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Friday Five: New Rules Hit the Market

New rules on tax inversions and fiduciary requirements made waves this week. What do they mean for investors?

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Jason Stipp: I'm Jason Stipp for Morningstar and welcome to The Friday Five, Morningstar's take on five stories in the market this week.

Joining me with the Friday Five is Morningstar markets editor Jeremy Glaser.

Jeremy, thanks for being here.

Glaser: You're welcome, Jason.

Stipp: The Treasury Department this week shifted some rules on tax inversion that threaten several potential mergers, and it also scuttled one that we learned about this week.

Glaser: There was lots of news out of Washington this week, and one of the big pieces was that the Treasury Department is changing some of the rules around inversions. This is probably going to impact a couple of deals, but the one that we saw this week was Pfizer and Allergan. This was an enormous deal that was going to have Pfizer move abroad to lower its tax rate and also to realize some synergies with Allergan. The board walked away almost immediately, which I think shows that taxes were a major portion of what was prompting this deal to go through. They just couldn't make it work otherwise.

For investors, this isn't all bad news. Allergan, we think, is a wide-moat company that is now trading at a significant discount to our fair value estimates, in 5-star range, so this could have opened up an investing opportunity there. We actually also think Pfizer is in 4-star territory, a bit undervalued.

So those rules changed, that merger is not going to happen, but there are still some investing opportunities.

Stipp: Also this week, the Department of Labor released the final version of its fiduciary rule. This has been in the news for a long time. There's a lot to go through here, but what's our first take on it?

Glaser: I think the big headline coming out of the final rule was that it's going to be less onerous than many people had originally expected.

It seems like the Department of Labor did listen to a lot of industry feedback, and made some changes. I talked to Scott Cooley, our director of policy and research, earlier this week about this. He thinks [the changes] will make it easier to implement and hopefully reduce the likelihood of some lawsuits challenging the new rules.

So the question is, what does this really mean for individual investors? I think for a lot of self-directed individual investors, it's probably not a big game-changer. They're probably already making a lot of their investment decisions by themselves or through their own research right now. But it could be a bigger change for investors who are relying more on their broker's advice for what to do with their retirement accounts--this rule only deals with retirement accounts.

For the asset management industry, Michael Wong and Gregg Warren, our analysts who cover it, think this is going to continue to accelerate some trends that we've seen developing: a move to fee-based, a move to passive, a move to these so-called robo-advisors. It's going to be disruptive there, but maybe not as disruptive as we originally thought, given the drafts of the rules.

Stipp: We also got minutes from the Fed, and it showed that they're in no hurry to raise rates, and the market responded to that this week.


Glaser: They definitely aren't, and we've heard from a lot of different Fed speakers, including Janet Yellen recently reiterating this point. The minutes are driving it home that there's not going to be a rate increase in April, and the Fed is concerned about continued slow global growth, and what impact that's going to have on the U.S. economy. We've had some shaky economic reports--not necessarily the labor report--but other reports haven't looked as strong, and the Fed seems totally willing to wait. They don't see enough inflation pressure that they're going to be forced to act.

I think it's interesting because we are adding new layers of what the Fed is looking at before they're making a decision to raise rates again. Before they were saying, we want hit these unemployment rate targets, and we're going to hit these inflation targets. That's really what they were focused on. Now they're saying, those are important, but we also care about some other metrics. We also care about some squishier [factors] with the rest of the global economy, and I think that means we are likely to see lower rates for longer.

Stipp: We also saw several headlines on the so-called "Panama Papers." Can you explain what these were, and also we think it could impact some of the wealth management firms we cover.

Glaser: Another big financial story this week was the leaking of the so-called Panama Papers. These are documents from a law firm in Panama that handles a lot of these shell corporations that have plenty of legitimate uses for estate planning and other things, but also potentially could have some illegitimate uses. A lot of news organizations are sorting through it, and I think we're going to be hearing a lot more about these Panama Papers in the months ahead.

Erin Davis, who covers a lot of international banks for us--it was mostly international wealth managers that are implicated in these papers--sees that this could potentially create some risks. You could have more regulatory scrutiny on a lot of these wealth management companies. Although we'd expect the vast majority were being used for legitimate purposes, if they do find that some weren't, that potentially could create more regulatory scrutiny and fines.

She's said that she is likely to increase her uncertainty ratings around some companies as these allegations come out. It does look like HSBC probably is the most exposed. They were the most mentioned, but again it's still early days there as well.

Stipp: Lastly, we got some unexpected news out of Disney. The COO, Tom Staggs, stepped down under some interesting circumstances.

Glaser: More drama at Disney. If you thought that the Eisner era was a center of boardroom drama, it really returned this week, as very unexpectedly, Tom Staggs, who is the COO, stepped down. He was seen as the handpicked successor to Bob Iger, and that when Iger was going to step down in 2018, Staggs would take that new role. It was cited as a good way to do succession planning.

Staggs left very unexpectedly. We're still getting some more details out about why the board and Iger decided they'd lost confidence in him. But they did tell him they were going to be looking for external candidates for CEO. That's still the story. It seems likely that Iger will just stay on as CEO.

This turmoil in the boardroom comes at an important time for Disney, where you see that they're about to open their Shanghai Disneyland resort. They're relaunching Star Wars, which has been successful so far, by keeping that initiative going. And then the continued concerns about ESPN, with cord-cutting and what's happening there. At this time of inflection, we're also having problems with management.

But overall, we still like the Disney story. We still think the shares are undervalued. I think some of these fears about ESPN are overblown, and we do see Disney shares as being attractive right now.

Stipp: A set of interesting headlines and interesting insights. Thanks for joining me, Jeremy.

Jeremy 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.