U.S. markets little changed after China raises interest rates

U.S. markets were little changed today, seemingly unaffected by China's interest rate hike on Saturday. The Dow fell 20.73 points or 0.18% to 11,552.76, while the S&P 500 rose 0.74 points or 0.06% to 1,257.51.

Last week, US markets were up on positive US economic data. For the week, the S&P 500 gained 1%, while the Dow was up 0.7%. It was the 4^th straight week of gains for the S&P 500 and the Dow. As of Friday, the S&P 500 had been up 6.5% so far in December, with gains of 12.7% for 2010.

Positive economic data last week included initial jobless claims, which fell slightly by 3,000 people to 420,000. GDP for the July to September quarter was also revised upwards from 2.5% to 2.6%. A report Thursday also showed Americans increased purchases for a 5^th consecutive month in November, while capital goods orders by companies increased. 

China raises rates and buys Portuguese bonds

On Saturday, China raised its interest rate by 0.25%. It was the second rate hike in two months, and the 6^th time that the Chinese Central Bank has intervened in the past 3 months. The benchmark lending rate was increased by 0.25% to 5.81%, while the deposit rate rose 0.25% to 2.75%. Most analysts were surprised, since they were not expecting a rate hike for the remainder of 2010.

China also reached a helping hand to the euro zone. A Portuguese newspaper reported last week that China was preparing to buy $4 to $5 billion euros of Portuguese government bonds. Portugal, along with other PIIGS nations, have been seeing the yields on their government bonds reach record highs in recent months, as investors perceive an increasing chance of default.

Unrest continues in the euro zone

As austerity budgets are pushed through across the euro zone, and citizens begin to feel the impact, unrest continues to remain in the region. Last week, Greece passed an austerity budget for 2011. Metropolitan transport workers conducted a 24-hour strike, causing traffic jams. National railway workers also went on strike, paralyzing train services.

Lookahead for this week

As 2010 draws to a close, investors have become very bullish in recent weeks. A year that has started relatively rough for the markets has now seen US markets up over 12%. Last Friday, the volatility index fell 10% to 16, its lowest level since April. Not surprisingly, early April was a high point for markets, after which they fell on the Greek crisis.

On December 23^rd, the American Association of Individual Investors' survey found bullish sentiment increased 13.1% to 63.3, which was a 6-year high. According to Bespoke, bullish sentiment reached a historical extreme last Thursday. As a result, investors should not be surprised to see most analysts at the major banks predicting 10% plus gains for markets in the upcoming year. However, it is precisely these overly bullish sentiment that point to a near-term correction. 

 

In fact, after the Santa Clause rally ends and 2010 draws to a close, investors will be faced with an increasingly tense debt crisis in the euro zone, as citizens react to austerity budgets. Billions of euros of government bonds will also need to be auctioned in early 2011. In addition, with China experiencing 5% plus inflation, investors can expect further tightening measures in 2011, with 3 to 4 interest rates hike for the year.

Markets head higher on US data and bullish sentiment

The S&P 500 edged higher to another 2-year high today, as the index rose 3.17 or 0.25% to 1,247.08. Meanwhile, the Dow slipped 13.78 or 0.12% to 11,478.13. The S&P 500 is up 5.7% so far in December, and 11.8% in 2010.

The S&P 500 rose 0.3% last week, while the Dow gained 0.7%. It was a week in which a list of US data either met expectations or were better than expected. The list included consumer spending, manufacturing indices and initial jobless rates.

As a result, analysts are turning increasingly bullish on upcoming US economic growth. For example, Bill Gross of PIMCO stated that fourth quarter US economic growth will be 3% to 3.5%, while Alan Greenspan sees US GDP growing 3% to 3.5% in 2011.

Euro zone crisis continues

Investors continue to pay attention to the euro zone. While negative news continue to emerge, developments there have not been large or negative enough to push markets lower. Today, Moody's downgraded 4 Irish banks and an insurer. This followed Moody's move on Friday, downgrading Ireland's credit rating by 5 notches, from Aa2 to Baa1.

Last Tuesday, the euro zone avoided further crisis when Italian Prime Minister Mario Berlusconi survived a confidence motion by 3 votes. On the same day, the S&P 500 warned that it could cut Belgium's rating. Later in week, Moody's put Spain's rating on negative watch. Meanwhile, strikes continued across Europe, as workers and tax-payers resisted austerity budgets. Protests have been particularly bad in Greece and the UK.

Outlook for the week

If negative news coming out of Europe continues to be too insignificant to weigh on markets, then North American indices can continue to rally on bullish sentiment and positive US data. However, investors will face a rude awakening in January at the latest, when the situation in the euro zone continues to deteriorate. In addition, with inflation at 5%, China needs to raise its interest rate 3 to 4 times next year even if it leaves rates unchanged for the rest of 2010. This represents another negative impact looming for markets.

RIMM is a bargain ahead of earnings

After rising over 40% since August 31, shares of RIMM have fallen in recent days.  On Dec. 15, RIMM closed at US$59.18.  It has fallen 7.44% since hitting $63.94 on Dec. 1. 

Many analysts have been issuing bearish reports in recent days ahead of earnings, helping to push shares lower.   However, despite bearish analysts painting a grim picture for RIMM in 2011, they see RIMM performing very strongly in Q3 results that will be announced after markets close today.

For example, analyst Jim Suva from Citigroup is one of the bearish analysts, with a US$55 target price on RIMM.  However, he still sees strong Q3 results, with EPS of $1.62, which is only $0.02 below consensus.

Most analysts see gloom and doom in 2011

Since even bearish analysts are forcasting strong earnings in Q3 and Q4, they are basing their "Sell" ratings on a bearish outlook for 2011 (FY 2012).  For example, according to the Wall Street Journal, Jim Suva of Citigroup stated the following on Dec. 14:

We believe investors may be overlooking RIMM’s smart phone market share losses (15% globally vs. 21% a year ago) which we believe will become more evident in the quarters ahead as Android gains more traction (especially in Europe), enterprises unlock from BlackBerry exclusivity (1H 2011), Verizon (RIMM’s largest carrier at 16% of RIMM sales) getting the iPhone, & what we believe will be a highly competitive tablet market (iPad+Android+white box) resulting in lower margins, developer confusion with & higher costs with RIMM running 2 operating systems.

Suva is also forecast RIM's EPS in 2011 to be $5.12, versus $5.99 in 2010.  Thus, he is seeing a 14.52% drop in earnings in 2011 compared to 2010.  This would be a strong reversal to the 20%+ increase in earnings and revenue that RIMM has been enjoying for years. 

QNX will save the day

However, these analysts do not realize that their fear of RIMM's sales dropping significantly in 2011 will not materialize.  This is because RIMM is expected to begin launching handsets running on the QNX OS beginning in the second half of 2011.

These handsets, some of which will have dual-core processors, will run on the QNX OS that powers the PlayBook tablet.  The micro-kernel architecture of the QNX OS means that it was designed from inception to support multi-tasking and multi-core processors.  It also delivers high performance and is extremely reliable.  For example, it currently powers nuclear powerplants from AECL and Westinghouse, the robotic arm of the space shuttle and unmanned aerial vehicles.

A bargain ahead of earnings

For investors who can stomach the risk, RIMM is clearly a bargain ahead of earnings.  With the PlayBook launching in Q1 2011, RIMM will be getting a completely new revenue stream in the tablet market. 

In addition, the migrating of handsets to the QNX OS means that the drop-off in earnings that bearish analysts predict, will actually not materialize.  With consensus EPS for next year at $6.41, shares of RIMM at $59.18 means a 9.23 times multiple for next year's earnings.  That is a true bargain for investors who see continued revenue and earnings growth of 20% plus in 2011.

Markets little changed as China tightens

North American markets changed very little on Monday, as the Dow gained 18.24 or 0.16% to close at 11,428.56, while the S&P 500 rose a mere 0.06 points to 1,240.46. Today, investors were mostly focused on further tightening in China. The Santa Claus rally also appears to be losing steam, as the euro zone debt crisis persists. 

 

On Friday, the S&P 500 rose 0.6% to 1,240.4, its highest close since mid-Sept. 2008. Meanwhile, the Dow gained 0.35% to 11,410.32. For the week, the Dow rose 0.2%, while the S&P 500 gained 1.3%. Late last week, U.S. December consumer sentiment was better than expected, and hit the highest level in 6 months. The country's trade deficit also dropped more than expected in October.

China tightens on strong growth

On Saturday, China reported November CPI of 5.1%, which was higher than expected. It was also greater than the previous month's reading of 4.4%, and was a 28-month high. The Chinese Central Bank had raised the reserve requirement ratio (RRR) for banks by 50 bp (basis points) ahead of the announcement.

Euro zone worries still present

The euro zone debt crisis continues, as protests and strikes continue to occur in some countries. Germany also continues to refuse to use its taxpayer money to assist other euro zone members. For example, Angela Merkel is resisting calls to increase the size of the $750 billion euro bailout fund. She has also pushed repeatedly for investors of PIIGS nations' government bonds to take losses in any debt restructuring. 

 

These comments by Germany, the largest economy in Europe, has spooked investors repeatedly in recent weeks. On Friday, the spread between the Portuguese and German 10-year government bonds increased 18 bp to 346 bp. The same spread between Irish and German bonds rose to 540 bp. It is believed that the ECB has slowed in its purchase of government bonds from PIIGS nations.

Outlook for this week

With analysts believing that China could raise its interest rate before the end of the year, and the euro zone debt crisis far from over, investors should expect markets to head lower this week. In fact, analysts expect the Chinese Central Bank to raise its interest rate 3-4 times next year, which could weigh on markets particular in the beginning of 2011.

The Santa Claus rally appears to be running out of steam, as it becomes overwhelmed by news from the euro zone and China. The S&P 500 is also running into technical resistance, as it reached its highest level since mid-Sept. 2008. However, investors should expect gold to outperform, as euro zone worries persist.

RIMM downgraded by 3 analysts in 2 days

RIMM has been downgraded by 3 analysts in 2 days.  Yesterday, Dec. 7, Gleacher & Co. analyst Mark McKechnie downgraded RIMM from "Buy" to "Neutral", but raised his target price from $60 to $70. 

Meanwhile, CLSA (formerly Credit Agricole) analyst Steve Fox downgraded RIMM two notches, from "Buy" to "underperform".  However, like McKechnie, he also raised his target price, from $65 to $68.

Today, Town Hall Investment Research analyst Jamie Towsend downgraded RIMM to "Sell" from "Avoid".

Strong results expected in Q3 and Q4

It is unusal for an analyst to raise a company's target price significantly, and yet downgrade their rating.  But that is exactly what McKechnie did, raising RIMM's target price by 16.67%, while downgrading the stock to Neutral.

The analysts increased their price targets due to their improved outlook for RIMM in Q3 and Q4, due to strong sales of the Torch, Bold 9780, Curve 3G and the Style.

For example, McKechnie's Q3 earnings estimate is above the Street's (EPS of $1.69 versus consensus of $1.63).  In addition, he raised his Q4 estimate. 
However, these analysts downgraded RIMM because of their pessimistic outlook for the PlayBook, QNX OS and competition.

What upgrade cycle?

McKechnie stated “We believe the near-term strength will prove temporary, as the upgrade cycle completes and competition accelerates.” 

It is questionable for McKenchie to use the term "upgrade cycle", since even he states that smartphone shipments will increase 31% in 2011. 

What is happening is that feature phone (non smartphone) users are dumping their phones for a smartphone.  This is not only happening in the U.S., but actually at a quicker pace in other regions, such as Middle East, South-East Asia, Latin America and South America.  The pace is only going to increase.  In fact, many research firms estimate that by mid-2011, half of cell phone users in the US will be carrying a smartphone. 

RIMM is taking advantage of this growth.  An article in Bloomberg on Nov. 11 showed that RIMM is currently the number 1 brand in Latin America, beating out Apple's iPhone.  The resolution of encryption issues with the UAE and Saudia Arabia in Oct. means that RIMM will continue to be highly popular in the Middle East.  Meanwhile, RIMM continues to be extremely popular among other countries in Latin and South America, such as Mexico, Venezuala and Brazil.  Furthermore, RIMM is promoting the BlackBerry as a consumer device in China (currently mostly used by enterprise users) which opens up a market of 1.3 billion consumers.

In other words, the "upgrade cycle" that McKenchnie states is actually non-existent.  Smartphone sales will continue to grow at 25 to 35% in the forseeable future, while RIMM's revenue and earnings will continue to grow at 20% plus.

PlayBook and QNX OS

Unlike analysts who have a $90 target price for RIMM, these analysts are far more pessimistic on the PlayBook and QNX OS.  For example, McKechnie states that QNX is not a "game changer".  Fox shares a similar view, saying that the PlayBook will have "limited" EPS impact.

Thus, to some analysts, a tablet that beats the iPad in every specification is not a "game changer" (e.g. front- and rear- facing cameras versus no cameras at all, 4 times as much RAM as the iPad, etc). 

In addition, they believe that the first available professional-grade tablet, with legendary RIMM encryption, and an operating system that also powers the robotic arm on the space shuttle, nuclear powerplants from AECL and Westinghouse, and unmanned aerial vehicles currently in combat in Afganistan, will have "limited" EPS impact.  Afterall, the QNX OS was designed from inception to multi-task, be reliable, high performance and support multi-core processors.   

Their tortured logic doesn't end there.  According the Barron's, Townsend states that "the use of the QNX operating system makes the device significantly different from a BlackBerry so that corporate IT manager’s won’t rush to embrace the thing out of loyalty to the existing platform." 

Thus, what Townsend implies is that IT managers will be willing to switch from the Blackberry platform to a new platform (i.e. to the iPad or Android) but not to the newer Blackberry QNX OS, out of loyalty to the existing Blackberry platform.  If this does not make any sense to you, don't worry, because by definition, it does not make any sense. 

RBC analyst offers hope

Thankfully, not all analysts are clueless.  RBC Capital Markets analyst Mike Abramsky today reiterated his "Top Pick" rating and $90 target price for RIMM.  He also published a 14-page note about the QNX Tablet OS.  He states QNX will “deliver a powerful, fast, true multitasking tablet and smartphone experience”.  He also sees the PlayBook appealing to enterprise, "pro" consumers (such as avid gamers) and people with greater productivity demands that cannot be satisfied by the iPad and other tablets.

For more reasons why RIMM will outperform in the months and years ahead, take a look at 5 Reasons to Buy RIMM Now, published on Nov. 14.

Markets fall on euro zone debt crisis

North American markets closed lower today on continuing concerns over the euro zone debt crisis. The S&P 500 fell 0.13% to 1,223.12, while the Dow fell 0.17% to 11,362.19. Last week, markets made strong gains despite euro zone troubles. For the week, the S&P 500 rose 3%, while the Dow rose 2.6%.

News from Germany helped to push markets lower, as Germany rejected calls by other euro zone countries to increase the size of the $750 billion euro bailout fund.

Gold shines

Spot gold rose to an all-time high of US$1,429.4/ounce today. Meanwhile, US December gold futures rose $9.90 to settle at $1,416.1/ounce. Gold rose today due to Ben Bernanke's interview on 60 Minutes, in which he discussed possible further quantitative easing beyond QE2.

Last week, gold also made gains. It rose 1.2% on Friday to $1,406/ounce. For the week, gold was up 3.1%. This was caused by euro zone woes, and the ECB's decision to support troubled euro zone countries using essentially quantitative easing measures.

Contagion spreads

Early last week, contagion in the euro zone spread from the riskier PIIGS nations to other countries. Belgium saw its spread against German government bonds rise. Belgium was targeted because of its 118% debt-to-GDP ratio, one of the highest in the euro zone. In addition, its government is considered to be unstable. Meanwhile, Italy became the next country in the centre of attention after Ireland, Portugal and Spain, as the nation's government bond spreads also rose.

Encouraging economic data

By the middle of the week, good economic data from China and other countries offset euro zone woes. For example, China's November PMI rose for 4 months in a row to 55.2, better than the 54.8 that markets expected.

ECB intervenes

On Thursday, the ECB announced measures to help the troubled PIIGS nations. The measures largely involved buying government bonds of the troubled countries. Thus, the measures are a form of quantitative easing, and the announcement pushed the price of gold higher.

The week ahead

With the euro zone debt crisis far from resolved, investors can expect markets to head lower this week. With Ireland having accepted a $85 billion euro bailout package, investors are now focused on Portugal, Spain, Italy and even Belgium. However, negative news can still emerge from Ireland, since the details of the bailout package have yet to be decided. In addition, the situation in Spain has been relatively stable, which leaves room for significant negative news to emerge. Thus, investors should expect gold to continue to outperform for the rest of the year.

Investors should also keep in mind that it is now the second week of December, so the Santa Claus rally is in full swing. In fact, positive sentiment last week limited falls due to euro zone concerns.