Weekly Portfolio Summary

Well, it would appear that the correction everyone has been waiting for has finally begun.  The breadth of the market's winners is slimmer than the most economy airplane seat, sentiment, as indicated by CNN's Fear and Greed Index is so fearful, people might be making bunkers and locking themselves away in hopes of being spared from the apocalypse.  I have to be completely honest here, despite the fact that this correction is very real, I can't help but feel like the reaction is so overdone it's a fright.  Only time will be able to tell me if I'm being smart and rational/factual, or if I'm just stone cold stupid.  Either way, I can't help but feel like the reaction is similar to that of 2008, however, the situation we're in is nothing like it, and therefore doesn't warrant the reaction.

Let's start looking at all the facts in front of us, starting with what is driving this selloff.  While the swiftest, and most painful downward moves happened the last couple trading days, this has been setting up for a little while now.  Since the beginning of the year, the market has been trading mostly sideways.  Yes, it has reached some new highs, but the S&P 500, which is a solid representation of the overall markets struggled to rise more than 3% all year long.  Inside that index, we've seen no consistent leadership out of sectors or industries either.  Every few weeks, there's a new story or narrative that forces a rotation from one area to the next.  Next, there's the consensus that the Fed must raise interest rates.  With US jobs and unemployment back at acceptable levels, wages starting to rise, and rates at near 0% it only seems logical that rates go up, right?  Well, yes and no because while these things have been going well, there is also a lack of inflation, so much so that we are seeing more of a deflationary signal from how the commodities, led by oil, have been free falling from where they were a year ago.  Falling commodity prices are generally good for our economy because so much of it is based on the consumption of those commodities, rather than the production of it.  While we do have production components, it's not going to force us into a recession.  However, there are many economies out there that do depend on commodities for its economy to stay strong, and this takes us to the fourth driver of the correction, global instability.  First it was Russia, then Greece, and now China.  All of these countries have had economic issues which generated huge amounts of fear in our own markets - be it right or wrong to do so.  The most recent selloff has been driven by how the Chinese stock market has plummeted.  We have so many companies doing business with and in China that our earnings are likely to plummet, appears to be the dominant story, and therefore earnings estimates have to go down and the valuation of stocks must go down.  Add to it a US dollar that has gained some strength this year due to faltering economies elsewhere and earnings, indeed, are feeling an impact for companies that have large amounts of international exposure.

Is everything about that really bad?  Not exactly.  I won't poo poo the downside risks to all those items, they're definitely real, but I don't think they're 20%+ real to the US stock market.  First, rising interest rates can have a slowing effect on the economy - if we were at a significant interest rate to begin with.  This economy can run well with 10 year treasuries at 5%-7% and still maintain the S&P valued at 15-18 times earnings.  There would be a pullback just on general fear that the economy will fall apart without the help of the Fed, though, before it can get better again.  Additionally, the global instability may prevent the Fed from raising rates, and/or continue to hold the 10 year down anyway.  It wasn't long ago rates were surging.  Now we're back down to where rates were in October of last year, pushing to go below the 2% mark again.  Then there's China.  Yep, they're crashing, and yes, probably have further to go.  In fact, this may lead to a country that has virtually no growth at all and it's a source of "so many people."  But how much impact does that really have on us?  On our companies?  There are companies that will take a hit due to potentially slower sales.

I've taken a lot of time talking about what has and is happening.  That leaves two questions.  The first, is what can work now?  Were the last 2 days any indication, not much, though there are stocks that tend to get hit less than others.  First are the safety stocks.  Utilities, stocks with yields above 4%, US based retailers and restaurants, healthcare, and finally housing stocks.  Many of these are getting hit lighter than the rest of the market and are the most likely to bounce more strongly when things turn. The second question is what could happen in the next couple months?  That seems like a really open ended question, but let's break it down just a little.  We'll start with the Fed.  They could raise rates in a couple weeks, if that happens, I feel it's safe to say the market has this event priced in already and then some.  At the same time, financials may get a pop considering the recent beating they've taken.  On the other side, if a hike doesn't happen, you could see the dollar weaken and that would cause industrial and global companies to show signs of strength.  The downside to the financials would be mostly priced in already, though they likely wouldn't have much reason to go higher either.  Healthcare stocks would be a safe zone regardless, and yield alternative stocks (MLPs, CPG companites, other high yielders) would see reason for more up side.  The second potential event would be China making some sort of drastic move to stop the decline in stocks (in a positive way), and stimulate growth.  This would likely cause tech and many international companies to rebound.  You would also see commodities stabilize, as projected demand for those materials would be seen as having a floor. 

I will do my best to take time to talk about where each stock sits in these scenarios so I properly call out the forward potential and the risks associated with it.


Notes:
Stock Ratings: 1 = buy at current stock prices, 2 = buy on a 5-10% dip in stock price, 3 = sell on a 5-10% increase in stock price, 4 = sell at current stock prices to raise cash. Ratings are based upon 12-18 month outlook on stock direction and not necessarily related to moves I make due to financial positioning.


Ones:
Citigroup (C, 53.60) - The stock has been crushed in line with the decreasing value in the 10 year interest rate, which again approaches 2%.  Being an international financial company, its primary risks are the interest rates and strength in the US dollar.  If the Fed raises rates, it should generally be good for financial stocks, however, the US dollar strength may be a factor as is the possibility that the 10 year stays low for some time despite what the Fed does.  There is still downside risk in these conditions, though I feel upside potential is much larger.  The company is capable of earning over $5.50 in earnings, and I estimate TBV to be at $60.50 at the end of the year.   I no longer see the near-term environment allowing for a stock price in excess of it's TBV, so I am going away from my multiple of 1.25 times and going back to a multiple of 1.  This lowers my target back to $60.50, but it's worth noting that the we could easily change to favorable conditions just as fast as the conditions have turned for the worse.  Should that happen, the $75 target would be back in play for 2016.  The technicals have dramatically shifted towards short-term oversold and it has barely cracked through the 200 day average (much less the 50 and 100 day) extremely fast.  I'd say the stock looks poised for a small bounced before it heads further down, unless conditions change and a 10% drop is not out of the question.  Citi is 14.6% of my portfolio.

Cedar Fair (FUN, 52.19) - Cedar Fair continues to work on solid growth of revenue while earnings are growing a little slower than expected due to increased investment.  The prediction of rising interest rates coupled with an association to energy stocks due to its MLP status creates pressure in the near-term.  Looking out, it would benefit from its mostly domestic strength, high yield, commodity stabilization, and a Fed that maintains low rates.  Technically, the stock seems to have some support with the 200 day average as it typically pops back up if it drops through.  Currently, it is broken through with light support around $51.50 and then no support until close to $45 - $47.  However, it also has the 50 day average as a current ceiling with a trend heading towards a death cross.  Many indicators are showing the stock to be oversold and reaching points where it's historically found floors.  I lowered my earnings estimate due to the second quarter results to $2.65 with a fair multiple around 25.  This gives a price target of $66.25.  Cedar Fair is 12.4% of my portfolio.

Honeywell (HON, 98.88) - To see this stock below $100 is almost enough to give me a heart attack and the speed and manner in which it happened is probably just as appalling.  This company would be lumped in with International companies being "hurt by the slowdown of China," and the strength of the US dollar.  This stock is over sold even if the Fed did raise rates.  Should nothing happen and/or China makes positive changes, the stock will jump back to the lower end of previous ranges ($100 - $102).  In a matter of 2 days, the stock blew below all of its moving averages and floors.  There's another floor in the $95 - $97 range, but then it's the upper $80s, where the stock hit in October of last year, before we see more support.  This stock is essentially over sold every way you look at it (though it's not to say it can't stay that way).  This is a stock to pick up as the market pulls out of this nose dive.  I can't say now is the time, but the stock is already down 8% and is at levels where I see no legitimate reason not to list this stock as a 1.  Guidance now sits at $6.05 - 6.15. My estimate on their 2015 stays at $6.12 with a multiple of 18 due to how consistently this company delivers. This resulted in my 2015 target of $110. HON is 20.1% of my portfolio.

Isis Pharmaceuticals (ISIS, 46.66) - Despite its typical strength, biotech stocks have been getting obliterated in these markets.  No one is willing to pay for their valuations at this time.  Isis, in particular, seems to have turned into a falling knife.  While this is good for accumulating stock cheap, it also makes determining what is "too cheap to be fair" harder.  Lack of near-term catalysts are one of the biggest pain points for the company right now.  They expect to maintain over $750M in cash, so we shouldn't see more dilution anytime soon, though it's something to watch out for.  Also the company has been making so many deals that I agree when analysts say it may become difficult for them to be acquired.  Despite the lack of ability to find buyers, nothing has really changed for the stock.  It's a good stock to be in regardless of the cycles of the economy and there's nothing the Fed or China can really do to hurt it or help it.  The technicals are mostly out the window at this time.  There are signs of the stock being over sold, however, there's not enough there to convince me we've found a bottom.  Something needs to happen to change sentiment before things will heat up.  A little toe-dipping might be OK now, but keep enough powder for if/when things get lower and we get that defining change.  I continue to learn how to value a stock on the "out years."  For now, my price target would be more in line with the low $60s.  Isis Pharmaceuticals is 6.3% of my portfolio.

Twos:
Home Depot (HD, 116.16) - Housing formations and average home prices continue to stabilize and provide positive moves, enticing a customer base to update and repair their homes and build new ones.  We continue to see growth in big ticket purchases and the Pro customer continues to strengthen as well.  Save some Mexico and Canada locations, the company is essentially shielded by the US economy which continues to show strength.  While risks include an economy that slows or goes into recessions, rising expenses due to increasing wages, and headwinds caused by higher interest rates, I feel many of these risks are currently unfounded or minimal.  Rising wages are the biggest reality, however, with a strengthening economy you see rising wages everywhere.  Add those to lower fuel, food, interest rates, and other commodity costs and you have a consumer more willing to spend on investing in their home, as has been the trend for the last few quarters.  On the technical side, the stock has pulled back near its 50 day average, which has commonly been a line of support.  That's not to say it can't go under it for a little, but it's been a good guideline.  Other indicators show the stock has plenty of room to go down further, with $110 being a line of support, by means of the 200 day and previous trend lines.  Guidance from the company is $5.31 - $5.36, but my guidance is now at $5.40.  I expect a 20-22 multiple to be fair for a company growing earnings at 14% (plus share buybacks), so I'm tempering my 2015 earnings expectations a little.  Instead, I'm looking out to 2016 and seeing continued strength.  My $130 target is now moved out to 2016.  HD is 15.1% of my portfolio.

On Semiconductor (ONNN, 9.18) - This stock, as are all semiconductor stocks, is being driven by one thing - China.  Ever since June started, the semis have been getting crushed.  This last week, the stock fell below the $10 support it had, likely being held by stock repurchases for awhile, and now it's next level of support is in the $8.20 - $8.80 range and it's heading there quick, so far.  I think we need some sort of information from China showing stabilization/strength and/or results that are so much better than what people are expecting to hear that these stocks regain strength.  Right now, I don't see that happening until late September, without China doing something first.  These are levels I'm much happier with buyback purchases than where they were at during the second quarter and hopefully it sets the stock up accordingly.  I maintain my $0.86 earnings estimates with roughly a 15 multiple resulting in a $13 target.  I think it's important to note that most people believe things are going to slow so much they're probably giving the stock a multiple in the 9 - 10 range, which puts a price target in line with the next level of support.  On Semiconductor is 9.4% of my portfolio.

Threes:

Pepsico (PEP, 96.25) - Last time I noted things were getting too rich for my taste and now I've been "justified."  Not sure how justifying it is to see a stock retreat while still holding it, but that's the position I'm in.  It's not down 5% yet, so in the grand scheme of things, it's sitting pretty well right now.  This is a stock that should benefit from the current scenarios - seeking protection, yield, and taking advantage of lower commodity costs, which will translate into increasing margins.  If the dollar stays stable or loses some strength, that'll be another benefit.  Should the Fed raise rates, and the dollar gain strength, we start to see some of the conditions come into play that I fear for the stock to suffer multiple contraction.  This is a rich stock at these valuations and when you have an environment where people aren't willing to pay as much for stocks, you'll see things go down.  The question is if this is an over reaction, or a reality.  I don't have enough shares to try the get out/get in game, so I just need to bide my time for now.  Technical indicators show a stock that's quickly changing in sentiment and starting to become over sold, but isn't there yet.  The stock is just below both the 50 and 200 day averages just when the 50 was about to cross above the 200 again.  The $94 area tends to be around where we have found support in the past.  For now, I still allow a 22 multiple on the stock with my guidance for 2015 to be $4.50.  This gives my upside target at $99.  Since the stock is already at that level, is showing significant struggles to surpass that point, and has a number of longer-term risks in front of it, I had to downgrade the stock for now.  I do not see downside risk that is beyond 5% right now, however, the upside feels capped as well.  PEP is 12.5% of my portfolio.