Tea Leaves
A stiff wind blows. Sand moves here or there, making indistinguishable what should be visible. One must try to see through this featureless facade. One must focus on the characteristics beneath in order to identify where opportunity lies, and conversely, where obstacles rise.
What has earnings season told investors so far? It's early. That said, we have seen some earnings growth -- not enough to get excited about -- on less revenue growth than expected. We know that for the banks, net interest margin is under pressure. Historically, this negative force serves to compress valuations across the industry. The winners there will be those banks that have managed to trade less badly and move revenue generation more rapidly toward a fee-based strategy.
We have learned that the rails can be a very puzzling industry, where performance can be very uneven. It feels to me that the entire equity space sits on pins and needles, overly reliant on the Fed's next move prior to making any significant move on its own.
Friday was a case in point. Equities rallied in the wake of dovish comments made by two voting members of the Federal Open Market Committee (FOMC), Richard Clarida and John Williams. Then markets made a midday reversal to the downside, either after the New York Fed tried to walk back Williams' overly dovish comments (which had been done well before the open) or in response to the U.S. Navy shooting down an Iranian drone and the Iranian seizure of a U.K. tanker. Maybe both?
Futures trading in Chicago that tries to handicap the forward trajectory for the Fed funds rate returned to its pre-Thursday standing. Clearly, the world still faces long-running geopolitical hurdles outside of trade. Clearly, even senior Fed officials cannot accurately articulate their message of monetary policy, only serving to muddy the waters, reducing incentive for investors either to get out in front or cut bait at these levels.
It may be important to note that trading volume declined at both the New York Stock Exchange as well as the Nasdaq Stock Market. Understand just how bizarre that is, as this past Friday was a monthly options expiration Friday, meaning that the final tally had a fundamental reason that forced the volume higher than it otherwise might have been.
This Week
Most importantly, the Fed enters its blackout period ahead of the FOMC's July 31 policy decision. While that will at least prevent this crew from any further short-term embarrassment (do they know enough to be embarrassed?), the European Central Bank (ECB) does step up to the plate Thursday morning in Frankfurt. Some economists are looking for that central bank to take the benchmark deposit rate from the already perverse -0.4% down another peg. Myself, I think that perhaps the posture is changed at this meeting to merely signal that such a move is coming, and then the idea is to get the ball moving toward cranking up the whole money machine again while ECB President Mario Draghi is still on the job.
Aside from the ECB's posture, the week will be about conflict in the Straits of Hormuz, the always-evolving relationship between the U.S. and China, and, of course, earnings. This will be the first truly busy week of the earnings season, with 159 component companies of the S&P 500 reporting alone. The FANG names will remain in focus in the wake of the Netflix (NFLX) severe (and somehow un-warned) miss on subscriptions last week, as Facebook (FB) reports this Wednesday, and both Alphabet (GOOGL) and Amazon (AMZN) release numbers on Thursday.
Caught My Eye
It was hard to miss, at least for news junkies, that over the weekend both The Wall Street Journal and Investor's Business Daily (IBD) ran lead articles of great interest to those of us who invest in the aerospace and defense space. First, we see in the Journal that China apparently has signed a pact with Cambodia that would permit the Chinese military access to the naval base on the Gulf of Thailand that just happens to be near an airport currently being built by a Chinese company. Wouldn't you know it, satellite images of this airport in the Ream area show it has longer runways that might accommodate Boeing (BA) 747s or long-range strategic bomber aircraft, as well the types of runway turns that would be required should fighter aircraft use the airport.
Remember that we in this space have long recognized the trade dispute between the world's two largest economies as more a conflict over both regional and global influence.
The IBD piece covers where Department of Defense spending is now and where the Pentagon is trying to take it. The Pentagon seems to acknowledge the advances that highly capable, potential adversaries such as China and Russia have made in upgrading their offensive abilities.
Sharpening the Blade
We have long discussed here the lead that both of those nations had taken in hyper-sonic weaponry. For those unaware, hyper-sonic weapons move at five times the speed of sound and are currently indefensible. In addition to this possibly horrific development, Russia appears to have made cyber-warfare that works in conjunction with conventional forces part of its strategy, while China makes overt attempt to modernize its naval and air forces as well develop laser weapons that might be used in space.
Developing U.S. strategies will focus on coordinated threats or attacks that, across a range of platforms, deter, or if push comes to shove, overwhelm an adversary that chooses to become an enemy. It will be key for U.S. forces to catch up and then take a commanding lead in this hyper-sonic weaponry as well as invest in an ability to play defense against such threats.
Artificial intelligence will be required in order to quickly coordinate forces through air, land and sea. This is an area where there must be permanent leadership. According to the article, a U.S. response would be quarterbacked perhaps from an F-35 (Lockheed Martin (LMT) ) stealth fighter, a B-21 Stealth Bomber (Northrop Grumman (NOC) ), or a Columbia class submarine (General Dynamics (GD) ). The missiles, both offensive and defensive, that these quarterbacks would command could be land-, air- or sea-based, and would be largely manufactured by Lockheed Martin, by Raytheon (RTN) and by Boeing. Note that Raytheon and United Technologies (UTX) have agreed to a still-to-be-completed merger of equals.
On top of this effort to mass coordinate, smaller contractors that I believe would benefit from current geopolitical development, and therefore names I am long myself, would be Kratos Defense & Security (KTOS) , a military drone specialist also involved in developing U.S. hypersonic capability; Mercury Systems (MRCY) , a provider of military electronics that aid in critical intelligence applications; and Coda Octopus Group (CODA) , a manufacturer of real-time 3-D sonar solutions to the U.S. Navy.
Of the defense stocks mentioned here, all the larger firms will report this week: LMT and UTX on Tuesday. BA, GD and NOC on Wednesday and RTN on Thursday. Of the smaller names mentioned, CODA reported in June and is not scheduled to do so again until September. Both KTOS and MRCY report next week.
My Defense Contractor Longs, Target Prices, Add Levels and Panic Points
LMT: Last.. 356.96, TP 375, Add 352, PP 312
UTX: Last.. 132.39, TP 153, Add 144, PP 122
KTOS: Last. 24.07, TP 25, Add 22, PP 18
MRCY: Last. 71.95, TP 80, Add 69, PP 64
CODA: Last. 13.51, TP 19, Add 12, PP 9
Notes: General Dynamics is trying to break out of a three-month cup with handle pattern and is very interesting to me on a take and hold of the $184 level. Northrop Grumman has run into earnings, making the name dangerous. I become interested perhaps on post-earnings profit taking. The level to watch is the 50-day simple moving average (SMA) of $314. I'm still avoiding Boeing.
Economics (All Times Eastern)
No significant domestic macro-economic data points scheduled for release.
The Fed (All Times Eastern)
Black-Out Period.
Today's Earnings Highlights (Consensus EPS Expectations)
