Author: Randy Watts

Randy Watts is Chief Investment Strategist for William O’Neil + Company. Mr. Watts manages William O’Neil + Company’s research department and guides the development of the company’s suite of services. He oversees the strategic direction and focus of the company’s research content, and his buy-side experience provides additional insight that allows the company to leverage its experience and expertise to help clients generate alpha. Mr. Watts has more than 25 years of equity asset management experience with specific focus on large- and small-cap growth stocks. He started his professional career as an Equity Analyst at Freedom Capital Management in Boston, MA. He spent nine years at Westfield Capital Management as an Equity Analyst then as a Partner and Portfolio Manager overseeing a $500+ million growth stock portfolio. Mr. Watts served as a Senior Managing Director for small- and mid-cap growth investments at The Boston Company, where he managed $4 billion in both long and long/short equity portfolios. During his tenure at the Boston Company, he hired, trained, and managed a team of investment professionals. Most recently, he ran a long/short equity hedge fund for Folger Hill Asset Management in New York, NY. Mr. Watts graduated from the University of Virginia with a degree in American Studies and is a Chartered Financial Analyst.

Strategy View

Posted on by Randy Watts

Key points from the report:

Index strength remains intact one-third though earnings season. Normal (~78% of S&P 500 companies) beats have occurred thus far.

Style-wise, large growth continues to be the standout, up 20% year-to-date and 17% over one year. Small growth is up 20% year-to-date, but only 5% over one year.

Notably, the top 10 stocks make up 35% of the large growth (0IKT) index: AAPL, MSFT, AMZN, FB, GOOG, GOOGL, V, HD, MA, UNH. The top 10 stocks in the small growth index only make up 6%.

Technology, the leading sector over one year, is also more represented in large growth than any other index, giving it another advantage.

Materials and Cyclicals look cheap on a forward multiple basis in both the S&P 500 and S&P 600 indices and could play catchup if overall strength continues…but only Cyclicals is showing relative improvement currently. Materials and Energy continue to lag far behind.

Health Care is sharply decelerating but is not yet at an historically extreme level of underperformance that it could make a successful reversion trade.

Strategy View

Posted on by Randy Watts

Key points from the report:

According to Bloomberg, from 2008 to Q3 2018, S&P 500 companies have spent $4.9T on buybacks versus only $3.4T on dividends.

Last year, partially fueled by lower corporate tax rates, S&P 500 constituents spent $770B purchasing their stock; this year it’s estimated they will spend close to $1T. This means that the S&P 500 will buy back more than 3% of its outstanding market capitalization in 2019. Given that S&P 500 earnings are only projected to grow +7% in 2019, shrinking the share base by 3% is significant.

Looking at a buyback proxy ETF (Invesco Buyback Achievers ETF-PKW, companies with at least 5% of shares bought back in trailing 12 months), we note that buybacks as a group outperformed the S&P 500 from March 2008 to March 2015. But, over the past four years, that trend reversed.

Lower interest rates likely played a large role in this difference. The outperformance period began as rates were lowered and ended when the Fed raised rates in 2015.

With the Fed currently on pause and talks of interest rate cuts picking up, the buyback group has begun to outperform again.

When looking at individual names that buy back shares, not all are equal. The table below shows that the best performers also have stronger growth (at the median level).

Interesting names that have both growth and 5%+ buybacks that performed well in the past year include NTAP, CHDN, UNP, AWI, CRMT, UBNT, ORLY, GLW, SBUX, CSCO, ATKR.

Strategy View

Posted on by Randy Watts

Key points from the report:

Q1 earnings season is expected to be a significant deceleration from Q4. Median S&P 500 sales and EPS growth of 3% and 4%, respectively, would be the lowest since 2016. We do expect normal beats of 1% for sales and ~3% for EPS. Any lower-than-normal sales and EPS beats, or poor guidance, will put significant pressure on the ongoing rally.

Bull investment advisor sentiment reading of 53% and a VIX of 13.5, are bullish  but not extreme, similarly making the results of this earnings season a large variable.

Index and sector setups are broadly positive ahead of earnings, with all now supported by upward-trending 50-DMA.

Best sector setups into earnings are Technology, Health Care, Cap Equip, and Staples.

While the number of actionable U.S. Focus List stocks is smaller than over the previous two months, a few strong setups include AMZN, PAGS, CCMP, ISRG, LULU, GLOB, and FOXF.

Strategy View

Posted on by Randy Watts

Key points from the report:

Inverted three-month ( 13-week ) to 10-year yield curve has been a good predictor of recessions ( about 12 months out ).

Inversion does not always lead to weak market performance but does so on average.

  • In all cases where the curve inverted on a weekly basis since 1962, average 4/8/13/26/52-week forward performance for the S&P 500 is negative.

Cyclicals and Utility tend to be weak, while Material has performed the best.

  • Interestingly, Utility is current the best performer over one year, while Material  is the worst. A mean reversion could be approaching.

Strategy View

Posted on by Randy Watts

Key points from the report:

 

  • 18%+ gains for every major index since December lows; all but Russell 2000 are above 50- and 200-DMA.
  • Sector performance is fairly tightly bunched, with all sectors within ~10% of each other. More divergence is very likely from here.
    • Since 1970, the average spread between the best and worst sectors on an annual basis is 40%.
    • Over the past six years, the average spread is 34%.
  • On a relative basis, Utility is still easily the best performer over the trailing year and recently reached an historic extreme of +20% versus the S&P 500. The spread may be near a relative peak, especially if the worst of the 10-year yield slide is over.
  • Material is by far the worst over the trailing year, lagging Utility by nearly 30%. The spread could be at a trough, but likely needs some economic improvement to revert.
  • Technology is just slightly outperforming the S&P 500 over the trailing year but is trending positively (Semis and Software both working now). Retail still holds a large lead but continues to decelerate relatively.
  • Energy’s relative trend is improving but still has some distance to make up before it becomes a leader.

Global Markets Overview

Posted on by Randy Watts

Key points from the report:

 

  • U.S. indices are overbought in the short term, strong precedence for longer-term gains.
    • Earnings trough in Q1? Recovering in latter part of year?
  • U.S. sectors are broadly positive, expecting more divergence going forward.
    • At the stock level, breadth likely at a peak/volatility at trough.
  • Number of U.S. breakouts back above normal level for first time in five months.
  • Number of U.S. of favored growth stock ideas back at a normal level.
    • Some top picks extended, but rotation occurring and still actionable names.
  • Global index likely to pause after 10 weeks of gains.
    • 80% of markets in Uptrend.
    • Favored 2018 markets, including Brazil, India, now lagging.
    • Big recoveries in Europe and large emerging markets like China, Hong Kong, South Korea.
  • Number of global stock breakouts back to a normal level.
  • Number of favored stocks (Focus List ideas) up sharply year-to-date.
    • Wider breadth of stocks to buy, especially from Europe and China/Hong Kong.

Strategy View

Posted on by Randy Watts

Guidance from S&P 500 companies during the Q4 2018 earnings release season revealed a stark change in trend for U.S. stocks. Even though actual results for this quarter sustained recent growth trends and positive earnings surprises,
forward guidance for Q1 2019 was significantly less than pre-earnings season expectations. As a result, median S&P 500 estimates for the current quarter call for a sharp deceleration from 14% earnings growth in Q4 2018 to
just 4% in Q1 2019.

Strategy View

Posted on by Randy Watts
Key points from the report:
  • An 18% rally on the DJIA since December lows with no 5% pullback is above the 14% average (11% median) leg in a bull market dating back to 1900. One leg is a 5%+ move in either direction.
  • A leg of a 15% gain immediately following a 15% loss is very rare, occurring only four times prior to the current leg. A ~6% pullback is typical following these v-shaped recoveries.

Strategy View

Posted on by Randy Watts

Key points from the report:

S&P 500 earnings are decelerating, but the S&P’s P/E ratio has also fallen significantly given rising 10-year yields.

Given the Fed’s pause, if yields continue to come off highs, P/E ratios could see moderate expansion once again.

A 6%+ gain since the January 4 follow-through day on the S&P 500 is in line with the average of second follow-through days, which have worked to continue past bull markets.

The S&P 500’s 7%+ gain in January was only the fifth time since 1970 when a 7% monthly loss was followed by a 7% monthly gain.

The four (1974, 1987, 2002, 2009) other instances ended prior bear markets, and one (2011) ended a large market correction.

Forward gains once this precedent is established are well above average for the next six months. An S&P 500 gain of >5% in January (nine prior instances since 1970), similarly leads to a well above average next six-month period.

Technical setups are much improved, with all indices and sectors above 50-DMA. Tests of the 200-DMA are looming for sectors and a majority remain more than 10% off highs. Breadth is also better, and recent actionable Focus List additions include NOW, CREE, BA, NEWR, FISV, DXCM.

Strategy View

Posted on by Randy Watts

Key Points:

Q4 sales and earnings growth is set to slow from the first three quarters of 2018 after downward revisions in nearly every sector over the past 90 days.

Median sales estimates of 4% and EPS estimates of 11% for S&P 500 companies would be slowest in seven and six quarters, respectively.

Median EPS estimates have fallen 2% in 90 days for the S&P 500 and 4% in 90 days for the S&P 600.

Index and sector trends heading into earnings are much improved (all major indices in a Confirmed Uptrend), however, the overhang of downward-trending moving averages and, in most cases, 10% or more before new highs remains.

U.S. Focus List count of mainly highly-rated growth stocks is up from a low of 24 in December to 30 but remains below the healthier total of 40+. We are hopeful earnings season will be better than anticipated and will result in a substantial increase in the number of stocks on our list.