Breakfast on Wall Street – 12 September 2013

MARKET COMMENTARY

The S&P 500 is up now for seven sessions in a row – turning in its best performance since early July. After a scary August for investors, its worst month since May 2012, the index has been up every trading day in September. The relief rally in the market continued yesterday as the S&P 500 moved up 0.31% to end the day at 1,689.13, while the Dow Jones Industrial Average, which is about to make its announced constituent changes effective from 23rd September, continued its upward move; the index was up nearly 135 points, or 0.89%, and ended the day at 15,326.60.

Usually, the three broad market indexes move in tandem. But yesterday was an exception. The Dow significantly outperformed the S& 500 due to IBM (NYSE: IBM). IBM announced yesterday the sale of customer care business processing unit for $505 million ($430 million cash and $75 million stock) to Synnex (NYSE: SNX). IBM has been steadily moving away from low value offerings and this was the latest in its move to an improved strategy. IBM was up $4.10, or 2.20%, on the news, which helped the Dow to outperform the broader index.

In a similar story, the NASDAQ Composite closed 0.11% lower, down 4.01 points, at 3,725.01. And here too, a single stock pushed the index, but in this case to the red. Apple Inc. (NASDAQ: AAPL) was down $26.93, or 5.44% and ended at $467.71. This was second day in a row that the stock was down for the same reason – a price point on its recent launch, the iPhone 5C, was not as low as the market was expecting. Since the announcement, the stock is down a whopping $38.46, which is 7.60%. We believe the markets are overreacting to the news since Apple’s other news in China is a significant positive that investors are overlooking. Apple announced yesterday that it had entered into an agreement with China Mobile (which has the world’s largest mobile phone subscriber base of 700 million). This is the market where Apple and other smart phone manufacturers need to be – and Apple has, finally, found a fantastic entry point. Readers can find a detailed analysis on Apple and the smartphone industry in our publications of the past two days, when we published a two-part outlook on it.

We believe the China Mobile story is a significant positive for the stock and the markets will react to, even if a little late. We ask the discerning investor to make a quick valuation call, and go with legendary investor Carl Icahn on this one. Mr. Icahn, already a very large shareholder of Apple, announced on his Twitter feed that he has bought more stocks in the company on this dip. Historically, whenever the CEO of Apple (very recently, the late Steve Jobs) finished an announcement and walked off the stage, the stock dipped. This has happened multiple times and the trend was followed yesterday with CEO Tim Cook. The market maxim of “Buy the Rumor, Sell the News” was evident. But the discerning investor knows better than that. Apple, to us, still has strong fundamentals and an entry into the largest smartphone market with the largest cell phone company is the first step in its emerging market success.

Unlike Apple, the broader markets moved up yesterday, again on news from Syria. As the US government increases a likely peaceful solution to the crisis in Syria, with help from Russia and other partners, we see oil prices falling and stocks heaving a sigh of relief.

THE LAST 24 HOURS

Fed to curb Banks Participation in Physical Commodities

The Federal Reserve will soon issue new guidelines restricting all US banking companies from participating in physical commodities trading. This regulation will curtail any possibilities of banks profiting enormously and potentially manipulating the prices of physical commodities by affecting the supply-demand chain. The banking companies have been already been restricted from participating in any kind of physical commodities trading without prior Fed-approval. This would mean an early exit for J.P. Morgan Chase & Co., Goldman Sachs Group Inc., and Morgan Stanley from physical-commodities businesses like metal, oil, and power.

Yucaipa Receives $235 million to Takeover Tesco’s US Arm

U.K.-based Tesco, the world’s No. 3 retailer after Wal-Mart Stores Inc. and Carrefour SA, has decided to quit the US retail market. The company will incur a total loss of £150 million ($235 million) and will, in essence, pay U.S. billionaire Ron Burkle’s Yucaipa Cos. to take over the entire assets and liabilities of the money-losing Fresh & Easy chain. Tesco is providing a loan of £80 million to the new business, which will absorb all of Tesco’s 4000 employees and its 150 Fresh & Easy stores. The deal is expected to close within three months.

China to Liberalize its Financial Sector

The Chinese premier, Li Keqiang, in his speech at the World Economic Forum in Dalian has asserted that he would take necessary steps towards financial sector reform in China. Opening up of the financial sector, which is dominated by the state-governed financial institutions, to private players; making interest rates and exchanges rates reflect the current market scenario; and steadily moving towards a full capital account convertibility of the Renminbi are few of the sweeping financial reforms that he has promised.

Tablet Sales to Surpass PCs

Demand for portable gadgets like the ipad and Kindle Fire are set to exceed that of PCs for the first time in the fourth quarter of 2013, according to analysts at IDC. PCs will comprise 20.2% of units shipped this year, compared with 14.6% cent from tablets and 65% from smartphones. The recent shift in trend vindicates the predictions made by Apple’s Steve Jobs about the “post-PC era.” More than two-thirds of the $622 billion connected-device market is predicted to comprise of cheaper smartphones and tablets costing within $350.

Pimco Total Return Fund Decreases Holdings In U.S. Government Securities In August

Total Return Fund, the world’s largest mutual fund with assets over $251 billion, cut its holdings of U.S. government-related securities and increased its mortgage holdings in August, data from the firm’s website showed. The exposure in U.S. government-related securities is now 35%, compared to 39% in July. The fund has also increased its exposure to money market and net cash equivalents to 7% in August, up from 3% in July. The Pimco Total Return Fund is down 4.09% this year, above 25% of peers, owing to price losses and investor withdrawals and it also a $41 billion drop in assets over the past four months.

THE NEXT 24 HOURS

We have jobless claims data coming out tomorrow. Consensus expects initial claims to increase to 330,000 from last week’s 323,000. Continuing claims are also expected to move up, from 2,951K last week to 2,960 this week. While we are not in a position to predict absolute numbers, we believe last week was an aberration and despite our call of a jobless recovery, the claims number will keep going down – as it has for the past few months.

If the data does turn out to be better than expected, we can see the upward move in the markets might reverse the trend. As investors realize, good news in the labor markets will increase worries of a larger Fed bond purchase tapering. We still hold that the scare is overdone as we see definite improvement in the fundamentals; we realize that better than expected data may cause markets to fall in the short run.

We also have import price index data coming out tomorrow. The Fed will ideally look at this data when deciding upon its monetary policy. If inflation is still at the low levels that we have seen since the crisis, we do not see the reason to worry about inflation and cut down on purchases. Due to the significant over capacity in the global economy and the strengthening dollar, we think inflation fears in developed markets do not have a base in economic fundamentals.

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