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.

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 24^th. 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.

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.

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.

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.