Friday Five: Fed Walks a Delicate Line

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, the Fed stood pat on interest rates this week. That was expected. But they did have a few unexpected things after their meeting.

Glaser: The dot plot, which shows where the Fed governors think that rates are going to be in the future, showed that they now only expect for there to be two rate increases in 2016; that's up from the three to four they thought going into the year. This is also basically what the market was thinking. The market thought that three or four was too aggressive and that there were going to be only two. This maybe is Fed accepting that reality, but it's still interesting to hear it directly from them.

Also notably, they said that, yes, rates will maybe rise a little bit slower than we thought in 2016, but it doesn't mean that it's going to accelerate in the years to come. It's still going to be a very steady path from the end of this year.

The real question is going to be, can inflation hold off long enough to allow the Fed the luxury of these very slow increases, the luxury of waiting until they really are seeing the data to be exactly what they want before raising rates. Bob Johnson, our director of economic analysis, thinks that there are some signs that inflation is starting to pick up. With energy stabilizing and maybe moving up a little bit, with services inflation running pretty high, the Fed might be forced to move a little bit faster than that.

It's interesting to see that dynamic of inflation potentially becoming a problem. At the same time, the Fed is saying that they are going to raise rates a little bit slower than they expected. It's a very delicate line for them, and I think one that is going to be very much on their minds in the April meeting and the June meeting, when we do expect there to be an increase.

Stipp: FedEx reported a good quarter. They offered some upbeat guidance, and the stock moved higher, but part of that potentially was because of Amazon somehow. What's the connection?

Glaser: This is a big gain for FedEx, over 10%, on Thursday after they released results late on Wednesday. Yes, they had a good quarter. They are making good progress on turning around their Express business and improving profitability--all the things we would like to see.

But the big piece of news was that they said… no single customer, including Amazon, represents more than 3% of revenue for the entire company, and 3% in any given segment. This is big news because there was some concern that Amazon was becoming a growing part of FedEx's business at the same time that Amazon is experimenting with different types of delivery mechanisms. You have independent contractors. You have couriers that are doing last-mile delivery. Amazon is even leasing some airplanes and are going to start some of that type of logistics operation themselves, given their big volume. That was a worry.

But FedEx basically said, this is not a huge impact on our business. Yes, they are an important customer, but they are not such a material part of our business that if a lot of that business did get siphoned off, it would be major problem for them in terms of their profitability or revenue. I think that was a big relief.

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Stipp: Pharma firm Valeant was in the news again this week, and once again not in a good way.

Glaser: They haven't had a lot of positive headlines recently. The concern this week that sent the shares over 50% at one point was that they are going to continue to delay the filing of their 10-K financials. That potentially gets them into some trouble with their debt covenants, with some of their lenders, because they are obligated to file these financials in a timely manner. That raises a host of concerns.

They still had some more earnings troubles where they brought down their guidance significantly below where analysts were thinking, below what they had originally said. They continue to work out their issues with the specialty pharmacy Philidor, which they used to have relationship with, as they bring on this new relationship with Walgreens. But it isn't clear exactly what impact that's going to have on the business yet, and we're seeing lots of concerns over that as well.

This raises the question of what it means for investors. We did lower our fair value estimate on Valeant this week and moved our uncertainty rating from "high" to "very high." The shares still do look undervalued on some measures, and by our fair value estimate measure. But that really is predicated on the fact that they can get past some of these short-term and medium-term issues to be able to realize the benefits of some of these positive businesses that they do own. But it's just very uncertain that they can do that, and that is why we have a very high uncertainty rating on the stock, because of that range of outcomes.

Most conservative investors who are looking for a long-term core holding probably are best off looking elsewhere and leaving this one to people who are looking for a more uncertain type of investment and are trying to take a rider on something.

Stipp: Wide-moat tech firm Oracle reported results this week. They looked pretty good, and that was driven a lot by the cloud.

Glaser: Oracle had a strong quarter. We've talked a lot about some of these pure-play cloud companies. We talked about Workday a couple of weeks ago and Salesforce.com. People get very excited about them, and even though Oracle may not quite match the incredible growth rates that those firms are posting, we still think it's achieved very good cloud growth. They are seeing 50% growth in the quarter, and margins are expanding while they are doing this.

I think it's a good sign that Oracle is making good progress in taking customers from their legacy software and database businesses and moving them into their cloud services. There is something about their switching costs or something about their sustainable competitive advantages that is allowing Oracle to win these customers in a very competitive environment. That's a good sign for Oracle in the years to come, as they continue to potentially move some of these legacy customers into new products.

Right now the shares are fairly valued after the runup following earnings and over the very recent past. It has closed that valuation gap, but it is still good to see them executing well.

Stipp: Lastly, just as it looked like the Starwood-Marriott merger was a done deal, Chinese insurer Anbang has crashed the ceremony.

Glaser: Chinese insurer Anbang is leading a consortium that had on Monday made an offer of $76 per share for Starwood.  We thought that was roughly equivalent with the Marriott offer, even if it was a little bit higher, when you factor in the breakup fee they'd have to pay and factor in some of the synergy that you'd see with Marriott and that you'd get those Marriott shares. We thought it was basically a roughly equal offer. But after Anbang raised their offer to $78 per share, the Starwood board did go ahead and accept that.

But this is not the end of the story yet. Marriott could come back and raise their offer and decide that it's worth maybe pursuing Starwood a little bit more. But certainly from a strategic standpoint, you could see why Marriott would want to bring in the more high-end brands that Starwood has to build out their portfolio, and become even larger than they are today. But we're still going to have to see how this one plays out.

Stipp: Great perspective on the news of the week, Jeremy. Thanks for joining me.

Glaser: You're welcome, Jason.

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