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Why the Markets Look Safe Until Summer


The data suggests that the equity markets have once again dodged the opportunity to correct in any meaningful manner.


One company playing to this domestics theme is Rite Aid (NYSE:RAD). RAD has new management, is a real estate play, has in store clinics, and our analyst (John Ransom) thinks it can have $1 billion in cash flow in 2015. While John projects only moderate price appreciation near term, over the next few years, as the turnaround takes place, he thinks the shares could trade meaningfully higher. As John writes in his company comment of April 12, 2013:

We are upgrading shares of RAD to Outperform from Market Perform... We believe that FY14 guidance (i.e., flat EBITDA) looks conservative and the company will start to generate meaningful free cash flow (FCF) in FY14, reaping the benefits from its recent refinancing. While we acknowledge y/y pressure from the lapse of the Lipitor and Plavix generic exclusivity period and from a (still) leveraged balance sheet (5.3x EBITDA), RAD will continue to benefit from deleveraging, debt refinancings (including $800 million in callable debt in May at 9.5%), script growth, its burgeoning loyalty program roll-out, file buys ($60 million per year), and store refresh initiatives, which should help buffer the aforementioned headwinds. We believe that RAD will generate ~$0.27 of FCF/share in FY14 ($0.36 in FY15), and that FCF growth should average 10-20% over the next three years, assuming modest EBITDA growth.

RAD also plays to one of the best performing industries of the year (drug retailers +20.03% YTD), as well as one of the better performing macro sectors. To be sure, the consumer discretionary sector has been the third best performing sector year-to-date at +14.60%, while consumer staples is second (+15.61) and health care is first (+19.60%) driven largely by the biotechnology industry (+34.80%). Moreover, since we are in earnings season, it is worth mentioning that of the 855 companies in the S&P 1500 that have reported, 59% have beaten the earnings estimates and 49% have bettered revenue estimates. Drilling down into the macro sectors, those showing the highest "beat rate" finds consumer staples first with a 69.6% beat rate, followed by consumer discretionary (+65.2%), and information technology (+63.5%).

As for the overall stock market, today is session 82 in the now legendary "buying stampede" because the Industrials have not experienced as much as a three consecutive session decline since the back-to-back 90% Upside Days of December 31, 2012 and January 2, 2013. At the time I was writing that, such back-to-back sessions have left the INDU up 12.8% three months later 100% of the time; while we didn't quite achieve that this year, we certainly came close. Last week's rally occurred from marginally oversold levels with the Buying Power Index rising while the Selling Pressures Index fell. Buying has also been broad based with all of the Advance/Decline metrics I monitor reaching new bull market highs.

In summary, the data suggests the equity markets have once again dodged the opportunity to correct in any meaningful manner; and I must admit, I have never seen anything like what has occurred since the "buying stampede" extended beyond the previous record of 53 sessions! That said, my work continues to suggest the equity markets do not face a period of serious vulnerability until this summer, unlike the last three years where "Sell in May and go away" has played so well, provided you redeployed the cash raised in the spring to stocks sometime during the summer months. I don't think the scenario plays that way this year.

The call for this week: This week will see a large 29 different economic indicators released with the most important being the ADP employment report, initial unemployment claims, the monthly non-farm payrolls report, the Chicago PMI, the ISM Manufacturing report, and the ISM Services report. Such a deluge of economic data within a one-week time period is fairly rare, so buckle up. All such reports can be market moving, but so far the bears, rubbing their collective hands together with glee over the fiscal cliff, sequestration, the continuing resolution, the debt ceiling, etc., have been totally w-r-o-n-g. I feel sorry for the bears waiting for the "crash" that they have been expecting for the past four years, all to no avail. It looks to me as if the stock market will continue its move irregularly higher until we get indications that something is irrevocably wrong. So far, nothing in the stock market's internal structure has told us to be anything more than cautious, but not bearish.
No positions in stocks mentioned.
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