March 4, 2018 Weekly Stock Market Report

THE GENERAL MARKET

February Ends in Volatile Session

The week started strong, as all major benchmarks surged for the third straight session. Tech shares led Monday’s broad rally with the Dow Jones surging 399.28 points while the tech-heavy Nasdaq added 84.07 points. The S&P 500 went up by 32.30 points.

Main Benchmarks as of 03/02/2018*

*Index closing, points & percentage decrease/increase on Friday

After a great start, the three indexes closed lower the following session. When Fed Chairman Jerome Powell highlighted the strengthening economy during his congressional testimony, investors grew jittery.

For them, it’s a sign that a tighter monetary policy is forthcoming. The Dow Jones tumbled by 299.24 points while the Nasdaq Composite Index declined 91.11 points. The S&P 500 index fell 35.32 points.

By mid-week, February ended in a volatile session. The last trading day of the month saw U.S. stocks close lower, reversing Wall Street’s earlier gains. The S&P 500 and the Dow Jones logged their worst monthly performance since January 2016. Both were coming off 10-month winning streaks. The Nasdaq posted its weakest month since October 2016.

Tumultuous March Opening

Analysts said that February 2018 will be remembered as the month where fear of unrestrained inflation met with valuations well beyond historical norms. However, little did they know that March will open with the threat of a trade war.

U.S. President Donald Trump seems to be hell-bent on uplifting the plight of American steel and aluminum manufacturers. On Thursday, he announced that he was imposing a 25% tariff on steel imports and 10% tariff on aluminum imports.

Trump met with steel and aluminum executives and assured them a policy is being drawn out. The president said during the meeting, “We’ll be signing it next week. And you’ll have protection for a long time in a while. You’ll have to regrow your industries, that’s all I’m asking,”

Market reaction

The U.S. stock market tumbled following Trump’s announcement with the blue-chip Dow Jones index plunging as much as 500-points during early trading. The shares of steel and aluminum makers rallied but shares of companies in auto and airplane manufacturing as well as others fell due to worries over the would-be impact of higher costs to pay for these metals.

Trade partners’ reaction

The trade partners are shocked, if not angered, by Trump’s tariff proposal. The European Union said it will respond accordingly. China is looking at import restrictions on U.S. soybeans.

The tariffs will not hit China as hard as it would Canada. About 16% of U.S. demand for steel is served by Canada, which is the top steel supplier in the U.S. Rounding up the top 5 are Brazil, South Korea, Mexico, and Russia. China ranks 11th

Chrystia Freeland, Canada’s foreign affairs minister, responded sharply to Trump’s desire. “Should restrictions be imposed on Canadian steel and aluminum products, Canada will take responsive measures to defend its trade interests and workers”, she said. 

The market weakness continued on Friday’s morning session, with stocks opening sharply lower before rebounding later in the day. The S&P 500 managed to advance 13.58 points while the Nasdaq added 77.31 points.

The Dow Jones finished lower for a fourth straight session. The blue-chip index went down below the 25,000 mark and closed the week at 24,608.98. It is lower by 701.01 points compared to the previous Friday. 

Trump’s intention is to safeguard and help the industries regrow. The responses from the trade partners are mostly rhetoric. However, the real reckoning will come when the U.S. president finally decides to impose the steep tariffs.

AEROSPACE & DEFENSE

Two Stocks That Can Survive A Trade War

Investors are worried about the potential trade war as a consequence of the steel and aluminum tariffs. Boeing Co. and Raytheon Co. are among the companies that have low trade war exposures according to Fundstrat Global Advisors.

The companies have an identical trade war exposure of 35.2%. The group looked at their overseas sourcing as a percentage of the cost of goods sold and their exports as a percentage of sales. If the sum total of the two percentages is less than 40%, then the company has a low exposure to a trade war.

Boeing Co. (BA) $344.67 as of 03/02/2018 (+16.87% YTD)

Boeing has been steering clear of the recent market turbulence. The aerospace and defense giant was Dow Jones’ best-performing stock in 2017. BA is up 16.87%, making it the best performing stock in the blue-chip index so far in 2018.

The strong airline orders for its 737 MAX 8 and 787 Dreamliner planes are helping offset poor sales in its defense business which dropped by 7% in 2017. Boeing is expecting that sales in defense, space and security will slightly improve this year. Its commercial airplane unit is expected to contribute about 62% to the overall revenue while the service division will provide the rest.

Analysts think Boeing will continue to surge even while the broader market remains volatile notwithstanding the possibility that new Fed Chairman Jerome Powell will raise interest rates sooner than expected. They contend that the healthy demand for new commercial jets will keep Boeing flying high.

Raytheon Co. (RTN) $214.78 as of 03/02/2018 (+14.34% YTD)

Raytheon Co. is a well-run defense contractor and its shares are up 61% since the 2016 election. The company’s $25.3 billion sales represent one-third of Pentagon’s the total sales outside of the United States.

The company sells precision weapons, anti-missile systems, electronic warfare systems, sensors, and radars which makes it one of the most diversified U.S. defense contractors.

Middle East countries use Raytheon’s Patriot missile systems as their first line of defense. The system is already gaining tremendous popularity elsewhere. The radars used by Lockheed Martin for its THAAD anti-ballistic system are from Raytheon too. The system is being deployed to counter North Korean threats.

 

The company ended 2017 with a $38.2 billion backlog, up 4% from the prior year. Raytheon sees its cash from operations to grow by more than 40% in 2018, including the tax reform benefits.

CONSUMER NON-DURABLES (Beverages: Alcoholic)

Johnnie Walker Transforms into Jane Walker

Diageo PLC (DEO) $132.79 as of 03/02/2018 (-9.07% YTD)

Liquor giant Diageo PLC, the maker of Johnnie Walker whiskey, is going to make a major logo makeover this March. The global leader among booze conglomerates will launch a special edition of its Black Label blend this month. For the first time in its 200 year history, the company will replace the iconic top-hatted striding man on the label with a top-hatted striding woman named “Jane Walker.”

Besides Johnnie Walker whiskey, Diageo is also the maker of Smirnoff, the world’s top-selling vodka and Bailey’s, the world’s top-selling liqueur. Diageo grew by 18% last year, outpacing many competitors.

DEO has not been performing well in 2018. The stock is down by 9.07%. After mid-February, DEO has never gone beyond the $140.00 mark. This week, the stock declined in each of the trading sessions. It finished the week lower at $132.79.

Besides Johnnie Walker whiskey, Diageo is also the maker of Smirnoff, the world’s top-selling vodka and Bailey’s, the world’s top-selling liqueur. Diageo grew by 18% last year, outpacing many competitors.

Back in 2016, the U.K.-based alcoholic beverage producer launched the “Keep Walking America” campaign. This year will see the latest part of that campaign. However, some women took to social media to express their displeasure.

The company said in a statement, “As a brand that has stood for progress for nearly 200 years, Johnnie Walker is proud to take this next step forward by introducing Jane Walker as another symbol of the brand’s commitment to progress.”

Some women took to social media to express their displeasure. They said that the change is just a mere marketing strategy to boost sales and that Jane Walker is not a symbol of gender equality.

250,000 special edition bottles will be available in the U.S. this month March and sell for $34 per bottle. Its release is timed for the Women’s History Month and International Women’s Day.

Diageo will donate $1 for every bottle of the Jane Walker Edition, up to a limit of $250,000. Women’s rights organizations will be the recipients of the donation. Johnny Walker will also donate an additional $150,000 to the Elizabeth Cady Stanton and Susan B. Anthony Statue Fund. Both are petitioning for a suffragette monument in Central Park.

The Struggle Continues to Brew

Boston Beer Co. Inc. (SAM) $164.55 as of 03/02/2018 (-13.98% YTD)

Shares of Boston Beer Company continues to struggle since the company reported its 4th quarter earnings last February 21. SAM took a spill and dropped 13.6% due to the disappointing results that missed estimates on both top and bottom lines.

The stock price was at $193.25 prior to reporting then fell sharply to $166.90. SAM continued its slide this week, closing at $163.05 by mid-week. The stock inched up slightly to finish the week at $164.55.

Investors are concerned at the ongoing weakness of its core Samuel Adams and Angry Orchard brands. But the brewing specialist remains upbeat about improving industry trends and continuing cost reduction measures that they’re predicting a return to growth later this year.

The maker of Sam Adams has been losing market share to craft beer. Revenue fell by 5.9% to $206.3 million which missed expectations. Looking at the bottom line, earnings per share adjusted for a tax gain came to $0.84, down from $1.75 a year ago and below the expected $0.94. that analysts had expected. The major factor that depleted profits is the 27% increase in advertising expenses.

Chairman Jim Koch said: “Although still negative, total company depletion (distributor sales to retailers) trends showed continued improvement during the last quarter. We are still seeing challenges across the industry, including a general softening of the craft beer and hard cider categories, more and more start-up brewers opening their doors, and retail shelves that offer an increasing number of options to drinkers.”

Dave Burwick, the former CEO of Peet’s Coffee, has been named CEO last week. He was hired to lead the beer brand’s comeback. The outlook for this year indicated some improvements. Depletions and shipments growth are expected to hover anywhere from flat to up 6%. A modest improvement in gross margin is also predicted.

The company is also planning to increase spending on advertising and on general and administrative expenses. This move could backfire if sales don’t improve.

The new CEO has a tough job ahead and would need to contend with the current trends and consumers’ shift to smaller craft brewers. An added threat to Boston Beer and the industry as a whole is the legalization of marijuana.

Boston Beer is not the only brewer that considers legal cannabis as a “risk factor” to beer sales. Molson Coors Brewing Co. (TAP) and Craft Brew Alliance (BREW) are concerned about the potential impact when recreational marijuana is legalized. 

Molson Coors is already suggesting that although the would-be impact is still unknown, the emergence of legal cannabis in certain U.S. states and Canada may result in a shift of discretionary income away from beer products or a change in consumer preferences away from beer.

If legal marijuana would cause a shift in consumer preferences away from beer or its consumption declines, it could have an adverse effect on the beer business and material impact on financial results.

BIOTECHNOLOGY

Global Fund Sees Buying Opportunity in Biotech

Oppenheimer Global Fund, the awardee of the 2018 U.S. Thomson Reuters Lipper Fund Award in the global large-cap growth fund category, said on Tuesday their focus would be biotech stocks. According to Rajeev Bhaman, portfolio manager of the $11.8 billion fund, the recent volatility in the global market opens a buying opportunity in the biotechnology sector.

Biotech Sector vs S&P 500 YTD Comparison Chart 

They see little impact of rising interest rates on biotech stocks because investors in the sector are more focused on the long-term potential of their drugs. Investors are slowly moving away from companies perceived as risky in light of anticipations the Feds will raise interest rates at least three times in 2018.

Value-oriented investors are focused on companies that have a strength that has not yet been recognized by the market. Biotech firms such as Bluebird Bio Inc. (BLUE)Ionis Pharmaceuticals Inc. (ION), and Sage Therapeutics Inc. (SAGE) have excellent potentials.

The drugs of these biotechs can have multiple uses rather than pinpointing a specific ailment.  “We look for things that have multiple ways to win once a proof of concept is worked out, so you have multiple shots at the apple,” Bhaman said.

Many institutional investors have increased their stakes in Bluebird Bio. The American International Group Inc. increased its stake by 9.6% during the 4th quarter. Other large investors like American Century Companies Inc., BlackRock Inc., Eagle Asset Management Inc., Frontier Capital Management Co. LLC, and Schwab Charles Investment Management Inc. also recently increased their positions.

Ion Pharmaceuticals, the pioneer in RNA-antisense technology, just saw its first commercial stage product Spinraza finish a record-breaking rookie season. The FDA has started reviewing Ion’s applications for two new drug candidates that could deliver nine-figure sales.

SAGE is not without institutional investors. Capital Fund Management bought shares in the fourth quarter. Other institutional investors like Ameritas Investment Partners Inc., Envestnet Asset Management Inc., First Mercantile Trust Co., Fortaleza Asset Management Inc., and Zurcher Kantonalbank Zurich Cantonalbank also recently modified their holdings.

THE WEEK AHEAD

U.S. stocks are moving up and down following the 10% correction to start February. Investors were trying to assess the positive economic data against increasing policy and interest rate uncertainties.

Many still maintain a positive outlook because the improving fundamentals of economic and earnings growth can support rising stock prices over time. The market’s weakness this week could be an opportunity for long-term investors to buy quality investments at lower prices.

 

While U.S. corporate profits are on track to achieve a growth of almost 20% this year, investors are also struggling on how to value those profits with price-to-earnings estimates. The issue of valuation resurfaced due to the rise in interest rates and bond yields, and concerns about increasing inflation.

Next week, the main focus of investors would be the U.S. employment report for February on Friday, March 9. It could be the test for equity valuations. The unexpected wage gains in January ignited inflation worries which in turn prompted the jump in yields and stock prices to drop.

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