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Friday Five: A Wild Week for Stocks; HP and Gap Make Changes

Jeremy Glaser
Christine Benz

Christine Benz: Hi, I'm Christine Benz for Morningstar.com. Welcome to the Friday Five. Joining me to discuss the market week that was is Morningstar markets editor Jeremy Glaser. Jeremy, thank you so much for being here.

Jeremy Glaser: You're welcome, Christine.

Benz: Jeremy, very volatile week in the equity markets. What, in your view, was driving all that volatility?

Glaser: I don't think there was any one determining factor--one kind of report or one catalyst--that really was sending the market up and down so wildly this week. You did kind of have to look at your calendar and make sure it wasn't 2011 again, given the kind of volatility we had. I think there are a few things weighing on the market right now.

The big one is just global growth. There are a lot of questions marks about what's happening with different types of growth--and we'll talk about that, I think, in a little bit--but that has certainly weighed. And then what impact it's going to have on global monetary policy. It's been a big driver of returns over the last couple of years, and what the growth picture looks like has a huge impact on that.

I think we're also in a time before earnings really get started and people start to get maybe a little bit worried about what those numbers are going to look like. If the growth is slowing down, what are [earnings] going to look like in the future? How do you discount that back into the market. So, when you're at these kinds of valuation levels, when things are fully or a little bit overvalued and you're priced for perfection, when you have some of these worries, you shouldn't be too surprised to see those changes.

I think we could see more volatility. We could potentially see a correction sometime in the future, given everything that's going on. I think for investors this is a great time to maybe take a step back, look at their asset allocation, make sure that they can really survive that kind of volatility, really survive a potential correction, be able to wait it out, if they need money in the short term that they should probably have that in more liquid securities--in cash--and really only have money in the stock market now that they really don't need for quite some time in case there is that kind of dislocation, they will have time to really make it up.

Benz: Do you think it's possible that some investors have perhaps gotten a little bit complacent about risk? We saw a lot of risk appetites increasing recently with a lot of interest in junk bonds and some of those other categories. Were investors maybe just a little bit spoiled?

Glaser: It could be possible. I think that's one explanation that we had--a placid environment where things just kept rising that maybe investors took off a little bit more risk than they really wanted. But I guess I would also warn that it's very difficult to make any kind of short-term market predictions about what's going to happen over the next three months or six months or what happened over the last three months or six months--if you're trying to determine precisely what drove that, I think it's basically impossible. Instead, you really have to focus out on what's going to happen over the next 10, 15, or 20 years when you're trying to make the decisions about where your money should go. I think those are the long-term decisions that people need to keep in mind instead of thinking more about, "How much risk can I afford to take on this week or this month?"

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Benz: One of the things you noted might be weighing on investors is that we're seeing a slowdown in global growth. Let's talk about that. The International Monetary Fund weighed in this week on their view about global growth. Not a super-positive picture there.

Glaser: It wasn't. They downgraded their growth picture again. There was no acceleration in growth from 2013-14. They had hoped to get some there. And that there will only be a slight boost to 3.8% from 3.3% in 2015 from those 2014 levels. This downgrade is really driven by pretty broad-based weakness, what they see as broad-based weakness in the eurozone, in Japan, in emerging markets--Brazil and Russia particularly had some pretty big downgrades and that weighed on the picture.

Now, one plus side actually was the United States where growth was upgraded. They expect that 2014 is actually going to look a little bit better than they had originally thought after that bounce back from those weather-related issues in the first half. But outside of the United States and some other small pockets, there really does seem to be a slowdown across the globe. And it's not just the IMF; this goes along with other data that we've seen out of a lot of different places over the last couple of months.

Benz: That's another thing that you wanted to discuss: The Federal Reserve released its minutes from its meeting last month. It looks as though slowing global growth is on the Fed's mind as well, along with potentially a stronger dollar and what those two could mean together.

Glaser: The Fed definitely does appear to be worried about a slowing global economy and what impact that's going to have on the U.S. and what impact that should have on their monetary policy. It seems like they are willing to be a little bit more cautious about when they are going to start raising rates. It's still likely to happen sometime in the middle of 2015, but maybe a little bit later because they are worried about what's happening elsewhere.

There is also some talk about the potential of a stronger dollar and how that could keep inflation at bay. That could be another reason they would be able to be cautious that it's less likely that you see inflationary pressures, which would force them to tighten rates before they are really ready.

Definitely, it seems like they do want to err on this side of making sure that all of the data is in, that the economy really can handle the rising rates before they go ahead and make that move, because I think they see that it's going to be much more difficult to back off of that and to ease policy a little bit after they start going down that tightening road. So, they really want to make sure that they get it right.

Benz: Shifting over to U.S. corporate news: HP, Hewlett Packard (HPQ), announced this week that it's splitting itself into two. Let's talk about what those two pieces are going to be and also what's the thinking behind that decision.

Glaser: So, they are going to split up into a PC and printer business and also an enterprise business that's focused on selling things directly to businesses--be it services or servers or things of that nature.

The idea is that, by splitting the businesses up, they can really have their own management teams be really focused on those segments, which really do behave fairly differently. So, you have this mature printer-PC business that can generate a fair amount of cash flow but that's not going to have a lot of growth and then the enterprise business, which presumably they hope will grow at a much faster clip and they want to be able to make those investments that are going to make that happen.

Now, Pete Wahlstrom, our HP analyst, doesn't see this as a transformative split. He thinks it's a good idea. He thinks that it could help raise its fair value a couple of dollars, but that a lot of the challenges that they had before the split they are still going to have after. They are still going to have to do restructuring, there will still have to be headcount reduction in order to really make the business work. But it seems like this is a step in the right direction over what's been a couple of years of HP really trying to clean itself up.

Benz: Switching over to another fabled California company: This one in the apparel business. Gap (GPS)--disappointing. What's going wrong at Gap?

Glaser: They had some disappointing numbers this week. They are really continuing to have trouble turning around that core Gap brand. They had a 3% decline in same-store sales in September. Old Navy and Banana Republic looked a little bit better, with gains, but that core Gap brand is really what's driving the company right now. But also very surprisingly, Glenn Murphy--he has been the CEO--just said that he was going to step down, that Art Peck was going to be taking over--he is a current Gap executive--and that he is really going to be the one who is going to try to lead more of this turnaround of Gap; [he's going to] lead more online initiatives, really trying to get things back on track here.

Bridget Weishaar, who is our Gap analyst at Morningstar, thinks that this is very possible, that Gap still has a narrow economic moat. They have a lot of brand equity; they have good returns on invested capital. They are able to make economic profit. But she sees the change in CEO and some of these continuing problems as a sign that it might take a little bit longer than many people expect in order to really get the company back. So, even after the shares sold off pretty aggressively, they are trading below our fair value estimate. It really is going to take a patient investor to wait for some of these brand equities really to pay off and for these investments to pay off before we could see the shares come back more to what the intrinsic value really is worth.

Benz: Jeremy, it's been a very volatile week. You think there will be more volatility before it's all over. Thank you for being here to recap the headlines.

Glaser: You are welcome, Christine.

Benz: Thanks for watching. I'm Christine Benz for Morningstar.com.