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Fed Hike: The News That Wasn't

Jeremy Glaser
Jason Stipp

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: You're welcome, Jason.

Stipp: Up first this week, obviously, is the Fed decision. They finally did decide to raise rates, and you say this is really the news story that wasn't news, and that's a good thing.

Glaser: Frankly, there isn't a lot to talk about with this rate increase of 25 basis points, because the Fed had spent so much time getting the market ready, getting investors ready for this shift toward the normalization of monetary policy. The real story would have been if they hadn't raised rates or if there was a big surprise in what they said about the path of rates, and we just didn't see that.

They still expect rates to go up a little bit, to around maybe 1.5% at the end of next year. That implies four increases in 2016. That's a very gradual path. They emphasized that in the press conference as well. They said they are going to be looking at inflation, making sure that employment continues to improve and look better. Really no surprises there.

I think this will help us stop being so focused on the Fed, as they have removed that uncertainty. I think it's one of the reasons the market rallied after the decision, and now we can start looking at more of those fundamentals.

We did publish a lot of content this week about what impact higher rates will have on particularly bond funds and also some other types of investments. We have a landing page with all of that content available.

Stipp: Beauty firm Avon took some steps to shore up its balance sheet this week. What was behind that move?

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Glaser: Avon has been struggling, and they did make some moves to shore up the balance sheet, as you mentioned.

They are going to spin off the North American business into a private company that's going to be more than 80% owned by Cerberus Capital, a private-equity fund, and also Cerberus is going to invest a fair amount of money into the international business to try to improve that balance sheet and give them the capability to invest in that business, which is the growth driver and profitability driver for Avon. They also suspended their dividend.

With these moves, Erin Lash, our Avon analyst, thinks they are moving in the right direction. We moved our Uncertainty Rating, which had been at "extreme," to "very high." We still think there is a lot of uncertainty around the stock, but not quite as much as before. We modestly reduced our fair value.

I think the real story here is that even though they are moving in the right direction, it's still not a great investment idea given that level of uncertainty. You'd want a really big margin of safety before taking a shot at a company like Avon.

Stipp: FedEx reported quarterly results this week that looked pretty solid, and a lot of that was driven by its Express business.

Glaser: FedEx had a good quarter. What happened in Express is revenue came down, and part of that is they are not charging fuel surcharges anymore with energy. Revenue was down 6%, but expenses actually fell 9% because, of course, fuel is a big component of those expenses--that declined--and also because of some other initiatives FedEx has had to improve their profitability. So, margins in Express were actually the best they have been in eight years. Volumes were up. Things were looking good there. Ground was a little bit of a mixed bag. It was mainly in line. The Freight business was a little bit disappointing.

But overall, FedEx had a solid quarter, and we do think the shares still look a little bit undervalued.

Stipp: Oracle also reported results this week, and the market was disappointed by those--mainly because of worries over the cloud.

Glaser: Rick Summer, who is our Oracle analyst, thinks the market is too focused on the threat of the cloud and is missing the bigger picture. Oracle is making good progress toward transitioning customers to the cloud, and that it's going to be a much longer process than many people think to move from that traditional software model into the cloud, given how mission-critical a lot of Oracle's products are, how high the switching costs are, and the workflow. There are a lot of things that have to change. It's not something that's going to happen overnight, and you could see Oracle's service revenue continuing to grow and people signing new service contracts as a sign that people aren't willing to move very quickly over to these new products.

Rick points to other companies that people are very worried about this shift to the cloud--Adobe being one and Autodesk, which makes architecture software. This was potentially going to be a major problem for them, and they were able to come through it. He thinks Oracle will as well. He thinks that the market really doesn't understand that story as well and that's created a buying opportunity today.

Stipp: As part of a strategic review Qualcomm decided not to split itself up this week. What's the outlook for that firm?

Glaser: Qualcomm for a while had been thinking of ways to boost their sagging stock price, and one thing that they had considered was splitting up the chip business and the licensing business into two pieces.

Brian Colello, our analyst on the stock, thinks in the short-term that may have boosted the stock price--people would value the licensing business at a much higher multiple without the chip business there. But he thinks over the long run, that wouldn't have been the right decision and that management deciding to keep things together is going to be the best thing for the company over time. The fact that they are willing to keep it together is a good sign of confidence that management thinks the chip business is going to see profitability stabilize, something that's been a bit of an open question. He sees that as a potentially good sign for the firm.

He also thinks Qualcomm's shares are undervalued right now. The market is a little bit disappointed that they didn't make the split, and that potentially has opened up an opportunity for investors with a longer time horizon.

Stipp: A lot of headlines this week, Jeremy. Thanks for helping us stay on top of it all.

Glaser: You're welcome, Jason.

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