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

Q3 2018 U.S. Market Preview:

After some rocky moments this winter, U.S. equity markets are now performing positively. Year-to-date, the Nasdaq (+11.6%), small-cap S&P 600 (+11.0%), and Russell 2000 (+9.6%) indices have been the clear leaders. But the DJIA (+2.5%) and S&P 500 (+4.3%) indices are now positive for the year as well after solid quarter-to-date gains. The broadening of the market to include small-cap stocks and other sectors besides Technology and Retail, including Consumer Cyclicals and Transportation, is a bullish sign for investors. Still, U.S. equity markets have uncertainties to deal with. The first, detailed in our Strategy View dated June 6, is the likely slowing of U.S. corporate earnings growth over the next year as quarterly comparisons toughen given this year’s new tax bill and lower corporate tax rates. Second, the Federal Reserve continues to tighten financial conditions
and is now expected to raise the Federal Funds rate four times in 2018. Finally, as shown in the bar chart below, U.S. markets are entering the historically weakest quarter of the year. From 1970 to present, Q3 U.S. equity returns have been, on average, the weakest of the year, with the S&P 500, DJIA, Nasdaq, and S&P 600 posting negligible positive returns and the Russell 2000 posting losses.

Strategy View

Posted on by Randy Watts
Key Points:

Q1 2018 Earnings Review

  • S&P 500 companies: Median +9% sales and +22% EPS growth. Second-best revenue surprise (+1.7%) in eight quarters and best EPS surprise (+4.9%) in six years.
    • Best growth in Energy, Cap, Tech, Retail sectors.
  • S&P 600 companies: Median +9% sales and +17% EPS growth.
    • Best growth in Energy, Cap, HC, Transports.
  • USFL earnings: 27 of 72 with sales/EPS growth acceleration. All but nine beat on revenues and all but six beat on EPS.
    • 20 stocks with sales/EPS acceleration, sales/EPS beat, and positive reaction to earnings. Of these, BABA, CRM, SCHW, TCBI, UNH, VEEV are actionable now.

2019 Earnings Deceleration

  • With big 2018 jump, 2019 S&P earnings to decelerate (~+18% to ~+10%), a risk to be aware of next year.
  • Since 1960, 14 instances of similar deceleration (see below).
    • Average 7% annual gain in decelerating year, versus 14% year before.
    • Four years of negative returns in 14 periods (1974, 1977, 1994, 2000).

Strategy View

Posted on by Randy Watts
Key Points:
  • We think the Russell 2000 may be due for a catch-up period after underperforming the S&P 500 by 1,700bps from 2011-2017 (lagged NDQC by 6,400bps). Prior outperformance cycles lasted 2-3 years.
  • YTD, the Russell 2000 has taken the clear lead, highlighted by a break to all-time highs late last week. Further, both the Russell 2000 Growth and Value indices are at highs.
  • Fundamentals seem to back the move. Russell 2000 earnings stagnated from 2012-2016. After a pickup to double digits in 2017 EPS growth, 2018 EPS growth is set to accelerate sharply. Growth is likely to outpace S&P 500 growth this year and next year for a couple of reasons:  

 #Median tax rates of 29% for Russell 2000 companies set to drop to around ~20%. This is a bigger drop than for S&P 500 companies.

#A much higher proportion of Russell 2000 companies are turning from negative EPS to positive both this year and next compared with the S&P 500. This is true in Industrial, Energy, and Cyclical sectors, where growth is also higher at the median than the S&P 500.

Strategy View

Posted on by Randy Watts

Key Points:

Four global investment themes currently in favor:

 

  1. China Education – Private education revenues set to rise by ~50% over next four years, according to Frost & Sullivan.
    1. Top Ideas are

      Education (

      ) – aggressive entry above $38; and China Maple Leaf Education ( MAPZ.HK) – extended, hold shares

  2. Indian Financials – For FY18, five Focus List names generated average loan growth of 25%, average EPS growth of 25%, average ROE of 22%, and gross NPA of less than 1.3%.
    1. Top Ideas are Kotak Mahindra Bank ( KOK.IN; KMB IN) – 8% above pivot, hold shares; Indiabulls Housing Finance ( IEZ.IN; IHFL IN) – consolidating; GRUH Finance ( GRU.IN; GRFS IN) – testing all-time highs, hold shares
  3. China Clean Energy – Natural gas, wind, solar, hydroelectric, and biomass rose to 20.8% of the total energy consumption in 2017, from 19.6% in 2016. Wind and solar capacity rose by 11% and 69%, y/y, respectively. The government also began a push to convert 4M households from coal to natural gas.
    1. Top picks are China Gas ( IWAI.HK; 384:HK) – actionable; and ENN Energy ( XINA.HK; 2688:HK) – extended, hold shares
  4. U.S. Crude Production Growth – Production to average 10.7 M/bpd for the full-year, before rising to 11.4 M/bpd on average in 2019, from 9.3 M/bpd in 2017. Despite supply growth, crude prices remain at three-year highs, driven by continued OPEC cuts, Iran tensions, solid demand growth.
    1. Top picks are Diamondback Energy ( FANG) – actionable; Wildhorse Resources ( WRD) – 29% above 50-DMA, trim but hold core position; Continental Resources ( CLR) – bounce off 21-DMA support, hold shares

Strategy View

Posted on by Randy Watts

Key Points:

  • In the trailing six months, since late October, the 10-year bond yield has risen by 63bps to the current 3.0%.
  • Since 1970, the U.S. 10-year bond yield has risen by at least 60bps in six months (using week-end yields) 478 times (of 2,522 total weeks). When this has happened in the past, the S&P has tended to struggle for three to six months before resuming more normal gains.

Strategy View

Posted on by Randy Watts

Global Markets

An 88 week stretch with a majority of 47 (46 until 1/1/2018) markets in a Confirmed Uptrend ended on March 19, 2018. During the stretch, the Russell Global Index gained 37% to its January peak and 30% from start to finish. For the purpose of displaying why the 50% threshold is key, we show the results of using a simple strategy of buying the Russell Global the day of a shift above 50% and selling once it breaks below.
The week of April 6, a large number of European markets had a follow-through day and were moved back into a Confirmed Uptrend. This took the percentage back to slightly above 50% where it remains currently. Since the latest shift, the Russell Global is up about 3%. We are cautiously optimistic that these gains can continue due to three factors. First, corporate earnings continue to improve, especially in the U.S. where Q1 2018 earnings season has started positively. Clients can refer to our Strategy View dated April 12, 2018 to see our expectations for Q1 2018 S&P 500 earnings. Next, while the Fed, BOJ, and ECB are all tightening, the rate cycle has been gradual and not caused any major dislocations. Finally, investor bullish sentiment has fallen from a record 17 straight weeks above 60% to the current level of 42%. As a result, we feel there is now a “wall of worry” that stocks can climb from present market levels.

Strategy View

Posted on by Randy Watts
Key Points:
  • While Q1 2018 GDP is likely to be below Q4 2017’s 2.9% GDP growth, resulting in slower revenue growth than the S&P 500’s +9% median figure from last quarter, we believe EPS growth will be equal to or better than Q4 2017’s +16%.
    • Three factors include weak dollar-boosting exports, tax reform, and higher energy production and prices.
  • EPS will likely surprise, as it has each quarter for the past six years.
  • Energy has by far the best growth estimates after having the best Q4 growth as well. Energy’s median Q1 sales and EPS are expected to grow 14% and 62%, y/y, respectively.
    • U.S. crude production hit another record of 10.5Mbd last week. Despite continued supply gains, daily average WTI prices rose 13% in Q1 2018 from Q4 and are already up another 3% in Q2 q/q.
  • Other strong expectations include Transports (7% sales, 20% EPS, driven by trucks and rails),  Retail (6% sales, 20% EPS, driven by high 2017 tax rates), and Financial (6% sales and 19% EPS, driven by regionals, investment banks/management companies, and payment processors).
  • Estimate revisions (versus 90 days ago) also strongly favor Energy. Also strong are Transportation and Retail. Cyclicals/Staples have had no net positive revisions (leisure-travel booking, media, housing, and autos have all seen negative median Q1 EPS revisions).
  • S&P 500 GAAP valuation is fairly high on a trailing 12-month basis (24x), but forward non-GAAP is reasonable, at 15x. Expect EPS, not P/E expansion, to drive market gains.
  • Most USFL earnings are over the next four weeks.
    • Actionable ideas that have reported accelerating sales/EPS growth and sales/EPS beats are OLLI, PVH, SPLK. LULU also meets these criteria but is slightly extended. Energy names CLR and WRD are also actionable with 3-4 weeks left to report.
  • Stocks from groups with weak expected growth that overlap with our laggards list include K, KHC, OMC, MET, AIG, GT.

Strategy View

Posted on by Randy Watts

Key Points:

*   Q1 2018 saw the return of volatility that investors had not seen in several years. Normally, Q1 is a positive time for U.S. equity markets.
*   Of the three major averages, only the Nasdaq is at or above its historical average for Q1. The DJIA and S&P 500 are down year-to-date.
*   Only the Technology and Retail sectors are at or even near their historical averages for Q1. We would like to see more sectors turning positive before we feel more confident in the market outlook.
*   Q2 in the second year of a presidential term is historically much weaker. Only Consumer Staples, Healthcare, and Retail have posted average positive returns in Q2 of the second year of a presidential cycle. All other sectors are down, with Transportation, Financials, Utilities, and Technology performing the worst. This poor performance is magnified even more if it is the second quarter of the second year of a first-term president, as is the current case.

Strategy View

Posted on by Randy Watts

Key Points:

  • The U.S. market is back in an Uptrend Under Pressure, with high volatility and continued narrow sector leadership adding to risk.
  • A majority of 47 global markets are in a Downtrend for the first time since July 2016.
  • We want to see better breadth and improvement in global conditions to become more aggressive. If/when this happens, these are a few multi-year themes from which we think leadership will continue:
    • Growing Semi Content in Autos: ON Semi ( ON ), Sunny Optical ( SOPT.HK; 2382:HK )
    • Growing Chinese Bio-Pharmaceutical Industry: Livzon Pharma ( LVZN.HK; 1513:HK ), 3SBio ( SBIL.HK, 1530:HK )
    • Evolving Digital Payments Landscape: Paypal ( PYPL ), Pagseguro ( PAGS )
    • Transition of Legacy Software Systems to Cloud: Atlassian ( TEAM ), Splunk ( SPLK )
    • Digital Video Game Distribution: Nintendo ( NNDO.JP; 7974:JP ), Activision Blizzard ( ATVI )
    • Low-Cost Airlines in Emerging and Frontier Markets: Jeju Air ( JJU.KR; 089590:KS), Azul ( AZL.BR; AZUL4:BZ )

Strategy View

Posted on by Randy Watts

U.S. equity markets have continued their upward trajectory after a brief correction in February. The Nasdaq remains the leading index year-to-date, up 9%, versus a 3% gain for the S&P 500 and 1% for the DJIA. While the market status remains an Uptrend, we are concerned by the recent increase in distribution days (five on the Nasdaq and four on both the S&P 500 and DJIA) and the lack of impressive accumulation volume on the indices. Also, the breadth of leadership is relatively narrow, although it has improved somewhat in the past couple of weeks.