Sunday, June 27, 2010

U.S. economic data pounded markets this past week


Following a week in which world markets rallied, this week, the TSX finished down 219.74 points. In the U.S., the Dow lost 2.8%, while the S&P 500 fell 3.6%. From a technical perspective, the S&P 500 closed below its 200-day moving average, which is a bearish indicator.



The negative movement in markets this week was caused by poor economic data from the U.S. Meanwhile, the biggest positive news for the week, that China is allowing its currency to trade in a larger range, provided little upside strength for the markets on Monday.

Last Sunday, I wrote that “economic data from the U.S...might not be positive for stocks, since recent data have been worse than expectations.” That has indeed been the theme this week, with the National Association of Realtors saying on Tuesday that sales of existing homes unexpectedly fell 2.2% in May. In addition, on Wednesday, the U.S. Commerce Department reported that sales of new single-family homes dropped 33% in May.

Upside for markets likely in the coming week

This week, the completion of the banking reform bill by the House and Senate will be positive for the financial sector, since the measures are not as harsh as some had anticipated. In fact, on Friday, Citigroup, JP Morgan, Goldman Sachs and Bank of America saw their shares rise 4.2%, 3.7%, 3.5% and 2.7% respectively. I expect to see U.S. banks continue to rally on Monday.

In addition, the conclusion of the G20 summit should add a sense of stability to the markets, after world leaders pledged to slash deficits. 




The continuing stabilization of the debt crisis in Europe should also provide some upward momentum to the markets. While some worries about Greece were briefly apparent this week, the overall situation has been stable in the euro zone in the past few weeks.

Finally, the steep losses suffered in North American markets also presents opportunities for bargain hunters, making it likely that the coming week will see markets end in the black.

Wednesday, June 23, 2010

RIM poised for big move up in coming weeks


Research in Motion (RIM), the maker of the BlackBerry, will announce its earnings results tomorrow after markets close. Consensus expectations are for $4.35 billion in revenue and profits of $1.34 per share. Investors have been quite bearish with the stock lately. For example, RIM's closing share price today was C$62.01, which is only 10 times next year's earnings. Analysts' comments have been bearish as well, citing competition with Apple's new iPhone 4 and Android smartphones.

However, given the current share price and the company's prospects, analysts are overly bearish and the stock is clearly undervalued. Last quarter, RIM missed consensus estimates for earnings by US$0.01, and shipments was 0.5 million less than consensus. 

However, that was caused by an inventory run-down at Verizon, as the carrier sold down the Tour 9630 in anticipation of receiving its replacement, the Bold 9650. In fact, while Verizon accounted for about 28% of RIM's total sales in the previous quarter, last quarter saw that number fall to the low single-digits, as a result of the one-time inventory move. Despite the move by its biggest customer, RIM still only missed consensus estimates by US$0.01. 
  

This quarter, inventory factors should be the opposite, as the brand-new Bold 9650 was being stocked up by carriers such as Verizon and Sprint. In addition, the Pearl 3G was also released this quarter, making its way into various carriers.

With the overall bearishness that analysts have relative to previous quarters, RIM has been set up to beat consensus estimates. My prediction is that RIM will beat earnings estimates by US$0.05, which makes profits of US$1.39.

However, what is far more important than tomorrow's earnings will be the imminent release of several new products by RIM. Widely expected to be released in July are the new web-kit browser and OS 6. While RIM's current internet browser has lagged behind rivals Apple and Android, the web-kit browser, which was publicly shown in February, is expected to put the BlackBerry on par with its rivals. In addition, the new operating system OS 6 also revolutionizes the current browser, and adds many new features.

In addition, RIM is also expected to announce the Bold/Torch 9800 at around the same time, which will be RIM's first ever qwerty keyboard-and-touchscreen smartphone. The Bold 9670, which has a clam-shell design, will be released at the same time. Both smartphones will have the new web-kit broswer and OS 6. 



As a result, a satisfactory earnings announcement tomorrow, and the timely announcement of a list of new software and smartphones should clear the bearishness surrounding the shares, and boost shares above their 52-week high. Currently at only a P/E ratio of 12.5 for the Canadian-listed shares, the shares represent a significant discount to the historical P/E ratio of 18. Add in a host of new products that will be announced this summer in the coming weeks, and RIM is clearly at a price that is very attractive.

Sunday, June 20, 2010

Continuing stability in Spain should provide upside momentum this week


It has been a great week for investors worldwide. Last Sunday, I wrote that given the increasing stability in Spain, stock markets were “poised to move higher this week”. Markets have certainly jumped higher this week on a range of encouraging news. The TSX closed up on 4 of 5 days, and is up 260.67 points this week. Overseas, the MSCI world index hit a 1-month high on Friday. In addition, European markets have been up for eight days in a row, while Asian stocks just posted their best week in 6 months. 


The euro, whose price these days is determined by the perceived strength of the euro zone economy, is at a 3-week high above US$1.24. The volatility index VIX has also fallen to 25 from a 14-month high of 47 in May.

This worldwide rally has been caused by the successful government bond sales in Europe. For example, Spain successfully raised €3.5-billion on Thursday. In addition, the fear that some investors had of a collapse in the Spanish banking sector has simply not materialized.

The continuing stabilization of the situation in Spain will provide further upside in this risk-asset rally. However, if the situation in Europe continues to stabilize, investors will increasingly look elsewhere to determine the direction of markets.

Investors will focus more on economic data from the U.S., which might not be positive for stocks, since recent data have been worse than expectations. For example, more data like last week's (which showed initial claims for jobless benefits rose in the week of June 7 by 12,000 to 472,000) would hurt upside momentum in markets.

The U.S. Federal Reserve will announce a decision on interest rates, and issues a policy statement on Wednesday. With a rate hike out of the question, investors will be reading the policy statement carefully to see the Fed's outlook for the U.S. economy. Other factors for markets this week are the first round of quarterly earnings, with Adobe giving its report on Tuesday, and Oracle and Research In Motion announcing theirs on Thursday.

Thursday, June 17, 2010

More evidence of Spain stabilizing


Markets have been rallying this week. I wrote an article on Sunday, stating that stock markets were “poised to move higher this week” as a result of the situation in Spain stabilizing. So far, that prediction has been correct. This week, the TSX has risen 0.42 points on Monday, 240.20 points on Tuesday, 13.51 points on Wednesday and 24.92 points today.

In addition, on Tuesday, the S&P 500 closed at 1115.23 points to break above its 200-day moving average, which is a bullish indicator. 


These positive movements have been caused by a stabilizing situation in Spain. In fact, some investors are beginning to realize that the situation there is turning out better than they expected. In particular, markets have been encouraged by successful bond sales. For example, Spain today successfully raised €3.5-billion from the sale of treasury bonds.

As for Spain's 45 regional savings banks, there has not been a bankruptcy in recent weeks. Last week, Caja Madrid merged with 5 smaller savings banks, then announced a merger with Bancaja to become Spain's largest savings bank. The Spainish government has ordered its savings banks to merge, in order for healthier banks to absorb weaker ones. So far, this strategy has been working.


If the situation in Spain continues to stabilize, a risk-asset rally that will move commodities and stocks higher can be expected to continue in the coming weeks. However, a factor that can potentially hinder this rally is the economic situation in the U.S. Economic data from the U.S. continues to be worse than expectations, with today's data showing that initial claims for jobless benefits rose last week by 12,000 to 472,000.


Sunday, June 13, 2010

Stock markets poised to move higher this week

After a flash crash, a correction and weeks of worrying over Europe, it appears that stock markets are poised to finally head higher in the coming week.

The Dow rose 2.8% this week, which is its biggest weekly rise in 3 months. As for the biggest factor determining movement in markets, Spain, the country successfully sold $3.9 billion of bonds on Thursday, leading European markets to rise for the third week in a row. In addition, major Spanish bank Banco Santander SA has seen its shares rise 14% this week.


In another sign of receding fears, the volatility index VIX fell 5.8 percent to settle at 28.79, its lowest level since May 13. The index has fallen about 28% since a few weeks earlier when Europe fears sent the index to 40.


However, all was not rosy. On Friday morning, the U.S. Commerce Department reported that U.S. retailers' sales unexpectedly fell in May for the first time in eight months. Retailers' sales fell 1.2%, which was worse than economists' estimate of a 0.2% rise. However, this bad news was off-set later in the day by a jump in a consumer sentiment index to a near two-and-a-half-year high. The University of Michigan Surveys of Consumers showed that consumer sentiment in June was 75.5, which was higher than expectations of 74.5.

Therefore, with the positive developments in the European (particular Spanish) and U.S. stock markets, and the receding fear as illustrated by the VIX, stock markets appear poised to head higher in the coming week.

Wednesday, June 9, 2010

U.S. and Spain – the worst case scenario


North American stock markets are currently directionless, going up slightly one day and down slightly the next. The TSX's performance in the past 3 days is the perfect example of this. On Monday, the TSX ended lower by 64.87 points, while it rose 11.53 points on Tuesday, and fell 66.54 points today.

At this point in the correction triggered by the Greek debt crisis, risk-aversion has driven gold to a record high on Wednesday of over $1250/ounce. In addition, a RBS analyst said yesterday that the likelihood of a double-dip recession has reached 50%. Meanwhile, the US economic research institute ECRI has had its leading indicator index fall to 0, which is its lowest level in 43 years. 


Clearly, investors are waiting for developments that would drive the markets significantly higher or lower. At this point in time, it is worthwhile to take a look at the worst-case scenario for the two biggest factors driving the markets.

Worst-case scenario in Europe

The biggest factor is clearly Europe (and Spain in particular). I have written before that events in Spain will determine the directions of stock markets for the next few weeks. If there is wide-spread bankruptcy among the 45 regional savings banks in Spain, the effect would be similar to the Lehman Brothers collapse in the US in 2008. 

In addition, tough austerity measures are going to spread throughout the entire European Union. The first austerity measures passed in Greece has also been adopted in Portugal, with Hungary being the next country in line. These austerity measures will cut government spending significantly, with the result being slower economic growth for years to come. Thus, austerity measures coupled with a collapse in the Spanish banking sector would guarantee a double-dip recession in Europe.


In terms of the impact of Europe to the stock market, a widespread bankruptcy in the Spanish banking industry would quickly result in a correction of 20% to 30% in North American stock markets. A double-dip recession in Europe would weigh on markets for months after the correction.


Worst-case scenario in the US

In most months since the end of the recession, job growth in the US has been lower than economists' estimates. For example, in May, 41,000 private-sector jobs were added, which was significantly lower than estimates of 139,000 new jobs. With the unemployment rate currently at 9.7%, a prolonged period of 8% to 9% unemployment, which is higher than previous cycles, would cause anemic economic growth in the US.

This would result in lower demand for commodities such as copper, iron and oil, since demand from the US and Europe would be weakened. It would also cause lower Canadian exports to the US and Europe.

The impact of anemic economic growth in the US on stock markets would be a long-term phenomenon. Commodities rallies would be relatively muted, while bull market rallies will be dampened.


Therefore, while US economic growth will have a significant effect on markets in the long term, the outcome in Europe will be clearly felt worldwide in the next few weeks. It will likely either be a vindication of the Spanish banking sector that spells the end of the correction, or a collapse in the sector that plunges worldwide markets deep into correction.

Monday, June 7, 2010

Apple announces iPhone 4 – nice update but few surprises


Apple CEO Steve Jobs today announced the new iPhone, called iPhone 4, which will be released in the U.S. on June 24th. However, a leaked iPhone, which was left at a bar by an Apple executive and exposed by Gizmodo, has already revealed most of the new iPhone's features, leaving few surprises. Key updates include a 24% thinner design, front-facing camera, limited multi-tasking and a video chat program called FaceTime.


The new iPhone is intended to allow Apple to continue to compete against its rivals, with smartphones using Google's Android continuing to enter the market, and RIM expected to release its OS 6 and new touch screen-and-keyboard Blackberry 9800 in July.

Apple (AAPL) shares closed today down 1.96% at US$250.94. It recently surpassed Microsoft as the most valuable technology company in the world. While Apple's shares have risen tremendously in the past 10 years, long-term challenges loom in the horizon. I see two main long-term challenges for Apple, both of which can slow its growth and take a significant chunk off of its share price.

The first long-term challenge to Apple is Steve Jobs himself. While it is certainly a plus for a company to have a brilliant and popular CEO, it can be a minus for the long-term. Apple's R&D is far more dependent on Steve Jobs than RIM or Google are on Mike Lazaridis or Eric Schmidt. For example, Jobs personally oversaw the development of the iPhone and the iPad. 

In addition, Steve Jobs has health problems, having appeared sick before undergoing a liver transplant and a 5-month leave of absence in 2009. At the age of 55, it is reasonable for a CEO to work another 10 years until the retirement age of 65. However, with Steve Jobs' history of health problems, 10 more years as the CEO is probably too optimistic. With his intense involvement in the development of Apple's key products, his departure would easily take 20% to 25% off of Apple's share price.


The second challenge facing Apple is directly caused by its success. Like Microsoft found out years ago, being the dominant number one player in an industry also comes with legal troubles. On May 28, it was announced that the US Department of Justice is in an antitrust investigation into Apple's practices. The investigation followed a complaint that Apple pressured music labels not to support Amazon's promotion. With a 70% share of the U.S. digital music download market, antitrust lawyers believe that federal antitrust regulators may be able to build a case against Apple.

One simply to look back at the legal troubles that Microsoft faced, especially from Europe, to realize that antitrust lawsuits can severely hamper Apple's growth.

Thus, while the short-term prospect for Apple remains bright, with its share price likely to hit US$300 in the next 12 months, its long-term prospects appear more troubling. The dependence of Apple on Steve Jobs and future antitrust cases raises the question of whether the $300 level is as high as Apple shares will ever get.

Sunday, June 6, 2010

Slow U.S. employment growth and Hungary combine to rout markets

On Friday, the TSX fell 242.27 points to close at 11,569.61. The US markets were equally hit hard, with the Dow falling 323.31 points to finish at 9,931.97, while the S&P 500 fell more than 3%. This fall in the markets was caused by two factors – worst than expected US job growth in May, and fear of Hungary becoming the next Greece.

The concern for Hungary was caused when a Hungarian government official said that economy is in a “very grave situation”, and that the country could be at risk of default. This caused the euro to fall to US$1.20, its lowest level in 4 years. Meanwhile, in the US, the 431,000 new jobs created in May was mostly caused by a surge in hiring of temporary federal workers to conduct the 2010 census. Private-sector employment increased by 41,000 jobs in May, which is significantly less than the 180,000 that was expected. It was also a sharp drop from the 231,000 private-sector jobs added in April.


These two pieces of news were certainly dire, and were reasonable in causing the sharp declines in the markets. US job creation has been below expectations in most months since the recession. While news of a worst-than-expected month can rout markets, and a better-than-expected month can take markets higher, more jobs data from the coming months is needed to determine the rate of post-recession economic growth in the US.

Meanwhile, the fear of the debt crisis spreading to Hungary appears to be exaggerated. The comment that caused the sell-off was made by an official of the ruling party, and the purpose was simply to criticize the country's previous government for falsifying economic numbers, causing this government's deficit to increase to 3.8% of GDP. In addition, Hungary's debt-to-GDP ratio is only 78%, which is far lower than Greece's 125% and Italy's 118%.

In terms of market reaction to the development of these two pieces of news, markets should rise on Monday when investors realize that the Hungary fears are exaggerated. However, the weaker-than-expected US job growth may weight on markets, with some investors taking it as another sign that US economic growth will be very slow for years to come.

Thursday, June 3, 2010

AT&T introduces tiered pricing for data - good news for RIMM

Yesterday, AT&T, the second largest mobile carrier in the US, announced the introduction of tiered data plans. A $15 plan for 200 megabytes a month and a $25 plan for 2 gigabytes will replace the original $30 unlimited plan for all new customers.

This move comes as AT&T, the only network that carries the iPhone in the US, struggles with congestion on the network. This has been caused by the explosion in the popularity of smartphones. The iPhone, for example, consumes 7 times more bandwidth than a regular cell phone.


This congestion has lead to frequent dropped calls and slow internet browsing. According to the Globe and Mail, Andrew Pierce, a 21-year-old student in New York, sometimes has to try three or four times before AT&T’s network connects him, and he puts up with two or three dropped calls each day.

In terms of the impact of this news on individual stocks, it is certainly bad for Apple (AAPL). Apple has created a popular entertainment device in the iPhone. However, the availability of tens of thousands of apps has led to increased bandwidth usage, and the congested state of AT&T's network today.

On the other hand, this is good news for RIM, since the Blackberry is much more efficient with bandwidth than the iPhone. For example, for a text-only email, the Blackberry uses only 10% of the bandwidth that the iPhone uses. In addition, the Blackberry only uses 41% of the bandwidth that the iPhone uses to load a webpage.


Carriers are spending billions of dollars to upgrade to 4G networks. While these 4G networks, which can handle more bandwidth, will be coming out in the next few years, it is not the only solution. Another solution is to make smartphones that are more efficient. RIM has a significant advantage over its competitors like Apple in this area, since the company has always evolved around the principle of doing as much as possible with as little as possible. Its superior compression technology is the reason why it uses less bandwidth than the iPhone.

Therefore, the congestion of wireless networks is a problem that is already upon us. Factors in this problem include the growth in smartphone users, the capacity of 4G networks and their launch dates. RIM has a clear advantage over Apple in this area. Only time will tell how big the problem becomes, and correspondingly, how big RIM's advantage is over Apple. For example, all it takes is a well-publicized case of a user fed up with dropped calls (like Andrew Pierce above) for a wave of users to switch from the iPhone to the Blackberry.

Tuesday, June 1, 2010

Bank of Canada raises interest rate, and once again, Europe causes markets to close lower

The Bank of Canada raised its benchmark overnight rate by 0.25%, as expected, resulting in a rate of 0.5%. With this move, Canada has become the first country in the G7 to raise interest rates after the financial crisis. In fact, this move is a testimony of Canada's relatively strong economy compared with the rest of the world, after its GDP grew by consecutive quarters of 4.9% and 6.1%.


The TSX closed down 191.02 points or 1.62% to end at 11,571.97 points today. While stock markets usually fall as a result of higher interest rates, the rate hike is not the cause today, since the move was widely expected.

Instead, Mark Carney's cautious statement about the condition in Europe seems to be part of the cause. The Bank of Canada governor warned that the global recovery is uneven, with emerging economies recovering sharply, while others are not. Thus, the Bank of Canada conveyed that there might not be a rapid series of rate hikes, saying “given the considerable uncertainty surrounding the outlook, any further reduction of monetary stimulus would have to be weighed carefully against domestic and global economic developments.”

The other cause of the TSX's downward movement is the fall in the price of oil, which fell almost 2 percent to below $73 a barrel, pushing down shares of oil companies. The fall in oil price, in turn, was caused by growth fears. This brings us once again to the single most important factor to stock markets for the next few weeks – Europe (and especially Spain). Fears of slow growth for the region dictated the downward movement of the TSX and the Dow today.