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Taking Action

Fri, 8 Jun 2012

Many central bank and corporate leaders were at least talking about, if not taking action this week.

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Video Transcript

Jason Stipp: I'm Jason Stipp for Morningstar, and welcome to the Friday Five.

Events this week showed policymakers and corporate executives moving into action.

Here to offer the details is Morningstar markets editor Jeremy Glaser.

Jeremy, thanks for being here.

Jeremy Glaser: You're welcome, Jason.

Stipp: So what do you have for the Friday Five this week?

Glaser: We're going to talk about central banks, China, Starbucks, Facebook and Nasdaq, and finally, REITs.

Stipp: So, Jeremy, we did in fact hear from a lot of central banks this week; they are at least talking the talk. What is it say about the state of the global economy that we are starting to hear them discuss stimulative measures?

Glaser: Well, this week, we really got a "well, we might do something or we might not" little dance from both the European Central Bank and the Federal Reserve. The European Central Bank has been a lot more reluctant to act than the Federal Reserve. A lot of that is just that their mandate is really to be focused on inflation--they have been laser-focused on that--and certainly they are very worried about stoking inflation. So, they still haven't lowered interest rates as far as they can, and this week they decided to keep interest rates at their current levels. But they did say they were seeing a lot of weakening in the economy, and they see that Europe is certainly in somewhat dire straits right now.

So, I think hearing that admission from the European Central Bank, hearing that some members of the ECB board are willing to lower rates--it's not a unanimous decision to keep them steady anymore--really had investors hoping that the ECB actually might be a little bit more active, even if they didn't announce any specific measures.

Stateside, the Federal Reserve has been a lot more stimulative. Between quantitative easing and operation twist and other things, they have really been trying to expand their balance sheet, and trying to keep the economy going and moving forward.

I think Ben Bernanke's comments this week [show] the Fed is still willing to act, that they still see weakness. It's also a sign that he sees some problems, [and] that the Fed is willing to put some more measures in place to be more stimulative.

So, what will come of that? When these measures could actually come is anybody's guess. The market is certainly hanging on every word, as they really see monetary policy as one of the few levers that can still be pulled to try to fend off another recession.

Stipp: So, if the ECB and Bernanke are standing ready to act, we did see China actually act and make a move on interest rates there. What does that say about the situation in China?

<TRANSCRIPT>

Glaser: One of the big questions for China watchers has certainly been, is there going to be a hard landing or a soft landing in the Chinese economy? Basically, the idea is that China is probably growing at an unsustainable rate, and is it suddenly just going to crash and we're going to see it fall off a cliff, or is it going to be a slow, steady move down to a more sustainable level?

Obviously, the Chinese government wants that to be a slow, sustainable move; they're not looking for any big changes in their economy very, very quickly. I think that having the Central Bank act here is just a sign that they are willing to pull all the levers that they have in order to make sure that a hard landing doesn't happen.

So the surprise interest rate cut on its own probably isn't going to have a huge impact and totally bring China back to that explosive growth they had just a few years ago. But I think certainly it shows that they are willing to act and that they are acting, and that the worry about China really slowing down and dragging on the rest of the [global] economy might be somewhat overblown if the government is willing to keep pumping up those numbers, at least for the short and medium term.

Stipp: In corporate news, Starbucks makes a move into, I guess you'd call it, a related market. What does this say for the company? Is this going to sweeten the pot for them?

Glaser: Starbucks this week spent about $100 million to buy bakery chain La Boulange, which is based mostly in the Bay Area right now. This is not a huge deal from a dollar perspective for Starbucks, which is a very large company. But our analyst R.J. Hottovy really sees this deal as another sign of Starbucks being able to profitably use the cash that's being thrown off from their core coffee business and invest into areas that could be really good [sources] of growth for them.

Food is an area that Starbucks has always struggled with. Certainly they attach a lot of food to the coffee that they sell, but no one really thinks of it as a dining destination. Adding some higher-quality products and potentially opening up new food-oriented cafes could help power growth and could really make it clear to see how Starbucks can keep growing more and more beyond just selling more lattes or just selling more Frappuccinos to people.

Add that in to their move into the consumer packaged good space with coffees and with instant coffee and with other stuff that they are selling on supermarket shelves, and you can really see Starbucks just continues to increase their competitive advantages, continues to expand, and just has really been on a great roll recently.

Stipp: Jeremy, this week Nasdaq was stirred to action to issue an apology to Facebook for the IPO troubles that they had. It just seems like social media is really not living up to the buzz so far, right?

Glaser: It has not been a great week for a lot of the social networking firms.

Facebook is really still trying to dig itself out of its IPO hole in some ways. I think just from a reputation standpoint, they really took a big hit, and one of the reasons was that their initial trading was a little bit bungled, and a lot of that was Nasdaq's fault.

[Nasdaq] came out this week and really admitted that [their] systems did not work the way [they] expected. [They're] going to compensate people for any of the trades that didn't quite go through the way that they expected. I think it's nice for Nasdaq to admit that and to try to make people right. But it doesn't really make it any easier for Facebook, which still has to now climb over those worries about the sustainability of its business, and it's really difficult to get some of those opening-day jitters out of people's minds. It could take some time for that to happen.

But elsewhere, LinkedIn had a really tough week, too. They had a pretty big privacy breach, where a number of passwords were exposed by a hacker and put on the Internet for everyone to see. They had to encourage people to reset their passwords, and it just highlights that a lot of these companies are susceptible to security breaches. ... [If such security issues] become too acute, and people decided to leave the service and move to another service that they thought was more secure, it could present a tail risk for some of these companies, and one that investors maybe haven't considered that much before. So certainly not a great couple of days for some of the public social networkers.

Stipp: Lastly, Jeremy, we've seen a trend of some corporations stirred to action to change their corporate structure to REITs [real estate investment trusts]. There are some unusual companies, maybe, that are looking into this structure. Why is this happening right now?

Glaser: I think it's difficult to generalize too much from a few cases. But certainly a lot of corporations are looking into the REIT structure. Not having to pay corporate income tax if you're paying out a big enough distribution to your shareholders is certainly very attractive. I think [it's] particularly [attractive to companies] now given that there's so much uncertainty around where tax rates are going to go and what the tax regime is going to look like in the next five to 10 years.

So, this week we saw that Iron Mountain is going to look into becoming a REIT. The board of directors approved this plan. It could be some time before that actually happens. There are a lot of moving parts [associated with] actually getting into the [REIT] structure, but they think that they can unlock a lot of value there.

We saw recently that Gaylord Hotels, which is an owner of these big convention hotels, decided to sell the management part of their business to Marriott International, and they're going to convert the actual property ownership business into a REIT. The stock rallied pretty strongly on that news.

So, I think really it's a combination of tax efficiency--they think that they can provide those better returns and not have to worry about a lot of big changes in tax law, assuming that REIT tax law doesn't change substantially in the next couple of years. And I think certainly they see it as a structure that works better for them.

So, it's probably too soon to tell if this is really the start of a huge trend that will see a lot of companies trying to restructuring this way, but it definitely shows that companies are thinking about tax law, they're thinking about how to optimize, and I think that's an interesting trend that we're certainly going to see.

Stipp: Jeremy, I'll be stirred to action to see you next week on the Friday Five, but thanks for joining me today.

Glaser: You're welcome, Jason.

Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.

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