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5 Disappointments for Investors

Jason Stipp
Jeremy Glaser

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

Investors faced a series of disappointments this week, and the markets were registering some of that displeasure.

Here with me to dig into the details is Morningstar markets editor, Jeremy Glaser.

Jeremy, thanks for joining.

Jeremy Glaser: Never a disappointment to be with you, Jason.

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

Glaser: Well, this week we're going to talk about Greece, the Federal Reserve, Microsoft, J.C. Penney, and finally Walgreen.

Stipp: So, Greece elections, I think, went better than some people thought they might, as far as the ability to form a coalition government, but if you were expecting resolutions on all of the issues that Greece is facing, you're probably going to be disappointed.

Glaser: Greece actually has a government now, which is nice. After the first round of elections, it wasn't possible for any of the parties to really form a coalition. It was really in disarray, and I think, the second election, we were worried that that same thing was going to happen again, and it didn’t.

The conservative New Democracy party was able to get just enough votes, and able to, with a coalition partner, go ahead and form the government, and one that looks like it is going to at least in the short term stick by some of those bailout terms, and really keep the country in the euro at least, again, in the very near term.

But I think this doesn't really get rid of any of those core problems that we have been talking about for years now. They still have a crippling debt load, growth is incredibly bad, and I think that whoever is in charge is really going to have to go back and probably renegotiate some of those terms, because they are just not tenable right now. They are just not going to be able to meet those targets that were hit.

So I think that this may have bought us a little bit of safety in the short term, but it certainly isn't providing us any security in the long term.

Stipp: The Fed met this week, and something on a lot of investors' minds is the hope for more stimulus, ultimately. The Fed certainly said they are ready to stand by and do that, but if you are expecting big, bold action, a lot of new plans out of Bernanke, you are probably disappointed.

What's your take on the Fed statement?

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Glaser: We did get some clarification as to what the Fed wants to do. They did say they are going to extend Operation Twist. They are going to keep extending out those maturities, being in the marketplace for few more months, which I think was somewhat welcome news. I think that wasn't a huge surprise.

But Bernanke did say, and reiterated, that he is going to be there. They are going to be standing by. That if they see employment get much, much worse, if they see a huge issue in Europe that looks like it's going to cascade over the Atlantic into the United States, that they are going to go ahead and maybe there could be another round of quantitative easing, maybe they will use some more unconventional measures in order to support the United States economy.

I think that monetary policy probably still has some trick up its sleeves. I think, certainly they can't do everything on their own. But Bernanke really was there saying that he would be supporting the economy, if he can, but I think investors were hoping for a little bit more clarity there.

Stipp: In corporate news, Jeremy, Microsoft lifting the veil on a product under development. It's sort of a cross between a tablet and a laptop. But you think that consumers might not be particularly excited about this product, and it might be somewhat of a disappointment. Why is that?

Glaser: Well I think certainly Microsoft pulled off somewhat of coup of having a bit of a secret press conference, where people didn’t know exactly what was coming beforehand--kind of Apple-esque measure there. But I think the product that they developed is not going to compete with Apple quite as much as they would like.

They came out with the Surface, which is a tablet that is really geared toward both enterprise and consumer users. Like you mentioned, it can also come with a keyboard that attaches on the case. One of the versions will run the full version of Windows 8 that will be powered by an Intel chip, which makes it extremely powerful, makes it probably more compatible with a lot of corporate networks out there.

But I think that a lot of things that happened in that press conference that Microsoft announced just showed some of the weaknesses that company has when trying to integrate that hardware and software.

They didn't provide price, so we don't know where they're coming out in there. But the availability is going to be quite a while from now; some of the models are not until early 2013. I think some of that is probably so that they don't upset their OEM or their manufacturing partners too much. [Those manufacturers] are trying to make tablets with Windows 8 on it as well. I think in some ways, Microsoft almost wanted to give them a heads-up so they know what kind of specs they need to be meeting and what kind of products people are going to want to see there.

So I think when you have the idea that you are introducing a product that's not going to come out for months to come, that it's going to have some confusing versions, that it's not really clear what the benefits are over the iPad--it's not thinner, it doesn't have a sharper screen, the price point is unlikely to be very competitive. I think it's going to be hard for Microsoft to move a lot of these into consumers' hands. I don't think there's going to be a big outcry for them. I think certainly Microsoft needs to be in the tablet space. I think they are trying to push their partners to produce better products by doing some of the in-house design work on their end, but I think this is not going to be a game-changer for Microsoft.

Stipp: Over in the retail sector, there was a management change at J.C. Penney after some disappointing results. Why has their turnaround not lived up to expectations so far?

Glaser: A lot of investors had very high hopes for J.C. Penney when Ron Johnson came over from Apple and was really going to turn around the business. He came up with some innovative ideas in terms of getting rid of all of those sales and instead just having everyday low pricing, remodeling the stores. And a big part of that was going to be with marketing, that he was going to bring in a lot of high-level executives from some other successful retailers who were going to help him turn around this business.

And Michael Francis who had come over to run marketing was one of those people. He was very suddenly let go, and a lot of people saw that as a sign that maybe Johnson was not as confident about the turnaround, wasn’t confident of his plan as they had hoped, and the stock sold off pretty sharply on this.

The Morningstar analyst staff really thinks that's just too soon to make that call. Maybe the marketing wasn’t as strong as it could be, the communication about the new sales structure maybe wasn’t as strong as it could have been, but certainly I think J.C. Penney has a lot of time to turn themselves around. It's a big ship. It's not going to happen overnight. That consumer re-education is not going to happen overnight. So I don’t think this is necessarily time to completely panic. It's going to be a long time before we know if this was successful or not.

Stipp: And also in retail news, Jeremy, for No. 5, Walgreen announced an acquisition. At least one person at Morningstar was disappointed in this news and the market also seemed to be disappointed. Why was this acquisition met with pessimism?

Glaser: Certainly, there weren't a lot of people, outside of Walgreen headquarters probably, who were really excited about this deal. Like you said, our analyst Matt Coffina thinks that Walgreens buying a 45% stake in a Europe-based pharmacy chain Alliance Boots for $6.9 billion is not something that makes a lot of strategic sense for the company.

It might seem like, OK, they are both pharmacies; maybe there are some synergies there. But the regulatory regime is just so vastly different on both sides of the Atlantic that it's really difficult to squeeze out any efficiencies there when it comes to negotiating drug prices or things like that. You're just not going to get that kind of scale that could make an acquisition like this really work for you.

When you consider that Walgreens has a lot of issues here at home, like dealing with the fallout from losing the Express Scripts customers when that pharmacy benefit manager walked away from Walgreen, it just seems like an odd use of management time to really go in there and try to make that joint venture work or to make that stake really work for them.

I think this is just a case that just shows you the risk of when a company has a lot of cash on the balance sheet, sometimes that just gives them a license to go and make deals, and to go and be adventurous in ways that maybe aren't necessarily accretive to shareholders.

Stipp: Jeremy, although investors may have been disappointed this week, I think our viewers will be delighted by your analysis. Thanks again for joining me.

Glaser: You're welcome, Jason.

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