The Friday Five
This week: Sizing up a possible debt ceiling compromise, a Yellen-led Fed, and more.
Jason Stipp: I'm Jason Stipp for Morningstar and welcome to The Friday Five: five stats from the market and the stories behind them.
Joining me, as always, with The Friday Five is Morningstar markets editor Jeremy Glaser.
Jeremy, thanks for being here.
Jeremy Glaser: You're welcome, Jason.
Stipp: What do you have for The Friday Five this week?
Glaser: The numbers are 6, 15, 2.9%, $80 billion, and finally, 4%.
Stipp: Six refers to the six-week extension to the debt ceiling, which is under serious consideration after a lot of gridlock in Washington. The market seemed to respond very favorably to news of this possible deal on Thursday. What's the latest?
Glaser: It does sound like we're making some progress in Washington. Although we just don't know what the exact outline of the deal looks like--it will probably be negotiated throughout today and this weekend--it sounds like we're going to be able to push off that debt ceiling limit by a few weeks here in order to create some time to negotiate some of these bigger fiscal issues.
But I would say to most investors not to get too excited about any kind of grand bargain or any kind of big deal coming from these negotiations. Both sides are just too far apart on what they would want out of a deal in order to bridge that gap in just a couple of weeks. There are just only so many pieces that can give or take in order to make something like that happen.
I think it's much more likely that we're going to see a much more limited, smaller deal that could deal with things like the medical device tax part of Obamacare; both Democrats and Republicans really dislike this part of the bill. I think we could see that chopped off and maybe revenue raised somewhere else to make up for that. We could see maybe tort reform come back as a negotiating point.
So I think we could see a little bit of give and take in that negotiation, but it's going to be much more limited in scope--so both sides can say that they were able to take something away from the table. It's unlikely to be some kind of major transformative deal that removes these debt ceiling and budget debates for years to come.
Stipp: So even if we push the debt ceiling off by a few weeks, it doesn't diminish the seriousness of going through that debt ceiling.
Glaser: It moves it out, but it does not eliminate that tail risk. I think that risk is incredibly small. There is probably a 1% to 2% chance that this happens. But if it did, it could be pretty bad. It's not as if we hit the debt ceiling, and we can't borrow, and the next day we automatically default on all the obligations. Treasury would probably have some cash on hand. Although it's not clear what the legal options are, it seems like you could do some prioritization to pay Treasury debt first and then pay other bills. But the problem is that even though over the course of the year tax revenues might be more than enough to cover interest payments, on any given day, the inflows and outflows don't really match up.
We could run into a situation where there is one day or a couple of days where there just wouldn't be enough money temporarily in order to pay that interest. How the market reacts to that kind of default, even if it's more technical in nature, is a huge question mark and probably a question that most investors don't want to see answered.
I think the fact that we're talking about a debt ceiling extension shows that both parties understand the seriousness of this. I think that makes it very unlikely that will happen--not zero--but much less likely than maybe we thought just a few days ago.
Stipp: Janet Yellen is President Obama's pick for the 15th chair of the Federal Reserve. What does this mean for changes that will or probably won't happen to the Fed?
Glaser: I don't think we should expect any major changes from the Fed. Janet Yellen really represents continuity for Bernanke's easy-money policy. She's been a big supporter of it for a long time. She's a known dove when it comes to monetary policy. So I don't think we're going to expect when she takes over the chairmanship, that all of a sudden she's going to start immediately tapering and then moving to raise rates, or moving to make any major changes.
I think, generally speaking, she's going to be a good choice as the Fed chairwoman. It sounds like she is well-respected from both the hawks and the doves on the committee. She would be able to really speak for both of those viewpoints and understands the importance of keeping that inflation target as something that the Fed needs to be concerned about--that you can't let inflation get away from you. I think she'll be focused on that as well.
It also sounds like her Senate confirmation should go fairly smoothly, based on some comments from senators on both sides of the aisle. So I would expect that she will present that continuity and really remove some uncertainty that was out in the market about what's going to be happening with the Fed.
Stipp: 2.9% is the IMF's new global GDP growth estimate. That's a downgrade. Why did they have to bring it down a little bit?
Glaser: Yes, it is. … We talk a lot about kind of slow growth in the United States and some of the problems that the U.S. is facing, but it really is a global phenomenon of slower growth that seems to be taking over. It's really being driven a lot by emerging markets slowing down considerably. Now, they're still going faster than advanced economies; the IMF is saying in 2013 we'll have 1.2% growth in advanced economies versus 4.5% in emerging and developing markets. So they're still growing much faster, but that's slower than it was just a few years ago. It's a downgrade from what they originally thought in 2013.
Although things look like they'll get a little bit better next year, according to the IMF, it's still not going to be incredible growth overall. The pace of global growth will be below 2011 levels, and again, that's really being driven by those slowing emerging markets.
This is a global problem and one that really colors a lot of the other debates we have and when we talk about [the fact that] corporations … all have to operate against this backdrop.
Stipp: Also down were mortgage originations at Wells Fargo; they came in at $80 billion. This is down considerably from prior periods. The housing market has been the bring spot in the economy, so do we have to be worried about housing going forward given this news?
Glaser: This definitely wasn't a surprise from Wells Fargo. They had said that they were going to see pretty decent drops in originations; as rates went up, people were much less excited about refinancing a mortgage. They already locked in a lower rate maybe a few months ago.
I think it just shows that higher interest rates are really a key potential trouble spot for the housing market. I don't know how many times we've talked about housing as a potential driver of GDP growth, a potential driver of the economy, and higher rates make it that much harder--but not impossible. Rates are still incredibly low. They've actually backed off from when they hit their height during the "taper tantrum." Housing affordability is still reasonably good in a lot of places. Inventories remain low. So I think the housing story isn't completely over by any stretch of the imagination, but higher rates do make it more difficult. I think Wells Fargo's results show that these high rates are going to have some consequences.
Speaking of consequences and big banks, JPMorgan also reported this week--the other big bank--and they announced a pretty incredible $9.15 billion pretax litigation charge. Again, this is something that we knew was coming. We know that JPMorgan continues to be embroiled in some of these big lawsuits. Jamie Dimon was talking about how the litigation is highly charged. It's really unpredictable, they don't know what's going to happen, and they could see some big charges in the future as well, even if they are going to fight them.
These really are the two major stories that are happening in big banking right now: how do higher interest rates impact mortgages and impact their businesses, and what's happening with regulation and litigation. And we saw that perfectly encapsulated in these two results this week.
Stipp: Lastly, Jeremy, 4% is the rise in Costco's same-store sales. How do these results look against other retailers?
Glaser: Costco is looking pretty good. Their September U.S. same-store sales at 4% was slightly below expectations, but really still much better than a lot of their peers across a broad group of retailers.
What's happening is that Costco really is still continuing to drive its value proposition. They're trying to keep prices low. They're pricing very aggressively, and you see that in membership renewals still looking pretty good in that 86%-86.5% range. People keep renewing year-after-year. So, obviously, they are seeing some value in their Costco membership. That's, again, being reflected in their sales numbers.
As far as the shares, they're pretty much exactly fairly valued right now. This is a company that we think has low levels of uncertainty; we're pretty confident about what those cash flows are going to look like. It has exemplary stewardship. The management team really has done a wonderful job over time protecting shareholders. Ken Perkins, our Costco analyst, says that we would need only a fairly modest discount to fair value before you could get interested in these shares. So if there is bit of a sell-off, this is definitely a retailer to keep on your radar screen.
Stipp: Dramatic week in the market, Jeremy. Thanks for helping us stay on top of everything.
Glaser: You're welcome, Jason.
Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.
Jason Stipp does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.