Financial Review

That’s a Print

Sinclair Noe — July 21, 2016

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

Subscribe: iTunes | Android | RSS

DOW – 77 = 18,517
SPX – 7 = 2165
NAS – 16 = 5073
10 Y – .01 = 1.56%
OIL – 1.19 = 44.56
GOLD + 15.40 = 1331.70

The stock market was probably a little tired. After 9 straight sessions with gains that pushed the Dow Industrials and the S&P 500 to record highs, the market takes a pause; and at this point that’s all we can say with certainty. Markets do not go up in a straight line, and it is very rare to see 9 consecutive up days. Remember that this market has been remarkably resilient.

The European Central Bank kept its interest rates and policy plans unchanged and said the immediate stress caused to markets by Britain’s shock vote to leave the European Union had been contained. ECB President Mario Draghi said it was too early to ascertain the full impact of Brexit, but he said the ECB was prepared to take more actions to lift inflation and economic growth if necessary. The bank kept its deposit rate at minus 0.4 percent and the main refinancing rate at 0.00 percent, both record lows.

The Federal Reserve will wait until the fourth quarter before raising interest rates, likely in December after the presidential election, according to a Reuters poll. Just over half the economists surveyed over the past week expect the Fed to raise its federal funds rate in the fourth quarter to 0.50-0.75 percent from 0.25-0.50 percent currently. The move is most likely to come in December as the November policy meeting is only days ahead of the Nov. 8 election.

Initial claims for state unemployment benefits slipped 1,000 to a seasonally adjusted 253,000 for the week ended July 16, the lowest reading since April.  Claims have now been below 300,000, a threshold associated with a healthy labor market, for 72 straight weeks, the longest stretch since 1973.

A couple of weeks after the nationwide jobs report we get updates on the individual states. Arizona lost 39,700 jobs in June, and the unemployment rate went up two-tenths of a percent to 5.6%. That compares to a 6.0% unemployment rate a year ago, but Arizona still lags the national average of 4.9% unemployment. In June, 40,700 government jobs were cut from Arizona’s payrolls, resulting in a net loss of 39.700 jobs in the state.

The National Association of Realtors says existing home sales increased 1.1 percent to an annual rate of 5.57 million units last month, the highest level since February 2007. Mortgage rates fell in June to their lowest levels since 2013 on bets the Federal Reserve would be cautious about raising short-term rates. First-time buyers made up 33 percent of sales in June, the biggest share in nearly four years.

The leading economic index for the U.S. rose 0.3% in June after declining in the prior month. A measure of current conditions increased 0.3%. A “lagging” index fell 0.1%. The LEI is a weighted gauge of 10 indicators designed to signal business-cycle peaks and valleys.

The Justice Department filed an antitrust lawsuit against Anthem and Cigna in federal court in Washington. The government will sue to block a pair of proposed deals that would consolidate the nation’s five biggest health insurers into just three: Anthem’s $48 billion takeover of rival health insurer Cigna and Aetna’s $37 billion bid for Humana. Three of the companies said they would fight the lawsuits, which could tie them up in months of litigation, dragging out deals that were announced about a year ago. Aetna did present two divestiture plans to the Justice Department in an effort to resolve the government’s concerns and allow the Humana deal to go forward.

Turkey’s President Erdogan declared a three-month state of emergency Wednesday night, allowing him to sidestep parliament in passing new laws against supporters of Friday’s coup. The Istanbul stock index is down 9.5% so far this week. Standard & Poor’s downgraded Turkey’s sovereign credit rating and lowered its outlook to “negative.”

General Motors reported second-quarter net income rose to $2.87 billion, or $1.81 a share, from $1.1 billion, or 67 cents a share, a year ago. GM also raised its forecast for full-year profits. Meanwhile, GM said it is recalling nearly 290,000 older Chevrolet Impala cars in the United States because the air bag may not deploy in the event of the crash. GM also said it may be forced by U.S. regulators to recall another 4.3 million vehicles for potentially defective Takata air bag inflators, a call-back that would cost it $550 million; this in addition to a 2,5 million vehicle recall announced in May and June.

Southwest Airlines experienced a tech outage, affecting multiple technology systems and grounding some planes. The airline said it expects to continue to move toward normal operations but that it will take time. Record revenue and cheaper fuel pushed Southwest Airlines’ second-quarter profit up by 35 percent, but that missed analysts’ expectations. However, investors are more concerned with the airline’s warning that it is expecting unit revenue to fall as much as 4% next quarter due to lower ticket prices and greater levels of competition.

Union Pacific dropped 2.8 percent after the No. 1 U.S. railroad posted a lower quarterly net profit, hurt by slumping freight volumes.

Southwest and Union Pacific dragged down the Dow Jones Transport index.

Unilever posted earnings results for the first half of fiscal 2016. The headline numbers met management’s forecast, but they were still marked by weak profit growth as demand for consumer products slowed across many key markets.

Swatch expects a recovery in the second half after net profit plunged 52% in the first half.

Roche confirmed its outlook for 2016 and reported results that exceeded expectations.

Lufthansa cut its full-year profit target, saying “terrorist attacks in Europe” weighed on its bookings.

The fears also hit Easyjet, with shares under pressure after weak third quarter revenues. Easyjet said the Brexit vote has already cost it $53 million, mainly from the drop in the value of the pound.

SABMiller’s net producer revenue grew 2% in the quarter. Meanwhile the Justice Department has approved the $107 billion merger with Anheuser-Busch InBev.

AT&T reported a 22 percent increase in quarterly operating revenue as it added television subscribers, helped by its acquisition of DirecTV. The company’s adjusted profit, however, was in line with the average analyst estimate.

Starbucks said global sales at company-owned cafes open at least 13 months rose 4 percent in the fiscal third quarter ended June 26 from the year-ago period. That was well short of the 5.6 percent gain analysts had expected.

Chipotle reported net income slumped to $25.6 million, or 87 cents per share, in the second quarter ended June 30, from $140.2 million, or $4.45 per share, a year earlier. Sales at restaurants open at least 13 months fell 23 percent. Revenue fell 16.6 percent. Which all sounds terrible, but they have been giving away free burritos and the loyalty program is working; sales inched higher in July. Still, that’s a lot of problems to overcome.

Roger Ailes has resigned as chairman and chief executive Fox News Channel following allegations of sexual harassment. The terms of Ailes’ exit package were not released. Former Fox News anchor Gretchen Carlson sued Ailes earlier this month, claiming sexual harassment. Ailes has denied the charges. Fox hired a law firm to conduct an internal investigation.

Paypal and Visa have announced a partnership which will allow Visa debit customers to move money instantly on Paypal and Venmo accounts. The agreement gives PayPal incentives for increased Visa card spending volumes from merchants and consumers. PayPal will join the Visa Digital Enablement Program to expand point-of-sale acceptance.

Tesla Motors unveiled its Secret Master Plan Part 2 in a blog post overnight. Highlights include an all-in bet on autonomous driving, ride sharing initiatives, urban transport concepts, and new models including pickups and heavy-duty trucks which are already in early development. The first order of business is solar power, that’s where the energy comes from. The pieces are already in place, almost: The Powerwall battery and Gigafactory battery plant, the pending acquisition of solar panel installation and financing firm SolarCity, and a fleet of Tesla vehicles with mobile batteries.

Selfie-fumblers rejoice: Corning just unveiled its newest version of Gorilla Glass, the chemically strengthened super glass that dozens of consumer electronics makers use in their devices. The new glass was formulated to improve drop performance from gadgets that fall onto rough surfaces from certain heights, and survives up to 80% of the time when dropped from 1.6 meters.

Space travel is unpredictable. We’re all familiar with the phrase, “Houston, we have a problem.” So much can go wrong, and it’s impossible to plan for and respond quickly to all of it. The International Space Station has its first 3D printer. If emergencies occur, astronauts can simply print the parts they need. Putting a 3D printer in orbit has huge implications for short- and long-term space travel. Until now, anything astronauts wanted either had to be sent up with them at launch, or delivered later during a resupply mission. Both options are expensive and can take days or weeks. In a dire situation, that’s not good enough. Now, instead of having to wait for a resupply or hack a tool from scraps, the crew can press a button and make one in a matter of hours.

Wednesday, April 23, 2014 - A Brilliant Future From Cool Ideas

Financial Review with Sinclair Noe

DOW – 12 = 16,501
SPX – 4 = 1875
NAS – 34 = 4126
10 YR YLD - .05 = 2.68%
OIL - .2- = 101.55
GOLD un 1284.70
SILV + .06 = 19.55

It’s earnings season, and this is a chance to compare and contrast. This morning, Facebook posted earnings of $642 million in net income, or 25 cents a share, in the first quarter, versus $219 million, or 9 cents a share in the year ago period. Overall revenue grew 72% year-on-year to $2.5 billion in the first quarter, topping estimates. Facebook now has 1.28 billion active users, and more than 1 billion do their Facebook stuff on a mobile device. Then Facebook announced their Financial Director was resigning. Shares were up about 3%.

Nobody puts on a better presentation than Apple, that’s how they grew to be the most valuable company in the world. Steve Jobs would walk out and announce Apple had created a new mp3 player, and also a new way to connect to the internet, and also a new camera. Wow, three new products, nope…, he would hold up the iPhone – just one very cool thing from Apple; tech geeks heads would explode.

Today, Apple posted earnings of $10.2 billion or $11.62 a share, on revenue of $45.6 billion. Analysts expected the company to report earnings excluding items of $10.18 a share; Apple reported a 4.6% rise in March-quarter revenue to $45.6 billion; Apple sold 43.7 million iPhones in the quarter. Then they announced they were adding to their stock buyback with an additional $30 billion over the next year. Then they announced a 7 for one stock split, to make their $500-plus shares a little more affordable. Wow, the share price exploded in after-hours trade by about 8%.

You see the difference.

The really cool thing that Apple is now working on is something you’ve probably never heard of and wasn’t part of the earnings report today. Apple is making sapphires. Natural sapphire is a gemstone variety of the mineral corundum, a crystalline form of aluminum oxide. Corundum is colorless, but in natural sapphires, various impurities create a range of colors: chromium makes the gem red, becoming a ruby; iron and titanium create the prized cornflower blue of a true sapphire. Synthetic sapphire is colorless, unless deliberately colored.

Sapphire has been used in a variety of specialized applications for years, where its purity, clarity, high stable dielectric conductive properties, and high optical quality, along with its hardness, have made it worthwhile despite its relatively high price. Think lasers and high end, luxury watch faces.  Apple is making a billion dollar bet on sapphire as a strategic material for mobile devices such as the iPhone, iPad and perhaps an iWatch. Though exactly what the company plans to do with the scratch-resistant crystal, and when, is still the subject of debate.

Apple is creating its own supply chain devoted to producing and finishing synthetic sapphire crystal in unprecedented quantities. The new Mesa, Ariz., plant, in a partnership with sapphire furnace maker GT Advanced Technologies, will make Apple one of the world’s largest sapphire producers when it reaches full capacity, probably in late 2014. By doing so, Apple is assured of a very large amount of sapphire and insulates itself from the ups and downs of sapphire material pricing in the global market.

The Arizona project was revealed in November, with Apple paying $578 million for GTAT to install and run its advanced sapphire growth furnaces in a plant built and owned by Apple. The news triggered a frenzy of speculation that Apple planned to use sapphire crystal sheets to replace the glass currently used in touch displays for its 2014 iPhones, iPads or a new line of “wearables” such as the long-rumored iWatch, or all of the above.

That’s only the tip of Apple’s investment. Once the synthetic sapphires emerge from the furnaces, they’ll be shipped to Apple’s supply chain partners in Asia for slicing, polishing, laser cutting, coating and eventual assembly. No one has used sapphire in large-scale consumer electronics or consumer goods products. Apple created a sapphire cover for the iPhone 5 camera lens, and for the iPhone 5s Touch ID fingerprint sensor. It’s mainly the sheer foundry capacity that Apple is creating in sapphire that fuels the speculation that it has big plans for sapphire in bigger uses, such  as a replacement for the cover glass, presumed to be Corning Gorilla Glass, in at least the high-end iPhone model.

A sapphire cover would presumably be less likely to break or scratch, but the big payoff could be the ability to change the underlying LCD technology of the screen, rendering more colors and using less power than today’s LCDs, while improving the speed and accuracy of the touch interface. 

It will cost more, by some estimates about $20 more per screen, but what it shows is that when Apple believes in a new technology or material, they’re willing to take a hit on the bill of materials costs. Of course, to commit for the long term, there needs to be a convincing cost reduction roadmap somewhere.

Some think technology stocks are poised for a 2000-style crash. And if they aren't ready to fall now, they may be soon. What is it about financial bubbles that make them so hard to detect? One reason is that memories are short. Some 20 years ago Wall Street merrily poured into technology stocks, and was horribly burned. Not many years later, the rest of America piled into residential real estate with similar abandon, and similar results. Meanwhile, big tech companies are using their stock to fund eye-popping mergers and acquisitions, most famously Facebook's $19 billion takeover of WhatsApp in February (of which $12 billion is in Facebook shares). Apple seems to be able to continue to do cool stuff, and maybe a billion dollars is a good price for a better iPhone screen. Maybe it’s a sign of over valuation in tech. David Einhorn of Greenlight Capital thinks tech may be ready to resume its slide, but it is a cautionary tale:

We have repeatedly noted that it is dangerous to short stocks that have disconnected from traditional valuation methods. After all, twice a silly price is not twice as silly; it’s still just silly. This understanding limited our enthusiasm for shorting the handful of momentum stocks that dominated the headlines last year.

Now there is a clear consensus that we are witnessing our second tech bubble in 15 years. What is uncertain is how much further the bubble can expand, and what might pop it.

In our view the current bubble is an echo of the previous tech bubble, but with fewer large capitalization stocks and much less public enthusiasm. Some indications that we are pretty far along include:

The rejection of conventional valuation methods;

Short-sellers forced to cover due to intolerable mark-to-market losses; and

Huge first day IPO pops for companies that have done little more than use the right buzzwords and attract the right venture capital.

And once again, certain “cool kid” companies and the cheerleading analysts are pretending that compensation paid in equity isn’t an expense because it is “non-cash.” Would these companies be able to retain their highly talented workforces if they stopped doling out large amounts of equity? If you are trying to determine the creditworthiness of these ventures, it might make sense to back out non-cash expenses. But if you are an equity holder trying to value the businesses as a multiple of profits, how can you ignore the real cost of future dilution that comes from paying the employees in stock?

Given the enormous stock price volatility, we decided to short a basket of bubble stocks. A basket approach makes sense because it allows each position to be very small, thereby reducing the risk of any particular high-flier becoming too costly. The corollary to “twice a silly price is not twice as silly” is that when the prices reconnect to traditional valuation methods, the derating can be substantial. There is a huge gap between the bubble price and the point where disciplined growth investors (let alone value investors) become interested buyers. When the last internet bubble popped, Cisco (the best of the best bubble stocks) fell 89%, Amazon fell 93%, and the lower quality stocks fell even more.

In the post-bubble period, people stopped talking about valuing companies based on eyeballs (average monthly users), total addressable market (TAM), or price-to-sales. When the re-rating occurred, the profitable former high-fliers again traded based on P/E ratios, and the unprofitable ones traded as a multiple of cash on the balance sheet.

Our criteria for selecting stocks for the bubble basket is that we estimate there to be at least 90% downside for each stock if and when the market reapplies traditional valuations to these stocks. While we aren’t predicting a complete repeat of the collapse, history illustrates that there is enough potential downside in these names to justify the risk of shorting them.

So is there a tech bubble, or isn't there? Maybe tech stocks aren’t overvalued; the market is more balanced now than it was in 2000. Back then, tech stocks accounted for 14% of all earnings in the S&P 500, but a third of the index's capitalization. Nowadays the two figures are about the same at 19%.  Nor is the IPO market overly frothy like it was 15 years ago. In the first quarter of 2000, 115 companies went public, raising $18 billion; in the first quarter of this year, 63 IPOs raised $11 billion. Moreover, the IPO market isn't as crazed as it was 15 years ago: The first day run-up in share prices after their IPO is a third of what is was in 2000, evidence that investors haven't lost all sense of proportion.

The problem is that bubbles, tech and otherwise, can easily be analyzed away. No one expects the tech bubble to explode using exactly the same formula it did 14 years ago. Tech is more bubble-prone than other industries. Investing by nature is betting on the future, but in the case of tech, the future is a growth story based on extracting a brilliant future from a cool idea.