February 26, 2019

If you want to read yet another wacky story of a world turned upside down, Somali pirates actually have set up a stock exchange to finance their operations. That’s right, you can actually invest in your favorite pirate clan and participate in the success of their ventures. As he took a Reuters reporter on a tour of this new bourse, Mohammed (a wealthy former pirate) said, “The shares are open to all and everybody can take part, whether personally at sea or on land by providing cash, weapons, or useful materials … we’ve made piracy a community activity.” What a happy thought! Organized exchange-traded pirates!

Crazy as that may seem, this helps highlight this one key point: Opportunity exists all over the place. Just because the news media beat the bearish drum doesn’t mean there’s no opportunity. Look at last fall and winter as an example. The rally from lows has been astonishing, to say the least. Let’s take a look:

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

My key takeaway is this: Growth has been leading us out of the ashes.  That’s a great thing, regardless of the reason.  By that I mean, whether growth was unfairly punished heading into the fall of last year, or if investors fled for fear, or if the consensus was that growth would grind to a halt – whatever the reason – it seems those reasons were either wrong or have been largely discounted to zero. The small caps are kings!

The U.S. dollar is strong, thereby hurting other currencies, and Europe is facing its fair share of problems.  Brexit looms over an already-worsening situation in Europe.  The flight from that landscape to U.S. small caps is clearly evident.  The Russell 2000 Index has rallied more than 25% from its December 24th lows. The Russell 2000 Growth index is up nearly 28% over the same time. The S&P Small Cap 600 Index is up +24.37% since Christmas. The value indexes are lagging while growth indexes are charging ahead.

As far as sectors go, we see a similar story: The four strongest sectors have been Industrials, Information Technology, Consumer Discretionary, and Energy. There is a lot of growth imbedded in these sectors.  Traditionally “safe” sectors, such as Utilities, Communications, Staples, and Real Estate, have lagged their better-performing peers.  With that said, their performance has nonetheless been excellent.

When we think back to the headlines swirling around at the end of the year – with all the big scary bears roaring – we must now ask, “How could they all have gotten it so wrong?”  Well, they’re not all admitting they are wrong! One interview I heard recently pointed out that bear markets fall in stages and the worst may be yet to come.  But I beg to differ.  There are countless examples of companies bucking the trend.

Could it be just a technical rally sparking us into overbought territory? I concede that is a possibility, yet while we are overbought, we have rallied for an excellent reason: Sales and earnings are largely working.

Don’t Fight Rising Earnings!

According to FactSet Earnings Insight as of February 22, 2019:

  • Earnings Scorecard: For Q4 2018 (with 89% of the companies in the S&P 500 reporting actual results for the quarter), 69% of S&P 500 companies have reported a positive EPS surprise and 61% have reported a positive revenue surprise.
  • Earnings Growth: For Q4 2018, the blended earnings growth rate for the S&P 500 is 13.1%. If 13.1% is the actual growth rate for the quarter, it will mark the fifth straight quarter of double-digit earnings growth for the index.
  • Earnings Revisions: On December 31, the estimated earnings growth rate for Q4 2018 was 12.1%. Seven sectors have higher growth rates today (compared to December 31) due to upward revisions to EPS estimates and positive EPS surprises.
  • Earnings Guidance: For Q1 2019, 68 S&P 500 companies have issued negative EPS guidance and 25 S&P 500 companies have issued positive EPS guidance.
  • Valuation: The forward 12-month P/E ratio for the S&P 500 is 16.2. This P/E ratio is below the 5-year average (16.4) but above the 10-year average (14.7).

What happened in late 2018 is that Wall Street generally revised their expectations downward to prepare for the pending end of earnings growth and slower global GDP growth.  They didn’t want to be caught flat-footed when the world slowed down, despite all the talk of rosy sales and earnings outlooks.

Well guess what – they were wrong and were caught flat-footed when the market went the other way!

Here’s a great example: The Trade Desk (TTD) is a company that’s been on our radar for a long time. A couple of days ago, John Egbert, an analyst at Stifel Nicolaus, downgraded the stock to a Hold citing amongst other things “a rapid rise in the share price.”  He issued a revised price target of $144, just before earnings were released. He was optimistic about earnings but said, “Consensus expectations are elevated.”

TTD then came out and absolutely smashed earnings estimates. Here are some highlights of their report:

  • Earnings per share (eps) of $1.09, double the $0.54 a year ago and well above consensus of $0.79.
  • Revenues of $160.5 million, up from $102.6 million last year vs. consensus of $148 million.
  • Full Year 2019 revenue projections of at least $637 million vs. consensus of $617 million.

This is what the chart looked like on Friday: +31.5% by day’s end!!!

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

Well, John, all I can say is, “Ouch! – that’ll leave a mark in the morning.”

Naturally, our whole focus here is to identify names like TTD beforehand, by trying to find unusual institutional buying, like we can see in the green bars in the chart below:

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

For those who hate self-back-patting, or calling attention to the other guy’s premature downgrade, what’s important here is that growth is alive and well and attracting capital. The story here is that the market is fighting back with a vengeance and equities are looking strong. We believe we are entering a more selectively narrow bull market in terms of opportunities – but many other good names are still out there.

As far as getting the market right, remember what Elbert Hubbard said: “Don’t take life too seriously; you’ll never get out alive.” (Hubbard went down with The Lusitania in May, 1915, at age 58)

About The Author

Jason Bodner

Jason Bodner writes Sector Spotlight in the weekly Marketmail publication and has authored several white papers for the company. He is also Co-Founder of Macro Analytics for Professionals which produces proprietary equity accumulation/distribution research for its clients. Previously, Mr. Bodner served as Director of European Equity Derivatives for Cantor Fitzgerald Europe in London, then moved to the role of Head of Equity Derivatives North America for the same company in New York. He also served as S.V.P. Equity Derivatives for Jefferies, LLC. He received a B.S. in business administration in 1996, with honors, from Skidmore College as a member of the Periclean Honors Society. *All content of “Sector Spotlight” represents the opinion of Jason Bodner*


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