Hear no Evil, See no Evil
As cautious investors continue to wait for a pullback to deploy cash on the sidelines, stocks continue to march higher, reflecting the US government’s latest attempt to kick the fiscal can down the road and surprisingly positive readings on the manufacturing sector globally. Despite our expectations for the payroll tax hike to dampen consumer spending domestically, the economy appears to be off to a reasonably good start so far this year. Blue chip US stocks have now gone four-for-four and are up 5 percent in 2013, rising each and every week of the New Year. Amidst increasing evidence that investors are rotating out of bonds and into stocks, Treasuries lost ground again, with yields on the benchmark 10-year security again pushing up against the 2 percent threshold.
Adding Insult to Injury
A back-half weighted year, slowing sales growth, slimmer margins, and declining estimates -- investors are all too familiar with these conditions often associated with a company reaching maturity. However, in this case, the subject matter doesn’t involve once mighty tech titans Microsoft, Cisco, or Intel, but rather erstwhile growth company Apple. After already declining nearly 30 percent from its highs, Apple stock plunged another 12 percent Thursday following the release of disappointing sales and lackluster profits. And just like that, $60 billion of market cap disappeared.
A Bad Apple?
That Apple’s sales growth slowed to 18 percent was not as shocking as the fact that its per share profits actually fell in the company’s December quarter, something that would have been considered heresy just months ago. Declining margins reflect a company struggling to manage a supply chain that was pushed to deliver enough inventory for Apple to sell 48 million iPhones and 23 million iPads in just 90 days. But factors beyond logistics are at play. Apple’s product mix has become less profitable, with telecom partners AT&T and Verizon Wireless reporting that an increasing number of new contract customers opted for older iPhone models.
Both market maturation and market demographics appear to explain Apple’s conundrum. First off, developed market smartphone penetration now exceeds 50 percent, so what might be called the “easy money” has already been made. New smartphone customers being signed up now are arguably less tech savvy and more price sensitive, so they are less willing to spend $200 for the latest iPhone 5 when a perfectly acceptable iPhone 4 can be had with a 2-year contract for free. Just as importantly, the huge potential to sell iPhones in emerging markets is complicated by the fact that fewer customers there make enough money to buy one, subsidized or not. Finally, and in a related vein, Apple is losing market share to the less expensive Android architecture delivered through competitors like Samsung, which offers competitively priced phones that carriers often prefer because of a lower subsidized cost.
We believe that Apple is working on lower-end devices to build market share, especially in international markets. However, those phones won’t be as profitable to sell. With diminished growth prospects, the onus is now on Apple to begin returning more of its prodigious cash flow to shareholders – through either share buybacks or a dividend boost.
While Apple was the headline act, tech companies took center stage during a week when hundreds of companies reported fourth quarter numbers. Profits continue to beat expectations by a margin similar to Q3, but the proportion of company’s delivering sales above estimates has improved. In an example of maturing tech done right, Google’s stock rallied on news of slower erosion in the price that advertisers pay the company for clicking on Google-driven ads. Behind better than expected mobile ad pricing is the fact that both tablet and smartphone clicks more than doubled in Q4, reflecting people’s increased comfort with transacting in the wireless realm. Evidence that Google is successfully navigating the transition from PC to mobile search is a key reason why the stock rose 7 percent on the week.
Hundreds of companies across industries will report on a daily basis next week in what we expect will be the heaviest week of the fourth quarter earnings season. The Fed will also convene its first meeting of the year, the result of which we expect will be communication indicating a continuation of the quantitative easing programs instituted last fall.
Our Takeaway from the Week
- Encouraging macroeconomic data and acceptable earnings results continue to put a bid into stocks