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Trifecta Stocks

Trifecta Stocks Weekly Roundup

By Chris Versace and Bob Lang | 2017-01-20 17:46:37.0

In the last Roundup we shared that this week would be a rather busy one, compressed into four days of trading, culminating with today's presidential inauguration. If you somehow you missed the coverage of that event, it was the center piece of cable news throughout the day, which left little discussion of the markets and the global economy. For the four trading days that we had, all three major market indices dipped modestly compared to last week. After surging during the last two months of 2016, the Dow Jones Industrial Average is largely unchanged year to date, while the S&P 500 is up 1.5% and the tech-heavy Nasdaq roughly 3%.

Compared to last week, we saw a shift in the portfolio's stronger performers, from tech companies Amazon (AMZN:Nasdaq), Facebook (FB:Nasdaq) and Alphabet (GOOGL:Nasdaq) to more defensive names such as McCormick & Co. (MKC:NYSE), International Flavors & Fragrances (IFF:NYSE) and AT&T (T:NYSE).

Given what is looking to be an increasingly mixed bag of earnings, we've instead preferred to keep cash on hand for opportunities that are likely to emerge in the coming weeks. We say this given the earnings thus far from JPMorgan Chase (JPM:NYSE), Bank of America (BAC:NYSE), PNC Bank (PNC:NYSE), United Continental (UAL:NYSE), WD-40 (WDFC:Nasdaq), CSX (CSX:NYSE), Netflix (NFLX:Nasdaq), General Electric (GE:NYSE) and Gigamon (GIMO:Nasdaq) as well as the negative pre-announcement from Target (TGT:NYSE).

Once again, we're seeing companies missing earnings relative to expectations lead to falling stock prices. Not a bad thing, considering how far and how fast the stock market has jumped since early November, especially if you've been a prudent investor like we have these past several weeks. We've been selective, only adding to our IFF position and bringing AMN Healthcare (AMN:NYSE) into the Trifecta fold while keeping our inverse ETF positions in play.

While a number of positions have moved nicely higher over the last several weeks, including Amazon (AMZN:Nasdaq), Facebook (FB:Nasdaq), Alphabet (GOOGL:Nasdaq) and Disney (DIS:NYSE), which certainly has us feeling pretty good, the opportunity to circle back to the ones that got away has us excited this earnings season. It's not that we want bad news, but rather the chance to buy well-positioned businesses at better prices.

This reminds us of one of "Uncle" Warren Buffett's most used sayings, "Price is what you pay. Value is what you get."

We suspect there will be far more value to be had in the stock market over the next few weeks compared to the last several, as December-quarter earnings kicks into gear. As we've shared in the last several Roundups, expectations have been running high, but recently more investors have been scratching their heads as they put the economic reality puzzle pieces together and reassess what is "expected."

What this tells us is should the news turn to something less than expected, we are bound to see a far bumpier time in the market than the largely smooth sailing since early November through mid-December. From corporate earnings to the political drama that is unfolding in the eurozone, we expect that once the presidential inauguration festivities are behind us, it will be back to business for the markets.

Over the last few years, earnings season has become a greater source of stock price volatility -- miss EPS expectations by a penny, and share prices fall 10%-20%, far greater than the single-digit selloffs that had been the norm several years ago. These tend to be short-term disruptions that give way to market forces, which means that as we continue to focus on the intersection of fundamentals, technicals and quant ratings, we'll be vigilant for opportunities presented by wide swings in stock prices.

With this in mind, we're holding off making any moves with the portfolio in the near term as we digest company comments regarding the tone of the economy, the impact of the dollar on business outlooks and, of course, their ability to further capitalize on still-blowing thematic tailwinds.

Next week, Trifecta holdings McCormick & Co, Alphabet and AT&T report quarterly earnings. Those reports are among a few hundred that include Caterpillar (CAT:NYSE), Microsoft (MSFT:NYSE), Starbucks (SBUX:NYSE), Comcast (CMCSA:NYSE) and Intel (INTC). What this means is we’ll be putting far more "meat" on the earnings bone. As we do this we’ll be mindful of what the collective guidance means for 2017 earnings expectations.

On the economic front, there will be a handful or reports, including the latest existing and new home sales reports as well as the same for durable orders. The big report next week, though, will be the initial fourth-quarter 2016 GDP numbers, and while the expectation is it will slip relative to 3.5% in 3Q 2016, expectations for 4Q are fairly widespread, between 1.9% (N.Y. Federal Reserve) to 2.9% (Atlanta Fed GDP Now). Odds are the Wall Street Journal's Economic Forecast Survey, which calls for 2.1%, will be more in line with reality.

No matter what that initial print is, we’ll be here next week to put all the economic data and earnings report puzzle pieces together.

Enjoy the weekend!

As a reminder, Ones are stocks we would buy right now, Twos are stocks that we'd buy on a pullback, Threes are stocks we would sell on strength and Fours are stocks we want to unload as soon as our trading restrictions allow. (The information in parenthesis at the start of each company rundown contains the company's stock symbol, the stock's most recent closing price and its percentage weighting in the model portfolio. For up-to-date information about the model portfolio, click here.)

ONES

Amazon (AMZN:Nasdaq; $808.33; 5.32%): Amazon shares gave back some recent gains falling 1% this week. However, the stock is still up around 8% year to date. During the week, Amazon announced two new fulfillment centers, one in Texas (its ninth) and the other in Maryland (its third) and patented an autonomous vehicle lane assignment system, which we suspect is part of its long-term strategy to focus on improving its logistics costs. Getting back to the core digital-shopping business, we were once again reminded of the struggles happening in bricks-and-mortar retail when Target (TGT:NYSE) missed expectations, joining joining the likes of Macy's (M:NYSE), Kohl's (KSS:NYSE) and others. We continue to see Amazon benefiting by several aspects of what we call the ever-increasing Connected Society across its digital shopping, Amazon Web Services and Alexa voice technology. We rate Amazon shares a One. The company will report its earnings on Feb. 2 and currently it is expected to deliver EPS of $1.35 on revenue of $44.66 billion. Given our three-pronged investment strategy, we will continue to monitor the Street Quant Rating to determine our next steps with the shares. Our price target remains $975.

Alphabet (GOOGL:NYSE; $828.17; 5.20%): GOOGL shares dipped modestly this week, but even so are still up 4.5% year to date. The shares received a positive mention by in Barron's Roundtable and closed out the trading week with a new "Outperform" rating from Pacific Crest Securities. The next catalyst for GOOGL shares will be next week (Jan. 26) when the company reports its 4Q 2016 earnings. Current expectations call for EPS of $9.64 on revenue of $25.2 billion. We're bullish heading into that report given the company’s position in search and video, which continue to benefit from our increasingly Connected Society and the shifting landscape of advertising dollars away from traditional media toward digital platforms. Those drivers have the company tracking to grow earnings over 20% and the shares trading at 20.0x 2017 consensus EPS expectations of $41.12, essentially a PEG ratio of 1.0. Also helping the bottom line, as we learned with its September earnings, Alphabet’s board authorized a new $7 billion share-repurchase program following the company’s completion of the prior program; we wouldn't be surprised to learn Alphabet was buying back shares during late November when GOOGL traded at $790-$795. We continue to rate GOOGL a One with a $975 price target. Initial Street Quant Rating: A-; current rating: A-.

Facebook (FB:Nasdaq; $127.04; 4.79%): Facebook shares declined 1% this week, but the year-to-date rise in the shares is more than 10%. Last week's upgrade by Raymond James was followed by today's new "Overweight" rating from Pacific Crest Securities. With Facebook monetizing more aspects of its platform and growing its global user base, we continue to see it as a share gainer as more advertising dollars move online from more traditional media, including broadcasting. Facebook will report its quarterly earnings on Feb. 1 and current expectations have the social media company delivering EPS of $1.30 on revenue of $8.49 billion. With 18% potential upside to our $150 price target, Facebook remains a One-rated position. Initial Street Quant Rating: A-.

International Flavors & Fragrances (IFF:NYSE; $118.13; 5.05%): During the shortened trading week, IFF rose shares more than 1%. IFF has closed its previously announced acquisition of Fragrance Resources, a player in the fine fragrances category. We’ve acknowledged the likely impact of the recent dollar strength on IFF given that roughly 75% of its business is conducted overseas. Even so, we continue to see several drivers that should power IFF’s business and shares over the coming quarters. These include rising disposable income, particularly in emerging markets, and also the shift in consumer preferences to natural/organic flavors. At the same time, soda companies such as Coca-Cola (KO:NYSE) and PepsiCo (PEP:NYSE) are looking to reformulate their products to exclude sugar or to utilize organic flavors and fragrances, which bodes well for IFF’s solutions. Longer term, the outlook remains bright for this market as the Freedonia Group’s forecast calls for global demand for flavors and fragrances to reach $26.3 billion by 2020, which would be a 21% increase from $21.7 billion in 2015. Our price target on this One-rated stock remains $145. Amid that longer-term view, should the shares close below $113, even though we continue to like IFF from a fundamental perspective, from a technical perspective we will be prompted to close the position. Initial Street Quant Rating: A; Current Street Quant Rating: B.

McCormick & Co. (MKC:NYSE; $93.30; 4.55%): Shares of this spice and marinade dividend dynamo company climbed 2% this week. McCormick will report its December- quarter earnings next week (Jan. 25) and the market anticipates EPS of $1.27 on $1.2 billion in revenue. We see the company’s business benefiting from shifting consumer preferences favoring eating at home over restaurants due to food deflation and for organic/natural foods, as well as rising disposable income outside developed markets that is spurring a step-up in diets (protein consumption, flavor). Given McCormick's exposure to markets outside the U.S., we expect the company's 4Q 2016 results to be weighed down by dollar strength, and for the company to discuss its performance on a constant currency and volume basis. We rate McCormick a One, with a price target of $110. Initial Street Quant Rating: A-.

ProShares Short S&P500 ETF (SH:NYSE; $36.04; 2.63%): The sideways move in the S&P 500 led our SH shares to be relatively unchanged this week. A few weeks ago the S&P 500 moved out of overbought territory but the Volatility Index remains at its lowest levels in several months. With the likely realization soon to hit the market that expectations have gotten ahead of near-term fundamentals, something we are hearing more and more about, we will not only continue to hold our inverse ETF positions, but look to strategically add to them in the coming days. Our rating on SH shares remains One. The Street Quant Rating on SH shares is D-, which easily fits with the mandate that inverse ETFs and shorts have a quant rating below C+.

ProShares Short Dow30 ETF (DOG:NYSE; $18.98; 2.57%): DOG shares have ticked slightly higher this week as investors increasingly question the Trump Trade ahead of the December-quarter earnings onslaught. We will keep our DOG position intact to help hedge the portfolio and limit losses in what is likely to be a more volatile market than what we’ve experienced over the last several weeks. In our view, quarterly results and guidance this earnings season will encounter several uncertainties, including the tone of the economy, recent dollar strength and political uncertainties in the eurozone. DOG shares have a Street Rating of D; that's well below a C rating, which meets our investment criteria for inverse ETFs. Our price target for DOG shares is $25.

ProShares Short Russell2000 ETF (RWM:NYSE; $49.05; 2.39%): RWM is an inverse ETF for the small-cap-heavy Russell 2000 Index (IWM:NYSE), which declined this week, leading RWM shares some 1.7% higher. In step with our comments above on both SH and DOG, we will continue to hold RWM as we expect the market to encounter more volatile times during this December-quarter earnings. RMW shares have a Street Quant Rating of D; that's well below a C rating, which means its inverse nature meets our investment criteria. Our price target for RWM shares is $67.

TWOS

AMN Healthcare (AMN:NYSE; $36.95; 2.98%). Shares of AMN, our most recent portfolio addition, were flat over the last week. This morning, the stock received a boost as a result of a new "Buy" recommendation from The Benchmark Company with a $46 price target, a few dollars higher than our $43 target. Benchmark's rationale -- unprecedented shortages of and demand for nurses and other health-care professionals -- closely echoes one of our core reasons for adding AMN. By 2020, the U.S. is expected to need 1.6 million more direct-care workers than in 2010, which equates to a 48% increase for nursing, home-health and personal-care aides over the decade, due primarily to the aging of 78 million baby boomers. With around 15% potential upside to our price target, we rate AMN shares a Two. Our intent is to nibble on the name closer to $35 to build out the position at better prices. Initial Street Quant Rating: A-.

AT&T (T:NYSE; $41.45; 4.20%): AT&T shares rose more than 1% this week, keeping them between $41 and $42 for the third consecutive week. While we continue to wait for progress on the pending merger with Time Warner (TWX:NYSE), this morning AT&T shared some of what we will hear next week when it reports its quarterly results on Jan. 25. Those items include a $1 billion non-cash, pretax loss of approximately $1 billion related to the annual re-measurement of pension and post-employment benefit plans. AT&T also gave a preview of subscriber metrics for the quarter, which include 900,000 branded net adds of domestic wireless subscribers (about 500,000 postpaid and 400,000 prepaid) with approximately 700,000 2G deactivations. With roughly 2.3 million remaining 2G subscribers at the end of 2016, we see the company’s recent discontinuance of 2G service resulting in more deactivations in the current quarter. Expectations for upcoming 4Q earnings sit at EPS of $0.66 on revenue of $42.03 billion. From our perspective, AT&T is making progress on transforming the business from a phone company to one that is more fitting in today's Connected Society, with the pending acquisition of Time Warner accelerating that change. As those details get sorted out, we're inclined to be patient with the shares given the expanding role of the Connected Society and the company’s place therein. AT&T’s board of directors has approved a 2.1% increase in the quarterly dividend to $0.49 per share from $0.48 payable on Feb. 1 to holders of record on Jan. 10. We believe this reflects the underlying strength of the core business as well as the company's confidence, not only in the proposed deal, but in its ability to fund it. We rate AT&T a Two with a $44 price target, and all things being equal are likely to add to the position below $40. As more clarity on the merger develops, we are likely to revisit both our rating and price target. Initial Street Quant Rating: A; current rating: A+.

Walt Disney (DIS:NYSE; $107.64; 4.93%): Disney shares were down slightly this past week as dueling rating changes took place. First, Goldman Sachs boosted its view on the stock to "Buy" from "Neutral," with a new price target of $134 vs. the prior $109. Next, BMO Capital downgraded Disney shares to "Underperform." We can understand both changes given our longer-term time horizon on Disney. Near term, the shares are likely to be range-bound, but as the company's film slate rolls out and other initiatives take hold we should see them move higher. We continue evaluate potential upside to our $110 price target, but for now we are sticking with that and our Two rating. We see Disney making the right investments (streaming media and turning studio content into park rides and attractions) to drive revenue and profits. Disney will report its December-quarter earnings on Feb. 7. We view the shares as far more attractive for fresh subscriber money closer to $100. Initial Street Quant Ratings: A-; current rating: A-.

MasterCard (MA:NYSE; $109.96; 4.77%): MasterCard shares were among the stronger performers this week climbing 1.2%. Over the last three weeks, the shares have climbed more than 6%. This week another investment bank turn bullish on MasterCard as Wedbush upped its rating to "Outperform" with a $126 price target. The rationale for the upgrade mirrors one of our core thesis points on the name: the disintermediation of cash/checks by electronic payments. Also this week, American Express (AXP:NYSE) missed expectations, primarily due to higher marketing fees, which, in our view, reflects continued growth by MasterCard and other alternatives. We continue to review our $117 price target, but for now we are keeping our Two rating on the shares. Fundamentally, we like MasterCard given that just 15% of global payments are occurring digitally and another $8 trillion can be converted to digital payments over the next five years. Initial Street Quant Rating: A+; current Street Quant Rating: A.

United Parcel Service (UPS:NYSE; $114.95; 4.95%): UPS shares moved 0.6% higher this week. Like many stocks, UPS has been treading water the last few weeks, but even so, there is only about 7% upside to our $122 price target. The company will report its 4Q 2016 earnings on Jan. 31, with Wall Street expecting the company to deliver EPS of $1.69 on revenue of $17.01 billion. Over the last several weeks we’ve shared a number of positive data points on UPS, which have served to confirm our digital shopping thesis on the shares. We expect an upbeat earnings report, but are cognizant that the company is likely to offer cautious comments on its international business in light of the dollar's strength. We rate UPS a Two. Initial Street Quant Rating: B; current rating: A-.

THREES

CVS Health (CVS:NYSE; $81.56; 5.15%): CVS shares were largely flat this week, which keeps them the treading water for the time being. The company will reports its 4Q 2016 earnings on Feb. 9, and current expectations call for it to deliver EPS of $1.67 on $46.56 billion in revenue. Remember, in December the company reset expectations and offered no new guidance at the recent J.P. Morgan Healthcare Conference. This would suggest the company is tracking relative to those reset expectations. The next catalyst for the shares will likely be how the Trump administration overhauls the Affordable Care Act, and following the inauguration it's likely to be only a matter of time before those details emerge. Near term, though, that presents an air of uncertainty for CVS and as such, our strategy remains to use market strength to scale down the position. Our price target on CVS is $85. Initial Street Quant Rating: A-; current rating: B-.

Foot Locker (FL:NYSE; $69.00; 3.47%): This retailer of shoes and apparel operates in two segments: Athletic Stores and Direct to Customers. The Athletic Stores unit operates more than 3,400 locations in 23 countries. The shares fell 2% this week following Big Five Sporting Goods' (BGFV:Nasdaq) pre-announcement. Big Five boosted its own EPS outlook, but offered softer revenue guidance vs. expectations for 4Q 2016, and also shared that its footwear category comps were slightly down. We’ll be looking for more data and commentary to determine if this was share loss at Big Five or something else. We’re inclined to think the former, given that several new products from Nike (NKE:NYSE) and Under Armour (UAA:NYSE), including the new Curry Three "Flight Jacket," and Nike's LeBron James Air Zoom Generation Retro and "Black Cat" Air Jordan 13 are starting to hit shelves. With the shares hovering around our $70 price target, we’ll look to trim this position on strength this earnings season. In keeping with our Three rating, we are not inclined to commit new capital to the position near term. Initial Street Quant Rating: A-; current rating: A.

Bonds, Stocks and Interest Rates -- Oh My!

A strange relationship exists between bonds and stocks. I only call it strange because the behavior of the investing public shows risk aversion when there is a desire for the safety of bonds, and risk appetite when stocks are in demand. Emotions and desires naturally run the spectrum of fear and greed as we look for the right balance.

But can we determine when it is the right time for bonds? How about when it's most appropriate for stocks? Further, how do interest-rate moves affect risk appetite? While we can look to several sources for the answer, interest rates are the biggest reason for flipping from stocks to bonds. Currently, we are in an upcycle for interest rates, perhaps the largest in more than 10 years.

The Fed sat on zero rates long enough for the economy to pull out of the endless doldrums of low growth, deflationary trends but with strong employment gains. A monetarist gauge known as the Phillips Curve was completely turned on its back (wage inflation was supposed to be lit up as the economy reached full employment, but that has not happened yet).

As interest rates start to rise, the taste for bonds becomes bittersweet. Bond prices drop as rates rise and fixed-income investors take a whiff of inflation (nothing a bond investor hates more). So, as bonds become less desirable, other alternatives are sought. Cash is always a viable alternative, but offers more safety than return. Stocks can be viable, too, if valuations are not off kilter with economic growth.

And that is the rub here: Can the economy grow enough to support stock prices? The stock market is the great discounting machine. So, it could be market players are ahead of themselves. But let's see how the economy is doing six to eight months from now -- then we'll have this same discussion. For now, stocks are the game to be played if bonds are being tossed aside.

Regards,

Chris Versace & Bob Lang
Co-Portfolio Managers, Trifecta Stocks

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