US Market Debrief 19th of July 2019

Stocks retreat while rate cut odds remain in focus

The S&P 500 faded into the close and lost 0.6% on Friday, as geopolitical angst and expectations for a smaller Fed rate cut weighed on the broader market. The Nasdaq Composite lost 0.7%, and the Russell 2000 lost 0.5%. 

The Dow Jones Industrial Average (-0.3%) fared slightly better, supported by shares of Boeing (BA 377.36, +16.25, +4.5%) after it announced a $4.9 billion charge for its 737 MAX grounding.

Price action for most of the day had been muted until Iran said it seized a British oil tanker and The Wall Street Journal reported that the Fed is signaling a 25-basis points rate cut at the July 30-31 FOMC meeting. 

The latter report dampened hopes for a 50-basis points rate cut, which had already been on the decline after a Fed spokesman dialed down comments from NY Fed President Williams that were perceived as dovish yesterday. In turn, the fed-funds sensitive 2-yr yield increased four basis points to 1.82%, while the 10-yr yield increased one basis point to 2.05%. The U.S. Dollar Index rose 0.4% to 97.15. 

According to the CME FedWatch Tool, the implied likelihood for the quarter-point cut climbed to 77.5% from 39.8% yesterday.

Heightened tensions in the Middle East did spur a rebound in oil prices ($55.66/bbl, +$0.47, +0.9%), which contributed to the outperformance of the S&P 500 energy sector (+0.5%). Still, losses in eight of the 11 S&P 500 sectors, including the real estate (-1.7%), utilities (-1.5%), and communication services (-1.3%) sectors, dragged on the broader market. 

Transport stocks outperformed on Friday after KC Southern (KSU 123.43, +5.44, +4.6%) reported better-than-expected earnings results. The Dow Jones Transportation Average advanced 0.6% to cut its weekly loss to just 0.3%. 

In other earnings news, Dow components Microsoft (MSFT 136.62, +0.20, +0.2%) and American Express (AXP 124.82, -3.58, -2.8%) beat earnings estimates, but the price action in shares was disappointing. MSFT was up as much as 3.1% today but faded alongside the broader market during the afternoon.

Friday’s lone economic report was the preliminary July reading for the University of Michigan Index of Consumer Sentiment: 

  • The preliminary University of Michigan Consumer Sentiment Index for July checked in at 98.4 (Briefing.com consensus 98.9) versus the final reading of 98.2 for June.
    • The key takeaway from the report is the finding that consumers’ expectations fall as their inflation expectations rise, so it will be assumed for the time being that consumer expectations will remain elevated since their one-year inflation expectations dipped from 2.7% to 2.6%.

Investors will not receive any notable economic data on Monday. 

  • Nasdaq Composite +22.8% YTD
  • S&P 500 +18.7% YTD
  • Dow Jones Industrial Average +16.4% YTD
  • Russell 2000 +14.8% YTD

Overseas: 

  • Europe: DAX +0.3%, FTSE +0.2%, CAC unch
  • Asia: Nikkei +2.0%, Hang Seng +1.1%, Shanghai +0.8%

Commodities: 

  • Crude Oil +0.47 @ 55.66
  • Nat Gas -0.02 @ 2.26
  • Gold -1.40 @ 1426.45
  • Silver unch @ 16.20
  • Copper +0.04 @ 2.75

Spotlight Issue: Microsoft runs to new highs after impressive earnings report

Microsoft (MSFT) hit a new all-time high following blowout fourth quarter results last night.

Revenue grew 12% to $33.72 bln, well above the company’s $32.2-32.9 bln guidance. Operating income grew 20% to $12.4 bln with growth in every segment as gross margins expanded 150 basis points to 69.1%.

Top line growth of 12% may seem tame relative to smaller software players, but it is awfully impressive at a $34 bln run rate.

Upside came from all three segments. Microsoft is firing on all cylinders as its shift to cloud services continues to show plenty of momentum.

Productivity and Business Processes revenue grew 17% in constant currency as operating income grew 31% ex-FX to $4.34 bln. Office Commercial products and cloud services revenue accelerated to 16% growth in constant currency, up from 14% growth in the third quarter. This was driven by Office 365 Commercial revenue growth of 34% in constant currency.

Intelligent Cloud revenue grew 21% in constant currency, as operating income grew 19% to $4.5 bln. Microsoft’s public cloud continues to be the number one share gainer. Azure grew 68% in constant currency on top of 85% growth in the fourth quarter of last year. There is plenty of room for both Azure and Amazon’s AWS in the burgeoning cloud computing industry, which has revolutionized entrepreneurship.

Personal Computing revenue grew 6% in constant currency as operating income grew 22% to $3.56 bln. Windows Commercial products and cloud services revenue increased 16% in constant currency and Surface revenue grew 17% in constant currency. Gaming was the one soft spot; revenue int hat segment fell 8% in constant currency. A slowdown in that very cyclical business is not a concern for investors. Xbox monthly active users grew 14% to 65 mln.

This morning, BMO noted that, normalizing for tax payments, MSFT grew FY19 FCF by 23% to ~$39.7 bln, and FCF margins increased 230 basis points to 31.5%. “Given ongoing double-digit revenue growth, with the potential to grow margins y/y in FY20, we continue to like the stock,” said the firm, which raised its target to $160/share. Most Wall Street analysts were gushing over the stock this morning.

Microsoft doesn’t garner as much media attention as its younger mega cap technology peers, but it is the largest publicly traded company in the world. Microsoft already came under the scrutiny of regulators some twenty years ago, so it doesn’t share that current elevated risk with its peers.

With a $1.07 trln valuation, the stock trades at ~27x EPS estimates, making it one of the cheapest software stocks in terms of an earnings and EV/EBITDA multiple. The ~20x forward FCF multiple is roughly on par with Dropbox (DBX)Palo Alto Networks (PANW) and Twitter (TWTR), a modest premium to Facebook (FB) and a modest discount to Amazon (AMZN).

The stock has been in a smooth, strong uptrend since breaking out to a twelve-year high in 2013. Chief Executive Satya Nadella has done a phenomenal job since taking over in 2014.

Microsoft’s core businesses have enviable moats, so the outlook remains quite strong despite increasingly difficult comparisons.

News Summary:

For a full rundown of today’s market and after hours developments, see Live In Play

  • Earnings/Guidance:
    • American Express (AXP) beats by $0.05, reports revs in-line; reaffirms FY19 EPS guidance, revs guidance
    • BlackRock (BLK) misses by $0.18, misses on revs
    • Boeing (BA) announces $4.9 bln after-tax charge for Q2 related to the 737 MAX grounding and associated delivery delays; 737 production costs increased by $1.7 bln during the quarter amid lower production rate
    • Capital One (COF) beats by $0.16, beats on revs
    • Chewy (CHWY) misses by $0.01, reports revs in-line; Q2 and FY20 revenue guidance compares favorably to Wall Street estimates
    • Chico’s FAS (CHS) reaffirms second quarter and full-year outlook
    • Citizens Financial Group (CFG) beats by $0.02; raised Q3 common dividend 13% to $0.36 per share
    • Cleveland-Cliffs (CLF) beats by $0.11, beats on revs
    • CrowdStrike (CRWD) beats by $0.01, reports revs in-line with pre-announced range; guides Q2 EPS above consensus, revs above consensus
    • E*TRADE (ETFC) beats by $0.02, misses on revs; announces new $1.5 bln share buyback program
    • Intuitive Surgical (ISRG) beats by $0.38, beats on revs; raises FY19 procedure growth to +16-17% from +15-17%
    • KC Southern (KSU) beats by $0.03, beats on revs; reduces FY19 volume growth outlook
    • Manpower (MAN) beats by $0.11, reports revs in-line; guides Q3 EPS below consensus
    • Marten Transport (MRTN) beats by $0.01, beats on revs
    • Microsoft (MSFT) beats by $0.16, beats on revs in all three segments; guides Q1 revenues in line
    • NVR (NVR) beats by $8.22, reports revs in-line
    • Regions Fincl (RF) misses by $0.02, misses on revs
    • Schlumberger (SLB) reports EPS in-line, beats on revs
    • Select Medical (SEM) provides upside Q2 guidance
    • Sensient (SXT) misses by $0.02, misses on revs; lowers FY19 EPS below consensus
    • Skechers USA (SKX) beats by $0.16, beats on revs; guides Q3 EPS above consensus, revs above consensus
    • State Street (STT) beats by $0.05, reports revs in-line
    • Synchrony Financial (SYF) beats by $0.01
  • General News:
    • Iran claims it has seized a British oil tanker, according to CNBC
    • President Trump speaking with reporters says he would never use the debt ceiling as a negotiating tool; says US credit is something “you just do not play with”
    • The Trump administration has sent House Speaker Nancy Pelosi suggested spending reductions for budget deal, according to Bloomberg
    • House Speaker Nancy Pelosi (D-CA) aims to reject White House offer for debt ceiling increase based on objection over spending cuts, according to Bloomberg
    • Fed officials are signaling a 25 basis point rate cut at the July meeting, according to The Wall Street Journal
    • USTR Robert Lighthizer spoke with China counterparts by phone yesterday, but divisions still exist, according to Bloomberg
    • President Trump nominates Gene Scalia as the new Secretary of Labor
    • AT&T (T) considering sale of Puerto Rican business to pay down debt, according to Bloomberg
    • The Hollywood Reporter expects CBS (CBS) to pay up to $15.4 bln for Viacom (VIAB) when they announce a merger agreement, expected on August 8, when both companies are scheduled to report second quarter results
    • Chico’s FAS (CHS) appoints Bonnie Brooks as CEO
    • Discover Financial Services (DFS) approved new $2.2 bln share repurchase program and increased quarterly common stock dividend to $0.44 per share from $0.40
    • JC Penney (JCP) has hired advisors for debt restructuring, according to Reuters
    • Schlumberger (SLB) names Olivier Le Peuch CEO and member of the Board effective August 1
    • Wal-Mart (WMT) will make exec changes to integrate stores with digital offerings, according to CNBC
    • WeWork founder Adam Neumann has cashed out $700 mln from the company ahead of IPO, according to Tech Crunch

Notable Ratings Changes:

  • Upgrades:
    • AXIS Capital (AXS) upgraded to Buy from Neutral at Buckingham Research; tgt raised to $70
    • American Intl (AIG) upgraded to Outperform from Mkt Perform at William Blair
    • HealthEquity (HQY) upgraded to Buy from Neutral at BofA/Merrill Lynch
    • KBR (KBR) upgraded to Outperform from Market Perform at Cowen; tgt raised to $31
    • Philip Morris International (PM) upgraded to Overweight from Equal Weight at Barclays; tgt raised to $100
    • Post (POST) upgraded to Overweight from Neutral at Piper Jaffray; tgt raised to $130
    • Public Storage (PSA) upgraded to Buy from Neutral at BofA/Merrill Lynch
    • Skechers USA (SKX) upgraded to Outperform from Neutral at Wedbush ; tgt raised to $46
    • Taiwan Semi (TSM) upgraded to Buy from Underperform at CLSA
    • WW (WW) upgraded to Buy from Neutral at DA Davidson; tgt raised to $32
  • Downgrades:
    • Arch Capital (ACGL) downgraded to Neutral from Buy at Buckingham Research; tgt $38
    • Alcoa (AA) downgraded to Hold from Buy at Argus
    • CubeSmart (CUBE) downgraded to Neutral from Buy at BofA/Merrill Lynch
    • CVB Financial (CVBF) downgraded to Neutral from Buy at Janney
    • Eagle Bancorp (EGBN) downgraded to Neutral from Overweight at Piper Jaffray; tgt lowered to $47
    • Ingevity (NGVT) downgraded to Hold from Buy at Jefferies; tgt lowered to $107
    • Invitation Homes (INVH) downgraded to Mkt Perform from Outperform at Keefe Bruyette; tgt $28.50
    • Michaels Stores (MIK) downgraded to Underperform from Neutral at BofA/Merrill Lynch; tgt lowered to $5
    • MSG Networks (MSGN) downgraded to Underweight from Neutral at JP Morgan; tgt lowered to $19
    • Paycom Software (PAYC) downgraded to Hold from Buy at Jefferies; tgt $233
    • SAP SE (SAP) downgraded to Hold from Buy at Deutsche Bank
    • Travelers (TRV) downgraded to Neutral from Buy at Buckingham Research; tgt $158
  • Others:
    • Altimmune (ALT) initiated with a Buy at ROTH Capital; tgt $8.30
    • AMC Entertainment (AMC) initiated with an Outperform at Credit Suisse; tgt $18
    • Chipotle Mexican Grill (CMG) resumed with a Sell at Northcoast; tgt $400
    • Cinemark (CNK) initiated with an Outperform at Credit Suisse; tgt $43
    • Dow (DOW) initiated with a Market Perform at Cowen; tgt lowered to $55
    • GrubHub (GRUB) initiated with a Buy at The Benchmark Company; tgt $95
    • MasterCard (MA) target raised to $310 from $285 at Barclays
    • Redfin (RDFN) initiated with a Sector Weight at KeyBanc Capital Markets
    • Smith Micro Software (SMSI) initiated with a Buy at B. Riley FBR; tgt $5
    • Sunoco LP (SUN) initiated with a Hold at Stifel; tgt $35
    • Visa (V) tgt to $195 from $181 at Barclays
    • Zillow (ZG/Z) resumed with an Overweight at KeyBanc Capital Markets; tgt $66

Upcoming Events:

  • Econ Data (Monday):
    • Nothing of note
  • Earnings:
    • Monday (July 22)
      • Pre-Market: CALM GNC HAL RPM
      • After-Hours: AKR BRO CR ELS HSTM HXL HMST LOGI AMTD WHR
    • Tuesday (July 23)
      • Pre-Market: ATI AN BIIB CNC CIT KO HOG HAS IPG IRDM JBLU LMT PII DGX SHW SWK TTS TRU UTX
      • After-Hours:  CNI CMG DFS EW IRBT MANH SNAP TXN V
    • Wednesday (July 24)
      • Pre-Market:  ANTM BA T BSX CAT CHKP FCX GWW HLT LAD MHO NDAQ NTRS NOC NSC OC TUP
      • After-Hours: ALGN ALGT AMP ANIK ARI ASGN BCOV CERN CLS CLB COR CUZ ECHO FFIV FB F GGG HP HNI KRA LSTR LVS LMAT MLNX NTGR ORLY OII PYPL NOW TSLA VAR XLNX
    • Thursday (July 25)
      • Pre-Market: MMM AAN ABB AAL BUD AZN BWA BMY CMCSA DLX DBD HSY LNTH TREE MNRO NVCR PRLB LUV TSCO WWE
      • After the close: ALK GOOG AMZN BJRI COLM DECK BOOM ENVA EXPE FTV JNPR MAT MGM MXL PEB PFPT PRO SNBR SBUX SYK VRSN UHS
    • Friday (July 26)
      • Pre-Market:  ABBV ABG COG CHTR CL ROCK GT ITW MCD TYPE PSX TWTR WETF
      • After-hours:  None
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