FINANCIAL REVIEW

Ugly With Snow Flurries

Sinclair Noe — January 27, 2015

Podcast: Play in new window | Download (Duration: 13:16 — 6.1MB)

DOW – 291 = 17,387
SPX – 27 = 2029
NAS – 90 = 4681
10 YR YLD un 1.82%
OIL + .65 = 42.80
GOLD + 10.80 = 1293.10
SILV + .13 = 18.13

New York City was shut down overnight. That “blizzard of the century” was indeed a bad storm but not the predicted “snowpocalyspe”, even though authorities shut down schools, roads, subways, and rail; and more than 8,000 flights were cancelled. Turned out to be an overabundance of caution. New England was socked quite solidly, but not the Big Apple. Weather forecasters got it wrong; not the first time. And once again we were reminded that the news media is centered in New York.

(The bad news is that Wall Street opened this morning.)

Let’s start with a few economic reports. Home prices edge 0.2% lower in November. The S&P/Case-Shiller 20-city composite index dipped 0.2% in November and that lowered the year-on-year advance to 4.3%, down from a reading of 4.5% in October. Phoenix posted a 0.2% increase in home prices in November, but the year-on-year advance was only 1.9%.

The Case-Shiller report looks at resales of existing homes. Also today, the Commerce Department reported a big increase in new home sales; up 11.6% last month to a seasonally adjusted annual rate of 481,000. The gains were not enough to offset essentially flat home-buying over the course of 2014. Just 435,000 new homes were bought last year, a modest 1.2% improvement from 2013.

Orders for durable goods dropped 3.4% in December, the fourth decline in the past five months, and well below expectations. Durable-goods orders for November were revised to show a 2.1% decline instead of a drop of 0.9%. Transportation led the decline in December, dropping 9.2%. Orders for core capital goods – a measure of business investment – fell 0.6% in December for the second straight month.

The Conference Board said its index of consumer confidence jumped to 102.9 in January from a revised 93.1 in December, first reported as 92.6. The index is at its highest since August 2007.

The ruble has recovered slightly, after ending Monday’s session over 6% lower at 68.79. The plunge followed yesterday’s move by S&P to downgrade Russia’s sovereign rating to junk due to weak economic growth prospects, low oil prices and Western sanctions. European Union leaders threatened to tighten sanctions on Russia as soon as Thursday over its support for pro-Kremlin rebels in eastern Ukraine, who are engaged in the worst clashes with government troops since a September truce.

Greek Prime Minister Alexis Tsipras named a cabinet of anti-austerity veterans and halted privatization of Greece’s biggest port. The new finance minister described Europe’s austerity policies as “fiscal waterboarding.” Tsipras quickly demonstrated that Europe must not treat Greece as a weak junior partner. His government denounced a European Council statement in which European leaders blamed Russia for the escalating violence in Ukraine and raised the prospect of new economic sanctions. Further sanctions cannot be approved without a unanimous vote from the leaders of European Union member nations.

Meanwhile, back on Wall Street it is earnings reporting season, and things turned ugly today. Actually, Microsoft got it rolling yesterday after the close. Microsoft’s net profit came in at $5.8B compared with $6.5B in the year-ago quarter. Microsoft also set its financial forecast for the remainder of the fiscal year, which ends in June, below Wall Street estimates.

Caterpillar gave a disappointing outlook for 2015, citing falling commodity prices, as the heavy-machinery maker also reported earnings for the fourth quarter that missed expectations. Caterpillar said it expects to post per-share earnings of $4.75 a share on revenue of $50 billion for the year. Analysts had projected $6.67 a share in earnings on $55 billion in revenue.

Freeport-McMoRan reported a fourth-quarter adjusted profit that missed expectations, and said it was taking aggressive action to defer capital expenditures as it combats the sharp drop in commodities prices. For the quarter ended Dec. 31, the company swung to a net loss of $2.9 billion, or $2.75 a share, from a profit of $707 million, or 68 cents a share, in the year-earlier period.

In other earnings news, Bristol-Myers Squibb forecast 2015 sales that trailed analysts’ estimates as a strong dollar cuts into the drugmaker’s revenue abroad. Pfizer offered downbeat guidance for the new year, citing a stronger U.S. dollar and drug-patent losses. The company posted adjusted profit of 54 cents a share on revenue of $13.12 billion. Analysts had projected earnings of 53 cents a share on $12.9 billion in revenue. DuPont posted a profit of 74 cents a share, but gave a disappointing outlook for 2015, citing a big hit on earnings from the strengthening dollar. Procter & Gamble missed fiscal second-quarter profit expectations and lowered its growth outlook for the year.

Are you starting to detect a theme here? A strong dollar is hurting multinational profits. Over 40% of revenues for S&P 500 companies comes from outside the US. More than 20% of companies in the S&P 500-stock index that have reported earnings have blamed a strong dollar as a negative drag on their profit results. You might expect that a company headquartered in the US that earns much of its revenue abroad would be well-versed in hedging against currency fluctuations, but that does not appear to be the case. And the US economy is not insulated from weak global demand.

Wall Street analysts have revised down their US profit estimates for 16 straight weeks. And that consistent lowering of profit expectations is starting to show up in lower growth expectations for coming quarters. Profit growth for the just-completed fourth quarter is tracking at 3.3%, according to Thomson Reuters I/B/E/S, putting the quarter on track for the slowest quarter of profit growth since the third quarter of 2012. What’s more striking is how quickly the growth projections have come down: On Jan. 1 analysts expected fourth-quarter growth of 4.2%, and back on Oct. 1 the expectation was for 11.2% growth.

A similar sharp slide in growth expectations is now occurring for 2015. Analysts now expect first-quarter 2015 profit growth of 1.9%, down from 5.3% on Jan. 1. Earnings growth forecasts have now been slashed for all four quarters this year. Full-year 2015 profit growth is now forecast at 5.7%, down from 8.1% on Jan. 1.

Falling commodity prices are hurting companies that deal in or provide services to resource related firms, and Big Oil companies haven’t reported yet. One might think that the steady slide in the price of oil that has continued since last July would result in a supply contraction at some point. However, that is not what industry statistics are indicating, at least not yet. In fact, oversupply accelerated in the past seven weeks. In the U.S. alone, the total oversupply increased by over 1.1 million barrels per day, judging by inventory data. Spare storage capacity in the US is quickly shrinking, and the short-term contango is widening. In other words, the majority of cutbacks are still to come.

Of course lower oil prices have a bright side. American Airlines reported higher fourth quarter revenue, while operating expenses fell, primarily because of a 17% drop in fuel cost. That helped the company post a $597 million profit in the final three months of the year, compared with a $1.95 billion combined loss for its two predecessor companies, AMR Corporation and US Airways, in 2013.

Airplanes are more crowded than ever, fares remain at a five-year high despite plummeting fuel costs and airlines are reporting record profits and soaring stock prices. The four major airlines all reported huge profits for 2014 in the past week and made clear that they have no plans to cut airfares or to increase the number of seats. American Airlines Group CEO Doug Parker said: “We’re going to continue operating American as though oil was still above $100 a barrel.”

So, that was the day on Wall Street: generally ugly with snow flurries. Then after the close of trade, Apple reported first-quarter revenue of $74.6 billion and earnings of $18 billion or $3.06 per share, easily surpassed analyst estimates of $67.7 billion in revenue and $2.60 per share for the three-month period ended Dec. 31. So, that was very good, and the details are even better. Apple sold 74.5 million iPhones during the quarter, beating expectations of around 66 million; most sales were the new iPhone 6 and the 6-plus. Demand in China led the way, and revenue from China was up 70% and Apple is now the top smartphone vendor in China.

Mac sales rose 14 percent to 5.5 million units. One sour note; for the fourth consecutive quarter, iPad unit sales fell, dropping 18% to 21.4 million units; but the iPad is a victim of the iPhone’s success. Who needs and iPad if you have a big screen phone? The average selling price of the iPhone beat expectations too. It was $687 last quarter, versus $668 expected. The iPhone alone generated $51.2 billion in revenue for Apple.

So, why was the quarter such a success? This was a “super cycle” for iPhone upgrades. For the first time, Apple launched two new iPhone models with bigger screens, finally catching up to the rest of the industry. Every iPhone competitor already offered phones with screens that were at least 4.5 inches. Apple was the only smartphone maker left that made phones with tiny screens. The only problem for Apple is they have now set the bar very high.

Yea, not a problem. Apple forecast the momentum would continue, with revenue projected to rise to $52 billion to $55 billion from $45.6 billion during the same period a year ago. Gross margins could widen to 38.5 percent to 39.5 percent compared with 39.3 percent a year earlier.

On a side note, not part of the earnings report, Apple apps are now bigger than Hollywood. It’s estimated that App store billings for 2014 will come in around $14 billion dollars, compared to Hollywood’s US box office revenue of around $10 billion. The app economy sustains more jobs (627,000 iOS jobs in the US vs. 374,000 in Hollywood) and is easier to enter and has wider reach.

And that, boys and girls, is how Apple grew to be the largest company on the planet.