US Videos

Friday Five: A Few Cobwebs in the GDP Report

Jason Stipp
Jeremy Glaser

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

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

Jeremy, thanks for being here.

Jeremy Glaser: You're welcome, Jason. Hopefully, there is nothing too scary for this Halloween.

Stipp: Well one thing that wasn't that scary this week was the GDP report. It came in better than expectations at 3.5%. That's the first read on third-quarter GDP. But when you look under the hood, maybe a few cobwebs?

Glaser: At 3.5% growth, which was above a 3% consensus, the report does look pretty rosy, but investors shouldn't get too excited or think that the U.S. economy is now on a much different growth trajectory. Our director of economic analysis Bob Johnson laid out a few reasons why this is not quite as strong of a report as it looks at first glance.

The first item is that we're still bouncing back from the really horrible weather in the first quarter, which shifted a lot of demand later into the year. Second, government spending was very high in the quarter, as expected, due to some defense expenditures; that's probably not repeatable. And also exports looked pretty strong, and given that the dollar is much stronger now and that the rest of the world's economy is growing so slowly, you wouldn't expect exports to continue to lead GDP higher.

When you see that consumer spending actually decelerated a little bit--it was not as high as it was in the previous quarter--you might think that we're not seeing quite the strength that the headline number shows. It's still better than what you're seeing in Europe, still the envy of a lot of other places, but maybe not as fast as you would hope, and it's certainly not a sign that we're out of this 2% to 2.5% slow-growth range.

Stipp: We got the Fed statement this week, and it did confirm that the bond-buying is officially over, but that doesn't mean that the accommodation is over.

Glaser: It's not. Quantitative easing, the bond-buying portion, is done. But we kept that "considerable time" language about when rates are going to rise, and the Fed actually did upgrade its opinion of the economy a little bit, saying that they're seeing a little bit less slack in the labor market. They don't see inflation as a major problem, nor do they see deflation as potentially a major problem. They think that lower energy prices are driving [lower inflation], and that may be more of a temporary factory.

All in all, we saw a slightly more hawkish side of the Fed starting to come out with this statement, saying that they are starting to see things looking a little bit better. I think this does set the stage for them to begin potentially raising rates next year. The exact timing, of course, we don't know. But instead of being focused on the question of, is it going to be the middle of the year or the end of the year, investors should instead think more about what's going happen in the long term: What will rates look like over the next five to 10 years? If we are still in this slow-growth mode, what should the natural interest rates be? Higher than it is now for sure, but maybe not as high as we've been used to in the past.

Stipp: Earnings continued to roll in this week, and both Visa and MasterCard popped after their earnings announcements. What were the drivers?

Glaser: What's happening is that payments are still growing by double-digit percentages as people are moving away from using cash to using their credit cards, and as consumer spending is going up a little bit, that's also helping both of these businesses.

Both companies saw that increase. One of the differences is that Visa kept their expenses under control in the quarter; MasterCard's went up a little bit as they are investing to guard against competition from PayPal to UnionPay. Those competitive threats are real for both of the networks, but we still think they are well positioned.

Jim Sinegal, our analyst on Visa and MasterCard, really thinks that these are rare businesses that are growing very quickly, and they have wide economic moats and a very powerful network effect, which will make it hard for competitors to get in there, and also they are very well managed.

Now, after these big runups, they are both trading in 3-star territory, right above their fair value estimates. So maybe these are not great bargains, but these could be excellent long-term holdings. If there is any pullback, they are certainly names that investors would want to consider.

Stipp: On the other hand, the two big social networks, Facebook and Twitter, had disappointing quarters. Why weren't they performing as well as folks expected?

Glaser: They were disappointing for slightly different reasons. On the Facebook side, it was about expenses. They had made some acquisitions--Oculus Rift, WhatsApp--and those were weighing on profitability, and management said that they are going to keep investing in projects that may not be profitable next year or the year after, or even the year after that, and that Facebook is willing to take that long-term view.

Rick Summer, our Facebook analyst, thinks the shares are still a little bit pricey today, but he sees that this disconnect between the market that's focused on short-term results and the management team focused on the long term could create some buying opportunities for investors who are willing to look past an investment period, given just how powerful Facebook's economic moat is.

For Twitter, the problem was user growth. This has been a big driver of the stock both up and down: the concern about whether Twitter can continue to attract new users. How big is their addressable audience? It really did not look as good this quarter as it had in the past. That drove the stock lower, but again, their shares still look pricey even after the fall.

Stipp: Fiat Chrysler's stock price drove up this week after earnings and an announcement. What was going on there?

Glaser: We talk a lot about automakers on The Friday Five, and part of that is because it's really one of the few true pockets of value in a market that still remains fully to slightly overvalued.

Fiat Chrysler was in 5-star territory, and the stock came up quite a bit after earnings and the announcement that they will be spinning off their Ferrari business, their luxury car business, into a separate company. They are going to take the proceeds from that sell-off and continue to invest in the combination of Fiat and Chrysler to try to find more cost synergies, find a way to get bigger. The conventional wisdom these days is that by getting bigger you are able to bring out more profitability in a very difficult marketplace.

We still think the stock is 5-star, we still think it's in buy territory. But investors should be aware, automakers are in very much a no-moat business. It's very challenging because it is high uncertainty--that cone of possibilities around it is relatively large--but it could be a compelling entry point.

Stipp: Jeremy, The Friday Five is hitting on all cylinders again this week. Thanks for joining me.

Glaser: You're welcome, Jason.

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