January 6, 2008: Morning Call

January 6, 2009: Morning Call

Fair Value: SP500 – 924.40; NDX: 1263.90; DOW – 8907.88

Technical Levels:

SPX: 685, 752-755, 848-852, 899 support/ 998-1002 resistance


Events:

04:00: Euro-zone PMI Services (December Final): 42.0; Composite: 38.3 (Services in-line at 42.1; Composite in-line at 38.2)
05:00: Euro-zone CPI Estimate (December YoY): 1.8% (actual: 1.6%)
09:00: MOS Earnings Call
10:00: ISM Non-Manufacturing (December): 37.0
10:00: US Factory Orders (November): -2.2%
10:00: US Pending Home Sales (November): -1.0% MoM
12:00: Apple Macworld Conference
14:00: Minutes of December 16 FOMC Meeting
17:00: ABC Consumer Confidence

Foreign Market Summary/Key Macro News/Commentary:

The S&P and NASDAQ futures are both trading 10 points above fair value at 7:30am ET. European markets are up 1.0% on increased confidence that the BOE and ECB will lower interest rates following more contained consumer price data (Euro-zone CPI came in at 1.6% vs. consensus of 1.8%, well below the 2% ECB ceiling). European markets were modestly lower at 4am but turned around after the PMI services data came in-line with expectations. The dollar is sharply higher against the Euro on increased confidence that the BOE and ECB will aggressively cut interest rates. Crude oil has crossed 50 this morning despite the strength in the dollar. Mining and Energy stocks continue to be the best performing sectors. Solar-related stocks are lower following an earnings warning from LDK. Asian markets closed modestly higher (Japan up 0.40%, Australia up 1.5%, Hong Kong down 0.35%, India up 0.59%).

US and European markets are up approximately 10% since the intra-day lows on December 29, 2008. I have been surprised by the magnitude of this recent advance and expected the market to be weaker heading into the New Year. I continue to have very little conviction on the short-term outlook (I would be long OTM puts instead of being short equities or futures given the low conviction) mainly because we are in a quiet period with very little significant economic and earnings news until the December jobs report on Friday and Q4 numbers later this month. Market participants are clearly positioning for a sharp recovery in the global economy in the second half of 2009 (Commodity prices are up sharply, Treasury Bonds are falling, Credit and MBS spreads have tightened modestly and Coal, Steel, Mining, and Energy sectors are leading the broader equity averages around the world). During this bear market, there have been numerous counter-trend rallies that had similar characteristics. Each of these tactical advances failed because the economic data and earnings results failed to support the global re-inflation thesis and traders got shook out of their long positions. Maybe this time will be different but I doubt it because the earnings outlook has not bottomed (the economy may have bottomed in December but the earnings outlook did not). I recognize that the path of maximum frustration likely remains to the upside because performance anxiety could easily spark a stronger underlying bid. But, risk is high and I would remain cautious.

Impact Research Calls/Market Moving News:

AAPL (94.58): Oppenheimer upgrades AAPL to outperform from perform citing comments regarding Steve Job’s health. Price target is 135.

AAPL: BMO Capital lowers estimates and price target to 108 from 120. Key Points: “1. We are lowering estimates for Apple for all forecast periods owing to our view on the incremental consumer (including educational) pullback in spending. We have reduced estimates in all product categories. We have made only modest changes to our December quarter forecast - primarily by lowering our assumed iPhone unit shipments to 4.9 million from 5.6 million. Given deferred accounting, the impact of lower iPhone unit sales is primarily in CY2009, not the December 2008 quarter. Net, our FY2009 EPS estimate moves to $4.60, from $5.11 and compares with the Street at $5.12.2. March guidance - how low can they go? For the March quarter, we project $7.9 billion in revenues and $1.02 in EPS, versus Street estimates of $8.4 billion in revenues and EPS of $1.15. As is typically the case, we believe that Apple will guide under Street/our estimates. The impact to the stock is not if it guides below, but by how much - meaning we believe that if Apple guides well below Street estimates, the stock will be negatively impacted in the short-term. As we look at historical trends (Exhibit 2), we believe that Apple will guide revenues to around $7.1-$7.5 billion in revenues, or a 24%-28% q/q decline, compared with Street December revenue estimates of approximately $9.9 billion. Over the past three years, Apple's average q/q decline in revenues, per guidance, has been 28%, which would suggest revenue guidance of $7.1 billion for the March quarter. We are above what we believe Apple's March revenue guidance range will be given that the recognition of deferred revenues will add about 580 basis points (bp) of q/q revenue growth. In other words, we project 18.5% q/q revenue decline for the March quarter, but if we eliminated the impact of deferred revenues, our q/q revenue decline would be 24.3%. For EPS, Apple has guided March EPS to decline q/q by an average of 46% over the past three years. Assuming that Apple reports EPS of $1.40 in the December quarter, this would suggest March quarter EPS guidance of $0.75. While Apple has on average guided EPS to decline by 46% q/q over the past three years, reported EPS has declined by 28%, which would suggest EPS of about $1.00 for the March quarter, about in line with our estimate. Further, we believe that the impact of incremental deferred revenue will add $0.10 in q/q EPS strength in the March quarter compared with December, which would suggest EPS closer to $1.10, when Apple reports the March quarter. Nevertheless, we believe that Apple will guide March quarter EPS to be in the range of $0.75-$0.85, which we believe ignores the positive impact of deferred revenues. 3. New valuation: $108, down from $120. Based on our estimate changes, we are lowering our target price to $108 from $120, based on three methods. First, we apply a 1x PEG to our CY2009 estimate (16x P/E) plus cash, which yields a target price of $101. Second, we apply a 12x-13x our CY2009 EBITDA estimate, which yields a target price of approximately $107. Finally, our five-year DCF, with major assumptions listed in Exhibit 3 below, yields a target price of $119. Our simple average is approximately $108, versus our previous target of $120. We note that Apple, like many of our stocks, currently benefits from negative sentiment, and recognition by buy-side investors that current Street estimates are too high. However, we don't think Apple will trade well between Macworld and its earnings conference call, with realistic concerns about March quarter guidance. We believe that buying the stock owing to weakness from guidance will prove profitable, given that Apple is typically overly conservative.”

AAPL (94.58): Apple's Jobs 'hormone imbalance' raises question of cancer, says the LA Times: The Times says the disclosure about having a hormone imbalance indicates he could be dealing with a recurrence of pancreatic cancer, according to some doctors. Dr. Heinz Lenz of USC's Keck School of Medicine says Jobs' description of his illness suggests his tumor "may be acting up a bit".

NUE (47.32): Nucor downgraded to neutral from buy at UBS: Though downgraded, the price target is increased to $50 from $48. Firm notes a limited upside and estimates are lowered in conjunction with the firm's lower steel price and volume forecasts

ICE (73.00): IntercontinentalExchange downgraded to neutral from buy at UBS: Price target decreased to $75 from $85. Firm notes weaker OTC volumes, a negative shift in futures pricing, and less expense flexibility in the near term. Estimates are lowered.

ICE (73.00): IntercontinentalExchange downgraded to neutral from buy at Goldman Sachs: The stock is also removed from the Conviction Buy List. Target is reduced to $80 from $100.

MOS (37.67): Mosaic reports Q2 EPS $1.53 ex-items vs Reuters $1.41: Note earnings exclude a $0.41 inventory valuation write-down and a $1.03 gain related to the sale of its interest in Saskferco. Company reports revenues of $3.01B vs Reuters $2.74B.

GRMN (22.00): Garmin downgraded to sell from neutral at Goldman Sachs: The stock is also added to the Conviction Sell List

DVN (70.98); NXY (19.63): Devon Energy (DVN), Nexen (NXY) downgraded to equal-weight from overweight at Barclays Capital: Firm also reduced its rating on the sector (large cap E&P names) to neutral from positive