Fri, 14 Sep 2012
Policymakers and corporate leaders appeared to take decisive steps this week, but are they moving in the right direction?
Jason Stipp: I'm Jason Stipp for Morningstar, and welcome to The Friday Five. Policymakers and corporate leaders took action this week, but to what end?
I'm here today with Morningstar markets editor Jeremy Glaser. He's going to give us the rundown.
Jeremy, thanks for joining me.
Jeremy Glaser: Jason, always a pleasure.
Stipp: What do you have for The Friday Five this week?
Glaser: Well, this week, we're going to talk about the Federal Reserve, two problems in Europe, China, EADS & BAE, and finally Chesapeake.
Stipp: We have to start with the biggest action, Bernanke and the Fed released a statement on Thursday about the actions they're going to take going forward, the so-called QE3. The markets initially at least were very happy about the results. What's your take, and is it going to get the conclusion that the Fed hopes?
Glaser: It's certainly too early to tell if this is really going to have all of the effects that Ben Bernanke hopes that it's going to, but I think it's a good idea to take a little closer look at exactly what they're proposing and what they're going to start doing.
The Fed is going to buy $40 billion of mortgage-backed securities every single month. I think there's three interesting things that are happening here that may be a little bit different from other programs.
The first is that this is open-ended, and this is probably one of the most important things about this program. It's not just, we're going to spend $600 billion, say, and then when that's over, it's done. They're going to keep doing this until employment looks a little bit better, until the economy looks like it's back on its feet, and that open-ended commitment to keep buying bonds is meant as a signal to the market that the Fed is really going to be there, no matter what, that they're going keep doing this until the economy totally heals, even if that is three, four, five years down the road. They want to make it clear that they're going to be there and they're going to keep buying these bonds.
The second one is that, this is not Treasuries that they're buying. Before, they were buying Treasury bonds and helping keep those rates low, but those rates are already extremely low, and I think they saw that maybe the mortgage bond market was an area that they could have more impact, and would be able to get those rates to come down, which could lead to lower mortgage rates, which they're hoping will lead to a better housing market, which they're hoping will then gain employment. Certainly, that transmission mechanism may be a little bit clearer there for getting to employment.
I think that brings us to that third big thing here, which is that this really is focused on employment. I think a lot of people forget that the Fed really has a dual mandate. They have to keep inflation under control, and they also have to keep employment very high. And sometimes those work at opposite ends of each other. But I think here they're really focusing on that employment aspect, where it's open-ended, but they said they're going to be looking at employment to see when to stop it. By targeting housing, again, they're looking directly at employment, and it's definitely an area that they seem to be focusing more and more on when they talk about how they're evaluating the economy, is how many people are getting back to work, and how do we bring that unemployment rate back to that normalized level and not to these really elevated levels that we see right now.
So, the Fed, this program, is going to be helpful, I think, in a lot of ways, but they can't do it on their own. We still have issues like the fiscal cliff; we still have issues in Europe, potentially in emerging markets that could still derail the recovery, and that could still keep things moving very slowly.
But I think the Fed is trying to make a bold statement here that they're going to stand behind the economy, that they're going to keep buying bonds until the cows come home essentially, and we'll have to see if it's enough and if it gives the space for the rest of the economy to continue to grow.
Stipp: You mentioned Europe in your answer there, which is also an area of concern for a lot of folks.
Some action recently in Europe. We have some movement in some areas. What's the latest story there? Are we getting out of the woods at all?
Glaser: This could have been a really bad week in Europe, and it wasn't, and I think it's because we saw some actions take place that really helped dodge two potential crises.
The first was that the German high court decided that the European Stability Mechanism, which is the permanent bailout mechanism for the EU, is in fact constitutional under German law and that's a big relief.
I think one of the big fears--kind of tail risks, if you will, though it wasn't even that much of a tail risk--was that the German court would say this is unconstitutional, Germany can't participate in the ESM, and without Germany that bailout fund really is not particularly effective and wouldn't really have come into existence.
So, I think the fact that you have that backing, that you have those funds, that you can create really this permanent institution really is incredibly important for keeping that long-term stability going in Europe, giving people access to that capital they know is not just going to go away. It ties in very much to the ECB bond-buying program we talked about last week, and really helps create more stability there than we've seen in quite a while.
The second action in Europe was in the Dutch elections, where they returned their centrist pro-Europe parties back into power, instead of going to some more fringe groups that for a while looked like they were really gaining support.
That just makes it a lot easier ... for Europe to come to some of these various agreements and decide how they're going to get a banking union and these other the things that they're talking about. If you had a country that's relatively important have a government that was intent on leaving the European Union or leaving the euro, it just makes everything that much more challenging, especially when you're dealing with decisions many of which have to be made unanimously. So, I think certainly in Europe we saw some positive actions this week.
Stipp: Spinning the globe to hotspot China, it looks like recent action there was going to fast-track some stimulus measures. But when you dig underneath the surface, though, some questions are raised.
Glaser: This has been a fascinating story--exactly what's happening in China. It's one we've talked about a lot here: Can China's growth continue to sustain itself? Is it going to come in for a hard landing? Is there going to be a sharp contraction in growth, or can the Chinese government manage to take [the country] from these really incredible rates of growth into more sustainable levels?
And our analyst Dan Rohr, who's a basic materials analyst at Morningstar, has done some really great work on exactly what's happening in China, and particularly on the infrastructure side. And like you said, there were some hopes late last week that China had fast-tracked a lot of projects, that they really were working on a second stimulus, and that this was an effort to keep the Chinese economy from growing too slowly.
But when Dan kind of dug into this a little bit more, he really saw that it was a much more nuanced message. A lot of the projects that were fast-tracked were really already part of regional government plans--they aren't really new plans. It's not clear that all of these projects are actually funded.
So, I think that it's probably too early to say that China really has embarked on a huge stimulative effort. Certainly, they are trying to keep their economy from slowing down too much. They've been doing a lot with monetary policy to that end, but if they're really willing to act and ready to act, we just don't know yet, and I think that a very slowing China remains a big risk to the global economy.
Stipp: In corporate news, aerospace firms EADS and BAE took some merger action recently in hopes to better compete against big-guy Boeing. What do you think the result of that is going to be?
Glaser: This could be an enormous merger. EADS is the parent company of Airbus. They really focus on commercial aircraft predominantly. BAE Systems is a British company that focuses on the defense side. And there's been a lot of talk about this combination, about creating the European champion in aerospace generally [in both defense and commercial], and certainly this would not be a small company. We're looking at probably €65 billion in sales, over 200,000 employees. It really would be a behemoth. But if they would truly be able to get a lot of synergy out of that, and really see a big margin expansion from this merger, is a lot less clear.
Our analyst Neal Dihora, who covers the sector, thinks that these are such politically connected entities, that the idea of closing a bunch of plants and laying off a bunch of workers is going to be extremely challenging. Probably even if you combine the two businesses, you're not going to see staffing levels cut that much, and it's not really clear that they're going to be able to really profoundly change the entire balance that we have right now between, like you said, Boeing and Lockheed Martin in the United States and with those companies in Europe.
So, certainly, it's going to be an impact, it's going to be a big deal, but it could, A, not come to fruition or B, probably isn't going to have a earth-shattering impact on say, Boeing.
Stipp: Lastly in the energy sector, Chesapeake after maybe a bit of a buying binge took some action to sell some assets recently. Is their house getting in order?
Glaser: Chesapeake is always a fascinating story. I think it's one that seems to come up a lot. They're an E&P natural gas company predominantly, and they have been just on a buying rampage over the last three years. They really have been going into emerging areas of natural gas and just buying up an incredible amount of land, often at a relatively large premium to what other players have offered to pay. This has really been a huge drain on their cash and has run into some financing issues relatively recently.
In response to these issues, management said that they were going to sell off somewhere between $13 billion and $14 billion worth of assets in order to raise capital to kind of shore up their position, and they really took a big step towards that this week. They sold off $7 billion worth of assets all across the spectrum, everything from midstream pipelines to oilfields, and certainly this is a good step towards raising that cash that they need, raising that capital to try to bring themselves to more of a sustainable business model. Exactly where that will shake out in the long run, we don't quite know yet, but certainly it's heartening to see them really beginning to execute on this plan.
Stipp: Jeremy, some bold actions this week. It also sounds like some big question marks remaining on whether those will actually have an effect. Thanks for joining me and for the reports this week.
Glaser: You're welcome, Jason.
Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.