VIDEO: Explaining Why We've Downgraded This Construction Name

In today’s Daily Rundown video, Chris Versace explains why Wednesday's market close could lead to an incrementally-dour mood on Wall Street and he sheds more light on the decision to downgrade Builders FirstSource BLDR shares to a Four rating.

He also shares tidbits picked up from Wednesday morning’s earnings reports from MSC Industrial MSM and Albertsons ACI, one of which sets up Costco’s COST December revenue report after Wednesday's market close. Finally, Chris explains why we’ll be interested in upcoming quarterly results from Jefferies JEF and why we’ll be focusing more on Thursday's five Fed speakers than Wednesday afternoon’s December Fed meeting minutes.

Transcript

CHRIS VERSACE: Hey, everyone, Chris Versace here. And it is Wednesday, January 8. Stocks, as you probably have noticed, are trading off today. And just so you're aware, we're going to pay very close attention to today's market close, the why behind that.

It is going to bring to a close the timing for the first five days indicator that we talked about a few weeks ago. You have to remember that folks look at this as a potential indicator for the coming year. And unfortunately, if it doesn't emerge, it means that we will have two back-to-back seasonal indicators, the Santa Claus rally, and the first five days indicator, that failed to emerge.

Now, why do we pay attention to this? Well, we could see that kind of trigger a more cautious mood in the market ahead of the December quarter earnings season. Remember, we're starting to see some companies trickle in now reporting. And we'll talk about a few in a moment.

But it's really next week, the 15, when we really start to see that earnings season really accelerate. So we're going to want to pay attention to that. But I also want to talk about our downgrade of Builders FirstSource shares to a 4-rating that we did this morning.

As you know, a little while ago, Builders passed our 145 panic point. And what we had said at the time is we're going to be careful. The shares are oversold. But we're going to pay very close attention to upcoming inflation data, what that could mean for the Fed, what that could mean for rate cuts, and all of the like.

So the data point that we were really looking to focus in on was the December service PMI reports that we got this week. And as we shared with you yesterday and again in an Alert this morning, the prices component in the December services PMI, especially from ISM, really jumped compared to November. In some respects, it was one of the highest ratings we've seen in the last year. Again, particularly for ISM's December service PMI pricing data.

Now, our thinking is that that continued sticky inflation, arguably accelerating inflation, is going to push out rate cut expectations even further than what we've seen. We talked about this in our Alert this morning with you, that the CME FedWatch tool is now looking maybe June, July instead of March just a week ago. So as we think about that, we take a look at the upward move in the 10-year Treasury yield over the last few weeks, the rise in the 30-year mortgage rate over the last few months, and the fall in the MBA new purchase mortgage index, it just all comes together to tell us that the expected rebound in the housing market is pushed that much further down the road.

And that likely means that the shares of Builder are going to be dead money for the next couple of months. Now, we also have to be a little mindful of a few things. One, we are starting to see sentiment on Wall Street sour on the homebuilders. In the Alert that we downgraded Builders, we talked about some big price cuts that were happening for some home builders-- Toll Brothers, DR Horton. We're likely to see more of that.

There's also the risk, as I pointed out, that Builders is probably going to have to revisit their outlook for 2025 most likely lower. So for all of those reasons, we opted to downgrade Builders FirstSource shares to a 4-rating. But as I said, they're oversold. So much like we did with PepsiCo, we're going to bide our time. And if we see a nice move higher in the shares, we'll start to unwind it.

However, we are mindful that Friday brings the December employment report. And early next week, we've got more December inflation data, CPI, PPI. And if what we see in these upcoming reports kind of hammers home the notion that the economy is on solid ground but inflation is kind of ticking back up, threatening any near-term viability of a rate cut, odds are that's going to lead us to start unwinding the position in Builders FirstSource rather than waiting for a bounce.

So the whole goal here is that we want to make sure that we limit the negative impact on Builders on the portfolio. It's also a lesson that, look, we have to follow the data. It's really that simple. I know some folks are probably disappointed in the decision, but we have to follow the data. We cannot be emotional about this.

If anything, we have to keep our emotions in check. Now, I also want to share a few other things from other companies that have reported so far this morning. First and foremost, Albertsons. So a food company, grocery company, they said that they're identical sales rose 2%. But the food and beverage sector, they said, was sequentially slower in December.

From my perspective, that really affirms our decision to exit PepsiCo shares a few weeks back. Albertsons also said the consumer is "being cautious and remaining price sensitive". From our perspective, that keeps us bullish on the shares of Costco and Amazon. And that kind of sets us up for what we'll get after the close today. I'm talking about Costco's December revenue report.

I suspect that we're going to see some big share gains. I know I was in Costco right around Christmas time stocking up for the big Christmas meals, New Year's meals, and boy was it busy.

I also want to talk about MSC Industrial. This isn't a name that we really talk about much, but it bears digging into their conference call comments from this morning because they are a wide array manufacturing company. They touch a lot of industries.

So what they had to say is that automotive, heavy truck, primary metals, fabricated metals, machinery, and equipment remains soft. Just another data point that tells us that the manufacturing economy that we track in the manufacturing PMI reports is soft and contracting. But there was something else that MSC had to say. And this is what it was, increasing personal expense and higher benefit inflation are leading to higher operating expenses heading into 2025.

Now, that is something that we want to be mindful of as we get ready for the December quarter earnings season. We continue to think that the December quarter earnings season is going to be focused, yes, on revenue, yes, on EPS. But given what we've seen on the topic of inflation, input costs, and other things, I suspect that margins and how they are reported for the December quarter and the outlook for 2025 are going to be a focus not just for us, but for the larger market as well.

So as we think about that and the implications for 2025 EPS guidance, we want to obviously pay attention to that not only for our companies, but also for the market overall. I also want to say, though too, that we're going to have some coming clarity, I guess, on tariffs. And MSC, on their earnings call, they said that they don't see anything when it comes to clarity on tariffs.

There is a lot of hedging out there-- ifs, maybes, what size, timing. And I think this is going to be something that we hear a lot more about in the next couple of weeks as well. Perhaps, once we get past inauguration date, maybe we'll start to see some greater clarity on tariffs. But I have to suspect that President Trump is likely to use a time-tested page from his playbook, which is keeping his negotiating opponents off balance.

This likely means that we're going to see a lot of uncertainty on the topic of tariffs until formal policy is announced. So we're going to have to keep our ear to the ground on that. But remember that the market does not like uncertainty. It abhors it, actually. But volatile markets, they can bring opportunities.

So we'll be watching for those both for existing positions, as well as potential new entrants either into the bullpen or into the portfolio. Now, let's talk about the road ahead, as it were. Coming up this afternoon, we've got the Fed Beige Book.

My comments earlier today, I do expect that we will hear the Fed talk more about why it's focusing on inflation. Maybe we get some insight onto when the Fed back in December thought there might be another rate cut. But two things to remember.

One, that December services PMI data on pricing was this week. So to some extent, the Fed minutes are going to be a little dated. But also, two, we have a reconstituted FOMC, which means that when we look at the new members, which we did in our alert to you this morning, the lineup looks a little less dovish.

So it's another reason that I think this afternoon's December Fed meeting minutes are going to get a little bit of a pass. Now, after the close, we also have Jefferies coming up. We are going to pay attention to what they say about the investment banking for the December quarter, but also their outlook for 2025. Why?

Well, because there'll be some useful data points for our Bank of America and Morgan Stanley positions. Tomorrow, the market is closed, but we will have five Fed speakers making the rounds throughout the day. Odds are, I think that their comments are going to be incrementally less dovish, incrementally more hawkish given the data that we've seen this week. But we'll be sure to parse those comments and share our findings early Friday morning at the latest as we get ready for the December employment report.

So we've got a lot of stuff going on this afternoon. Closing out the week, please be sure to pay attention to your emails and your Alerts. We want to make sure you're getting our latest thoughts. And as I like to say, if we make any moves with the portfolio, we want to make sure that you are right there with us. Thanks for watching.

At the time of publication, TheStreet Pro Portfolio was long BLDR and COST.