Fri, 11 Jul 2014
This week: The Fed discloses an end to the taper, eurozone concerns resurface, and a cupcake firm crumbles.
Christine Benz: Hi, I'm Christine Benz for Morningstar.com and welcome to The Friday Five. Joining us as always to share five events of the past week is Morningstar markets editor Jeremy Glaser. Jeremy, thank you so much for being here.
Jeremy Glaser: You're welcome, Christine.
Benz: Jeremy, let's start with the Fed minutes released this week. Let's talk about what inventors took away from them?
Glaser: The big news was that we finally got a confirmation that the taper is planned to end in October. You can kind of back out what we've seen so far, and that seemed to be the end date. But we've heard the Fed governors say, this is absolutely going to be done by October. In November, we're not going to be buying new bonds anymore. Again, this isn't a surprise given that the jobless numbers have looked much better over the last couple of months, even as the economy has gone through some growth issues, particularly through the winter and last quarter with the poor weather.
I think investors are now going to start to focus on when rates are going to rise. When will we see that hike to short-term rates? It could be as soon as 2015, but I don't think it should be something that really keeps you up at night. The Fed isn't going to start going down that road until the economy will looks strong enough to actually handle it. I think that the Fed, if they've shown nothing else throughout the crisis is how flexible they're willing to be or going to be in order to support the economy, getting rid of this unconventional program with something that was definitely going to happen. But in terms of those conventional monetary policy moves, I think we're not going to see it until we see serious signs of inflation, which is not the case yet, or until the economy is looking much stronger and they feel like [an increase in rates] could be done safely.
Benz: How did the markets react, Jeremy, when this news came out of the Fed minutes? Did everybody sort of shrug and say "This is what we expected?"
Glaser: Yes, for the most part. Shares kind of traded down a little bit and then up a little bit. But it's one of these situations where, again, when you kind of backed out, if we kept losing about $10 billion a month of these purchases, that kind of October-November time frame is where that takes you.
Benz: Europe provided bad flashbacks from a couple of years ago. Portugal was in the news this week, let's talk about what's going on in Portugal's banking sector.
Glaser: Yes, it was like all of a sudden investors remembered that the European banks really aren't in great shape, and that didn't magically change, just with the passing of time necessarily. We have seen a lot of big recapitalizations in the European banking space, but they still are far behind in many ways from, say, the American banks that were much more aggressive in raising capital and kind of cleaning up their balance sheets in the wake of the financial crisis.
This week, Banco Espirito Santo, which is a large Portuguese lender, their parent company ran into some issues, delaying some coupon payments, some short-term bonds that they have. There have been some other financial irregularities and some other concerns about this conglomerate over the past couple of weeks, and this really kind of crystallized it, I think, in a lot of people's minds.
Does this particular bank or the particular issues here pose some huge systemic risk? Are we back to kind of those bad old days of the eurozone crisis? No. It's nothing quite that serious yet, but I think it is a reminder again that these banks probably are going to still need a lot more time probably to raise more capital to really become a much more stable, and that as these banks continue to work through these issues, it's going to have an impact on growth. Bank lending is an important part of what drives European business. If these banks really aren't quite strong enough to be doing that lending, it poses a challenge to really get that growth going again.
Benz: So it looks like investors flocked to, at least in Europe, some of the safe havens away from some of these riskier asset types.
Glaser: Yes, it's that, risk-on, risk-off trade that we talked about so much in 2011, this idea that all of a sudden people only want German bonds, Treasuries, or gold. They were certainly looking for those safe havens late this week.
Benz: Elsewhere in the news AbbVie continues to aggressively pursue the Irish-based pharmaceutical company, Shire. Let's talk about what's going on there? AbbVie seems to really want to buy Shire.
Glaser: They really do. They raised their offer by 11%, to over a $50 billion value for Shire; and they're now almost at 50% above where Shire's shares were trading before this offer was announced, the first offer. So, that's a pretty hefty buyout premium, and AbbVie's justifying it by saying that they're going to get a lot of tax savings, this so-called tax inversion where they're able to pay things at a non-U.S. rate. They suspect that will be advantageous over the long run. I think, for investors, there probably is some truth to this that they will have some tax savings, but that's only going to be true up to a point. If you overpay, too much, then you really, aren't going to really reap those benefits very much. We saw Pfizer walk away from that AstraZeneca deal because of valuation concerns. I think AbbVie will have to be somewhat disciplined, to not keep chasing this forever. These tax benefits are only worth so much.
Benz: You also think Samsung's latest earnings release is worth a look; that investors should think about it in the context of the whole phone industry. Let's talk about that?
Glaser: I think it's important, obviously, to look at it as an industry, to see what's growing and what's happening with market share. And Samsung had a disappointing quarter. When you try to strip out some of the other things that are going on with the business, it does look like, their mid-range and low-range phones just weren't selling as well.
But Brian Colello, who covers the smartphone industry for us at Morningstar, says that this is not necessarily a sign that the market is shrinking considerably or that Apple is going to degrade that or that if Samsung is doing poorly, then that must mean that Apple is doing really well. That's not necessarily how this is going to work. In the high-end [market], Samsung probably was still doing pretty well; that's where they compete with Apple. And you can't really just look at the industry as "It's just Samsung and just Apple." That might be true, again, at the high end. But for the rest of the market, there are a lot of other players there, some growing very quickly, and those are the ones to look at. So, for Apple shareholders, which there's many more of here in the U.S., than there are Samsung shareholders, they shouldn't get too excited about this result meaning that Apple's going to have a blow-out quarter because Samsung was stumbling.
Benz: Elsewhere in the news we saw maybe a sign that the cupcake bubble is coming to an end. Let's talk about what's going on there?
Glaser: We'll have to see. Crumbs closed all of their stores on Monday somewhat unexpectedly, and I think this is a story or maybe a cautionary tale for investors of why a competitive advantage, looking for economic moats, is really important. This was kind of a classic no-moat business. Opening a cupcake shop is not particularly challenging; it is supply-chain logistics. A lot of people have access to flour and butter. Crumbs expanded very quickly, they took on a lot of debt, and they just weren't really able to keep it going. That really, finally caught up to them.
I know it can be tempting. You see these stories where they're growing really quickly. They're adding a lot of stores. You think that growth could be exciting, and you get in at the ground floor. You have to make sure it's a business that really can have that advantage around it that they're going to able to either shift to consumer tastes or really keep competitors at bay. Crumbs, obviously, wasn't able to do that, and I think it's just one of many of kind of these trendy businesses that didn't have moats that are now no longer with us.
Benz: What's the next food fab?
Glaser: Well, you know there's some talk of maybe the frozen yogurt bubble, but I don't know if that's ready to go yet, but at least here in Chicago, donuts seem to be the next big thing, and personally I am happy about that than the cupcake fad.
Benz: Jeremy, thank you so much for being here.
Glaser: You're welcome Christine.
Benz: Thanks for watching. I'm Christine Benz for Morningstar.com