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Friday Five: Volatility Settles In

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: You're welcome Jason.

Stipp: First up this week, obviously, the volatility continued in the markets. What were some of the drivers this week?

Glaser: Anyone hoping that the volatility we've seen so far this month was going to die down was sorely disappointed this week. The drivers are the same things that we've been talking about. We got a GDP report on China that was below expectations, but not remarkably so. But Bob Johnson, our director of economic analysis, thinks that the markets were hoping to hear more talk of additional stimulus measures, additional things the China government was going to do to help boost the Chinese economy. We didn't hear much of that. I think that got investors somewhat concerned.

We did hear about stimulus measures, actually, from the European Central Bank. They said at their March meeting, they could look at different measures, that they were open to a lot of different things, to try to get the European markets moving again and to make sure they stay insulated from some of these other issues. That had a more of a positive effect.

And also oil remained in very sharp focus. As oil rallied, stocks rallied, and as it fell, stocks fell as well. The market is very focused on what do these lower oil prices mean for the global economy and corporate earnings?

It doesn't seem like this volatility is going away any time soon, given that a lot of these question marks are still very much there. Chinese growth isn't going to correct itself overnight. Oil doesn't seem like it's going to stabilize any time soon. So I think we're going to be in for a wild ride for at least some more time here.

Stipp: One of the big questions we've been asking as the market has moved lower is, are we starting to see any bargains in the market? After some of the volatility this week, is anything starting to look attractive now?

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Glaser: Things are getting cheaper, but certainly you wouldn't call the entire market incredibly cheap. We like to look at our price-to-fair value measure, which rolls up our analyst estimates on the stocks that we cover. Right now the median stock is trading at about a 15% discount to our fair value. That might sound like a decent discount, and certainly it's more than we've seen in the very recent past. But you have to remember that there is still some uncertainty around that; you still would need a margin of safety before buying. It's not like we're seeing an incredible number of bargains. We are still not quite as cheap as we saw in the 2011 eurozone crisis; at the height of that, stocks got a little bit cheaper. We're also nowhere close to the almost 50% discount we saw during the financial crisis. Certainly things are looking a little bit better, but they aren't screaming buys yet.

One area we think there are some opportunities opening up are in the big banks. Jim Sinegal, who is our banking analyst, thinks it could be time to look at some of the big banks right now. There is lot of fear that these institutions have a lot of exposure to energy, either directly or indirectly, and if we were to see bankruptcies in the energy space, if we were to see more dislocations due to falling energy prices, [there are worries that] the banks would be very exposed, and there could be systemic issues. He thinks those fears are overblown. They don't have quite the exposure they did in '80s, when that was a bigger problem.

There are risks, of course. He cites the low interest environment, which continues to persist. That's a big headwind to earnings. But he thinks on a valuation basis, Citigroup looks quite attractive and Wells Fargo also looks attractive--not quite as cheap, but a more stable business.

Stipp: You might have missed it with China and oil and the markets dominating the headlines, but earnings season has gotten under way, including some high-profile earnings reports this week. IBM is one of those, and we saw more of the same for Big Blue.

Glaser: No big changes in their trajectory, which is that their core legacy businesses continue to decline, continue to face headwinds, both on a reported basis from currency, but even after the currency effects are stripped out. Those declines are only being partially offset by growth in their strategic areas--things like cloud, analytics, security, and mobile--that they are trying to push. These are growing quickly but off a very small base, and it's just not enough to offset the losses that they are seeing elsewhere in the business. This is something that could persist for quite some time as they try to make that transition happen. Right now we just don't see a big enough margin of safety in the shares for it to look attractive, even with some of the weakness we've seen in IBM shares.

Stipp: Netflix also reported. They are having some success overseas, but their domestic subscriber growth was below expectations.

Glaser: That was probably the big story out of this quarter. International subscriber growth was well above what they had expected, and domestic subscribers came up short. This comes after their announcement earlier this month that they have expanded basically to every country in the world, except for China, and that they are in all of these markets and this is going to be a big push for them.

But Neil Macker, who covers Netflix for us, says that yes, it's impressive they were able to launch all of these countries at once. But you have to remember that many of these launches were very skinny launches. They have the Netflix Original Programming; they have some generally English language programming that they have global rights for. But they don't have a lot of local programming. It's not a very localized product yet. He thinks that keeps it pretty niche for the time being in a lot of these markets. You might not see a really big adoption even though you have a lot of expense there.

So we will still have to wait and see how the profitability of this international expansion works out for them, if they are able to keep growing subscribers at this nice clip, and we do see Netflix shares as overvalued today.

Stipp: Lastly in healthcare, UnitedHealth reported results, and they are seeing some pressure at least partially because of the ACA exchanges. What's the takeaway from their report?

Glaser: UnitedHealth is always an interesting one to watch, given what a huge player they are in the managed care space. This quarter they did have pressures from higher medical costs and other issues. Like you mentioned, the Affordable Care Act exchange plans that they sold just weren't working out the way that they expected.

Now, we knew that this was the case in November. They said they were having some problems and that they were going to pull back from this market, and that it wasn't going to be a big part of their business. Maybe they'd even walk away from it completely if need be.

I think that's a sign that management really is willing to be flexible in terms of finding profitable growth, and not just growing for the sake of getting new people in the door, even if they aren't buying plans or if that business just doesn't make sense for them.

Vishnu Lekraj, our UnitedHealth analyst, thinks the company is still very well positioned over the long term. Yes, it's a very volatile space right now. There are a lot of moving parts, a lot of uncertainty about what the healthcare market is going to look like. But given their size and some of the other competitive advantages that they have, UnitedHealth will continue to be able to do well no matter what gets thrown at them. Management, like I mentioned, is nimble enough to be able to do that, and it's a good sign for them.

The stock isn't cheap right now--it's in 3-star territory--but we still think their competitive advantage looks good, even with some of the issues they are having with these exchange-sold plans.

Stipp: Another eventful week in the market, Jeremy. Thanks for keeping on top of all the news.

Glaser: You're welcome, Jason.

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