Wednesday, January 28, 2015

A Neutral Fed Announcement Spooks Markets

The Federal Open Markets Committee (FOMC) issued a statement today that sent the US markets into a nose-dive.  With earnings across most sectors disappointing the markets throughout January, and with economic data being a further disappointment, speculation on the street was pushing estimates of interest rate hikes out into the September time-frame.  The Fed dispelled those notions this afternoon, and the Dow tumbled 190 points in response.

In today's release, FOMC stated, "Based on its current assessment, the Committee judges that it can be patient in beginning to normalize the stance of monetary policy."  This is being interpreted as indicating a rate increase announcement no earlier than June, however it's not the dovish indicator the markets were hoping for.

It doesn't help that the FOMC's assessment of current economic conditions appears to be a bit rosier than those being seen by investors and traders.  Consider the following statements:

FOMC stated, "Labor market conditions have improved further, with strong job gains and a lower unemployment rate."  While it's true that unemployment has declined to about the 5.6% level, the Participation Index - a much more accurate measure of the workforce - has declined to its lowest level (62.7%) since 1978 and it continues to decline.  This would indicate that the number of eligible workers that are unemployed is increasing, not decreasing.  As to job gains, if you take Texas, Washington DC, Arkansas, and Utah out of the mix, the nation is actually shedding jobs at a rapid rate.  Almost all of the net national gains are coming just from the state of Texas.

Job Gains vs Unemployment

Here's the raw data just for Texas: Joint Economic Committee - Texas Economic Data

Next, the FOMC stated, "Household spending is rising moderately."  That's an interesting view, considering the Retail Sales number recently released was the largest decline experienced in 11 months.  If household spending is rising, one must question where they are spending it since it clearly wasn't in retail stores last month. 

They stated, "Recent declines in energy prices have boosted household purchasing power."  There's certainly more money in the consumer's pockets resulting from a decline in gas prices, however, as has been discussed several times over the past couple of weeks, there is no evidence that the consumer is spending that money.  In fact, there's evidence mounting that the decline in energy prices is about to have an extreme negative impact in the oil producing states that have driven the overall job growth since the recession.  With oil rigs closing, and oil companies starting massive layoffs, the conditions in states like Texas, Oklahoma, California, and North Dakota, among others, will quickly deteriorate.

Finally, FOMC stated, "Inflation has declined further below the Committee’s longer-run objective, largely reflecting declines in energy prices.  Market-based measures of inflation compensation have declined substantially in recent months; survey-based measures of longer-term inflation expectations have remained stable."  The problem with this statement is that both CPI and Core CPI are down.  This means that, even excluding food and energy, inflation is down. It makes sense, since wages are not increasing.  (Average in the latest release was a mere 1.7%.)  In other words, inflation is dropping, not because of energy prices, but because of a gradual softening of the economy as a whole.

What may have spooked the market the most is this phrase in their press release: "In determining how long to maintain this target range, the Committee will assess progress--both realized and expected--toward its objectives of maximum employment and 2 percent inflation." It's that "and expected" part that is disturbing.  Since their assessment of inflation to date is not accurate, the thought that they will react based on what they expect to happen implies a rate hike that will be premature in an economy that cannot tolerate it.

The only truly encouraging statement in the release is in the very last sentence: "The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run."  This is, from what we can determine, the only acknowledgement that there are global economic forces that are providing extreme headwinds to US economic growth.  The strength of the dollar, a crumbling European economy, the renewed threat of a Greek Crisis, and the evaporation of Russia's economy are enough to give even the most bullish investor pause.  Add to that a reduction in the rate of growth in China and India, and there's the prospect of a US economy barely able to sustain forward momentum.

We're nearing the end of this quarter's earnings season.  There are definitely very strong sectors that will provide excellent trading opportunities in this uncertain market.  Aerospace, Auto Parts, and Utilities are all looking pretty good right now.  Keep an eye on the remaining announcements, and trade into strength (or short into weakness, if that's to your liking.)  For now, though, expect volatility to remain high given the uncertainty around when the Fed will decide to move on rates.

Directionless Microsoft is Out of Touch With Consumer Demand

What do you do when a product launch is so horrendous that it's not only completely rejected by the consumer, it also drives down the sales of other companies' hardware that would potentially use that product?  Well, if you're Microsoft (Nasdaq: MSFT) you repeat the error on an even bigger scale.

Windows 8, a complete makeover of Microsoft's operating system, was a complete failure in the PC market.  (Windows XP and Windows 7 were highly successful.  To capitalize on that success, Microsoft threw the entire OS out and redesigned it into something the consumer loathed.  You'd think they'd have learned from Windows/ME, wouldn't you?) While it had some success in the company's tiny portions of the phone and tablet worlds, PC users rejected the entire concept in droves.  Even in the laptop space, where you could argue that there was some chance of success, I continue to be stunned by the number of people that ask me how they could replace the Windows 8 that came with the box with Windows 7.  The message was loud and clear, or at least it should have been.  Not, apparently, for Microsoft.

Enter Windows 10.  Yet another new look for the OS, Windows 10 seeks to continue down the same path as Windows 8 by providing a single interface between the phone, the tablet, the laptop, and the PC.  At some point, we can only hope that someone in Redmond realizes that the demands of a user looking at a 5 inch screen are dramatically different from the user looking at two 29 inch screens.  Interaction with a screen 8 inches from my nose is dramatically different from my interaction with a screen 2 feet away.  On a phone, I'm looking for a simple interface with lettering large enough to read with rapidly aging eyes.  On a PC, I'm looking to maximize real estate on screens larger than the TV set I had in my living room as a kid.  The needs are different, the user behavior is different, the way you interact with the devices is different.  The concept of a one-sized-fits-all operating system is, and always will be, a failure.

Next we have the one component virtually every user touches almost constantly: the web browser.  Now, everyone has their favorite browser, for a variety of reasons, and the defense of their favorite browser frequently turns into a Holy War.  At present, there are really only four choices in the browser world - Internet Explorer, Firefox, Chrome, and Safari.  None of them are perfect, but with the exception of IE, the others are at least stable, and offer a bit of backward compatibility.  I'd be doing cartwheels over Firefox, in fact, if they'd only fix the memory issue that's plagued that browser for close to a decade.

Enter Cortana.  This is yet another attempt by Microsoft to prove they cannot distinguish between a phone and a desktop.  Basically, Microsoft is attempting to bring Apple's Siri to the desktop.  There's only one problem.  I don't need Siri on my desktop.  I don't need a hands-free desktop experience; in fact, I don't want a hands-free desktop experience.  There's nothing I've seen in any of the Cortana demos to date that leads me to conclude that this is the browser solution of the future.  Certainly, it's not about to make me run out and install Windows 10 - an operating system I intend to avoid with even more gusto than I avoided Windows 8.  A point Microsoft seems to be forgetting is that there is no revenue generated just from the browser.  Certainly, there's potential revenue from Bing - their search engine - however the competition with Google is fierce, and given the amount of data Google collects, they have the distinct advantage (except in China.)  Cortana isn't about to increase revenue for Microsoft, and after the Windows 8 and now Windows 10 fiascoes, that's precisely what Microsoft needs.

Finally, have you looked at the bundles attached to new laptops, lately?  Office 365, complete with a "free" one-year subscription, now seems to be the standard offering.  Office 365 is a subscription based software service, forcing users to make extensive use of Microsoft's cloud offering just to use basic functions like word processing, spreadsheets, etc.  While connectivity isn't necessarily an issue in the desktop space (although it's a bit presumptuous to assume that everyone using a spreadsheet has Internet connectivity all the time) it's definitely an issue in the laptop space.  The concept of a laptop is portability, and there are plenty of times I find myself with my laptop outside of a WiFi zone.  Not, mind you, that I'm willing to use a public WiFi for anything confidential, anyway.

Now, there may be plenty of people willing to enter into a subscription contract for software.  Adobe's had a bit of success with that in the photo editing space, but that's more of a function of the outrageous price of Photoshop, for anyone other than a student.  I'm not one of those people.  There may also be plenty of people willing to store their documents "in the cloud" - meaning, on servers in a data center over which you have zero control.  Sure, I'll let you store my grocery list in the cloud.  Financial and personal data?  Not a chance.  Google "Identity Theft" if you're curious as to why.

Microsoft has clearly lost their vision with regards to consumer requirements.  The only reason I now have to run a Windows based PC is for online gaming.  Everything else I do on a PC can be done for far less cost running a Linux OS, and using open source solutions like Open Office to do everything Microsoft Office can do without the high cost or a subscription charge for the latter.  (In fact, I have Ubuntu on a laptop that dates to 2004, is a single core processor running 1 GB of memory, and it outperforms this quad-core desktop with 6 GB of memory running Windows 7.)  With the exception of playing an online MMO, there's nothing I do today on a Windows box that cannot be done under Linux for a fraction of the cost and a fraction of the CPU and Memory requirements.

Microsoft's stock was absolutely crushed following their latest earnings announcement and their conference call.  Their earnings were in-line with expectations, and their revenue beat by $140 million.  So why were they crushed?  (They're down over 10% from their pre-announcement price.)  They were - and still are - getting crushed because they have lost sight of what the consumer wants.  The products they are delivering in 2015 are not products in demand by the consumer.  In fact, it's fair to say that the consumer is demanding the exact opposite of what's being delivered.  This is a company in turmoil, and until there are fundamental changes at the top of the house, it will be a stock to avoid.

Sunday, January 25, 2015

Greece's Leftist Syriza Just Shy of Absolute Majority

Greek elections were held today, and the leftist Syriza party emerged the clear victors, taking 149 seats in the 300 seat Parliament.  Despite the solid win, they fell just short of an outright majority.  Party leader Alexis Tsipras hailed his victory as an end to the "vicious cycle of austerity," although Tsipras significantly toned down the anti-austerity rhetoric as the election drew near.

Tsipras now finds himself in a precarious position, balanced between his anti-euro political base, and the reality of Greek creditors trying to fend off a default on their massive debt.  Whether or not Greece remains in the Eurozone is now a matter of debate, although in recent weeks, both Tsipras and German Chancellor Merkel have insisted that Greece should remain.  A Greek exit would be destabilizing at best, not only for Greece, but for the Eurozone as a whole.  To be sure, Italy and Spain will be keeping a close eye on Greece's decision.

Uncertainty in Greece has left financial markets unsettled several times in the past few years, and with the shift in the balance of power today, there's definitely an element of uncertainty heading into tomorrow's open. The outcome of today's election has been heralded in the polls for several months, but the moderation of Tsipras' anti-euro public sentiments can be seen as an indication that he is transitioning away from the political rhetoric needed to win and towards the reality of what it will take to lead.  That may help impose a measure of stability as we wait and see how the new government takes shape.

What also remains to be seen is how the political landscape, and not just the economic landscape, develops with Syriza in power.  They have publicly supported a Greek exit from NATO, and - not surprisingly - have criticized economic sanctions against Russia.  As is the case with their anti-eurozone rhetoric, however, Tsipras has backed away from the extreme anti-NATO views in recent weeks.  As Bloomberg stated, "Syriza is sacrificing its more revolutionary ambitions to the overriding goal of getting better terms for Greece’s economic aid package."

It will now be interesting to watch the market dynamics.  Last week, we had a huge adrenaline boost on Thursday with the ECB's announcement of Quantitative Easing measures that far surpassed expectations.  The adrenaline high wore off on Friday, though, as earnings reports in the US were mostly lackluster.  Now we have the Greek elections upon which to focus tomorrow.  Between the Greek elections and several important economic announcements in Europe tomorrow, including the Eurogroup Meeting, three IFO announcements, and December's Retail Sales report, Monday should be an interesting - and possibly quite volatile - trading day overseas.  It will be interesting to see how this spills over into the US market, heading into some key domestic releases mid-week.

Saturday, January 24, 2015

Union Pacific Sees US Economic Growth; Cites Several Uncertainties

The overall theme of strong US economic growth in 2015 continues with Union Pacific (NYSE: UNP) forecasting strength in several key domestic arenas.  With 31,838 route miles providing rail access to and from both the Pacific Coast and the Gulf Coast shipping ports, this 150 year old railroad corporation has the inside track on a wide range of industrial and consumer goods being transported around the nation.  What they are forecasting for 2015 is very promising on the domestic front.

Agricultural demand looks strong in the US, although there's oversupply internationally so demand for US agricultural products overseas looks weak.  There is also some short-term weakness evident in demand for ethanol - which will impact demand for corn - however with plunging gas prices in the US, demand for ethanol is forecast to increase as we head towards higher demand for gasoline through the first half of this year.

For those interested in the automotive sector, the news on that front continues to be positive.  UNP saw continued strength in consumer demand for both finished products (i.e. new cars) as well as increased demand for automotive parts.  They see this trend as continuing into the 2015.  Seasonally adjusted, shipments of new cars in the 4th quarter increased by over one million vehicles.  Shipments of parts also saw a 2% increase in the 4th quarter. 

On the energy front, strong demand for coal continues to be forecast.  Inventories are currently low, and UNP expects strong demand to replenish those supplies.  The price of natural gas, however, could put pressure on demand for coal since a lower natural gas price will decrease the demand for coal across the nation.  While UNP has yet to see this impact in their shipment orders, they have called this out as a concern for their coal segment in 2015.

The price of crude oil is already having an impact on shipments, and that's expected to continue into 2015.  Volumes in the Bakken fields are down significantly already, and as long as crude prices stay below $75 to $80 per barrel, declines there will escalate.  The Uinta Basin and Niobrara Basin have increased shipment volumes, however I'd be concerned about Niobrara maintaining that trend.  The Uinta Basin produces traditional natural gas and oil, and is increasing overall production while decreasing the number of rigs, primarily through horizontal drilling.  The increased volume per rig is currently able to offset the impact of decreased margins, although if prices remain low, that will not be enough to sustain profitability.  The Niobrara Basin, however, has a very high exposure to margin risks associated with shale extraction - the most expensive of the oil production methods in use today.  Low oil prices will cripple production in this basin.  This will also have an impact on UNP's shipment of frac sand which accounted for 35% of their 28% increase in non-metallic minerals volume in 2014.

Switching to the construction industry, UNP is seeing sustained growth in the shipment of construction materials and they expect that to continue into 2015.  This growth is in both residential and non-residential building materials, and it's also being seen in lumber shipments. 

Intermodal shipments continue to grow domestically as well.  This is of interest since intermodal shipments transcend the various transport providers including trucking, rail, and shipping.  There's weakness being felt in imports, however, due to the long-running labor dispute in the west coast ports.  A much-hoped-for deal in mid-2014 didn't manifest, and the impact is being felt along the coast.

UNP reported strong demand for imported beer in 2014, and they forecast increased demand in 2015.  I'm not sure if there's a trading opportunity here, but in the interest of full disclosure, I will state that I'm doing my part to ensure demand remains high.

UNP did cite several uncertainties in their 2015 forecast, but by now they are uncertainties of which we are all aware:
  • Crude oil prices will impact multiple industries, especially if they remain this low for any length of time.
  • Global economies are softening, primarily in Europe, Japan, and Russia.  China's growth has slowed, (although it's projected to be close to 7% in 2015, so that's still a significant amount of demand.)
  • The west coast labor dispute will continue to add import pressures.
Based on UNP's assessment of shipment volume projections in 2015, keeping an eye on the automotive industry and the construction industry should provide some interesting trading opportunities.  On the speculative side, it's worth keeping an eye on the interaction between coal and natural gas demand as the energy price dynamic plays out through the first half of the year.

GE Sees Strong Regional Growth, Large Impact From Oil

General Electric (NYSE: GE) released earnings yesterday, and provided a detailed sector by sector view of how 2015 should develop around the globe.  Confirming the outlook provided by other key global companies, they see strong growth in the US continuing through the next year.  Reading through their transcript, the forecast for India and China appears to be a bit more subdued, and the major drags on the world economy will be Russia, Europe, and Japan.

The two major forces dragging on profits continue to be the strength of the US dollar and the extremely low price of oil.  While the latter is helping a few sectors - primarily aviation and transportation - it is having a much more significant negative impact elsewhere.  In fact, GE is already implementing job reductions, restructuring in certain areas, and the execution of simplification projects all in an attempt to reduce cost structures.  The longer oil prices remain this low, the greater will be the impact.

The impact of oil prices can be felt in other areas as well.  Subsea orders dropped 38%, and orders for drilling equipment dropped 72%.  The decline makes sense, since oil is now trading below the break-even point for most types of extraction.  Expect this area to continue to be depressed well into 2015, and expect to see regional economic pressures in areas dependent upon oil exploration and production.

The one energy area experiencing tremendous growth, however, is natural gas.  Orders for turbo machinery related to natural gas were up 60%, primarily in North America, the Middle East, and Russia.  That's not much of a surprise given the amount of natural gas produced in those three regions.  It's a good indication that there are some plays out there in the exploration and production sector, since those companies were beaten to a pulp in the last quarter.  Scouring that list for companies with a strong natural gas presence should provide an excellent entry opportunity. 

As to the US dollar, there is no indication of weakening on the horizon.  With the ECB's QE announcement on Thursday, in fact, there's further strength being forecast, coupled with a significant weakening of the Euro.  This effect, however, is projected to be manageable.  GE, for example, is forecasting only a $0.01 per share impact in 2015 based on currency exchange.

Aviation continues to be a major success story in the US and around the globe. Passenger Kilometers revenue was up 6.1% internationally and 5.3% in the US.  If the price of fuel remains low, this revenue stream will continue to grow.  Airlines should be a strong play at least through the first half of 2015.  GE confirms what Alcoa told us a couple of weeks ago.  Demand is extremely high, and GE experienced aviation orders up 15%.  Equipment orders are up 8%, primarily from commercial engines.  Again, that confirms what Alcoa was seeing for new aircraft orders, and it has me considering a play on B/E Aerospace before they report this week.

Healthcare is another growing segment in the US, up 9%.  There is significant growth in diagnostic equipment orders for CT, Ultrasound, and MR.  Globally, however, the sector is extremely depressed. There were sharp declines in Japan, Russia, and the Middle East.  China is only expected to see modest growth in this sector for 2015.  It looks like the healthcare plays for 2015 are primarily domestic.

Transportation experienced its strongest growth ever in 2014, driven primarily by a surge of locomotive orders in the US.  That has to be great news for the freight industry, so we'll be taking a hard look at Union Pacific's forecast.  (They released earnings on Thursday, so their transcript is available now.)

An interesting item that came out of their lighting department is the report of 72% growth in their LED business.  LED comprised 27% of their revenues in that department, at a time when they saw a sharp decline in demand for traditional lighting products.  This warrants a closer inspection since LEDs are now being used in a wide variety of consumer products.  A surge in demand for LEDs implies very strong demand in consumer discretionaries as well as in technology, at least in the US.

Overall, the outlook from GE is similar to what we're hearing from other global companies.  The US is strong, China moderate, but Europe, Russia, and Japan are economic millstones.  Look to aviation, transportation, and healthcare for some strong growth.  Consumer discretionary may also provide an opportunity based on hints from the lighting market, but that's going to require a closer inspection.

Friday, January 23, 2015

IBM - a Once and Future Giant or Is It a Has Been?

For a company founded in 1911, you would think that 2015 would be a bit late for a mid-life crisis.  That, however, is what appears to be happening with IBM (NYSE: IBM) since they no longer appear to know what they want to be when they grow up. That's assuming, of course, that IBM is able to recover from some extremely poor strategic decisions, coupled with an inability to deliver what the market truly requires.

Consider that, since the 1960s, IBM was the computer hardware company, driving the business technology world through the information revolution and into a world where computing technology is a given in our everyday lives.  The phrase, "Nobody ever got fired for buying IBM" was inevitably heard in any management discussion regarding a decision on acquiring new technologies.  Computer hardware and software was IBM's domain, and it was IBM's to lose.  And lose it, they did.

After driving their competition out of business, IBM emerged as the sole provider of Mainframe hardware (including the current z/12 mainframe family and the just-announced z13 mainframe family.)  They are also the sole provider of the mainframe operating systems as well as the only mainframe transaction processors (CICS, IMS, or Websphere for z/OS.)  There's only one problem.  IBM is not increasing their mainframe footprint, and existing mainframe customers are gradually migrating new applications into the non-mainframe space.  The mainframe market is shrinking rapidly, and you can thank IBM's own internal marketing competition for that shrinkage.

IBM managed, though the early part of the 21st century, to undercut and cannibalize their own advantage.  They introduced the P/Series hardware technology as a direct competitor, encouraging mainframe customers to migrate to the faster (at the time) mid-range technologies running their AIX operating system.  The amount of Level 2 cache on the the P/Series boxes was a fraction of what was on the mainframe, though, so multi-tasking was not a forte in the mid-range space.  Websphere Application Server (WAS) is the transaction processor of choice off the mainframe, however it's a major resource hog and can't compete with CICS when it comes to scalability, performance, or stability.  (Ask any WAS specialist how often they hear "A JVM is looping."  Stability and WAS are mutually exclusive.)  Yet, the number of WAS licenses dwarfs the number of CICS licenses, thanks to IBM's efforts to increase P/Series and x86 based sales.

The industry trend now, is to migrate off the mid-range P/Series that IBM sold by the bushels a decade ago.  AIX as an operating system was deemed too expensive and is rapidly losing to Linux as the Unix-based operating system of choice.  Linux can run on all platforms - including the mainframe - and the application code running under Linux is highly portable.  This is where scalability is factoring into the demise of IBM.

Unlike the monopoly IBM was able to develop in the mainframe space, the non-mainframe server space is highly competitive.  HP is emerging as the market leader in that space.  IBM was #2, but in a move that still mystifies me, IBM sold that advantage to Lenovo.  The x86 server space is growing rapidly, and IBM gave it away.  Dell is also in the top 3 in that space, giving customers plenty of options for the lower cost but highly scalable non-mainframe servers.  When you look at the hardware filling all of those expanding data centers, you'll find endless racks of x86 based servers.  Why would a major hardware company even think of abandoning that huge growth market?

In the database space, there are two main competitors and a bunch of also-rans.  You're looking at either Oracle or DB2.  On the mainframe, running under z/OS, DB2 is the only option (although there are still plenty of mainframe shops storing data primarily in VSAM, which comes with the operating system.)  In the non-mainframe space, however, Oracle is a huge factor.  In 2014, the two were neck-and-neck for market share with a very slight edge to IBM's DB2.  Oracle, however, is gaining rapidly.  With some of the acquisitions Oracle - the company, not the database - made over the past few years, they are now a force to be reckoned with in both the hardware and software spaces.

So what are IBM's plans for the future?  Well, we know they've abandoned the chip market and they've abandoned the x86 market.  They are hanging their hat on remaking themselves as a "Cloud Services" provider, a Software company, and, of course, they are touting the just-announced z13.  It's not enough.

To be a viable cloud provider, they should never have abandoned their x86 business.  The competition in that space is huge, and by selling the x86 to Lenovo, they have relinquished a huge cost advantage in that space.  Let an HP or a Dell partner with either Oracle or EMC, and you'll have a stake driven through IBM's cloud-based heart.  IBM's Global Services division - their technology outsourcing business - is hemorrhaging market share to the India based outsourcers.  Let an Infosys, or a Wipro, or a TCS partner with one of those combinations I mention above and IBM's cloud dreams are down for the count.

On the z13 front, IBM mentioned all of the major buzz-words that make senior executives salivate.  They mentioned "Cloud" and "Mobile" in the same breath, and that always makes the non-technical executives swoon.  Under the covers, though, you merely have the next release in their standard mainframe offering with some improved performance, improved throughput in their FICON channels and their zIIP specialty engines.  They've made some nice improvements in the zBX blade-bolt on to the mainframe.  But, at the end of the day, it's still a mainframe, and you're not going to see anyone flock to the z13 to satisfy a cloud or mobile requirement.  For existing mainframe customers, it may delay a migration to the distributed world, but it's not likely to attract new mainframe customers, and as companies world-wide continue to squeeze their expense budgets, new customers is precisely what IBM requires.  They're not able to squeeze more revenue from their existing customer base. 

The direction IBM is taking at the moment does not lead me to believe they are on the right course.  Rather, I see them heading in the exact opposite direction from where they need to go.  For now, the only thing IBM has going for it is its name.  Of course, there was a time when one might have said the same for Sperry Rand.

Wednesday, January 21, 2015

Netflix Posts Strong Results, But For How Long?

Netflix (NASDAQ: NFLX) posted better than expected earnings, revenue, and subscription growth after the close yesterday, propelling the stock to a 17.3% gain today.  Of note are their projections for a consistent year over year gain of 5 million subscribers, coupled with their entry into international markets.  At first glance, it's no wonder that the stock soared today.

It's prudent to question, however, just what the long term prospects are for this style of low-cost subscription based streaming.  Challenges in this space are not limited to Netflix, so there's no provider of this service available today with an edge, and when it comes to availability and content Netflix is the clear winner. Today.  They are available on more devices - especially in the older Blu Ray player market - and they are the hands-down winner when it comes to the number of shows or movies available. Today.

The fundamental problem facing Netflix is that we live in an instant gratification society, but for streaming content, the wait may be well over a year before it becomes available.  Before a streaming license is granted, all other revenue streams are exhausted.  The extremely popular HBO series "Game of Thrones," for example, is still not available for streaming on Netflix even though the series enters its fifth season this April.  They offer it in their DVD subscription, but not their streaming subscription.

Another challenge facing these providers is the ability to maintain the licensing for existing content.  Recently, for example, Netflix announced that their license with the BBC expires at the end of the month, and - except for a handful of popular shows - it is not being renewed.  It's not uncommon for a viewer to be midway through watching a series when the license is pulled and the remainder of the series becomes unavailable.  (This happened to me with the Highlander series in which the license was pulled when I had only the last episode - the second half of a cliff-hanger - to watch in the entire series!)

While Netflix must deal with the frustrations of its current user base, the number of competitors in that space continue to grow stronger.  Amazon Prime and HuluPlus are two with a similar model, and both are adding content at a very rapid pace.  They are all competitively priced.  While they, too, suffer from the same licensing issues, they are all competing for the same customer demographic.

In their Letter to Shareholders that accompanied the earnings announcement, Netflix admitted that they have serious competition from piracy, and a graphic they used to accompany the release showed BitTorrent styled client "Popcorn Time" surging into the Netflix market share space in September 2014, and keeping pace with Netflix ever since.  There are plenty of other pirate streaming sites out there that are equally popular, and that popularity is growing.  Piracy would be far less of an issue of Netflix were able to secure the licensing for current shows.

One pay-as-you-go site that is a real threat to Netflix is Vudu.  This site allows you to buy or rent movies and TV shows almost immediately, and for a very competitive price.  The most current episode of a TV show is available immediately, even before it appears in an On Demand menu at your cable provider.  When it comes to legal - not pirated - instant gratification, this service fulfills every need.

Original content is the way subscription services are getting around the instant gratification issue, however the competition in that space is growing rapidly.  Amazon Prime and Netflix are adding original content at a rapid pace, so there's really no edge to Netflix here.

For the moment, I understand Netflix' soaring stock price, and I understand the enthusiasm around the subscription rates.  What I don't believe, however, is that it is sustainable.  As other providers enter the game, as the popularity of current-show services (like Vudu) grows, and as major players like HBO begin to offer their own streaming for shows, I expect the decline in Netflix' subscriptions to be rapid.  Time will tell, but I don't think time is on the side of Netflix.

Tuesday, January 20, 2015

IMF Paints Dismal Picture for 2015

In what is sure to spook investors in companies with high global exposure, the International Monetary Fund (IMF) has lowered their global growth forecasts for 2015.  The big hit was in their forecast for China, lowering their forecasts to a 6.8% growth rate.  That's 0.8% lower than China experienced in 2014, and last year was already down from 2013.

That 6.8% growth rate is still almost double the anticipated growth rate world-wide, which the IMF is forecasting to decline to 3.5%.  While Chief Economist Olivier Blanchard acknowledged that the declining price in oil was providing a bit of an economic boost, he does not believe that it will be enough to stem the amount of global economic weakness that is forecast.

Interestingly, the IMF only cut their forecast for the Eurozone to by 0.2% to 1.2%.  From what we've seen to date, it's optimistic to assume that growth will be positive as Europe appears poised for recession.  They also cut Japan drastically, and with a consumer confidence level under 40 and falling, that appears more than justified.  In fact, the 0.6% growth level they are projecting may even be optimistic.

One major challenge related to validating the IMF's gloomy view of China is the lack of confidence in numbers produced by the Chinese government.  Instead, we'll need to rely on forward guidance from some of the larger US corporations with high exposure in that region.  Alcoa, for example, provided a stronger view of 2015 Chinese growth than is predicted by the IMF.  Caterpillar reports next Tuesday (01/27) and it will be most beneficial to compare their forecasts with Alcoa's.  Between CAT and AA, I trust their assessment of global economic conditions far more than I trust the judgement of either the Chinese government's reporting, or the somewhat pessimistic view of the IMF.

Despite my overall skepticism related to numbers coming out of China, there is one release this week that does warrant watch.  The HSBC Manufacturing Purchasing Managers Index for China is released at 01:45 GMT on Friday (8:45 PM EST on Thursday.)  The December number was 49.6, so there's a bit of interest in the direction it takes for January.  A reading above 50 signals economic expansion, whereas a number below 50 signals contraction.  It has been slowly - very slowly - trending down since 2009.

It's no exaggeration to say that China will make or break global economic health as we navigate a troubled period in Europe and Japan.  A strong US dollar is not helping there since the Chinese Yuan is pegged to the dollar.  The strong dollar is adding downward pressure on the health of their currency, which raises the prospect that they could decouple from the dollar for added relief.  That may provide a needed boost by improving their export market.

There's a lot to consider related to China and it's interaction with other markets.  For now, pay attention to the PMI number on Friday, but pay even closer attention to the guidance from companies with extreme exposure overseas.  You can count on them being far more forthcoming than the numbers coming out of any government release.

Monday, January 19, 2015

France's Hollande Claims QE Announcement on Thursday

In a bit of political daring-do, French President François Hollande stated today that the European Central Bank (ECB) will announce a Quantitative Easing (QE) policy when it meets on Thursday.  Given the ECB's strong resistance to political pressure, it's surprising to hear that Hollande is predicting the outcome of Thursday's meeting.  Speaking to business leaders at the Élysée Palace, Hollande said, "On Thursday, the ECB will take the decision to buy sovereign debt, which will provide significant liquidity to the European economy and create a movement that is favorable to growth."  The Stoxx Europe 600 soared to a 7-year high on the prospect.

This is a bit of a dangerous tightrope being walked by President Hollande, and given the number of false starts in the ECB QE saga, he is apparently doing it without a net.  His comments came as a surprise to analysts despite widespread belief that the ECB will indeed take action this week.  That action is already built into the bond market, in fact, which means a failure to act will result in some wild price action, especially now that Hollande has upped the ante by upstaging Draghi.

The question here, though, is what it means for the US markets.  When Japan introduced their flavor of QE, that increased liquidity flowed right out of Japan and into the much stronger US and European markets.  Similarly, when the US introduced QE, that money flowed out of the States and into emerging markets that were viewed as the stronger growth play at the time.  It's reasonable, therefore, to assume that the US stocks and bonds markets will benefit from that increase in European liquidity. 

There's no question that US bonds are a more attractive, more stable, and safer investment in the fixed-income space.  The equity side, though, will benefit from the perceived strength of the US economy, rising in stark contrast to a European economy in a deflationary spiral on the brink of recession.  The US Dollar will strengthen even further as a result of this move, however, and that will place added pressure on US equities that have significant exposure to Europe - meaning a large portion of the S&P 500.  Short term, of course, there's likely to be excitement and buying pressure in US equities, even if that rise is short term over-exuberance.

At the very least, thanks to Hollande's comments, if Draghi's announcement on Thursday wasn't already the most anticipated economic release of the week, it has certainly vaulted onto that stage now.  I suspect the news will at least take some of the downward pressure coming out of Europe off the table, at least through the early part of the week.  Whether or not the "buy on rumor; sell on news" adage manifests, though, will be one to watch.  After all the anticipation, it's possible that Draghi's press statements on Thursday will be anti-climatic.  The market expects the QE package to include €500 billion to €600 billion of sovereign bonds, and another €400 billion in private assets.  Failure to deliver on that expectation will almost certainly be punished in the US, UK, and European markets.

The ECB will announce their interest rates decision Thursday at 12:45 GMT (7:45 EST) and the much anticipated ECB Monetary Policy Statement and Press Conference follows at 13:30 GMT (8:30 EST).  With the US markets opening an hour after that press conference starts, expect much of the morning's trading to be dominated by reaction to Draghi's comments. 

Keeping an Eye on Southwest Airlines

Southwest Airlines (NYSE: LUV) reports earnings at 6:30 AM EST this Thursday.  The conditions are ripe for this low-budget airline to continue to their steady upward climb.  In their October announcement, they talked a bit about their entry into the international market, and with fuel costs driving downward and the strength of the US Dollar driving upward, there couldn't be a better time for them to branch out beyond our borders.

They plan to offer flights to Costa Rica starting in March, which is a perfect time weather-wise to vacation in that beautiful Central American tourist spot.  It will be interesting to see if there's any mention of ticket sales to that destination in Thursday's conference call.  International travel currently accounts for only 1% of Southwest's business, so the potential global upside is tremendous.  They describe their international plans for 2015 as "modest" and that suits me just fine.  Slow and steady, gaining reputation and market share, provides opportunity for long-term continuous growth.

Throughout the last quarter, Southwest continued to add destinations.  They added seven new non-stop destinations in October, and eight more in November.  As a reminder, they acquired a number of slots at Ronald Reagan National Airport (DCA) from American Airlines, and that has allowed them to add 44 new daily departures to seven new destinations. 

International flights from Houston won't be coming online until later in 2015, so you won't see that reflected in Thursdays numbers, but it's something to consider as you look at LUV's growth potential in the out-years.  The cities they are targeting, though, are impressive.  They already fly to Cancun, Mexico City, and Los Cabos from other cities in the US.  Add Puerto Vallarta and San Jose, Costa Rica and Belize City, Belize to the list for 2015, along with a major US tourist spot: Aruba.

Their expansion in Love Field, Dallas has been highly successful, where they added 16 new destinations.  Load capacity as of October was topping 90%, and as tourist travel increases in the US, demand for seats will be highly competitive.  What makes Southwest even more attractive in this regard is that, in addition to very competitive ticket prices, they still permit travelers to carry two bags free on international flights.  That's a sure-fire market share winner on competitive routes, although it will be interesting to see where they pick up that revenue stream that other airlines are currently grabbing.

Read more here:

Thursday's earnings announcement will be interesting.  I believe Southwest has excellent growth potential, especially with their low-cost international travel, but some strong numbers and strong forward guidance will be necessary this week for Southwest to overcome their currently high valuation compared to earnings.  In the meantime, stay tuned to Delta Airlines' earnings announcement tomorrow for some clues as to where this industry is headed in 2015.