This commentary was excerpted from the Weekly Roundup sent to subscribers of Action Alerts PLUS, a charitable trust co-managed by Jim Cramer and the AAP staff. Click here to learn about this actively traded stock portfolio.
Markets moved slightly higher this week, continuing to press up against all-time highs. Despite the continued uncertainty regarding policies out of Washington, strong earnings results, coupled with many S&P 500 companies increasing full-year guidance, have continued to support and, more importantly, justify the somewhat high valuations.
Important economic readings this week included the personal consumption index, a measure that is closely followed by the Fed as a means of tracking inflation, and the nonfarm payrolls for July (more below). While the S&P 500 appears to be taking a breather on its climb to 2500, the DOW successfully closed over 22,000 this week for the first time.
Treasury yields were down slightly but benefited from a strong bounce on Friday on the back of a stronger-than-expected jobs report for July. Gold was lower this week as the jobs report also caused the dollar to strengthen against the euro. As a result of Friday's move, the dollar ended the week relatively unchanged against the euro. Lastly, oil was relatively flat for the week, trending slightly lower but managing to find support at the $49 level after topping out on Monday at just above $50 a barrel.
Second-quarter earnings have gotten off to a good start. In the portfolio this week, we heard from Apple, Magellan Midstream Partners, NXP Semiconductors, Allergan, Apache and Newell.
On Monday, Apple (AAPL) reported a top- and bottom-line beat for the company's fiscal third quarter. Revenue increased 7% year over year to $45.4 billion, topping the consensus of $44.89 billion, while EPS for the quarter increased 17% year over year to $1.67, beating the consensus of $1.57.
Strong sales across all the company's business segments contributed to the beat. Originally viewed as a transitory quarter due to the upcoming release of the iPhone 8, growth in sales for its iPhone, iPad, Mac and other products and Services business came in higher than anticipated. Looking further, the Services business has increased in size to that of a Fortune 100 company. In addition, with little indication that the highly anticipated iPhone 8, which will replace older models that are at the end of their life cycle, will be delayed in the fall, management guidance remains strong for the rest of the year.
On Wednesday, Magellan Midstream Partners (MMP) reported a top- and bottom-line beat, with revenue of $619.9 million (increasing 19% year over year) topping the consensus of $563.58 million, while EPS of $0.91 beat the consensus by $0.02.
Importantly, MMP generated $250.3 million of distributable cash flow (DCF) for the quarter, beating expectations of $244.2 million. With this, management increased their guidance for 2017 DCF to $1.02 billion, reaffirming the target coverage ratio of 1.2x. The profitable quarter and increased DCF guidance should erase concerns that the company would cut its dividend. Digging deeper, the quarter did not seem to be affected by a declining price in oil, validating that its fee-based transportation model leaves little exposure to the underlying price of the commodity.
Wednesday evening, NXP Semiconductors (NXPI) reported an in-line quarter. Revenues of $2.2 billion slightly edged out consensus of $2.196 billion, while adjusted earnings of $1.51 fell one penny short of consensus.
By segment, NXPI's automotive division recorded record sales again for the quarter, reaching $938 million in revenue (increasing 9% year over year). Rounding out the company's other segments, secured connected devices increased 14% year over year; secure identification decreased 33% year over year; and secure interface and infrastructure declined 1% year over year. Similar to last quarter, management did not provide a guidance outlook, and a conference call was not held following the press release due to the pending merger with Qualcomm (QCOM) .
Thursday morning, Allergan (AGN) reported a top- and bottom-line beat for the quarter. Revenue increased 9% year over year to $4 billion, which slightly edged out the consensus of $3.95 billion. In addition, adjusted EPS came in at $4.02, which beat out the consensus by $0.10.
By division, U.S. specialized therapeutics grew 15.2% year over year to $1.72 billion. Strong growth in CoolScultping from the company's Zeltiq acquisition drove sales, while its Restasis product lagged due to competition. That being said, management expects Restasis to remain stable following the second quarter. U.S. general medicine declined 1.5% in revenue year over year to $1.427 billion due to generic drug pressures. Still, within this, the company's central-nervous-system franchise remains encouraging, growing 9% year over year. Cash flows improved this quarter thanks to the company's sale in its Teva (TEVA) holdings. Looking forward, management expects to generate about $3 billion to $4 billion in cash flows over the second half of the year, as they also raised their full-year revenue and EPS guidance.
Also Thursday morning, Apache (APA) reported second-quarter earnings and missed on both the top and bottom lines. Revenue of $1.38 billion fell short of the consensus $1.41 billion, while adjusted EPS came in at -$0.21, 20 cents lower than the consensus.
Despite its low all-in cost model, the company could not turn a profit for the quarter, hindered by a decline in the price of crude that was lower than the company's estimated range that caused production to bottom. That being said, APA anticipates relief in pressure through the back half of the year and into 2018. In addition, while investment remains strong in the Alpine High, key data points were not released during the conference call that would have swung sentiment for the quarter.
Lastly, on Friday Newell Brands (NWL) reported second-quarter earnings, which were mostly in line with expectations. The company beat on the top line, reporting revenue of $4.1 billion, an increase of 5.1% year over year, and beat the consensus of $3.95 billion, while EPS of $0.87 matched expectations.
Importantly, core sales growth increased 2.5% for the quarter. This was on the lower end of analyst expectations, but was on target with what management had anticipated. By segment, "Live" core sales increased 0.2%, "Learn" core sales increased 6.6% and "Work" core sales grew 6.3%, while "Play" and "Others" core sales declined 1.2% and 2.1%, respectively. Also of note, e-commerce revenue growth remained in the double digits, and the heavy investment in this area remain a focus for management. Lastly, for guidance, management raised their full-year 2017 revenue estimates, increasing their range from $14.52 billion-$14.72 billion to $14.8 billion-$15 billion, while reaffirming the core sales growth target of 2.5% to 4%.
Turning to the economic front, on Monday the National Association of Realtors (NAR) reported that pending home sales index in June rose 1.5% to 110.2. The reading exceeded expectations for a rise of 0.9% and marks the first gain after three consecutive months of decline. Recall that the pending home sales number represents contracts signed for existing homes for sale that will close in one to two months. In addition to the rise, the NAR revised May's reading up to 108.6. On a year-over-year basis, pending home sales are up 0.5%, the first annual increase since last March.
Partly affecting the reading is the lack of supply, which as we've pointed out continues to be an issue in the overall housing market and is causing upward pressure on the price of homes. According to NAR chief economist Lawrence Yun, "Low supply is an ongoing issue holding back activity. Housing inventory declined last month and is a staggering 7.1% lower than a year ago." Yun expects existing home sales to rise 2.6% compared to 2016 levels and expects the median existing home price to rise 5% compared to last year's levels.
By region, on a month-over-month basis, pending sales rose in the Northeast (0.7%), South (2.1%) and West (2.9%), while falling in the Midwest (0.5%). Annually, sales have increased in the Northeast (2.9%) and South (2.6%), while decreasing in the Midwest (3.4%) and West (1.1%).
On Tuesday, the Commerce Department reported that month-over-month personal income was relatively flat, decreasing by $4.2 billion (less than 0.1%) and missing expectations of a 0.4% rise in June. Personal consumption expenditure (PCE) -- i.e., personal spending (over two-thirds of U.S. economic activity) -- increased $8.1 billion (0.1%), in line with expectations. The month-over-month increase for personal income in May was revised down from 0.4% to 0.3% while the month-over-month increase in personal spending for May was revised up from 0.1% to 0.2%.
The decline in personal income resulted primarily from a decrease in personal dividend and interest income. However, this was partially offset by a rise in employee compensation. The rise in personal consumption can be attributed to increased spending on services (primarily healthcare); however, this was partially offset by a decline in spending on durable and nondurable goods.
Importantly, the PCE price index was flat (as it was in May) after falling 0.2% in March and rising 0.2% in April. Core PCE (which takes out food and energy to reduce month-to-month volatility) rose 0.1% in June (following a 0.1% increase in May), in line with expectations. More importantly, on a year-over-year basis, the core PCE price index is up 1.5% (in line with May's reading but down from a 1.6% year-over-year rise in March and April). This measure is closely followed given that it represents the Fed's preferred measure of inflation, which is one portion of the Fed's dual mandate when determining the outlook for rates (the other being maximizing employment). Yearly readings for core PCE have fallen from 1.9% in February to 1.6% in March to 1.5% in May.
Recall that the Fed ideally targets a 2% rate of inflation -- the core PCE has generally run below this target in recent years, and despite some strength in prior months, investors must balance rate hike expectations this year with the declines in core PCE in recent months.
Also on Tuesday, the Institute of Supply Management (ISM) reported that the July manufacturing index fell 1.5% to 56.3, coming up just short of expectations of 56.4. Recall that anything above 50 represents expansion while anything below 50 indicates a contraction. The rise comes on the heels of June's 57.8, which marked the fastest rate of growth for American manufacturers in roughly three years. July marked the 98th consecutive month of expansion in the overall economy and the 11th in the manufacturing sector.
Digging deeper, of the 18 manufacturing industries tracked by ISM, 15 showed growth in July. The coal products; apparel, leather and allied products; and textile mills industries were the only three to indicate a contraction. The latter two industries accounted for two of the three industries that showed a contraction in June as well.
The new-orders index fell 3.1% month over month to 60.4 (indicating a slower rate of growth) and production decreased 1.8% to 60.6, slowing down after an acceleration last month. The employment index also decreased, falling 2% to 55.2, while prices surged 7% to 62 (indicating that prices are increasing at an accelerated pace).
On Thursday, the Commerce Department reported that new orders for manufactured goods increased in June after two consecutive months of declines, rising 3% (the largest jump in the last eight months) following a 0.3% decrease in May (revised up from -0.8% previously reported) and edging out lofty expectations of a 2.9% gain. Shipments fell 0.2% following a 0.3% increase in May. Unfilled orders increased for the third time in four months, rising 1.3% after a 0.1% decrease in May, while inventories rose for the seventh time in eight months, rising 0.2% after a 0.2% decline in May.
Importantly, the Commerce Department also revised estimates for orders of non-defense capital goods excluding aircraft (i.e., core capital goods) upward, from down 0.1% to unchanged in June. Capital goods are not sold to consumers; rather, they are tangible goods used in the manufacturing of consumer goods. For this reason, core capital goods are a key metric that many consider to be a proxy for business investments. It is important to consider new orders excluding transportation equipment (planes and automobiles) because the high value of these goods can easily skew month-to-month readings, increasing volatility and making it more difficult to analyze the underlying trend.
Breaking down the reading, new orders for manufactured durable goods rose for the first time in three months, jumping 6.4% (revised down from 6.5% previously reported). The reading was led by orders for transportation equipment, which surged 19% after two consecutive months of decline. New orders for nondurable manufactured goods fell 0.3%. Shipments for manufactured durable goods were virtually unchanged, falling $100 million, driven by a 0.5% decline in transportation equipment shipments, which fell for the fifth time in six months. Shipments of manufactured nondurable goods fell 0.3%, the third decline in four months. Leading the decrease was a 2.7% decline in shipments of petroleum and coal products. Unfilled orders for manufactured durable goods rose 1.3%, led by a 1.7% increase in transportation equipment. Finally, inventories of manufactured durable goods rose for the 11th time in the past 12 months, increasing 0.5% (revised up from 0.4% previously reported), driven by a 1.3% increase in machinery. Inventories of manufactured nondurable goods fell for the fourth consecutive month, down 0.3% after a 0.7% decrease in May.
Finally, on Friday, the Labor Department reported that the economy added 209,000 jobs in July, exceeding expectations of roughly 183,000. Employment numbers were also revised up for June to 231,000 (from 222,000 previously reported), while being revised down for May to 145,000 (from 152,000 previously reported). Job gains now average 195,000 a month for the last three months. While the better-than-expected headline number appears to support the Fed's June decision to increase short-term interest rates, the question now becomes, can the economy sustain a pace that will warrant an additional hike before the end of the year as the Fed looks to reduce its massive balance sheet?
The unemployment rate was relatively unchanged and in line with expectations at 4.3%, following 4.3% and 4.4% readings in June and May, respectively.
In line with the steady unemployment rate, labor-force participation was up very slightly in July at 62.9%, following rates of 62.8% and 62.7% in June and May, respectively. The low participation rate suggests that many able-bodied Americans are remaining on the sidelines despite what appears to be growing optimism within the economy.
Digging deeper, food services and drinking places led the way, adding 53,000 jobs in July, followed closely by professional and business services, which added 49,000 jobs last month.
Average hourly wages are up roughly 2.5% on a yearly basis, relatively unchanged from May's year-over-year rise, while the average workweek ticked up 0.1 hours from the same time last year to 35.5 hours. The average workweek remained unchanged on a month-over-month basis.
For those skeptical of the headline measure of unemployment (for reasons such as the decline in the labor-force participation rate), a different, broad measure of unemployment and underemployment known as the U-6 -- which accounts for those working part time due to the inability to find full-time work -- was 8.6% in July, unchanged from June's reading. The U-6 had averaged around 8.3% in the years before the recession.
Overall, the report was relatively positive. The bigger focus will now be on the longer term, questioning whether we are beyond peak employment and if the labor market can continue to carry the economy.
On Thursday, the Department of Labor reported that initial jobless claims for the week ending July 29 were 240,000, a decrease of 5,000 claims from the prior week's revised numbers (revised up from 244,000 to 245,000) and 3,000 claims lower than expectations of 243,000 initial claims. Importantly, the four-week moving average for claims (used as a gauge to offset volatility in the weekly numbers) was 241,750, a decrease of 2,500 from last week's revised average (revised up from 244,000 to 244,250). The low rate of layoffs reflects a strengthening labor market as claims have remained below 300,000 -- the threshold typically used to categorize a healthy jobs market -- for an astounding 99 straight weeks (compared with 126 weeks under the older seasonal-adjustment process, according to the updated data), the longest streak since 1970.
On the commodity front, oil was relatively flat for the week, oscillating in the upper $40s but failing to meaningfully break above $50 as investors remain skeptical that enough is being done to reduce the worldwide supply glut. Compounding these concerns are worries about what will happen when the OPEC production-cut deal expires in March. Recall that the deal calls on member countries, as a group, to reduce global supplies by 2%.
On Sunday, The Wall Street Journal published an article discussing why OPEC has had such a tough time committing to the production cuts previously put in place by the cartel. The most notable takeaway was that member countries require such high prices per barrel in order to balance their national budgets, and many simply cannot afford to voluntarily reduce output in such a low-price environment.
The result is a catch-22-type scenario; member countries require higher oil prices to balance their budgets and thus cannot afford to give up what profits they could have by reducing output in a low-price environment. At the same time, the organization cannot succeed in raising prices unless member countries agree to restrict output (thus forgoing short-term profits).
Notably, Kuwait appears to be the only country that can maintain a balanced budget at around $49 a barrel. Iraq, the second-largest member of OPEC, requires a price of roughly $54 a barrel, whereas Saudi Arabia, the largest member, requires prices to be around a whopping $83 a barrel. Nigeria, the most recent member to agree to cap production, requires the highest price per barrel of all members at $139 a barrel (recall that, until last week, Nigeria was exempt from the production cut).
When taking this into account, coupled with the fact that continued production in the U.S. (which the Energy Information Administration reported on Wednesday reached a two-year high last week) is replacing at least part of what OPEC is taking out of the market, it becomes increasingly clear why there is no "cookie-cutter" solution to increasing the price per barrel for oil.
Moving on to the broader market, second-quarter earnings are under way and relatively positive vs. expectations, with 71.6% of companies reporting a positive EPS surprise. Total second-quarter earnings growth increased roughly 11.6% year over year vs. expectations for an overall 10.42% increase throughout the season; of the 338 non-financials that reported, earnings growth is up 12.4%. Revenues are up 5.2% vs. expectations throughout the season for a 4.94% increase; 71.6% of companies beat EPS expectations, 19.2% missed the mark and 9.2% were in line with consensus. On a year-over-year comparison basis, 77.81% beat the prior year's EPS results, 1.99% came up short and 20.2% were virtually in line. Healthcare and information tech have had the strongest performance so far this year vs. estimates, whereas consumer discretionary, telecom and energy have posted the worst results in the S&P 500 thus far.