Apple's Latest Launch: iFinance
The inventor of the iPhone may be more adept at financial innovation these days than at product innovation. The markets await Janet Yellen's words.
Let's hear it for Trader Tim! That's Apple Chief Executive Tim Cook to you, whose day job is supposed to be leading the world's biggest company, which conjures the devices that have become objects of desire throughout the globe.
Or at least used to. As if by magic, Apple (ticker: AAPL) once produced things of wonder that we didn't know we needed but, once having had them, could not imagine doing without -- the iPod, the iPad, and especially the iPhone. That was after its much-admired computers converted millions into Macolytes. And, of course, these products all were introduced under the aegis of the late Steve Jobs.
More recently, however, Apple's products have been overtaken by competitors, notably phones and tablets using Google's (GOOG) Android operating system, whose imitation Apple doesn't take as a sincere form of flattery. While the lawyers fight it out in court, Android phones have grabbed the largest share of the smartphone market and, in a symbolic development, Google Friday became the second-largest company in terms of stock-market value, behind Apple and overtaking ExxonMobil (XOM).
Where Apple has given ground in technological innovation, it has stepped up its prowess in financial engineering. Last week, Cook told The Wall Street Journal that the company bought back $14 billion of its shares after they swooned last month in reaction to its disappointing results. Cook allowed that he was surprised by the 8% drop on Jan. 28, so he wanted to be "aggressive" and "opportunistic" in accelerating the stock-repurchase program.
Cook pointed out that Apple has bought back $40 billion of its shares over the past 12 months, which he asserted was a record for any company over such a period. He called the buybacks, which are part of a previously announced $60 billion repurchase program, a sign of confidence. "We are betting on Apple," he said, adding, "It means that we are really confident on what we are doing and what we plan to do."
Corporate-finance textbooks say companies should return cash to shareholders, either through dividends or share repurchases, if they can't find investment opportunities that will return more than the cost of capital. For that reason, Warren Buffett's Berkshire Hathaway (BRK.A) has never paid a dividend while the Oracle of Omaha reckons he can put the money to work more profitably.
To be sure, Apple is sitting on a cash pile of $160 billion that's earning today's ultralow interest rates. And while Cook has responded to critics, such as Carl Icahn, who want Apple to return some of that excess cash to shareholders, the CEO told the Wall Street Journal that he wanted to keep some dry powder. "We may see a huge company tomorrow that we want to acquire, or something may happen in the stock market that's unpredictable," he added.
Apple also has been opportunistic in other forms of financial engineering, notably in raising some $17 billion last year, in what was then a record corporate-bond offering near the nadir in bond yields. Thanks to propitious timing and its triple-A credit rating, Apple paid just 0.45% on three-year notes, 1% on five-year notes, 2.40% on 10-year notes, and 3.85% on 30-year bonds last April. That bond offering effectively replaced shares with a 2.35% dividend yield with lower-cost and tax-deductible debt. Finance professors call that a capital structure and tax arbitrage; normal folks would call it a free lunch.
Other tech outfits have been even more aggressive in their financial engineering. During the heady dot-com bubble days of the late 1990s, some would sell put options on their stock, which would generate premium income that constituted a free lunch as long as their share prices continued to soar.
And, indeed, this might be a tack for Apple to ponder. Selling puts at strike prices below Friday's $519.68 close would generate premium income the company could pocket if the stock doesn't fall. And if the stock did decline, the company would be obligated to buy the shares -- which it presumably wants to do anyway, under the repurchase scheme.
Again, all textbook stuff. But a student of history would also note that the best growth days were no longer ahead for some of the companies most adept at extracting financial gains during the dot-com daffiness. Among prominent examples were Microsoft (MSFT), which has yet to return to its peak of 2000 (after adjusting for splits and its $3 special dividend in 2004) and computer maker Dell, taken private last year at about one-fourth of its peak price.
There's no question that capital allocation is a major job of management. Icahn has called for an additional $50 billion buyback by Apple to return some of the company's cash hoard, but others, such as Calpers, the giant California public pension fund, have opposed the activist's plans.
Whatever the merits of the arguments, the experience of the past year has shown Apple to be more adept at financial innovation than at launching new products. Its projection that the current quarter's revenue would fall short of the level a year ago helped tank the stock late last month. Would that management's response were a great new product, instead of a call to its broker.
But as long as cheap money from central banks provides an easier option, why expect anything different?
BETTING ON THE STOCK MARKET didn't seem like much of an idea at the beginning of the week, when the major averages tumbled more than of 2% and sent their charts through major trendlines in reaction to a much-weaker-than-expected January report on the manufacturing sector from the Institute for Supply Management. By week's end, however, those losses and more were recouped after percent-plus gains Thursday and Friday, despite a much-weaker-than-expected gain in payrolls for January.
Not exactly what the fundamental economic data would imply, but there are other considerations, notably the human element. It would appear that there was a stampede away from the stock side of the boat and into bonds, which made the equity vessel a bit tippy. As our colleague Brendan Conway reported on Barrons.com Friday, equity mutual funds saw record outflows of $28.3 billion in the week ended Feb. 5, while bond funds had the biggest inflows since 2010's third quarter.
That suggested some significant rebalancing by asset allocators from equities, 2013's winner, to fixed-income, last year's loser. In contrast, municipal-bond outflows resumed last week after three weeks of inflows. In any case, the exodus from equity funds apparently left stocks oversold after Monday's downdraft, and so January's correction got corrected to the upside.
That all happened ahead of the employment report Friday, which showed an increase of 113,000 in non-farm payrolls, less than two-thirds of the consensus forecast, making for the second straight weak month after December's 75,000 rise, which was revised up by an insignificant 1,000. Despite this winter's polar vortex, weather didn't play a role in the weak numbers, the Labor Department said.
In contrast, the separate survey of households was strong, which lowered the jobless rate to 6.6% last month from 6.7%, and for once for the right reason—more folks finding jobs, instead of dropping out of the workforce. The underemployment rate, which takes into account part-timers who want a full-time gig and discouraged workers who have stopped looking, fell to 12.7% from 13.1%.
The labor-force participation rate did tick up, to 63% from 62.8%, but remains around lows not seen since 1978, notes Joshua Shapiro, chief U.S. economist for MFR. This indicates that labor-market conditions are significantly worse than the reported jobless rate. Indeed, he adds, if the participation rate were at 66% -- around where it was in the years before the recession -- the headline jobless rate would be four percentage points higher.
The labor market is likely to be topic A when Federal Reserve Chair Janet Yellen gives her first congressional testimony Tuesday as the head of the central bank, and in her return performance Thursday. The Fed has made unemployment a key policy target, in no small part because of Yellen's influence while she was vice chair. "We always expected the hearing(s) would be a headline generator but given two consecutive weak jobs reports, we expect it will be a blockbuster -- certainly politically and probably for the markets, too," write Brian Gardner and Michael Michaud, Washington analysts for Keefe, Bruyette & Woods.
There is a little likelihood Yellen will depart from the current course, set with Bernanke at the helm, notably the tapering of the Fed's quantitative easing, which has been trimmed, via two $10 billion decreases, to $65 billion a month at the past two meetings of the Federal Open Market Committee. There had been market chatter of a taper of the taper -- slowing the rate of reduction of bond purchases -- but more concrete signs of economic weakness would be needed for that to happen.
The real key will be her discussion of the Fed's main policy tool, the overnight federal funds rate. The FOMC's latest statement indicated that it would be "appropriate" to keep this near zero "well past the time the unemployment rate declines below 6½%," which is just a tenth below January's jobless rate. That is, as long as inflation remains contained, and the personal consumption expenditure deflator, excluding food and energy, the Fed's favored measure, is running at a 1.2% year-over-year rate, comfortably below the central bank's target.
The markets are eagerly waiting to see how Yellen explains (or doesn't) all this to Congress.