Portfolio Review: January 25, 2016


You're not the only one feeling queasy

Ever been seasick? This phenomenon occurs when the movement our eyes observe doesn't jibe with what our inner ears and neural receptors sense.

That confusion, which tends to occur when waves get rough, can cause dizziness and nausea. Sounds like what we've seen in the market lately. The Dow Industrials have fallen more than 1,600 points (9.5%) so far this year, but the decline doesn't tell the whole story.

• In each of the first two calendar weeks of 2016, the Industrials fell more than 2%; we last saw such wretched back-to-back performance in 2011.

• The average's 6.8% decline in the first week of the year was the worst week in more than five years.

• Both the Industrials and the S&P 500 Index are testing August lows, just as earnings releases start to roll in.

The Dow Theory turned bearish Jan. 6, and at the moment we're holding 21% to 24% of our buy lists in a short-term bond fund. A negative reaction to earnings reports would probably spur us to raise more short-term reserves.

Cold winds shake bank shares

December-quarter earnings per share rose at many of the largest U.S. banks, as executives augmented meager sales growth with cuts to operating expenses. Most banks reported healthy loan growth and expressed optimism about continuing economic expansion. At the same time, some large banks increased their loan-loss provisions to backstop potential trouble in the energy sector.

J.P. Morgan Chase ($56; JPM) earned $1.32 per share in the December quarter, up 11% and $0.07 above the consensus. The bank's profitability primarily benefited from a 7% decline in noninterest expenses and 41% lower legal expenses. Revenue crept 1% higher to $23.75 billion, also ahead of the consensus. Sales growth from consumer banking (up 2%) offset slight declines in revenue from commercial banking, asset management, and investment baking. J.P. Morgan set aside $124 million for potential defaults on energy loans and said it would boost reserves by $750 million if oil stayed at $30 a barrel for 18 months. J.P. Morgan is a Long-Term Buy.

U.S. Bancorp's ($39; USB) December-quarter earnings per share held flat at $0.79 excluding special items, matching the consensus. Revenue, up 1% to $5.21 billion, exceeded analyst expectations. The bank's average total loans rose 4%, driven by 10% growth in commercial loans and 12% growth in automobile loans. Like J.P. Morgan, U.S. Bancorp said net interest margin rose from September-quarter levels. U.S. Bancorp is a Long-Term Buy.

Wells Fargo ($48; WFC) said per-share profits inched 1% higher to $1.03 in the December quarter, easing past the consensus by a penny. Revenue increased 1% to $21.59 billion, missing the consensus, on modest growth from each of Wells Fargo's three units: wholesale banking, community banking, and wealth and investment management. Unlike J.P. Morgan's mortgage business, which suffered a 10% revenue decline, Wells Fargo's mortgage-banking sales grew 10%, as the volume of home loans rose 7%. The company raised its reserve for bad loans more than 70%, while trying to assure investors that more than 90% of its oil and gas loans were current on interest payments at the end of 2015. Wells Fargo surpassed Citigroup ($40; C), moving into third place among U.S. banks for total assets. Wells Fargo is a Buy and a Long-Term Buy.

With few exceptions, bank stocks have slumped on earnings reports. The S&P 500 Financial Sector Index is down 12% so far this year, versus the index's overall 9% decline. Shares of big banks have generally fared even worse, perhaps due to concerns that volatility in global markets will cause the Federal Reserve to raise interest rates at a slower pace than previously thought, prolonging the industry's tepid growth.

Corporate roundup

Apple ($97; AAPL) has asked India's government for permission to open retail stores and sell its products over the internet. Apple currently sells its iPhone and other devices through Indian-owned distributors and retailers. India is projected to overtake the U.S. as the second-largest smartphone market by 2017. Apple currently has less than 2% of India's smartphone market. Apple is a Focus List Buy and a Long-Term Buy.

Comcast ($54; CMCSa) has begun to shrink the size of its basic cable package by moving several networks to premium tiers. The move is designed to keep down the cost of subscribers' bills and slow the pace of cord-cutting, though it has also angered Viacom ($41; VIAb) and other content providers. In other news, Comcast's NBCUniversal said advertising sales for the 2016 Summer Olympics in Rio de Janeiro should exceed sales from the 2012 London Olympics, which totaled $1.3 billion. Comcast is a Focus List Buy and a Long-Term Buy. Viacom is rated B (average).

CSX ($22; CSX) reported earnings per share of $0.48 in the December quarter, down 2% but $0.02 above the consensus. Revenue fell 13% to $2.78 billion. With volumes down 6%, management described a "freight recession." For the coming year, CSX expects the strong U.S. dollar to hurt international freight, and it anticipates lower demand for transporting materials in all industries except automobiles and housing. CSX is rated B (average).

In an interview with The Wall Street Journal, John Skipper, president of Disney's ($93; DIS) ESPN, blamed the network's subscriber losses primarily on consumers trading down to smaller cable packages. He says the lost subscribers tended to be older, less affluent, and uninterested in sports. As a result, the lower subscriber numbers have yet to hurt ESPN's advertising revenues or ratings, as the lost customers weren't likely to watch ESPN in the first place. Although ESPN has no intention of abandoning the cable-package model, Skipper says ESPN is considering offering direct-to-consumer packages for individual games or entire seasons. Disney is a Long-Term Buy.

In 2011, Wal-Mart Stores ($61; WMT) began to expand in urban areas with its smaller Walmart Express stores. But these stores proved less profitable than the big supercenters, and Wal-Mart is abandoning the strategy, closing all 102 Express locations. Wal-Mart said it will shutter 269 stores in all, including 154 in the U.S. and 115 in Latin America. The company does plan to open more than 300 stores in the fiscal year ending January 2017, so the closures look like a slowdown, rather than a full retreat. Wal-Mart Stores is rated A (above average).

Sizing up semiconductors

F5 Networks ($90; FFIV) earned $1.73 per share excluding special items in the December quarter, up 12%, and $0.13 above the consensus estimate. Sales grew 6% to $489 million, also ahead of analyst expectations. For the March quarter, F5 sees per-share profits rising 1% to 3% to $1.61 to $1.64; the consensus stood at $1.68 at the time of the announcement. Management expects sales to rise 2% to 4%, below the consensus target of 6% growth. Known for its conservative guidance, F5 remains a Buy and a Long-Term Buy.

Lam Research ($70; LRCX) does not report December-quarter results until Jan. 27, but two industry bellwethers offered a glimpse of what may be in store for the semiconductor-equipment maker. Intel's ($30; INTC) December-quarter earnings held flat at $0.74 per share, topping the consensus by $0.11. Sales rose 1% to $14.91 billion as Intel coped with the ongoing decline in personal-computer sales and slowing growth from data centers. Taiwan Semiconductor Manufacturing ($21; TSM) reported 9% lower December-quarter profits, which exceeded analyst estimates and caused its shares to rally.

More important to Lam is the capital budgets of these key customers. Intel now expects 2016 capital spending of about $9.5 billion, down from $10 billion it projected in November. Taiwan Semiconductor set its 2016 budget for capital spending at $9 billion to $10 billion, up 11% to 23% from last year. Taiwan Semiconductor accounts for more than 10% of Lam's annual revenue. Intel and Taiwan Semiconductor each generate more than 10% of KLA-Tencor's ($65; KLAC) revenue; Lam agreed in October to acquire KLA for $10.6 billion. Lam is a Buy and a Long-Term Buy. Intel is rated A (above average).

Nvidia ($27; NVDA) and Alibaba Group ($69; BABA) formed at $1 billion partnership to work on projects involving cloud computing and artificial intelligence. Nvidia is a Long-Term Buy.

Qualcomm ($46; QCOM) formed a $3 billion joint venture with Japan's TDK that will supply components for smartphones, drones, and other wireless devices. The move could put Qualcomm into closer competition with Skyworks Solutions ($62; SWKS). Skyworks is a Buy and a Long-Term Buy. Qualcomm is rated B (average).

Rank Changes

No changes were made this week in Dow Theory Forecasts.

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