Bull Trap or Trend Knockout?
Current Market Outlook
Last week brought the long-awaited breakout by the major indexes, but after a couple of days at new high ground, most sank back into their prior five-plus-week ranges today; small-cap indexes even broke their 50-day lines. With that said, most indexes remain in good shape, and the same can be said about the vast majority of stocks (a bunch of which have gapped up on earnings) and sectors—in other words, the evidence remains far more positive than not. Because of that, it’s fine to take a swing at some strong stocks on pullbacks, especially those that have recently shown great accumulation. However, we’re going to leave our Market Monitor at level 7 today given the lack of progress in the indexes, and we’ll keep our eyes open should today’s selling persist.
The good news is that this week’s list is chock-full of earnings winners that should find support on weakness. Many look enticing, but our Top Pick is Skyworks (SWKS), which is one of many super-strong chip stocks that just enjoyed a big earnings gap as investors anticipate better results ahead.
| Stock Name | Price | ||
|---|---|---|---|
| Allegheny Technologies (ATI) | 27.78 | ||
| Broadcom Limited (AVGO) | 266.26 | ||
| Cheniere Energy (LNG) | 63.82 | ||
| Citizens Financial Group (CFG) | 0.00 | ||
| Eagle Materials Inc. (EXP) | 0.00 | ||
| International Paper Company (IP) | 0.00 | ||
| Micron Technology, Inc. (MU) | 43.31 | ||
| Royal Caribbean Cruises (RCL) | 0.00 | ||
| Seagate Technology (STX) | 0.00 | ||
| Skyworks Solutions (SWKS) | 0.00 |
Allegheny Technologies (ATI)
Why the Strength
Traditional steel stocks have weakened, but specialty metals firms like Allegheny Technology are doing well. As opposed to a commodity, Allegheny produces specialty products like titanium-, nickel- and cobalt-based alloys, along with certain stainless steel sheets and plates, selling them to a variety of industries including aerospace, oil and gas, electrical energy, autos and even medicals (including materials for knee and hip replacements). In recent years, the company has been transitioning heavily toward the aerospace sector—it now makes up 51% of revenue, with oil and gas contributing 9%, and everything else smaller than that. A crash in its oil and gas business and some softness elsewhere hurt business this year, but the good news is that most of the firm’s aerospace business is commercial based, and that area is in a long-term expansion phase as global airline capacity increases and new jets come online (next-generation jet engines should be a major growth driver) and the oil and gas business should rebound thanks to steady $50 oil prices. That’s why the stock is strong today—fourth-quarter results were better than expected, and management gave a positive forecast for 2017 thanks to both anticipated sales gains and the benefits from many quarters of cost reductions. Analysts see earnings of 60 cents per share this year and lots of growth beyond that. It’s an intriguing turnaround situation.
Technical Analysis
ATI hit 119 way back in 2007, with lower highs of 74 in 2011 and 46 in 2014. And then the wheels really came off, with the stock imploding to 7 early last year. A quick rebound to 18 was followed by a huge, 10-month consolidation. It wasn’t a leading stock by any means, but last Tuesday’s earnings report caused a buying eruption—ATI gapped up to its highest level since August 2015 on seven times average volume and held those gains for the rest of the week. If you’re game, you can buy around here or on dips, with a stop near 17.
ATI Weekly Chart
ATI Daily Chart
Broadcom Limited (AVGO)
Why the Strength
It was big news in May 2015 when Avago Technologies announced that it would buy its rival Broadcom for $37 billion in cash and stock. This was only the latest in Avago’s program of growing by acquisition, and created a major company in the semiconductor business. The new company, which kept the Broadcom name, but still uses the Avago stock symbol, is a global chipmaker that counts Apple and other smart phone makers among its customers. Broadcom’s revenue grew by 94% in fiscal 2016 and has booked triple-digit revenue growth in the last three quarters, with earnings growing from 26% to 31% to 41% in those quarters. Broadcom is in investors’ sights right now because of its great earnings report on December 8, and because of the firm’s latest acquisition news. Broadcom will acquire Brocade, a leader in “fibre channel storage area network switching and IP networking” for $5.9 billion. The deal will augment Broadcom’s integrated networking and storage portfolio, and the announcement kicked off another rapid rally in Broadcom’s stock. With an aggressive acquisition strategy (bolstered by a history of successfully integrating takeover targets) and positive momentum in the chip industry, Broadcom and its 2% annual dividend yield look like a solid choice.
Technical Analysis
AVGO has been in a long-term uptrend, but went flat from May 2015 through May 2016, finally breaking above resistance at 150 in June. AVGO rallied to 179 in late August, then roller-coastered until December when a good earnings report got things moving again. After consolidating its gap up for a few weeks, the stock got another boost two weeks ago from the Brocade acquisition news. AVGO looks like a reasonable buy on any dip toward 200, with a stop around 185.
AVGO Weekly Chart
AVGO Daily Chart
Cheniere Energy (LNG)
Why the Strength
Cheniere operates the Sabine Pass LNG terminal on the border between Texas and Louisiana where it has been expanding liquefaction and purification facilities, called “trains.” These trains convert natural gas into LNG. The stock has been doing well since the election, but enjoyed a big rally last week as news that several of Australia’s planned LNG export terminals won’t be up and running until 2018 or later, rather than in 2017, as had been expected. Cheniere is a major beneficiary of this, and that’s one more positive for the country’s first LNG exporter. The company’s third train (currently being commissioned) is now expected to come on line well ahead of the June 2017 target date. That news comes after the company announced it shipped 12 cargoes in December, a new monthly record. It might tie that number in January (10 shipped through 1/25, with two loading at the time of this writing). Demand in Asia has been growing (and will likely continue to if Australia is delayed), and Trump has enacted executive orders to clear pipeline developments and reduce environmental and regulatory review of infrastructure projects. All of this is good for Cheniere (though maybe not for the environment). Forward growth is massive as operations ramp up. We’re looking for 380% revenue growth in 2016 with 50% EPS growth, followed by 150% revenue growth in 2017, with 92% EPS growth. The company should be profitable in 2018.
Technical Analysis
LNG is up 100% from its February 2016 low, up 30% since the election and up 14% over the last four sessions. The stock had previously made a run above 45 in August and September, but that rally faded in October as energy prices retreated. It turned around at 35 after the election, and crossed above its 50-day line in late November (at 40). Two modest pullbacks occurred in December and January, but shares have remained above the 50-day. Last week, the stock hit a 52-week high at 50.53.
LNG Weekly Chart
LNG Daily Chart
Citizens Financial Group (CFG)
Why the Strength
Citizens Financial Group is the holding company for a string of Citizens Banks with over 1,200 branches and 3,200 ATMs in 11 states in the New England, mid-Atlantic and Midwest regions. The company was spun off from the Royal Bank of Scotland group in 2014 and came public in September 2014, but its basic structure was built by a series of takeovers of local banks during the RBS years. Citizens is now a thriving regional bank with assets of $150 billion. There’s not much that’s unique about Citizens Bank; it’s a well-run regional bank that pays close attention to expenses and customer satisfaction and pays a 1.5% annual dividend yield. The company bought back $250 million of its stock in 2015 and increased its dividend by 20% in Q2 2016. The banking industry is experiencing a renewal of interest from investors based on expectations of increasing interest rates, and Citizens is a good choice to play that move.
Technical Analysis
CFG came public at 22 in September 2014 and rallied as high as 29 in June 2015 before starting a slide that picked up speed in January and February 2016. The stock formed a double bottom at 18 in February and July, then worked its way back to 27 in November when the post-election rally kicked in, pushing CFG to 37 at the beginning of January. CFG traded as high as 38, but cooled off over the past two days to 36. With a reasonable 19 P/E ratio, CFG looks like a good buy below 37. A mental stop at 33 is prudent.
CFG Weekly Chart
CFG Daily Chart
Eagle Materials Inc. (EXP)
Why the Strength
Eagle Materials is one of many infrastructure-related stocks that rallied strongly after the U.S. election, marked time for more than a month and has now come to life. Eagle is a low-cost producer of materials that go into all construction markets—it’s a major producer of gypsum and wallboard, does good business in construction aggregates and is boosting its cement business via an upcoming buyout of Cemex’s Ohio-based cement plant. (It even has a frac sand operation, though that’s very small.) The firm has positioned itself as a low-cost producer in most of its markets, which, combined with an improving environment (last year’s Federal Transportation bill should boost demand for cement and aggregates steadily during the next few years), has led to consistent cash flow growth with some of the highest profit margins (18.6% after-tax margin in Q4!) in the industry. There remains some risk that the residential construction-focused gypsum and wallboard areas could soften if interest rates spike, but so far there’s no sign of that. In fact, in the fourth quarter, gypsum and wallboard earnings rose 12%, contributing to the company’s 27% earnings pop. The longer-term attraction is that many construction markets appear to be in the early innings of a major recovery phase, especially if the economy accelerates as many indicators suggest. Analysts see earnings rising 24% in the fiscal year that starts in April.
Technical Analysis
EXP did the big-slide-and-recovery pattern seen among most cyclical stocks in 2015 and 2016. It built a good-looking base from August through October, then surged to 103 by early December in the post-election rally. Like the market, shares then went straight sideways, found support near their 50-day line two weeks ago, and then pushed to new all-time price highs last week before dipping to end the week. We think buying here with a tight stop just below the 50-day line makes for a good risk-reward trade.
EXP Weekly Chart
EXP Daily Chart
International Paper Company (IP)
Why the Strength
International Paper is just what the name says, a maker of pulp, paper and packaging with operations in 24 countries and nearly 340,000 acres of renewably farmed forestland. The company gets nearly two-thirds of its revenue ($14.5 billion in net sales) from industrial packaging like corrugated containers, with $5 billion coming from paper and pulp sales and the rest ($2.9 billion) coming from consumer packaging. While revenue has been slipping for the past seven quarters, investors are favoring International now because the outlook for sales of both container board and market pulp are improving. Analysts say the whole packaging and paper industry is recovering from its Q1 bottom and they expect a $50 per ton increase in containerboard prices to be announced in February and implemented in the spring. International Paper’s stock boasts a nice 3.2% dividend yield. The company will release its Q4 and full-year 2016 results before the markets open on February 2. Analysts expect 71 cents per share in earnings and $5.34 billion in revenue for Q4 and $3.34 per share and $21.0 billion in revenue for the year. Note: On January 22, the largest pulp digester and power house at International’s Pensacola, Florida pulp and paper mill sustained “significant structural damage,” releasing wood fiber and pulping liquor into the surrounding community. The mill is closed as the company assesses the damage, cleans up and looking at options to meet the needs of customers. Investors will be watching closely.
Technical Analysis
IP peaked at 58 in early 2014, then corrected for a full year, bottoming at 33 in February 2016. The stock rallied in March and April, consolidated through May and June, then got another burst of energy in mid-July. Another pullback and rally left IP trading pancake flat under resistance at 55 from early December through January 20, when it caught a strong updraft and bounced higher on increasing volume. With earnings out on Thursday, it’s best to keep any initial investments small.
IP Weekly Chart
IP Daily Chart
Micron Technology, Inc. (MU)
Why the Strength
We’ve been proponents of data storage stocks over the past two months for a very simple reason—they’re cyclical and right now, the cycle is up. We’re featuring Micron again this week because the company specializes in DRAM (58% of revenue) and NAND memory (33% of revenue), and dabbles in NOR flash memory and image sensors as well. The cycle was down in 2015, and Micron suffered six consecutive quarters of negative revenue growth and seven consecutive quarters of negative EPS growth. That sobering trend ended with Micron’s fiscal Q1 2017, which was reported on December 21, 2016. Revenue was up by 18.5% and EPS was up by 10%. That result drove the stock up 10% and inspired us to feature Micron in early January due to better DRAM pricing (i.e., the end of pricing wars), success migrating customers to 3D NAND and gross margin improvement. This past week, reports from Silicon Motion, Samsung and Lam Research all suggest continued tight supply in Micron’s markets. Interpretation: Micron has been selling a lot of memory at higher margins. Our thesis is supported by recent data from DRAMeXchange showing month-over-month price increases for PC DRAM, server DRAM and NAND. The bottom line is that Micron should beat fiscal Q2 estimates by roughly $600 million in revenue and $0.06 on EPS. Analysts are upgrading. We’re still bullish.
Technical Analysis
MU reached 36 at the peak of the last cycle, but dove to 10 in early 2016 during the bottom. The recovery gained steam after the fiscal Q3 quarterly report on June 30, after which the stock rallied from 12 to 18 over three months. A consolidation period lasted through early November, then shares got moving again, and the December 21 earnings release drove a gap up to 23. Shares pulled back in early 2017, then jumped last week from 22 to 24 upon evidence of pricing/margin improvement. We think you can buy MU here and set a stop just below the 50-day line.
MU Weekly Chart
MU Daily Chart
Royal Caribbean Cruises (RCL)
Why the Strength
There is a group of generally cyclical stocks that are strong today because (a) they were hit hard during the past year or two as investors anticipated earnings declines, but (b) that decline never came and now business is motoring ahead as the economy accelerates. That’s the basic reason Royal Caribbean is strong today—the stock remains below where it was at the start of 2016 but earnings continue to crank ahead, last week’s fourth-quarter report was encouraging, and management issued a bullish outlook for 2017. The company, of course, remains one of the largest cruise ship operators in the country, with 25 ships that visit 77 port countries. Revenues have been growing slowly (partially held back by currency movements), but the top brass has done a great job keeping costs in line (fourth-quarter cruise costs were up 0.3% excluding fuel), helping earnings to surge 31% and top expectations. Most important, the future looks bright—management said bookings are at record levels (and at higher prices than a year ago, too) and that earnings should grow toward $7 (around 15%) for the year. While currency movements and rising fuel prices can cause some volatility in the firm’s results, the stock’s valuation (16 times trailing earnings) and solid dividend (2.0% annual yield) tell you the stock isn’t exactly priced for perfection. It’s not changing the world but we think the stock will work higher from here.
Technical Analysis
RCL ran as high as 103 at the end of 2015, then crashed to 65 during the market’s early-year drop. Shares then bottomed out for many months, retesting the 65 to 70 area a few times through October. RCL rallied to the mid-80s after the election, then tightened up with the market for a few weeks before surging last week on earnings, rising 9% on more than quadruple normal volume. There’s some old resistance near 100, but we think you could buy some here or on dips with a stop in the mid-80s.
RCL Weekly Chart
RCL Daily Chart
Seagate Technology (STX)
Why the Strength
Along with Western Digital, Seagate Technology is one of the leading hard-disk drive producers, which is about as cyclical an industry you can get in the technology sector, though in fairness, as storage needs expand due to the explosion of data online, the move to cloud-based operations and the use of mobile devices should reduce cyclical swings. Seagate is strong today because, after a tough couple of years, it looks like the earnings decline is clearly over, with the December quarter blowing away tame expectations—while revenues shrank from a year ago, this was the third-straight sequential improvement, while quarterly earnings per share and after-tax profit margins scored multi-year highs. Probably the most important metric is cash flow, as Seagate had been a cash cow in recent years following the industry’s supply chain disruption in late-2011, and that’s starting to reassert itself as demand strengthens—free cash flow was $561 million ($1.90 per share), which Seagate uses to fund a healthy dividend (5.7% annual yield) and a solid share buyback program (it’s bought back 7.1 million shares during the past two quarters (a bit over 2% of the share count), which could accelerate in the quarters ahead. All told, management sounded a bullish tone on the conference call, guiding analysts toward the higher end of their profit margin range; analysts see earnings booming to nearly $4.50 per share for the current fiscal year (ending in June) and remaining around that level for many quarters after that. With a cheap valuation and a big dividend, Seagate should continue to find buyers.
Technical Analysis
The market plunge of 2015 and early 2016 coincided with a decline in Seagate’s earnings, causing STX to crash from 69 to 18. Then came the rebound, with shares showing great persistence through the end of September. A three-and-a-half-month basing process followed, with STX sitting at 37 before last week’s earnings caused a huge-volume (nearly 10 times average volume) gap up. The stock reversed a bit on the earnings day but has gained ground since. We think it’s buyable around here or on minor weakness.
STX Weekly Chart
STX Daily Chart
Skyworks Solutions (SWKS)
Why the Strength
Skyworks is an Internet of Things (IoT) play that jumped onto our radar when the company reported a Q1 beat on both revenue (down 1.3% to $914 million) and EPS (down 1% to $1.61), and authorized a $500 million share buyback program. Those results from the electronic components manufacturer aren’t earth shattering, but revenues were only up 1% in 2016 and EPS was only up 6%. This most recent quarter set the stage for 10% revenue growth in 2017 and 12% EPS growth, and that outlook has driven shares up 15% over the past seven sessions. The story behind the numbers is that Skyworks makes analog and mixed-signal amplifiers, attenuators, detectors, diodes and other components that wind up in cars, cell tower infrastructure, smart thermostats, mobile devices and medical equipment. The company sees growth in smartphone content (Samsung, Apple and a number of Chinese manufacturers, including Vivo, Meizu, Xiaomi), IoT devices (Google, Amazon, Microsoft), automobiles (connected autonomous vehicles), and 5G mobile networks. It generates around 60% of revenue from mobile devices, but that appears to be shifting with greater emphasis on IoT, auto and 5G. That’s a good thing, and with very solid net profit margin (around 33%), a dividend (1.3% yield), share buyback and 10% estimated revenue growth, there’s a lot to like with this IoT play.
Technical Analysis
SWKS had a rocky start to 2016 but gained momentum after a dip to 57 in July. From there, it had a choppy rally that topped out at 82 in October, then a consolidation phase (72 to 81) ensued for three months. Its Q1 report on January 19 appears to have caught the market off guard, especially the forward guidance (better than expected), and sent shares up from 79 to 92, initially with very heavy volume. We think this breakout can be bought, provided you set a stop above the most recent consolidation phase.
SWKS Weekly Chart
SWKS Daily Chart
Previously Recommended Stocks
Below you’ll find Cabot Top Ten Trader recommended stocks. Those rated HOLD are stocks that traded within our suggested buy range within two weeks of appearing in the Top Ten and still look good; hold if you own them. Stocks rated WAIT have yet to dip into our suggested buy range … but can be bought if they do so within the next week.
Those stocks rated SELL should be sold if you own them; they will no longer be listed here. Finally, Stocks in the DROPPED category are those that failed to trade within our buy range within two weeks of our recommendation; that’s not a bad thing, we just never got the price we wanted. Please use this list to keep up with our latest thinking, and don’t hesitate to call or email us with any questions you may have. New recommendations each week are in green.
