Apple’s Demise: Greatly Exaggerated
It wasn’t that long ago – two months to be exact – that the bandwagon of Apple (AAPL) haters was gaining steam. After topping out above $130 last summer, its share price steadily sank lower as bad economic news out of China sparked fears over the impact that might have on Apple’s revenue.
By mid-February Apple was trading below $95, a disconcerting 27% decline in only seven months. Despite CEO Tim Cook’s repeated pronouncements that all was well, conventional wisdom held that the company could not grow earnings without the strong financial winds of China’s economy at its back. After two years of shooting up the charts, it appeared Apple would finally get the comeuppance its critics had long and gleefully predicted.
But something funny happened on the way to Apple’s funeral: the company suddenly leapt back to life in February when the stock market also reversed course. Last week its share price topped $110 for the first time since last December, and with its next quarterly earnings announcement scheduled for April 25, it appears many investors are beginning to believe that those numbers will be much better than originally feared.
Apple’s quick turnaround illustrates the danger in extrapolating broad macro trends into specific stock market trades. Yes, China’s economy as a whole is clearly slowing down. But that doesn’t necessarily mean that each company doing business there will be affected the same. So far the slowdown in China’s economy has been sector specific, with anything related to the manufacturing process – such as construction and industrial metals – taking the biggest hits.
China’s recent financial travails have been attributed to its need to pivot towards a more consumption-oriented economy, and away from manufacturing. And one of the things Chinese consumers like to buy most is Apple’s products.
So, if this much needed transition is in fact taking place, then Apple stands to be one of its biggest beneficiaries. Ironically, that may mean the slowdown in the growth rate of China’s economy could actually be construed as proof of Apple’s future success, and not its failure.
I admit that line of reasoning is a bit convoluted, but sometimes that’s how you have to think when it comes to evaluating individual companies when you’re basing your analysis on a broad macro theme. For example, the recent spike in oil prices should be bad for transportation companies that consume a lot fuel, such as airlines and truckers, but that’s not how it’s playing out so far.
On Thursday, Delta Airlines (DAL) released its first quarter earnings, which shot up 27% due primarily to lower fuel costs. The company spent only two-thirds as much on fuel this year than it did in the same quarter last year, with most of that savings dropping to the bottom line. But the company also admitted that its profit margin would get squeezed by higher fuel prices this quarter, with the price of oil now more than 50% higher than its February low.
You might expect Delta’s stock to drop on that tidbit, since investors should be more concerned about the impact higher fuel costs will have on future earnings than what happened in the past. Instead, just the opposite occurred: its share price jumped more than 1% after the announcement, pushing it within 10% of its all-time high reached last December.
That’s because chronically weak oil and other commodity prices might eventually lead to deflation, which would be awful for the economy and most likely result in significantly less money spent on vacation and business travel. So long as the economy is growing at a moderate pace, Delta should be able to raise airfares to offset gradually rising fuel costs, provided the price of oil doesn’t shoot through the roof.
It is this type of “Goldilocks” economy that the stock market likes most. There’s just enough inflation to keep prices (and corporate profits) constantly moving higher, but not so much as to result in hyper-inflation that would be its undoing. With unemployment at 5% and the price of oil back above $40/barrel, two of the critical components for this type of “not-too-hot, not-too-cold but just right” environment are already in place.
A couple of the other missing ingredients, including a firm – but not overly strong – dollar, and growth in domestic manufacturing, appear to be falling into place. The Euro has rebounded 5% against the dollar over the past five months, and earlier this month the Institute for Supply Management reported that “Economic activity in the (U.S.) manufacturing sector expanded in March for the first time in the last six months”.
To be clear, we are still a long way from being out of the woods. And with this being a Presidential election year, investors are understandably skittish about possible changes in national economic policy come next February. But so far the behavior of stocks like Apple and Delta suggest that the second half of this year may not be so bad after all.
That is why we rely on our IDEAL stock rating system during difficult times to tell us which stocks to buy. Apple and Delta are both holdings in our Personal Finance growth portfolio due to their high IDEAL scores. In fact, Apple’s IDEAL score went up when its share price dipped below $100, confirming our belief that there was nothing fundamentally wrong with the company. We don’t pretend to know which way the stock market is going, but we do believe we can identify which companies are most likely to perform the best.