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Friday Five: Fed Aims for Normalcy, Greece Buys Some Time

Jason Stipp
Jeremy Glaser

Jason Stipp: I'm Jason Stipp for Morningstar, and 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, Greece was in the headlines again, but it may be the last time we talk about Greece for a little while anyway?

Glaser: They did buy themselves a little bit of breathing room.

Last week, on Friday, they came to an agreement to extend their bailout by four months, and this week the Troika, the lenders, agreed to that deal after Greece provided a list of potential reforms that they are going to after. In order to get this extension, Greece basically had to back away from a lot of their earlier demands to make big changes to the austerity programs and reforms they have been asked to do under the existing agreement.

This just sets the stage for more negotiations. We are nowhere close to a long-term agreement. This is still very much kicking the can down the road. It fits with our thesis on this situation, which is that there will be a lot of noise, but not necessarily any catastrophic results, and in the end, Greece will acquiesce to the terms of the lenders, and the lenders will give maybe just enough in order to keep everyone happy and keep Greece in the eurozone. Although they are willing to let it happen if they get pushed too far, it's probably not ideal for anyone for Greece to leave the eurozone, and we very much saw that in play this week.

We are going to see a lot of these headlines play out again four months from now as we worry about this and what the implications could be. And yes, I think there still is a tail risk that you could see a Greek exit, that it could have some sort of systemic impact, but it seems the likelihood of that continues to shrink, and investors should really keep that perspective in mind when we are talking about this again in a few months.

Stipp: Although inflation data this week would seem to indicate the Fed has a lot of breathing room, testimony from Janet Yellen also shows they are still thinking about raising those rates.

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Glaser: Yellen addressed Congress this week, and it did seem like they are getting ready to drop the "patient" guidance from the statement, and that really lays the groundwork for raising rates sometime this year. This comes as the Fed is eager to normalize monetary policy. After spending so much time doing extraordinary measures for years, they want to say, look, we are getting back to normal--these things aren't going to go on forever--and they want to get the market used to that.

But as they are laying the groundwork for these rate hikes based on the strength of the employment market, which is half of their mandate, if you look at the other half of their mandate, inflation, you see it looking pretty subdued. CPI data this week showed a decline again from December to January levels, driven a lot by energy prices, but also a year-over-year decline--the first time we have seen that in a couple of years. Again, energy prices were the big driver there. But even looking at core inflation, it's still very subdued.

The Fed is going to have to be somewhat worried about inflation running so far below their target; defending that inflation target over the long term is obviously very important to them. So, they may have more room to raise rates a little bit later; they don't have to do it at the first possible opportunity, given that inflation doesn't seem like a major concern. Maybe it means that they raise rates just a little bit, but don't have to aggressively raise rates to counter inflation.

That's going to be a big story--how they balance those two mandates--as we talk about these rate increases.

Stipp: In earnings news, HP reported results and the stock took a hit. What was weighing there?

Glaser: HP had a few issues in this quarter, including foreign exchange, which has been a recurring issue through earnings season, both in terms of the direct translation of earnings [into U.S. dollars] and also in that it made some of their competitors' products look more attractive. They had some execution issues. They are dealing with slow economic growth in a lot of the world, and that really weighed on their results. They also brought down their guidance a little bit because of some of these issues.

Now, it wasn't all bad news for HP. They did see profitability tick up in a lot of their segments, which shows that management is focused on these costs even when revenue growth doesn't look so great. But overall, it was not a great quarter for HP, and the stock sell-off really represents this.

HP is still very much a turnaround story. As they get ready for their split into two companies and transform a lot of the ways that their businesses work, we are going to see some choppiness. Pete Wahlstrom, Morningstar's HP analyst, thinks that given the potential of choppiness with the turnaround, given a lot of the risks that are there, the valuations just doesn't really look attractive enough in order to make HP a good buy right now, even after the big sell-off.

Stipp: On the other hand, Home Depot and Lowe's reported results that looked pretty good, which is a continuation of a trend.

Glaser: Very robust growth from both of them, and some good guidance, too, as they are seeing strength in their core home improvement business.

That is a good sign for the broader economy. The reason we look at these firms is not so much that Home Depot or Lowe's are so interesting or so important, but it does give a good sign of what's happening in the housing market: Are people confident enough to make improvements to their homes? Maybe they want to make some changes before they put it on the market or they bought a new home and need to make some changes. The companies' results are a good barometer of that, a barometer of the kind of confidence consumers have.

Seeing housing improve is going to be a big part of what could drive economic growth through this year. When you see other growth areas stalling--the energy boom obviously is starting to back off with oil prices lower, with some of the currency issues--housing is potentially a big driver of growth, and seeing good results and good guidance from Home Depot and Lowe's is a sign that could possibly come to fruition.

Stipp: Lastly, Macy's reported results indicating their plan is also being executed well.

Glaser: Macy's had been a turnaround story, and they really seem to have made a lot of progress. Their growth was fairly modest, 2% same-store sales growth, but they were able to have much better profitability, as they are focusing on those improvements very carefully.

But one of the big headlines out of this quarter was that Macy's is going to spend more in capital spending, is going to try to focus on some growth initiatives--everything from possibly creating an off-price Macy's brand to having more online presence, to thinking about international expansion. It seems that they really want to invest some money in those areas.

Morningstar's Macy's analyst Paul Swinand warns that a lot of retailers have wanted to expand outside of their core business and have had trouble doing that in the past; it's not as easy as slapping your brand on some other stores and hoping that it's going to work out. It's a challenging proposition.

He still sees that this no-moat company is making a lot of progress, is doing a lot of things right, but given the fact that competitors probably could replicate a lot of what's happening in the medium term, and given that Macy's valuation is fair but nothing too compelling, it might make sense for investors to look elsewhere.

Stipp: Great insights on the news of the week as usual, Jeremy. Thanks for joining me.

Glaser: Thanks Jason.

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