iPad, iPhone 4, Android and the stock market

This is another try at a topic I think is important and that I’ve been thinking about for a while.

haves vs. have nots

AAPL just announced that it has sold 3 million iPads in the first 80 days of the product’s existence, or more than a million units a month.

Early estimates are that the company will sell a million of its newest iPhones on day 1, that is, today.  Even so, AAPL seems to be losing market share among smartphone makers to offerings using GOOG’s Android operating system.

Transportation companies like FedEx are working over time–and making lots of money–just getting enough of these devices into the stores so that consumers can buy them.

Step back for a second and figure how much money consumers are spending on just these two AAPL products.  Four million devices times, say, $600 each, and you get $2.4 billion–in less than three months and on what are, when you get down to it, super-cool but by no means essential purchases.  Frivolous is too strong a word, but it gets you going in the right direction.

What does this mean?  My take is that affluent people have lots of money to use to indulge themselves, and are willing to spend it.  I don’t mean this too critically.  We’re a Verizon/Android family, with four smartphones in service and climbing.  But these are not the sort of purchases you’d make if you were worried about being laid off tomorrow or were concerned about where the money for the next mortgage payment is coming from.

This group of consumers appears to be on solid ground in thinking economic recovery is underway.  One recurring theme in recent company earnings announcements has been that revenues are growing rapidly but earnings aren’t going to keep pace for a while, because firms are restoring cuts to wages and benefits made during the recession.

That’s one side of the US economy coin.

The other side is an unemployment rate of close to 10%, continuing large numbers of home foreclosures caused by delinquent mortgages, WalMart customers trading down to the dollar stores.

what about the stock market?

It’s clear that, unlike the case of any government bond market, there’s typically a much weaker link between a country’s domestic economic performance and its stock market.  In the case of the US market today, for example, half the earning power of publicly listed companies comes from outside the US.  Of the domestic portion, housing, construction, real estate, autos–areas of the greatest economic concern–have almost no direct stock market presence.  Perhaps their biggest representation is indirect, through a portion of the loan portfolios of listed financial companies.

Many times in the past in the US, investors have been willing and able to make sharp industry or sector distinctions that separated winning areas of the market from losing ones, even in shaky economic times.  From 1975-84, for example, small stocks soared while the Nifty Fifty trended downward for years.  When oil prices collapsed in the early Eighties, investors focussed on disinflation beneficiaries like utilities or consumer staples firms, which had a decade-long run.  Similarly, restructured American industry was a big focus of the first half of the Nineties, with technology taking up the running in the second half.  Traditional value stocks were a big money-making opportunity after the internet bubble collapsed.

Until now, the stock market recovery from the lows of last March has followed the typical pattern:  economically sensitive stocks have done well, defensives have lagged.

where to from here?

What strikes me as odd about the current market in the US is that we seem to still be trading very heavily on overall macroeconomic news and not on what I think are very clear company by company and industry by industry performance differences that are developing.

The heavy betting should be on the idea that the “invisible hand” is still hard at work and that these differences are emerging–the problem being me, that I’m just not seeing them yet.  You have to add more weight to this possibility because I’ve been generally right about the market over the past year or so, which would imply that I’ve gotten a little lazy and can’t match the research intensity of others seeking to make up lost ground.

Two other thoughts have been nagging at me recently, though.  One, which you’ll hear about soon, has to do with the “invisible hand,” which is the ultimate source of the efficient markets hypothesis and ultimately comes from theological speculation (not a good sign).  The other is the changing balance among styles of money management.

There has been a slow drift of equity money toward index strategies over the past twenty years or more, based on the tendency of active money managers as a whole to deliver worse than index performance.  But I think there are also three other developments that are affecting trading today:

–retail investors seem to me to have hit an inflection point of disillusionment with financial advisors/ mutual funds, and are switching away from active managers to ETFs

–major brokerage houses have laid off many of their most experienced securities analysts during the financial crisis as a way of cutting costs, with the result that company-specific information is not disseminated as widely or as quickly as it was even five years ago

–institutions like pension funds have been also been switching from traditional money managers to hedge funds.  Many of the latter are former brokerage house traders, who understand macroeconomics and short-term market trends, but have little training or experience in microeconomics or securities analysts.

The effect of these changes?   In the final analysis, I think company fundamentals win out.  The journey may be longer and more volatile, however, if not everyone is following the same roadmap.  Less focus on company or sector economic developments may also explain why technical analysis seems to have been more effective than usual as a tool during this upturn.

Disney’s movie business is doing (even) better than it seems

five movies

DIS has had five major releases since its fiscal 2010 began in November: The Princess and the Frog, Alice in Wonderland, IronMan 2, Prince of Persia: The Sands of Time and Toy Story III.

ratings

According to Rotten Tomatoes, critical reviews have been mixed.  Out of a possible 100–based on the percentage of positive reviews, scores are as follows:

Toy Story 3 98

Princess 84

IM 2 75

Alice 51

Prince of Persia 38.

Prince of Persia turns out to have the second-highest score of any movie based on a video game.  Most in this genre are relatively low-budget films that hope for modest box office success.  As a big budget (an estimated $200 million–more than IM2, Prince breaks with this pattern in hopes of wider consumer acceptance than video game aficionados.

box office

————————–US————-foreign——–total

Alice $334.1 mill            $685.6           $1019.7

IM2 $304.6                    $300               $604.6

Prince $81.4                      $213.1             $294.5

Princess $104.4                   $162.6             $267

TS3 $125.9                    $44.8              $170.7   —in its first weekend, limited foreign release

note the strong foreign sales

Together Prince and Princess will probably break even, thanks to much stronger foreign box office than US receipts.  Alice was a mega-hit.  IM2 is inching toward total US box office for IM ($318.4 million) but has already blown by the original’s foreign take of $266.7 million.  In addition to its strong domestic start, TS3 has set records for an animated release in China and Latin America.  In addition to its extremely good critical reviews, the film is demonstrating unusually strong appeal to young adults–apparently because they grew up with the earlier TS movies.

Over and above box office, revenue for DIS will come from:

merchandise sales

DIS is estimating that TS3 will generate $2.4 billion in sales of licensed merchandise this year.  IM2 may not match that number but it will doubtless handily exceed the take from IM, where uncertainty as to the success of the film meant only small amounts of related merchandise were available on its release.

dvds

Several years ago, DVD sales made up over half of a typical movie’s revenue.  DVD purchases have been severely curtailed since the financial crisis hit, however.  The one exception:  blockbusters like the original IM. My guess is that the same will prove true for IM2 and TS3.  Alice is also one to watch carefully.  DIS has begun selling Alice DVDs much closer to the box office release date, in hopes of benefitting from the positive glow of the movie’s success, as well as from the promotional spending that accompanies a movie’s debut.  It will be interesting to see how well the experiment works.  In any event, for DIS’s strongest films, there’s a good chance that DVD sales will be better than expected.

conservative accounting?

Film companies write off production costs by estimating total film revenues, calculating the percentage of that estimate that is being recognized in a given accounting period, and subtracting the same percentage of costs.  In other words, they use project accounting.

Given the fact that DVD sales have been deteriorating over the past couple of years, I don’t see any reason for DIS’s accountants to make the aggressive assumption that the company’s films will counter that trend.  In the case of TS3 and IM2, and maybe for Alice, DVD sales will likely be very good.  But it’s much better to write off costs early and have a positive surprise than to be too optimistic and end up having to write off a bunch of costs at the end of a film’s earning life.  The latter is what DIS, ex Pixar and Marvel, was doing at the end of last fiscal year.

It seems to me that the result will be that the writeoff of costs will be aggressive in the beginning, with surprisingly high profits being recognized later on.



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John Plender: today’s US = post-WWI UK

As regular readers of Practical Stock Investing will have gathered, my favorite financial newspaper is the Financial Times (the New York Times would be a distant second).  I don’t know the FT columnist John Plender well enough to say I’m a fan, but he has written a very interesting recent column about how the structural government deficit problem in the US is playing out.  Here’s my paraphrase (with some additions of my own):

One of the most striking features of the US for any investor, especially one with experience in developing markets, is that the government is able to borrow large amounts of money at reasonable rates of interest.  During the past ten years, the country has swung from a government budget surplus to a deep deficit.  The bulk of the spending seems to be supporting consumption rather than investment–thereby generating no economic return in future years that might go toward servicing the debt.  The US depends heavily on foreigners, particularly in recent years on China, for financing–that is, sources that are arguably less committed than citizens to fund the country.  Finally, Washington seems oblivious either to the need to formulate any plans either to restore itself to fiscal balance or to the possibility that it might one day reach the limit of its metaphorical credit line.

The situation in the US is far different from that of a developing country.  For one thing, it’s a large industrialized country with lots of accumulated wealth.  For another–and this is doubtless much more important–the US dollar is the world’s de facto reserve currency.  In other words, the US runs the bank, so it’s much easier for it than for any other country to get a new loan.

Two years or so ago, it was beginning to look pretty grim for the US.  It seemed the country was fast coming to the end of its credit line.  A Wall Street-Washington alliance of political favors and campaign contributions, complete with a regulatory apparatus that looked the other way, led to rampant speculation and the near destruction of the banking system–requiring a mammoth increase in government debt to fund a rescue.   An alarmed China, a very large creditor, began to look for places to unload its very large dollar holdings–mostly by buying physical assets or lending funds to other developing nations–trying to reduce its exposure to assets it felt sure would depreciate in value.  Washington, of course, seemed unwilling/unable to grasp what was transpiring.

Then a new political party came into power in Greece and announced the former government had been falsifying that country’s national accounts for years.  As we all know, the euro imploded as a result.

Ironically, in the short term this has been a good outcome for the US and Europe. 

To Mr. Plender’s eyes, the US situation today resembles that of the UK between the two world wars.  As still the center of the global financial system, Britain’s government debt instruments continued to have safe haven status, even though that country had become a shadow of its former robust economic self.

I don’t know enough about economic history to judge how exact the parallels are.  But the main Plender point is that the collapse of the euro has perversely alleviated near-term economic pressures for all parties.  The entire EU has devalued, not just Greece.  That fact may not alter the relatively poor situation of Athens vis-a-vis the rest of Europe, but it does mean that the EU as a whole has gotten an economic shot in the arm. 

At first blush, this seems to be an unequivocal negative for the US.   But the collapse of the euro has knocked out the only credible rival for the US dollar as a safe haven currency for the globe.  By default, then, despite the fact that the US is no longer a pristine credit, the rest of the world is continuing to lend to it as if it were. 

This period, which may last for a number of years, is not a pardon.  It’s more like a stay of execution, or a grace period in which the US has the opportunity to get its fiscal house in order without suffering any severe financial consequences.  At the same time, there’s the risk that a profligate Washington will run up an even bigger tab–causing that much more future pain–before the bill becomes due.  As Mr. Plender puts it:

“In such circumstances the question is not whether the dollar will retain its haven status, because it will, but how much damage will be done as global investors offer US policymakers the rope with which to hang themselves. That is the long and the short of it.”

Chinese renminbi unpegged from the US$: what it means

what China is doing

Over the weekend, the People’s Bank of China announced that it was changing its policy of closely managing its currency to mimic the movements of the US$.

From now on the renminbi will be linked instead to a basket of currencies representing China’s major trading partners, the largest of whom is the European Union at 16.3% of total trade (the US follows with 12.9%, ASEAN with 10.4%, Japan with 9.4% and Hong Kong with 7.5%).  There’s nothing unusual about this change.  It’s what emerging economies with global trade typically do.

China won’t have a free float, however.  Allowable daily currency fluctuations will be limited and the central bank will manage the float by setting the midpoint of the daily trading band.

no dramatic short-term movements

Economists are speculating that the renminbi will appreciate vs. the US$ by one or two percentage points in the coming year.  The People’s Bank is making it clear it doesn’t intend to do more.  And, given that the euro has fallen by about 20% against the euro over the past six months, if China were following its basket rule, it would be depreciating its currency by about 3% against the basket.

market gains today

Nevertheless, China allowed the renminbi to appreciate by .42% against the US$ today, its largest gain in five years.  World stock markets have responded enthusiastically, both to the Chinese announcement and the market action of the currency.

implications for China

As I’ve written extensively in this blog, the standard strategy for developing economies to achieve technology transfer from the developed world is to offer cheap labor.  Japan is the poster child in Asia of this strategy.  The developing country will make sure it retains its labor cost advantage by pegging its currency to that of its target trading partner, usually the US.

In theory, as time passes the developing country begins to allow its currency to appreciate as a way of steering its industry toward higher value-added activity.  This process should at the very least begin before the country runs out of labor and triggers an inflationary wage spiral.  In practice, the newly prosperous labor-intensive industries have enough political clout to preserve the status quo, and their profits, despite the fact that this begins to do long-term economic damage.

One sign that a country is near the point of exhausting the available labor force for a given level of technology–and that currency appreciation is the appropriate response–is when strikes, or other forms of labor dispute, arise and large wage increases result from them.  This appears to be happening in many places in China today.  A political struggle also appears to be occurring between economic planners, who favor a stronger currency, and forces of the status quo, who want to preserve their current position.

The strong financial market response to China’s (so far) modest currency move seems to me to be a sign of relief that events appear to be moving in the right direction.

implications for the US

In one way of looking at things, if a developing country decides to make a continuing massive subsidy to its trading partners by undervaluing the labor content of the goods it sells, the recipients should say a silent “thank you” and keep on accepting the gift.  But doing so on a large enough scale may end up distorting the recipients’ economies.  Put aside (for a later post) the long-term effects of this and for now look at the short term and at the US.

The political drama surrounding trade with China became ritualized in the US during the frequent Congressional hearings on renewing that country’s most favored nation trade status.  Congress would posture for a domestic audience by threatening trade sanctions.  One house or the other would sometimes introduce protectionist legislation, confident that the president would veto it if the bills got that far.

This time around, Senator Charles Schumer of  New York, noted more for his fund-raising from Wall Street than his knowledge of economic history, has introduced a twenty-first century version of the Smoot Hawley tariff law (the one that caused the Great Depression of the 1930s).  Observers have feared that neither Mr. Schumer nor Mr. Obama knows his role in the drama–that Mr. Schumer will push too hard for his bill’s passage and that a weak president will sign it into law.

A second reason for rising stock markets today is the thought that this outcome is now less likely.

implications for stocks

The standard rules apply:  having revenues in an appreciating currency and costs in weaker currencies is the best position to be in.

One other thought–workers who get large raises and who also receive them in an appreciating currency have a lot more purchasing power.  So sellers of euro- or dollar-cost merchandise in China should do relatively well.  Outbound tourism from china should also boom.  The first stop is likely Macau and Hong Kong.  Next comes Japan, then the EU.  As Marriott has recently pointed out, the US may not be a big beneficiary, however.  The government’s anti-terrorism concerns have made it difficult for ordinary Chinese citizens to get a visa to visit.

world trade is booming again: two pieces of evidence

container shipping

According to the Financial Times, major container shipping lines are finding that their business is growing much faster than they had anticipated or planned for.  Deliveries from Asia to Europe are a particular sore spot.  They are advancing at a 23% year on year pace, well more than double the rate anyone thought six months ago. 

Combine this with the fact that ships are travelling more slowly than usual to save on fuel costs, and the result is that the shipping lines are running short of containers to put their customers’ wares in.

We’re not at the same point of high demand that we were a few years ago, when the bottleneck was the ability of the departure and destination ports to load and unload shipments.  Still, it’s possible that some customers will be turned away during the runup to the yearend holiday season.

While the current boom is much better than it’s opposite, it may not be an unadulterated positive for the shippers.  They are having to take ships out of mothballs in Europe simply to have them steam back to Asia full of empty containers.  It’s also possible that they’ll have to send some ships half-full to Europe, while Asian warehouses are bulging with merchandise waiting for shipment.  If that proves to be the case, added costs will take some of the sheen away from potential profit gains.

FedEx

FedEx is in a similar situation.  As I mentioned in an earlier post, the company went out of its way in its latest earnings conference call to sy it thought investors were much too gloomy about global economic prospects–because they didn’t understand how strong the recovery in world trade is proving to be.

The company cited the fast growth in air shipment of small, high-value technology goods from Asia to both the US and Europe as a bright spot for it.  Volumes were up 23% year on year in the May quarter, with prices rising 6% in addition. Bbusiness is so good that FedEx is accelerating its capital expenditure program and incurring additional expense to remove freight planes from storage and get them ready for work again.  Such expenditures, plus added personnel costs–raises reinstated, higher medical costs, larger pension expense–will prevent this strength from dropping down to the bottom line for the next six months or so.  The fact that these expenses are temporary has escaped the notice of TV commentators–implying it has also been missed by the analysts feeding them the information. 

what to make of this?

In both cases, the consensus–and the companies–have not been optimistic enough.    Interestingly enough, in both cases increased revenues may be temporarily overwhelmed by higher costs, although this situation will certainly reverse itself as the firms adjust to the higher revenue inflow.  I think the first point to be made is that there’s no reason not to be optimistic about the cyclical upturn in the global economy.

Thre’s also an important distinction to be made between air transport and sea transport.  The latter services deal with general merchandise, where speed is not of the essence, where items may be bulky–and therefore not suitable for air transport, and where shipping costs are paramount.  I think the fact that sea traffic to Europe is up so much implies that the general EU economies are faring better than investors now think.  There’s no evidence from these reports that the same is happening in the US.  This doesn’t mean that the US isn’t faring at least as well as Europe.  Strictly speaking, we know nothing, but the fact that the optimistic shipping report doesn’t mention the US might tilt me a bit toward thinking the US isn’t enjoying the same sort of uplift as Europe is.  This is not a thought to bet the farm on, but it’s a reason to pay attention more closely to precisely what companies say about the US in the upcoming weeks.

Air transport is for lightweight, high value-added items–meaning IT, smartphones, laptops and components in particular.  This would imply that positive earnings surprises could be coming from companies linked with these devices–industry in general and sellers of IT products in particular, as well as younger and more affluent consumers (who tend to be disproportionately large users of tech gear.

Of all of this, the most important to me is the suggestion that financial woes in Europe and the plunge of the euro have not damaged the region to the extent the consensus believes.