The following commentary was originally sent to Action Alerts PLUS subscribers on Oct. 13, 2016.
Despite markets trading relatively flat in a quiet trading session yesterday (Wednesday, Oct. 12th), there were some important stories impacting key Action Alerts PLUS holdings that we wanted to make sure did not go overlooked. Today, markets appear to be pulling back on renewed concerns regarding global growth as weak trade data out of China indicated that the world's second-largest economy saw exports drop 10% year over year in September, raising questions about global demand. September's drop marks the sixth consecutive monthly decline for exports out of China. Imports also declined, suggesting a weakening economy on the mainland. Difficult trade compares from last year and Samsung's continued issues (China is an important part of the supply chain) both played a role in the weaker-than-expected data, although there is no denying China's recent struggles.
From a broader standpoint, focus yesterday shifted to the release of the Federal Reserve's September meeting minutes, where investors hoped to get a clearer idea as to when the committee would make its next move. Leading up to the release of the minutes, bond yields and the dollar rose in the first half of the day as investors placed their bets on a December rate hike, discounting the potential for a move in November. According to the CME's Fed Watch Tool, the probability of a rate hike at the November meeting is just 9.3% while the probability of a hike at the December meeting sits at 69.9%.
Once the meeting minutes were released, stocks were little changed in afternoon trading as the Fed, in its typical fashion, seemed noncommittal on its rate hike outlook, noting the need for additional data to confirm the economy's direction. As has become custom in the Fed's recent meetings, there were disagreements over those who viewed the decision as a close call and those who required more data supporting a hike. The topic of the labor market appeared to be the culprit of the growing divide, with one camp calling out remaining slack while others were concerned that continued pumping of cheap money into the economy could cause the labor market to tighten too quickly. That being said, the general feeling of the committee seemed to reinforce the belief that there would be a move in December: 14 of 17 Fed officials indicated they expected to raise rates before the end of the year.
Regardless, we expect the committee to remain data-dependent, judging improvements in the economy up to the very moment of the start of the Dec. 13-14 meeting. While reports since the Sept. 20-21 meeting have been largely positive -- with manufacturing showing improvements and the labor market displaying continued strength (in persistently low claims, rising rages, and higher participation) -- we also recognize that movements abroad, such as the fall of the British pound, complicate the Fed's discussions as resulting increases in the dollar could curb inflation and limit exports. Individual Fed officials will continue to voice their opinions in the coming months, likely moving markets, but we must be careful not to be overly captivated by these comments, which have strayed markets awry over the past year. Bottom line: we will keep an eye on the data.
Newell: Shares traded higher yesterday after the company announced that Stanley Black & Decker (SWK) had agreed to purchase the tools business for $1.95 billion in cash, or 2.6x sales and 13x trailing EBITDA. Importantly, these are much higher multiples than investors were expecting. The announcement came not too soon after management laid out their plans last week to exit about 10% of the brand portfolio inclusive of the majority of the Tools Segment, the Winter Sports businesses, the Heaters Humidifiers and Fans businesses, and the Consumer Storage Container business. We view the sale positively. Not only will it allow management to pay down debt (which is a stated priority), but also proves management's (intelligent) desire to find the right buyers for those businesses involved in the strategic review. SWK is a proven leader in the tools space and NWL's tools business is far better suited alongside SWK's brands and expertise. By aggressively pursuing strategic buyers who will achieve higher relative synergies, NWL can likely command favorable prices for the rest of the portfolio. More broadly, we reiterate our positive stance on Newell and appreciate management's drive to streamline its business model, focusing on growth and margin opportunities and exiting non-core businesses, as the Jarden integration continues. We believe this strategic overhaul will lead to an upward re-rating longer-term and we continue to look for opportunities to bulk up our position.
Allergan: Shares of Allergan traded lower yesterday, exacerbating the decline in the stock that began at the beginning of this week following the presidential debate. The unfortunate truth is that Allergan remains in the political cross hairs and thus, regardless of the long-term growth profile, investors are attempting to stay as far away as possible. With recent commentary indicating the possibility that the democrats could take both the house and the senate in the upcoming election, there is an even more heightened focus on those pharma and biotech companies having any link whatsoever to price gauging. As we have noted in the past, Allergan has gotten unfairly grouped with the rest of the culprits, but that is how the market thinks. Allergan has demonstrated its commitment to both innovation (via an early- stage acquisition) and pricing controls (via CEO Brent Saunders' commentary on Mad Money and in company blog posts where he expressed Allergan's intent to limit price increases to single digits annually), both of which should appease the regulator.
See some of our recent Alerts here detailing Allergan's response to criticisms and innovative moves. Unfortunately, Allergan's ongoing dedication to novel, innovative treatments and fair pricing simply doesn't matter in this politically driven environment. We expect the volatility to continue in the near- term, and while we still view the company as best-in-class and believe shares will climb higher over the long-term, we recognize that the political headlines will continue to weigh on the stock until the election has passed and the markets are provided with a clearer picture of whether government will go after the drug industry. For those subscribers with a low risk appetite in the near-term, we do not recommend buying until after the election, although we recommend holding current positions for the long-term upside. The distraction of the election will pass, at which time we expect regulators and investors alike to recognize Allergan's differentiated growth profile and commitment to its customers through fair pricing.
Wells Fargo: After the market close yesterday, Wells Fargo announced that CEO John Stumpf would be retiring effective immediately, and that the board had elected COO and president Tim Sloan as the successor. Tim Sloan is a 29-year veteran of Wells Fargo and has held many leadership roles at the company, including the head of Wholesale Banking. Importantly, Mr. Stumpf will not receive a severance package, following the board's prior decision to relinquish $41 million in unvested equity. As we have reiterated in previous bulletins and on our members call this week, we remain categorically against the bank's unlawful sales practices. Stumpf had taken the brunt of the criticism from regulators and we are not surprised to see the bank making a change during this sensitive time. That being said, we believe the change ultimately lowers the downside in the stock but doesn't necessarily add to the upside as the government may have preferred to have seen an outside executive hired to lead the company out of the controversy. While headlines surrounding the bank will likely persist, Stumpf's retiring should temper some regulator concerns as it represents a further acknowledgement of the bank's mistakes. The upside, on the other hand, continues to lie in the macro economy and the prospect for higher rates. We believe risk is adequately diminished in the $44-$45 range as expectations have come down dramatically, yet we want to make it clear that regulators will continue to dig deep to figure out how Wells got away with these practices to ensure consumers are not cheated again in the future. We await tomorrow's earnings call where we expect to hear more about the bank's executive shakeup and plans for the future.
Cisco: Shares of CSCO fell hard yesterday following disappointing pre- announcements from two companies, Fortinet (FTNT) and Ericsson (ERIC) , which both operate in business segments in which Cisco operates -- Fortinet in network security and Ericsson networking service. We believe the selloff that spilled over into CSCO shares was overdone for a couple of reasons. First off, as for Ericsson's negative news, Cisco is no longer a play on service providers. As we have pointed out in multiple bulletins, Cisco has undergone a shift towards cloud and software and away from hardware since Chuck Robbins took over as CEO. Through streamlining the business and strategic acquisitions, CSCO has overhauled its operations and prepared itself for the future. Secondly, while Fortinet does operate in network security, which is an increasing area of focus for Cisco, Cisco has cleaned up its execution in the space and Fortinet pointed towards a disruption due to its new sales organization in North America, a transition that does not concern Cisco. In addition, Cisco appears to be undergoing an upgrade cycle to its next-gen firewall platform, which represents a significant technological improvement from the prior version and should entice customers to continue spending. Lastly, from a broader view, we believe the selloff discounts Cisco's overall shift to higher- margin, more predictable, recurring revenue businesses as well as the company's massive cash balance and free cash flow generation. If nothing else, the now 3.5% dividend yield remains extremely compelling in this current environment. We continue to like the company as a core holding for the long-term.
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