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Kuby’s Commentary

Market Bounces with Good, Bad, and Ugly Headlines

Feb 10, 2020

Last Week:

Fortunately we don’t need to repeat the repeat of “Rally Interrupted”, as the market posted its best performance since November 2018 as the S&P 500 jumped 3.2% and the Nasdaq composite surged 4%. As is often the case, there was good, bad, and ugly news for equities during the week.

The Good:

Our fundamental belief is that stock prices are determined in the long run by a combination of corporate earnings and interest rates. It appears that the stage is set for corporate earnings to resume growth after stalling out in 2019 (during which time the S&P 500 surged over 30%, challenging our fundamental belief, but that’s a complicated discussion for another day). The blended earnings growth rate for the fourth quarter is now 0.7%, which is above the earnings decline of -0.5% last week. Positive earnings surprises recorded by companies in the Communication Services sector were mainly responsible for the increase in the overall earnings growth rate during the week. If 0.7% is the actual growth rate for the quarter, it will mark the first time the index has reported year-over-year growth in earnings since the fourth quarter of 2018. The yield on the Ten-Year Treasury remained stable at very low levels, inching up 5 basis points to 1.57%.

The January jobs report showed better growth than expected with a slight uptick in the unemployment rate as more workers entered the work force. Goldilocks felt the porridge was a bit warm, but certainly not hot enough to change the Fed’s current path of leaving interest rates unchanged.

China pumped more than $200 billion in liquidity into the financial system, at least temporarily reversing the sharp downturn in their markets.

President Trump’s impeachment trial in the Senate came to a conclusion.

The Bad:

We had lunch with Professor Robert Z. Aliber on Friday (the company and food were fine; it was Bob’s outlook that was indigestion inducing). For the last 30 years we have relied on Bob to frame the big macro picture, and his forecasts have been extremely prescient, including calling the top and bottom during the financial crisis. A key tenet of Bob’s framework is the very long cycles of prices of different asset classes. He points out that stock prices increased three-fold in the 1980s and then declined by thirty five percent. Stock prices then increased throughout the 1990s, and especially sharply in the last several years of the decade. Bob sold his stocks in the late spring of 1999, and then bought the German bunds, avoiding the losses on the stock market downturn and capturing both the rise of the Euro versus the dollar and the decline in interest rates. After the financial crisis, Bob turned positive on the economy and market in January 2009, staying long until the summer of 2017. His concerns have been heightened by recent developments, most notably the outbreak of the coronavirus, which will exacerbate the stiff economic headwinds blowing from the Far East, that could depress corporate earnings. Additionally, if foreign investors, such as the Chinese, either slow their purchases or liquidate their U.S. dollar holdings, then the prices of U.S. stocks and bonds could suffer materially along with the decline of the dollar. As such, we continue to monitor the dollar index as one of our “canaries in the coal mine”. So far the dollar is holding steady near its highs and the birds are singing a healthy tune.

Randall W. Forsyth in the Feb 10 Barron’s edition points out that one data point was “conspicuous in its absence” from the State of the Union address-the federal budget deficit. He points out that “red ink is flowing at a $ 1 trillion annual rate. More important than the headline number is that the deficit is hitting that level in the 11th year of a long-running economic expansion”. Normally a government would be running a surplus in such a robust economy. To quote the conservative economist Herbert Stein, “If something cannot go on forever, it will stop”. I pestered Professor Aliber for the input or event that will end the party, and he pointed out that the spike in interest rates that would result if foreigners lost their appetite for financing our deficits could certainly be such a trigger.

In short, it’s a good idea to be particularly mindful that whereas stocks are great investments for the long-run, that the market goes through lengthy unpredictable periods of rising and falling. As such, it’s prudent to maintain a portfolio consistent with your own tolerance, without letting greed seduce you into excess risk-taking.

The Ugly:

Politics, but what else is new.
The Chicago Bulls, but what else is new.

The coronavirus continued to spread at a rapid pace, with over 31,000 confirmed cases, and over 600 deaths. The White House said the crisis could affect China’s ability to buy $200 billion in U.S. goods as agreed to as part of the phase-one trade pact.

This Week:

During the upcoming week, 65 S&P 500 companies are scheduled to report results for the fourth quarter. On Thursday the BLS will release the consumer price index for January, with expectations of a 2.5% year-over-year rise. Given the massive increase in the money supply, the subdued inflation rate remains a puzzle, and takes the pressure to raise rates off the Fed. On Friday the University of Michigan will release its Consumer Sentiment Survey for February. We watch this gauge closely as another “canary” which continues to whistle a happy tune with readings near record highs.

Developments relating to the coronavirus will continue to be important.

Stocks on the Move:

CAH +13.8%: Cardinal Health is the third-largest global logistics provider engaged in wholesale pharmaceutical and medical products. Cardinal Health reported fiscal Q2 non-GAAP EPS of $1.52, up from $1.29 in the year-ago quarter and above the Capital IQ estimate of $1.22 a share. Revenue totaled $39.7 billion, up from $37.7 billion a year ago and higher than the Street projection of $39.3 billion. Additionally, the company said it expects fiscal 2020 non-GAAP EPS to be in the range of $5.20 to $5.40, higher than the previous guidance of $4.85 to $5.10 and ahead of expectations for $5.04 a share. “With the first half of the year behind us, we are raising our fiscal year 2020 guidance,” said Mike Kaufmann, CEO of Cardinal Health. “This increase was driven by improved performance across our Pharmaceutical segment, particularly within our generics program. As we look forward, we remain focused on executing our strategic growth initiatives.” CAH is a 1.63% holding in the North Star Opportunity Fund.

MDP +16.0%: Meredith Corporation reaches 180 million unduplicated American consumers every month, including nearly 90 percent of U.S. millennial women. Meredith is a leader in creating content across media platforms and life stages in key consumer interest areas such as entertainment, food, lifestyle, parenting and home. Meredith is the No. 1 magazine operator in the U.S., and owner of the largest premium content digital network for American consumers. The company reported quarterly results that exceeded expectations. “We are pleased to report a strong second quarter driven by excellent advertising performance across both businesses,” said Meredith President and CEO Tom Harty. “With our two-year integration process of the Time Inc. acquisition largely complete, we are now in the strongest competitive position in Meredith’s history. We’ve built a significant digital business of scale with tremendous reach to American women and unmatched first-party data; we are clearly the country’s top magazine publisher and are taking share at a strong rate; and we are growing consumer related revenues that is reducing our reliance on traditional advertising. At the same time, our local television business continues to perform at record levels, and we anticipate strong political advertising in calendar 2020.” “Importantly, both of our businesses continue to generate strong cash flow,” continued Harty. “This enabled us to continue to reward our long-term shareholders with our 27th consecutive annual dividend increase, while at the same time emphasizing debt reduction.” MDP is a 1.13% holding in the North Star Opportunity Fund and MDP corporate bonds are a 0.89% holding in the North Star Opportunity Fund and a 2.68% holding in the North Star Bond Fund.

BOOT -14.9%: Boot Barn Holdings, Inc. is the nation’s leading lifestyle retailer of western and work-related footwear, apparel and accessories for men, women and children. The Company announced that for net sales increased 11.8% to $284.0 million for the quarter ending December 28, 2019 from $254.0 million in the prior-year period. Consolidated same store sales increased 6.7% with retail store same store sales up 5.7% and e-commerce same store sales up 11.0%. Net income was $24.8 million, or $0.85 per diluted share, compared to $19.0 million, or $0.66 per diluted share in the prior-year period. Jim Conroy, Chief Executive Officer, commented, “Our third quarter results reflect continued focus on our key strategic initiatives. Consolidated same store sales increased for the 11th consecutive quarter with healthy growth in both customer count and transaction size. We continue to experience nice gains in the business due to effective marketing, compelling merchandise assortments, and great selling and service in the stores. During the quarter, we expanded our physical footprint with the opening of three new stores and are on pace to meet our annual target of 10%-unit growth this fiscal year. Importantly, we are converting our top-line success into significant bottom line improvement thanks to enhanced merchandise margin and operating expense leverage. The high level of execution across the organization has us well positioned to deliver a solid finish to fiscal 2020 and carry our momentum into next year.” Despite the recent sell-off, BOOT shares have still returned 42.59% over the last 12 months. BOOT is a 3.84% holding in the North Star Micro Cap Fund.

NSSC -23.3%: NAPCO Security Technologies, Inc. is one of the world’s leading manufacturers of high-tech electronic security devices that are fueling the Company’s fast growing recurring service revenues, as well as a leading provider of school safety solutions. Net sales for the three months ended December 31, 2019 increased 4% to a record second quarter revenue of $25.8 million, and net income increased 25% to a second quarter record of $3.6 million, or $0.19 per diluted share, as compared to $2.9 million, or $0.15 per share, for the same quarter last year. Richard Soloway, Chairman and President, commented, “Our focus in marketing innovative security products aimed at strong growth markets, which provide NAPCO with high gross margin and recurring service revenue (RSR) growth, continues to drive our Company to record profitability and sales levels. This past Q2 marked our 22nd consecutive quarter of year over year sales growth and as importantly, saw our net income increase by 25% to deliver record second quarter profitability. We will continue to prioritize our resources on driving these opportunity areas.” NSSC is a 1.75% holding in the North Star Micro Cap Fund.

The information provided in this commentary is not an offer to sell or the solicitation of an offer to purchase any security, product, or brokerage service. The information is not intended to be used as the basis for investment decisions, nor should the information be construed as advice designed to meet the particular needs of any investor. This commentary is presented to illustrate examples of the securities that North Star Investment Management Corporation and/or its affiliates (“North Star”) may have bought for client accounts and the diversity of markets in which North Star Investments may invest, and may not be representative of current or future investments. You should not assume that the future performance of any specific investment, investment strategy, or product made reference to directly or indirectly in this commentary will be profitable or will be equal to any corresponding performance levels that might be indicated. Past performance is no guarantee of future results. Investments in securities involve risks including the possible loss of the principal invested. North Star and others associated with it, including employees, may have positions in and effect transactions in securities of companies mentioned or indirectly referenced in this commentary. North Star may buy, sell or hold these securities in proprietary or client accounts. North Star will not be providing regular updates or advising you of any changes in the views expressed herein. Investors should consider their investment objectives, risk tolerance, and financial situation and needs before investing in any security. Tax considerations, commissions, fees and other costs should be carefully evaluated with one’s investment and/or tax advisors. Information provided is obtained from sources deemed to be reliable, but North Star cannot guarantee the accuracy or completeness of the information. This material may not be reproduced, distributed or transmitted to any other person in whole or in part without the prior written consent of North Star. A copy of North Star Investment Management Corporation’s Form ADV Brochure, Privacy Notice and Business Continuity Plan summary can be obtained by calling 312-580-0900.

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