Q1 Earnings Ready to Take Flight

It was a quiet week for stocks, with the averages breaking a two-week win streak as rising crude pulled the market lower directly ahead of Q1 earnings season. For the week, the S&P 500 fell a marginal .3% to remain glued to the recent 2-year high.

The market’s lackluster performance this week was largely a product of what is happening with crude, closing the week above $113 a barrel on general concern about inflation and ongoing instability in the Middle East. Although higher crude prices are great for energy companies, it’s like a black flag for the rest of the economy.

It makes traveling more expensive, hitting consumers at the gas station and impacting discretionary spending. It makes shipping goods more expensive, cutting into profitability and creating cost-push inflation. It also affects input costs for companies like chemical makers that rely on crude and natural gas as feed stock for their products.

So as you can see, this is a very tangled web that rising energy prices have created for the market, and so far, it looks like the Street is choosing to take a cautious approach to see how the private sector will adjust to another curve ball.

That will come in the form of Q1 earnings, set to kick off this week with Alcoa’s report on Monday morning. The actual results will be important, as always, but the Street will be paying even closer attention to guidance, where reporting companies will provide more insight into how higher energy costs are affecting demand and the cost of doing business. Let’s look for our beloved and battle-tested S&P 500 to step up and show the world that it will once again find a way to work around an inconvenient reality.

Mixed Week for the Portfolio

We saw a little bit of weakness creep into the portfolio this week, with a few of our stocks trading into the red in the flat market. Let’s go ahead and take a closer look.

The laggard of the group was EZCORP, Inc. (EZPW), taking an 8% haircut on Friday after word spread that the Senate Business and Commerce Committee would be moving a bill to the Senate floor to curb payday lending. That development comes fresh on the heels of the same committee putting a previous bill to curb payday lending to rest. Although this latest development isn’t exactly great news, it’s important to put it into context.

Once a bill hits the floor, it can sit in limbo for quite some time, so there is no pending deadline confronting EZCORP’s business. And even if this most recent bill clears the Senate, the general consensus is that it doesn’t have enough support to clear the House. Taking the conversation one step further, EZCORP has been aggressively reducing its exposure to payday lending, recently falling to just 16% of the company’s total revenue. Moving forward, that number will continue to decline. So basically what you have is a regulatory initiative that is considered to be a long shot that would affect a very small portion of EZCORPS’s revenue causing some anxiety in the market. That is completely understandable, but the reaction seems a bit overdone. So for the time being we are going to sit tight and look for the rebound.

We also saw some weakness from Amerigroup Corp. (AGP) and VeriFone Systems, Inc. (PAY), each pulling back from recent highs and falling about 4.5% on the week. Although on the surface these two companies might not appear to have much in common, a closer look reveals two things. Number one, they are two of the higher P/E stocks in the portfolio, and although neither of these names is overvalued, higher P/E stocks tend to be more vulnerable in a weak market. And secondly, both had seen fairly sharp gains over the last few weeks, so it looks like some short-term profit taking was also in play. Moving forward, AGP, our play on Medicare and Medicaid, and VeriFone Systems, our play on electronic financial transactions should be fine, but it’s a good example of the kind of volatility involved in owning stocks that have the potential to produce outsized gains.

But it wasn’t all about team red, team green scored a few points too, led by our junior gold miners ETF Market Vectors Junior Gold Miners (GDXJ), gaining almost 9% on the week after gold logged three consecutive new all-time highs. The gold conversation could hardly be any hotter right now, with no shortage of speculation about the sustainability of what is basically a 10-year rally. It’s anyone’s guess what will happen, but with the Federal government looking insanely indebted and firmly committed to sacrificing the Dollar to maintain solvency, there is a very good reason why we have voted with our wallets and locked into a solid gold position.

Speaking of the Federal government, we also saw a strong performance from our short position on US Treasury’s, iPath US Treasury Long Bond Bear (DLBS), gaining a little more than 3% on the week as fixed-income investors continue to demand higher returns to accept the risk of lending to the Federal government. That’s great on a short-term basis, but on a loner-term basis, interest rates really only have one way to go, which should continue to provide support for our position in DLBS.

And finally, we have PowerShares DB Oil Fund (DBO), our energy ETF that tracks the performance of crude oil, finishing the week just shy of a 5% gain. This week was a great example of why we own DBO, because in spite of higher crude prices, our oil stocks followed the market with a mostly neutral performance. So even though DBO won’t crank as hard as our oil stocks in the long run, it gives us the kind of balanced and diversified approach we need in our energy suite to keep the portfolio charging higher in all kinds of different markets.

That’s all for this week, but until our next update, here are two articles for everyone to check out. The first one discusses how investors are demanding higher interest rates from US Treasuries and the second one is a quick look at the current inflation and demand driven rally that has lifted commodities to a two-year high. Enjoy.

10-Year Treasury’s Slide on Inflation Bets

Commodites Rise for Seventh Day to 2-Year High

Your Investment Partner,

Mike

ABOUT THE AUTHOR

Michael Vodicka

Michael Vodicka is the president and founder of the Vodicka Group Inc., a licensed investment advisor (Series 65) and a financial journalist.