by Ed Elfenbein | August 11, 2012 8:00 am
In this week’s CWS Market Review, we’ll take a closer look at what could be the end of Wall Street’s huge defensive rotation. Plus, we’ll preview Sysco’s (NYSE:SYY) earnings report. SYY currently yields a hefty 3.76%, and I’m expecting them to increase their dividend for the 43rd year in a row. Not many stocks can say that. But first, let’s look at the new mood on Wall Street.
On July 26th, ECB President Mario Draghi dropped a bomb on world markets when he said: “Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.”
Heavens to Murgatroyd! Central bankers aren’t supposed to speak in such dramatic tones. I mean, that’s just not done. Of course, the worry is that if he thinks there’s a reason to say “believe me,” that must mean that there are plenty of folks who, in fact, don’t believe him.
But any reason for doubt shouldn’t rest solely with Mr. Draghi and his level of commitment. For one, Draghi seems to be blurring the lines between monetary policy and fiscal policy. Plus, we still have to contend with the familiar question: “Will the Europeans set aside their bickering and do what it takes to save the euro?” As always, the Europeans appear to be a quintessential “hot bed of cold feet.”
The Germans, for example, are very much opposed to more bond buying. If anything, their opposition seems to be growing. If a new bond buying program does start — and it most certainly will — it will only be for countries in the periphery and after a formal request.
But let’s turn back to Mr. Draghi’s remarks. I’ll give him credit for one thing — he shook up the markets. Long-term bonds in Italy and Spain have rallied, and stock markets there have come back to life. The day before Draghi spoke, the Spanish 10-year yield peaked at 7.751%. Recently, it’s been below 6.8%.
The effect isn’t just in Europe, but it’s being felt in the U.S. as well. Here’s what you need to understand: Investors are creeping away from their tightly-held defensive posture and they’re slowly taking on more risk. Just look at the U.S. bond market: The yield on the 10-year Treasury jumped from an all-time low of 1.39% on July 24th to 1.69% on Thursday.
I thought it was interesting that the U.S. Treasury had a lousy auction this week for a fresh batch of 10-year bonds. The auction had the lowest big-to-cover ratio in three years. Perhaps investors have finally grown weary of ultra-low risk.
Before Draghi’s remark, investors were shunning risk at every chance. I mentioned last week’s how dramatic the defensive posture had become. Consider that from July 5th to August 1st, the Russell 2000, which is a gauge of small-cap stocks (think “higher risk”), dropped by 5.7% while the S&P 500 managed to make a small gain. No one wanted anything with a hint of risk. But since August 1st, the tables have turned. The Russell has gained 4.1% which is more than double the S&P 500.
The move toward offense can also be seen with the highest-yielder on our Buy List, Reynolds America (NYSE:RAI). The stock soared to a new high but dropped 90 cents per share on Tuesday. That’s a very big drop for a stock like Reynolds. I think it has less to do with the company’s business outlook, which is fine, than with the fact that investors are searching for growth opportunities. We’ve also seen key defensive sectors like Healthcare (NYSE:XLV), Utilities (NYSE:XLU) and Consumer Staples (NYSE:XLP) trail the market in recent days.
It’s too early to say if this turn towards the offensive will last. For now, our strategy is to focus on high-quality stocks, especially ones that the market doesn’t get.
Speaking of which, let me say a few words about DirecTV (NYSE:DTV) and Wright Express (NYSE:WXS) because these are perfect examples of why our strategy of concentrating on high-quality stocks works.
Last week, I highlighted the market’s bizarre reactions to the earnings reports from DirecTV and Wright Express. The earnings reports certainly weren’t outstanding, but the market initially treated both stocks as if they’re in serious trouble. That’s clearly not the case.
Yet all we had to do was wait a few days as both stocks recovered. In the last six days, WXS gained 6.4% and DirecTV is on the cusp of making a new 52-week high. Wright Express is an excellent buy anytime and I’m also raising my buy price on DirecTV.
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