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Friday Five: A Different Kind of Greek Tragedy

Jason Stipp
Jeremy Glaser

Jason Stipp: I'm Jason Stipp for Morningstar. Welcome to The Friday Five, Morningstar's take on five stories in the market this week. Joining me with The Friday Five is Morningstar markets editor Jeremy Glaser.

Jeremy, thanks for being here.

Jeremy Glaser: Glad to be here, Jason.

Stipp: The Fed said this week they are on track to raise rates this year. But they also took some steps to soothe the market, which has been wringing its hands over the rate increase for quite a while. What's your take on the situation?

Glaser: This meeting was the first that you could call "a live meeting," where there was a possibility that they could raise rates. And although no one expected them to--and they didn't--we did get some information about how they are thinking about rate increases later this year.

As you mentioned, they did confirm that yes, they are on track and that the economic data is looking better, and that the slowdown we saw in the first part of the year was transitory. Due to those transitory factors and the fact that things are starting to look better, [they said] it would be appropriate to raise rates.

But they also said that the rate of those increases is actually going to be much slower than people might have expected. Instead of two increases in 2015, there is probably only going to be one. And then it's going to be years and years until we get back to a normalized interest rate environment.

I think that Yellen was really trying to calm investors down. Yes, they are on the path of normalizing monetary policy, but this is a very long road, and they are not going to pull away the punch bowl too quickly. They are going to continue to look at the data and make sure that they support the economy. It's not going to be this cataclysmic event.

The market seemed to be quite soothed by that, and I think we are going to see very gradual moves from the Fed in the years to come.

Stipp: Talks over the Greek situation have been breaking down, which is creating quite a tight situation for them. What's the latest?

Glaser: Last weekend we saw the talks basically collapse, and there wasn't a lot of progress this week, either. All eyes are looking to next week when there is a number of meetings of eurozone leaders, and there is hope that some deal will come out of that.

We've seen some volatility around this, but I think investors need to keep the entire Greek situation in perspective when they are reading these headlines and are thinking about if they need to make any portfolio moves.

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First off, it's not 2010 again. The 2015 Greek crisis does look quite a bit different. I talked to Bob Johnson, our director of economic analysis, about this earlier in the week. Really, the key difference is that the contagion risk is much smaller. A lot of the Greek debt, instead of being owned by European banks who in 2010 were not terribly well capitalized, is owned in more sovereign nations and international funds that have a better capacity to withstand default. We are in much better shape from a global financial stability standpoint, so that you are not worried that a Greek default is all of a sudden going to cause lot of problems in European banks, which could cause problems in U.S. banks, which could cause problems in Asia banks. Those linkages are not as strong as they were. That's a positive.

I think it's also good to keep in mind that it's still likely a deal is going to get done. For political reasons, both sides have every incentive to wait until the last minute to claim that they were driving a really hard bargain, doing everything that they can to get everything that they could. If you make a deal too early before that deadline, it might seem like you left something on the table, and that's more difficult to sell [politically]. So we could yet see a deal.

But generally speaking, even if there is a default, we don't think there will be a major impact on the global economy. We could see some temporary ripples, but we don't think it's going to mean the end of the eurozone or the end of the euro, or that you will see big systemic impacts. So investors should keep this perspective as they are reading the headlines.

Stipp: A federal court ruling this week removed some headline risk from AIG but also raised some interesting questions. This is all harkening back to the financial crisis. What's your take on that ruling?

Glaser: This was a fascinating case. Hank Greenberg, representing the original shareholders of AIG, had sued the federal government saying that when AIG had their bailout at the height of the financial crisis, the federal government had overstepped their bounds. He argued that they didn't have the legal authority to do this and the legal authority to dilute the existing shareholders.

And a federal judge actually agreed with him, saying there wasn't a legal basis for this bailout, but he awarded zero damages, because he said without the federal government's intervention, AIG would have gone bankrupt and shareholders would have gotten nothing. So therefore ... they aren't due any damages.

This is a positive ruling for the current AIG. It eliminates the headline risk that there would be any type of compensation they'd have to pay to those shareholders and lets them continue to focus on their business.

But as you mentioned, it does raise some interesting questions about what happens in the next financial crisis. The government's ability to bail out companies has already been restricted under Dodd-Frank. You add in this ruling, and it does raise some questions about what exactly are the powers, and how do you interpret the powers in Dodd-Frank, and in terms of other powers that regulators have and what can they do to intervene if we do get into another crisis.

I think this points to the fact that prevention is the best medicine, and the regulators do need to continue to be watching for these systemic risks and making sure they don't get so big that you have to have these bailouts again. That's the spirit of Dodd-Frank, and I think this ruling really underscores why that would be important to do.

Stipp: In an interesting deal this week, Target is selling off its pharmacies to be run by CVS within Target stores. What's our take on this deal?

Glaser: This is an interesting one, and we think it does make sense from both sides.

In Target's case, their pharmacy never really had a lot of scale. Scale advantages in terms of being able to negotiate prices in order to have a large network of customers is something that's very important in the retail pharmacy business. Target wasn't going to get there; it wasn't something that was going to be a core competency for them.

We think that they probably operated at essentially a breakeven standpoint and that was really just a service more than a profit driver. So for them, getting out of that business makes a lot of sense; they could get some cash out of it.

From CVS' standpoint, that scale gets even better for them, as they add more of these pharmacies to their network. And it gives the two companies a chance to work together on developing some of these smaller-format Target stores in urban areas where the pharmacy might be a more important component. It gives CVS a good partner there as well.

We think this deal does make sense for both sides, and offers a way for Target to focus on what it does best and for CVS to focus on its strengths as well.

Stipp: Lastly, the market has been down on Gap recently, but after a recent analyst day, our analyst on Gap is pretty upbeat.

Glaser: She is. Bridget Weishaar, who covers Gap for us, thinks there is a lot of value in the shares right now and some room for improvement operationally as well.

She says that management does understand that they need to come up and have identified what is really the brand image for Gap and also for Old Navy and Banana Republic. Who are those customers, how do we get the right apparel to them in order to stay a relevant brand? She thinks they really do still have relevancy in the marketplace today. If you do that you are able to drive some top-line growth.

But they are also focusing on their supply chains, so that they can have profitable growth as well and are able to improve margins--something she thinks is coming in the years ahead. Moves like closing a lot of underperforming stores also seem to make sense. Yes, there will be some onetime costs associated with that, but it does give you a better platform for growth if you are focusing on those stores that you know are going to be able to do well and not chasing underperformers.

Gap stock is trading in 4-star territory in a sector that doesn't have a lot of value, so it could be an interesting one for investors to take a closer look at.

Stipp: The Friday Five is always a perfect fit for investors. Jeremy, thanks for joining me.

Glaser: Thanks, Jason.

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