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Friday Five: Fed Grows Cautious, Facebook Flies

Fri, 29 Jan 2016

A March rate hike seems slightly less likely, following the Fed's comments this week. Plus, our read on Facebook, Apple, Boeing, and P&G earnings.

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Video Transcript

Christine Benz: Hi, I'm Christine Benz for Morningstar.com. Welcome to The Friday Five. The Federal Reserve sounded a cautious note in its statements this week. Joining me to discuss this and other market and economic news is Morningstar markets editor Jeremy Glaser.

Jeremy, thank you so much for being here.

Jeremy Glaser: You're welcome Christine.

Benz: Let's discuss the Fed's most recent statement; it did sound a cautious note. Let's talk about that and what it means for a potential rate movement in March.

Glaser: No one expected the Fed to move rates at this January meeting after raising rates in December. But we were interested to see what they had to say about the state of the economy. The Fed said they are seeing a slowdown, which is something we haven't heard them talk about in a long time. They said they are very carefully looking at what's happening abroad and seeing what impact it's having on employment and inflation. It's obviously something they are worried about [and could pose] a risk to their outlook.

They left the door open to increase rates in March. They certainly are open to doing that if the economic data continues to look pretty strong. Let's say we have a few good jobs reports or core inflation starts to look a little bit better. But it's not a done deal yet. If you look at what the market's predicting, [market watchers] don't expect rates to be increased in March. They think the Fed is going to be forced to wait--maybe we aren't going to see four increases this year, which is what the Fed was saying was going to happen as we entered 2016.

So, obviously a very cautious note here. [A rate increase is] still a possibility, but it seems like a March rate hike seems slightly less likely, given what's going on in the world right now.

Benz: Some market watchers, I know, are even looking back to December's rate move and saying, maybe the Fed was a little too aggressive there.

Glaser: It's always hard to say exactly what would have happened if they hadn't raised rates. Would we would have seen this type of volatility? We very well may have, given that the issues in China probably aren't super-dependent on it.

But certainly a tightening Federal Reserve and the divergent global central bank policies is part of what's driving this. I think that's why the Fed is being so cautious now and being very clear that they want to have a very slow path of increases, that they are willing to be patient and wait to make sure another increase doesn't create even more problems.

Benz: Turning over to earnings news. Facebook stock popped after issuing some decent earnings during the quarter.

Glaser: Facebook had another strong quarter, and this was, at least from a price standpoint, one of the big winners of 2015. That's continued, at least in terms of results, into 2016. Facebook is doing a good job of continuing to engage their users. They are not seeing the same kind of problems that Twitter is having in keeping people engaged with the platform. People want to use Facebook; they want to use Instagram. They are on WhatsApp. Facebook is doing a good job at keeping them and then also monetizing that. They are seeing good gains in the number of ads they are able to sell against people; revenue was up 52% year-over-year--a pretty good growth rate for them, given that they are getting quite big.

Now, costs are rising as well--they were up 21%--but that really is expected. They need to keep investing in the business. They want to remain on top. They are not ready to rest on their laurels yet, and it seems like they are making some smart capital-allocation decisions. There aren't signs they are throwing money away or burning money for the sake of it. That's good to see from an expense side.

Profit was over $1 billion for the first time. Overall, it was another strong quarter from Facebook.

Benz: Apple was a little more disappointing. I think a lot of people are looking at Apple today and wondering, is it possible that this great company's best days are behind it?

Glaser: It was a much gloomier picture from Apple. That was being driven by some headwinds they are facing. Everything from currency--they obviously sell across the world--and the strong dollar is challenging for that. It seems like demand for the new iPhone--the iPhone 6S and 6S Plus--was not as strong as the upgrade cycle into the 6. They just barely saw growth, and depending on how you look at it, there might even have been a small decline looking at those actual end-user sales. That certainly is a big challenge for them.

Brian Colello, Morningstar's Apple analyst, thinks that this is not the end of the road for them. The average selling price of an iPhone remains very high, despite some of the currency issues; that shows people are willing to pay a premium. There just isn't any sign of a premium iPhone killer out there. Maybe there will be some lengthening of the upgrade cycle. They do need to roll out some new features in the next phone that will excite people and prompt them to upgrade. But it's not a completely dead story yet.

Right now, the stock is being priced as if the iPhone will never grow again, that it's basically over. Brian just doesn't think that's the case. He still sees some value in Apple shares after the sell-off.

Benz: Boeing issued a disappointing outlook for 2016. What's driving that?

Glaser: This was a tough quarter for Boeing. It saw one of its largest one-day declines in years. That was because of their guidance. They cut how many airplanes they said that they are going to deliver in 2016 versus 2015. Investors thought it would be flat, and they actually said it's going to be down. They said they are doing this to balance the differences between demand for their planes, particularly as they move into launching their next-generation 777 and 737 products. They want to make sure they are prepared for that turnover.

Commercial aviation and aircraft sales have been a bright spot through the recession. Even when other parts of the economy weren't doing so great, there has been robust demand for commercial aircraft, and maybe there are some signs that's starting to slow down a little bit. A lot of that came from emerging markets, from China. If we're seeing slowdowns there, maybe the demand for some of these aircraft is lower. That got investors a little bit worried.

We're not as concerned about it. We did bring down our fair value estimate because of some of this news, but even with that decline, we still think the stock is in 4-star territory and looks undervalued.

Benz: Procter & Gamble has been trying to execute a turnaround. Let's talk about whether there are any signs of hope on that front.

Glaser: Erin Lash, Morningstar's P&G analyst, thinks there are, and that P&G's turnaround is gaining traction. You could see that in this quarter.

From a sales perspective, it wasn't a fantastic quarter. It was a little bit better than the third quarter, but not great. They are still grappling with the same issues that have impacted a lot of consumer packaged goods firms--everything from that currency impact we've been talking about to slower macroeconomic growth.

But gross margins rose 290 basis points, which is a big increase in that kind of environment. That shows their investments in cost-cutting and focusing on their core brands are starting to gain some traction. They are getting rid of those unprofitable brands that were bloating their portfolio. This is the right move for them.

Erin thinks as they continue to invest in those core brands and are able to get more products that consumers want, and as they remain a trusted partner for retailers, something this really important, that will continue to support their economic moat and valuation and even though shares have run up a little bit on the back of some of this news, we still see value in those shares as well.

Benz: Jeremy, it was a busy market week as always. Thank you so much for being here to share your insights.

Glaser: You're welcome Christine.

Benz: Thanks for watching. I'm Christine Benz for Morningstar.com.

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