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

Q4 2017 Earnings Preview

Similar sales and EPS growth expected in Q4 versus Q3 for the S&P 500 and most sectors. But, consistent upside EPS surprises over six years are likely to continue. Assuming normal beats (+3%), about 11-12% EPS growth expected, versus 9% in Q3.

Energy, Materials, Tech, and Retail have best sales/EPS growth estimates.

Jan/Q1 Market Seasonality

Typical January pause or weakness following strong prior year has been absent thus far. Tax reform is likely offsetting this historical pattern, p.6

Overall, Q1 is usually good following a strong prior year, but investors should note that the first quarter of the second year of a presidential cycle normally has muted returns.

2018 Outlook, YTD Performance/Current Trend

From 2010–2018, Energy and Materials have drastically underperformed versus their own longer-term averages and versus all other sectors. We think this has a good chance to change in 2018, especially given the positive earnings outlook for the two sectors and recent relative price improvement.

Our picks from the two sectors are FANG, CDEV, JAG, COG, NBLX, NEP, EXP, USCR.

All major indices are at 52-week and/or all-time highs. The Nasdaq has resumed outperformance. On a style basis, large growth has also resumed outperformance.

There has been a sharp increase in the number of actionable names on our U.S. Focus List in the first two weeks of 2018. Buyable names include ATVI, PYPL, NFLX, CDEV, RNG, VRTX, ZION, WAL, BABA.

U.S. Focus List Earnings

Financials will kick off earnings season next week (MS, SCHW, GPN). The heaviest earnings weeks are the second and third weeks in February.

Especially favorable companies on our list are those that expect sales/EPS growth acceleration. These include NFLX, EXP, SIVB, ILMN, AMZN, TYL, GRUB, NBLX, AMAT, PRAH, COG, RP, USCR, AVGO, RHT, JAG.

 

Strategy View

Posted on by Randy Watts

Low distribution across the major indices and strong price action in both indices and growth stocks means we are still bullish.

What to Buy Now: Activision Blizzard (

), Broadcom (

), Diamondback Energy (

), Eagle Materials (

), Estee Lauder (

), Facebook (

), Fidelity Natl Info Svcs (

), Jagged Peak Energy (

 

), Global Payments (

), Illumina (

), Nextera Energy Partners (

),

Semiconductor (

), RingCentral (

), Servicenow (

), Texas Capital Bancshares (

), Tyler Technologies (

), Vantiv (

), Western Alliance Bancorp (

), Zayo Group (

), Zions Bancorp (ZI

)
Most Recent Focus List Addition: Jagged Peak Energy (

‘>

 

)

1.  Moving into 2018, risks to be aware of include:
Higher interest rates
Historically high market valuation
Extended period with no market correction
Extreme lows in volatility
Extreme highs in investors advisor and retail investor sentiment
High hedge fund leverage

Investment Strategy: Winners from Tax Overhaul

Posted on by Randy Watts

Key points:

  • We do not think the potential positive boost to earnings from the lower corporate tax rates from the tax overhaul are fully discounted in the U.S. equity markets.
  • Companies with businesses that are primarily domestic focused tend to have higher tax rates on average. Similarly, small cap stocks, which are generally more U.S. centric, could see strong earnings revisions if the Tax Bill passes.
  • Energy currently has the highest corporate tax rate and would see major relief. Technology, on the other hand, has the second lowest and would not have as large earnings revisions.
  • If the Tax Bill passes in its current form, Wall Street consensus is that S&P 500 earnings estimates may rise by as much as $10. That would take 2018 EPS from roughly $146 per share to $156 (+19% y/y).

Strategy View

Posted on by Randy Watts

Q1 2018 Market Preview
As an investment year, 2017 is ending with a continuation of the strength it showed earlier. As of November 28, the DJIA is +19.67%, the S&P 500 is
+16.41%, and the NASDAQ Composite is +27.85%. Clearly this has been an excellent performance year for the major averages. With this in mind, we will examine the implications of this strong performance historically for the upcoming Q1 and all of 2018.
Since 1970, Q1 market averages have been second best among the four quarters across the three major U.S. indices, trailing only Q4. However, in the second year of a presidency, averages are only about half as good. Of note, Energy and Technology are the only two sectors to post negative returns during the 1970- 2017 time period. Given the strong performance both sectors have had recently, a counter-trend move may be possible in Q1 2018. In addition, Consumer Cyclical and Retail, two groups that have lagged YTD but have shown some strength in Q4, tend to perform well in the first quarter of the second year of a
presidency.

Strategy View

Posted on by Randy Watts

Some highlights from the report:

  • With 90% of S&P 500 companies having reported Q3 earnings, median sales growth of 6% is in line with Q2, while median EPS growth of 9% decelerated a bit from 11% in Q2.

o   Health Care and Retail are the two sectors that showed median acceleration in both sales and EPS growth. Financial showed slight sales growth acceleration but slight EPS growth deceleration.

o   Tech had another great quarter, with the second-best median sales growth (7%) and tied-for-best median EPS growth (13%).

  • EPS surprises: As expected, the median surprise was about 3%, in line with the last six years. Energy (+9%) and Tech (+6%) had the best median surprises.
  • Day-of Reactions: Reactions to earnings were not great, about flat across all companies. Despite growth acceleration, Health Care and Retail had the worst reactions. Cyclicals and Energy had the best reactions, possibly attributed to outsized EPS beats.
  • Looking at our U.S. Focus List, companies that reported sales/EPS growth acceleration, sales/EPS beats, and reacted positively on the day of earnings include: WING, CDEV, OLED, EL, SIVB, GOOGL, ALGN, MPWR, ABMD, RHT, PYPL, PRAH, NOW. Those highlighted in green remain buyable.
  • Other actionable names include BABA, AMZN, ADSK, AVGO, COG, SCHW, COR, ESNT, FB, FIVE, FLT, GPN, ILMN, MB, MS, NFLX, QTWO, RP, SKX, SWKS, TNET, WB, WAL.

Strategy View

Posted on by Randy Watts

Remain bullish and be prepared to be quick.

U.S. equity markets’ current rally is reaching historic levels. Presently, we remain bullish given that we follow a discipline based on quantitative and technical measures. While the bull market may be starting to get long in the tooth, the final phase may produce strong gains that we want to capture. Furthermore, we believe our method of identifying stock market distribution and technical failure will allow us to exit positions before pullbacks from the peak are too great. As of November 3, the S&P 500 has only one distribution day and the NASDAQ has only three. Generally, if the major U.S. indices were to experience distribution day counts greater than seven, especially if this occurred over a period of 25 trading days or fewer, then we would likely become more cautious. It is important to remember that distribution can occur in a rising market if money flows are to the downside. However, for now, investors should stay positively inclined and invested.

Slow and Steady Wins the Race

In terms of performance, the current bull market (defining -25% from highs as the end of a bull market) is the fifth-best on record since 1903, rising 263%. This gain has occurred over 451 weeks, the third-longest stretch ever. This is atypical versus the average bull market length of 199 weeks and is now the longest rally since 1900 without a 5% correction in the DJIA.

Strategy View

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All-time performance records are in sight, but some caution is warranted.
1) DJIA Record in Sight
a. Second longest rally without a 5% correction, will become the longest if DJIA hits new highs next week, p.3–7
b. Current longest stretch, November 1994–March 1996, ended with a 6% correction, p.3–4
2) S&P 500 Records
a. October would be the 12th consecutive monthly gain for the total return index (assuming reinvested dividends). For the total return index,
this would match the two longest stretches which occurred in 1935–1936 and 1949–1950.
b. However, in the two prior 12 month periods, the S&P 500 sold off 5% and 7% respectively, in the 13th month.

Strategy View

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Q3 2017 Earnings Preview
a. Slight sales/EPS growth deceleration expected in Q3 for the S&P 500 and most sectors. But, consistent upside EPS surprises over six
years likely to continue. Assuming normal beats, about 9% EPS growth expected versus 11% in Q2, p.3–5
b. Excluding Energy (many coming from negative EPS in Q3 2017), Technology is expected to have the best EPS growth for a second
quarter. Energy and Technology have had the biggest EPS beats over the past two quarters, p.3–5
c. Q4 guidance will be key, as the expectation is for reacceleration of EPS growth in Q4, p.3–5
d. S&P 500 valuation full relative to history, so expect growth to be EPS driven instead of multiple expansion, p.6

Strategy View Report

Posted on by Randy Watts

Due to low inflation and yields, stocks still remain the best game in town. This was reflected in the first half of 2017 by strong performance in domestic and international equities. In the U.S., equity performance was stronger than normal for the first year of a presidency. The U.S. DJIA, S&P 500, and Nasdaq rose, 12%, 19%, and 11%, respectively, to recent peaks. Likewise, Asia enjoyed strong gains with the AAXJ rising over 30% to last week’s highs. In Europe, the Stoxx 600 was up about 10% through May before tapering off over the past three months. This raises three questions. First, what does typical seasonality look for the last quarter of the year? Second, when there are exceptions to these patterns, what do they normally look like? Third, given historical patterns and the current quantitative and technical patterns seen through the O’Neil Methodology lens, how should U.S. portfolios be positioned for Q4?