Stocks look like they will extend their profit recession for a fifth quarter in a row, but not all stocks reported lower earnings. Bret Jensen shares which stocks and sectors that he is bullish on and those that he wants to avoid for the time being.
The markets keep grinding up and hitting all-time highs as we start to get into the meat of the second quarter earnings season. The consensus that earnings would be down five percent overall for the quarter seems overly pessimistic. However, it does appear that profits within the S&P 500 will be down on a year-over-year basis for the fifth straight quarter in a row, something that has not happened since 2009. Here are a few quick observations on some key sectors of the market and economy based on quarterly results so far.
Results at major banks have largely beat the very low expectations set for them even as earnings are largely down from a year ago. Energy loans continue to sour and the long run of increasing credit quality and lower write-offs seem to be over. Default rates on credit card balances and auto loans are slowly creeping. All six major banks saw profit margins contract this quarter, and Wells Fargo (NYSE: WFC) and JPMorgan Chase (NYSE: JPM) added to their loan loss reserves for the first time since 2009.
On the bright side, mortgage originations are benefiting from historically low interest rates. Banks will continue to cut costs to offset lower net interest margins thanks to rock-bottom yields. However, there are few growth drivers across the industry and I continue to underweight the sector.
We have not heard from the major producers like Exxon Mobil (NYES: XOM) yet, but oil services firms Halliburton (NYSE: HAL) and Sclumberger (NYSE: SLB) have announced quarterly results. Both provided slightly better than expected bottom line numbers. Halliburton believes the North American market has turned and Sclumberger says it will try to roll back pricing concessions as contracts renew. However, both firms are still laying off workers. This is happening even as Halliburton’s workforce is already down 40% from its 2014 peak. Contracting demand from the energy sector also dented the otherwise solid results of conglomerates General Electric (NYSE: GE) and Honeywell International (NYSE: HON) this quarter. Oil has also slumped 10% recently, so the outlook for energy is too murky for my taste and I am significantly underweighting this sector of the market as well.
Housing and Construction:
I am much more optimistic on these parts of the economy. You can see an improving construction and housing market in several quarterly reports so far this earnings season. Leading equipment rental firm, United Rentals (NYSE: URI), has had a huge rally since reporting stellar results compared to the consensus on July 20. Homebuilder, PulteGroup (NYSE: PHM), beat both the top and bottom-line estimates on July 21. D. R. Horton (NYSE: DHI) did not do as well with a slight miss. That stock has already had a big run from its lows this year, and order backlog was still up a respectable 15% year-over-year.
Finally, Whirlpool (NYSE: WHR) delivered a beat last week thanks to growth in North America, even with substantial currency headwinds and the aftermath of the Brexit. I will continue to overweight this space. My favorite small cap home builder, LGI Homes (NASDAQ: LGIH), should report results in the second week of August. Given home closings are up nearly 30% in first half of 2016 over the same period last year, I am expecting more than solid gains in revenue and earnings. I continue to hold the shares despite their considerable rally in 2016.
We will get a good handle on this industry’s business fundamentals by looking at the earnings of these biotech behemoths: Amgen (NASDAQ: AMGN), Celgene (NASDAQ: CELG) and Gilead Sciences (NASDAQ: GILD).
Gilead reported after the bell on Monday, and even though it beat earnings, the stock traded lower on Tuesday. This stock needs a real positive catalyst such as a new acquisition, partnership, drug approval, or dividend boost to get back on track.
Celgene reports earnings before the market opens on Thursday, July 28.
Biogen (NASDAQ: BIIB) had a nice rally last week after reporting a 22% surge in earnings on the back of a 12% increase in revenue from the same period a year ago. I am hoping that good earnings and an uptick in M&A like last week’s purchase of “Best Idea”, Relypsa (NASDAQ: RLYP), will provide the next leg of a rally for the entire sector. This small biopharma, which was a recommendation in my Small Cap Gems and Biotech Gems portfolios, was up 60% last week on this offer. The biotech sector overall is up some 15% from its lows this year and is within a few percent of a stubborn resistance level that has been in place throughout 2016.
If we can get a five percent or so rise from here, I think there is substantial upside in the space. The collective valuation of the large caps in the sector is as low as it has been in years. In addition, it is one of the few areas of the market that is actually seeing decent revenue and earnings growth despite a very challenging global backdrop. I am heavily overweighting the sector which is still down more than 25% from its last peak last summer.
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Positions: Long AMGN, CELG, GILD, LGIH, and URI