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The Friday Five

Fri, 14 Mar 2014

China cools, Fannie and Freddie fall, and Amazon's wide moat backs a Prime decision.

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Video Transcript

Jason Stipp: I'm Jason Stipp for Morningstar and welcome to The Friday Five: Morningstar's take on five big stories this week.

Joining me with The Friday Five, as always, is Morningstar markets editor Jeremy Glaser.

Jeremy, thanks for being here.

Jeremy Glaser: You're welcome, Jason.

Stipp: Up first this week is China. We got some data points from them. Expectations were low for that data, and it didn't even meet those. What does this mean for the Chinese economy and the world economy?

Glaser: Anyone who was hoping that Chinese growth was going to power the global economy over the next few years was deeply disappointed by the data that we saw this week and that we've seen recently out of the country.

Although they're still growing at a more than a 7% GDP rate--and that looks great from a U.S. perspective--that's a big slowdown for them. What seems to be happening is the story that we have talked about for some time of this transition from an investment-led economy to more of a consumption-led economy, and some of the challenges that come along with that.

I talked to Morningstar director of economic analysis Bob Johnson about this earlier this week, and he expects that the impact on the United States in particular probably won't be enormous. But this is a story we're going to be talking about for quite for some time and one that is very important to the broader global economy.

Stipp: A bipartisan proposal this week to wind down Fannie Mae and Freddie Mac hit those stocks hard, as well as a few notable investors. What's the takeaway from this situation?

Glaser: We did get a deal from the Senate Banking Committee, maybe a little bit earlier than expected, to finally wind down these government-sponsored entities and get the government most of the way out of the mortgage market, which was one of the big unresolved issues from the 2008 financial crisis.

The deal they came up with would essentially create an insurance scheme that would hopefully allow banks to continue to issue the 30-year fixed-rate mortgages that Congress has decided are important, but without the government playing such a central role in the mechanics of the actual mortgage system.

This is far from a done deal. I think there is going to be a lot of lobbying, a lot of discussion about whether this is the right way to do this over the coming years. It's not going to be something that will happen in the short term.

But it did hit Fannie's and Freddie's shares pretty hard. Now, these shares are not traded on a major exchange anymore, and even though they have had these big runs, it's off of a very low base. I think average investors don't need to be terribly concerned about it.

But there are some mutual funds, like Bruce Berkowitz's Fairholme, and some hedge fund investors, like Bill Ackman, that do have big stakes there and do have a vested interest in trying to keep these entities going or to get some of the profits flowing back to shareholders. So that will be a big political fight that we are likely to see. But I think generally, the impact at least for the investment community in the short term, will be relatively minor.

Stipp: You mentioned Bill Ackman. He is still on his mission against Herbalife with some more news this week. Also a probe announced by the government against Herbalife really raises the drama on this stock. What should investors think about all this?

Glaser: I think most investors can safely steer clear of this one. Bill Ackman has really been pushing a lot of government regulators and a lot of elected officials and a lot of community groups for some time to put a lot of intense pressure on Herbalife. He has a big short against it, and he thinks that it's a pyramid scheme and not a legitimate business. This week, the FTC launched a probe--it was a win for him--as they are looking into some of their business practices, saying that they could possibly be deceptive in some ways.

But even though Bill Ackman feels very strongly about this, Carl Icahn, on the other hand, feels strongly and has a big long position in Herbalife. I think the stock just isn't really being driven by the fundamentals of the business right now. It's being driven by the potential of these probes. It's being driven by these big movements of hedge funds in and out of the stock. And I think it's just not a place that most individual investors should be looking right now. They are probably better off looking at companies that are going to be more focused on how the business is actually doing and less focused on the drama around it.

Stipp: GE this week announced an IPO to spin off its North American retail lending business. What does this mean for the stock, and how do the shares look now for investors?

Glaser: I have two big takeaways here. The first is that they are naming this company Synchrony, and we have to think that somebody actually got paid to come up with that name. So maybe we need a change of profession.

And secondly, I think it just shows that GE really is continuing to focus on the businesses that it has competitive advantages in--things like infrastructure spending and some banking still, but in areas like aircraft leasing where they think that they really can have a competitive advantage over time, and getting out of things like retail lending where they're not going to be able to really carve an advantage out.

Daniel Holland, who covers GE for Morningstar, does think the shares are somewhat undervalued right now. We have it rated 4 stars, and it could be an interesting opportunity.

Stipp: Amazon this week announced it's raising the price for its Prime service. What was driving that decision for the giant online retailer?

Glaser: Amazon is citing higher fuel costs and some other issues for why they want to move this price up to $99. I think the real story here is that Amazon is seeing that they're delivering a good customer experience and that customers are seeing the value, and they think that they can basically take some extra cash from these most loyal customers.

Prime is really incredible. R.J. Hottovy, our Amazon analyst, has talked about it numerous times. Prime is really helping them create switching costs in a place where there really shouldn't be a lot. If you think of online shopping, it should be basically frictionless to buy something from Amazon versus a different website--it's just a matter of entering your credit card and shipping information again. But Amazon really is capturing a lot of these customers, and they are providing that value, and it's really a win on both sides.

This increase probably isn't going to cause an exodus from the Prime platform and should be a key step into helping improve Amazon's operating margins.

Stipp: Jeremy, The Friday Five always delivers on time. Thanks for joining me again.

Glaser: You're welcome, Jason.

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

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