Breakfast on Wall Street – 11 September 2013


The relief rally in the market continued yesterday as the S&P 500 moved up 0.73% to end the day at 1,683.99, while the NASDAQ Composite closed 0.62% higher, up 22.84 points, at 3,729.02. The S&P 500 has now been up for six sessions in a row – turning in its best performance since early July. After a dismal August, its worst month since May 2012, the index has been up every trading day in September. The gains yesterday came in across the board, with every sector index of the S&P moving up, including the energy sector, which is facing pressure from falling crude prices. The Dow Jones Industrial Average, which replaced three constituents yesterday, continued its upward moves; the Index was up nearly 128 points, or 0.85%, and ended the day at 15,191.06.

We ask the discerning investor to look for global cues when trading the US markets. The world economy has progressively become more integrated – and looking at the US data alone is not enough to gauge market sentiments. The reasons for yesterday’s rally were essentially the same ones that we saw on Monday – positive macroeconomic news from China and diplomatic/political news from Syria.

The Syrian government seems to be clutching at straws as it tries to avoid US air strikes by considering a Russian proposal that urges the Assad government to hand over its stockpile of chemical weapons to international control. Yesterday, Syria acknowledged that it has chemical weapons and assured the international community that it will not only cease production of these weapons, but also disclose the locations of its stockpiles to the United Nations, Russia and other nations. With the likelihood of an unpopular US military intervention in Syria decreasing, oil prices moved down and stock markets reacted positively.

News from China has made the markets react positively – yet again. Although Chinese retail sales growth had not looked promising in light of the past five years, the 13.4% YoY growth in August —its fastest pace this year —is higher than consensus estimates of 13.2%. Chinese industrial production, too, which showed a 10.4% growth YoY in August, has significantly improved when compared to July’s growth rate of 9.7%.

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While industrial production has been one of the major drivers of Chinese stocks, the change in the Dow Jones Industrial Average yesterday reflected the US economy’s continuing move towards the service sector. Hewlett-Packard (NASDAQ: HPQ), Alcoa Inc. (NYSE: AA) and Bank of America (NYSE: BAC) were dropped from the Dow, making way for Goldman Sachs (NYSE: GS), Visa (NYSE: V) and Nike (NYSE: NKE). To avoid the price-weighted index from getting crowded by stocks that are trading above the $200 range, the largest and third-largest US companies, Apple (NASDAQ: AAPL) and Google (NASDAQ: GOOG), were overlooked again due to their high prices.

Today’s Menu


While the announcements from Apple were considered disappointing by investors, we continue with our fundamental outlook of the tablet and smartphone industry, with a special focus on Apple and its competitors. Yesterday’s special provided a broad outlook on the industry, concentrating on its global performance and trends. Today’s report follows up with a closer look at the individual firms in the industry, with special coverage of Apple’s announcements – and its success and failures with investors. .

With iPhone sales growth dipping to all-time lows and in a downward trajectory for the past two years, Apple needs to show some strong signs of innovations or new market penetration. While we will create a broader outlook around these announcements, our sister publication Hot Off the Wire (HOTW), will provide commentary on Apple’s updates and what are its implication on the stock for the short run.

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China tie-ups – As we saw from the data and charts yesterday that it is its APAC and China policy that will guide the Apple’s future course. In yesterday’s outlook, we had published a detailed analysis on the importance of China and the emerging markets for the future of Apple and smartphone sales. We, like many others, are hoping that today’s meeting in Beijing will bring some clarity on its proposed deals in China. If Apple can provide a clear guidance on a deal with China Mobile (the world’s largest mobile phone user base of 700 million), we will expect the stock to gain back the entire losses from yesterday. As we go to press, we have just received word that Apple has now secured the final license necessary for its iPhone to operate on China Mobile Ltd.‘s mobile network. This will now pave the path for Apple’s entry into China Mobile’s 700-million customer base, which will of course be a game changer in the market. We expect Apple’s stock to shoot up on this news.

The Low End – Apple finally announced the iPhone 5C at a price point of $549 without a contract. The price point with the contract is sweeter – at $99 with a two-year contract –very similar to an iPhone 4S. While this might be a positive in the US and some developed markets where most users use long-term contracts, in the fast-growing emerging markets (EM) long-term contracts are rare.

We analyzed the sharp growth in EM demand for smartphones yesterday, but the graphic below will clarify why investors are not too happy with this price point. At $549, the phone without a contract is at the mid-high price band. According to data from IDC, nearly all the growth in the market has been in the low cost smartphone market – the firm expects this trend to continue. According to IDC’s estimates, by 2017, phones priced higher than $400 will make up 28% of market share, down from the 39% now.

Apple’s rival, Samsung, has been capitalizing on this price band, despite its top-end phones, which compete directly with Apple’s iPhone. With the current price tag for 5C, we do not see how it will help Apple in its future in the EMs and the growing demand for low cost smartphones.

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The Colors –Apple has decided make the 5C available in different colors, although not similar to the ones in its regular line. This might help in maintaining the exclusivity of the main line and be a useful differentiator between the regular iPhone series and the cheaper 5C. The new colors are green, blue, yellow and pink – which also reflect Apple’s intention to target a younger market for the 5C.

Operating System – Though the iOS is one of the market leaders, its market share in comparison to Android has been falling. Apple CEO, Tim Cook, has dubbed the iOS 7, which is supposed to get to the markets on September 18th, as the most significant change to the operating system since the iPhone was created. But critics who have tried it have found it “underwhelming” and “confusing”.

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We believe that this is a huge risk as we have seen with the Blackberry (NASDAQ: BBRY) when its software became a major hindrance in its growth path. This decision has also made space for a third OS to possibly get entry into this market. With Apple’s arch rival Microsoft (NASDAQ: MSFT) acquiring Nokia’s handset business, we see an opportunity for Windows Mobile to make a major entry into the market in the recent future.

The High End – The iPhone 5S is marginally different from the iPhone 5. The 5S has a home button, which is also finger print scanner. This allows the user to have additional security for the phone and for the apps. This is a pretty cool device that will set it apart. The touch ID will be used only on the phone and Apple will not store the finger print data on its servers or cloud.

What Apple did not Announce

Trade-Ins – Analysts expected a trade-in or buyback scheme from Apple, which has been successful for it in some local markets. This would have created a brand loyalty that is essential in a high-end market. We hope that the management makes this change, as it will aid in a long-run growth story.
Smart Watch –Apple disappointed those who were expecting an iWatch, a competition to Samsung’s Smart Watch, especially since it is predicted that wearable technology is the wave of the future – an idea led by the Google Glass.

The Last 24 Hours

Alcoa, H-P And Bank Of America Dropped From Dow Jones, To Be Replaced By Goldman Sachs, Nike And Visa

By next week, Alcoa Inc. (NYSE: AA), Hewlett-Packard Co. (NYSE: HPQ) and Bank of America Corp. (NYSE: BK) will be dropped from the Dow Jones Industrial Average, as Goldman Sachs (NYSE: GS), Nike (NYSE: NKE) and Visa Inc. (NYSE: V) will join the benchmark index. The changes were prompted by the stock performance of the three companies and to diversify the industry participation. Market experts feel that the changes will make the index better with each trading day, while Bank of America Corp. maintained that the changes will have little bearing on its strategy and business as the company is committed to deliver shareholder value.

Verizon To Make History For Biggest Ever Debt Sale

Verizon is on course to sell bonds worth $49bn, to make it the biggest corporate debt sale ever. The sale is expected to be nearly three times as large as Apple’s $17bn issue in April. Verizon will sell a combination of fixed and floating rate debt spread across six maturities ranging from three to 30 years, with prices expected on Wednesday. Verizon’s new 10-year bond offer may reach $15bn and pay about 225 basis points more than US Treasuries with similar maturities. In order to attract new investors, Verizon is offering higher yields when compared to its existing bonds.

Wheat Futures to Rise on Record Sales in the Last Six Years

The record wheat sales in the last six years have resulted in a depletion of wheat inventories across the globe. As per the U.S. Department of Agriculture estimates, the inventories are down to a five-year low even after a bumper harvest. The easing of drought conditions has led to a 32% decline in wheat futures from a four-year high in July 2012. China, the world’s largest importer is set to triple its wheat import, while Brazil has increased its import from the US by over 41 times. In the last three months, the wheat export from the US has increased 38%. The high overseas demand will lead to a 15%rise in the futures for the next season to $7.40 per bushel.

Syria Promises to Surrender its Chemical Weapons

Amidst rising tension of the US undertaking military action against Syria, Bashar al-Assad’s led Syrian government has accepted the Russian offer to surrender its chemical weapons to international control. The Russian President has said that such a move would only be possible when Washington decides to drop the idea of military intervention. However, the White House is resolutely pushing for a resolution in the Congress for the military action and is appears unmoved by the Syrian assurance.

Crop Insurance: a Tool of Money Laundering

The US crop insurers are using the $14 billion federal crop insurance program as a cash minting business. In 2012, the US government had created the program to pay 60% of total farmers’ insurance payouts. This is a chunk of the total operating cost for the companies and a major revenue source at times of drought season. These companies further pass over the 55% of total risk cover to a third party reinsurer and get benefits out of the government schemes. Thus, by undertaking risk and passing it over to the third party, these intuitions make a lot of money. The US Department of Agriculture is now planning to shelve such programs in future.

The Next 24 Hours

TYesterday’s data release for Small Business Optimism came in worse than expected, but it is a signal the markets tend to ignore. Small businesses are the backbone of hiring and if this sector does not pick up, we will continue to see the problems in the labor markets.

Today, we have the MBA Mortgage Applications coming in at 7 AM. Last week’s data surprised to the upside and mortgage activity has been steadily picking up. But this week and in the recent future it might disappoint due to the rising mortgage rates. The government is planning on a mortgage rate cap, but it is unlikely right now and that is a negative for the housing market.

We also have data on Wholesale Trade and Inventories coming in from the Census Bureau. A lower inventory predicts higher economic activity. We will use the data tomorrow to predict a business outlook for the near future.

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