docket, with many Beltway watchers suggesting that corporate tax reform has a better chance of
success than individual income tax reform.

With top marginal corporate tax rates nearing 40%, KPMG lists the United States as having the highest corporate tax rates
globally, among developed countries. Of course, there are nuances in the comparisons, but there appears to be consensus,
even in Washington, that U.S. corporate rates need to be reduced. The timing of legislation is unclear, with most policy
analysts suggesting that 1Q18 or 2Q18 is most likely. We may see a framework for the legislation released this week.

The President has suggested the new corporate rate should be near 15%. While it is unlikely that new legislation will go that
far, even a reduction to 25% would have a meaningful impact on corporate profits. Roughly 70% of S&P 500 constituent
revenue comes from domestic sources. That ratio is higher in U.S. focused sectors like Telecom (96.2%) and Utilities (95.3%),
and lower in global sectors like Materials (53.1%) and Energy (57.6%). For the broader index, if U.S. pre-tax income was taxed
at a 25% rate, instead of the current 33% effective rate, the index could see a ~7.5% boost to net income. That would put S&P
500 EPS estimates (assuming a static share count) for 2018 slightly above $155. Under this scenario, earnings would be up 19%
in 2018 and the current price-earnings multiple on the index would be 16x 2018 estimates. That is a constructive backdrop for
stocks. The prospect of corporate tax reform may encourage hibernating bears to stay in their dens.

25 Sep C.J. Lawrence Weekly – “Inflation & the Rule of 20” – September 18, 2017

Higher gas prices and housing costs helped push last month’s Consumer Price Index (CPI) reading to 0.4%, versus the 0.3% most economists were expecting.  Interestingly, it was the medical cost category that restrained the index, growing at the slowest pace since 1965, according to the U.S. Bureau of Labor Statistics.  The higher-than-expected result helped raise the annual CPI rate to 1.9%.  That was welcome news for inflation seekers, but domestic inflation remains at historically low levels and below the Federal Reserve’s 2.0% target.  The U.S. 10-Year Treasury Bond responded to the report by tacking on 15 basis points of yield, finishing the week at 2.20%.

The rate of inflation is watched closely by equity investors.  In the early 1980’s, C.J. Lawrence Investment Strategist, and our current Chairman, Jim Moltz, pioneered the CJL Rule of 20 as a measuring stick for the relationship between the market multiple and inflation.  The simple calculation behind the Rule suggested that the sum of the S&P 500 price-earnings multiple and the annual rate of inflation should equal about 20.  The premise suggested that so long as inflation remains tame, the market multiple can climb and remain elevated.  Using Factset consensus S&P 500 earnings per share forecasts of $131 for 2017, and $145 for 2018, and a 2.0% CPI estimate, puts the current reading between 21.2 and 19.3, with a midpoint of 20.3.  That sounds about right.

The current result suggests that the market is certainly not undervalued, but that the valuation is also not stretched beyond historical norms.  In 25 out of the last 50 years, the ratio has held between 19 and 22.  Out of those 25 periods, only three experienced negative equity returns.  Two of those periods were the 1973-1974 period when the S&P 500 returned -14% and -37% consecutively in the bear market of the early 1970’s.  The other negative return period was 2008, at the onset of the credit crisis and subsequent recession.  The average return for the full 25 periods was 9.5%.  There are plenty of risks to equity prices, but the current market multiple, given the historical relationship with inflation, does not look to be close to the top of the list.

Terry Gardner is a Senior Managing Director and Portfolio Strategist at New York based C.J. Lawrence.

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