Penn Wealth Publishing

2018.11.04 Penn Wealth Report Vol 6 Issue 04

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04 Nov 2018 PeNN Wealth RepoRt volume 6 issue 04 17 Penn Wealth RePoRt Copyright 2018. All Rights Reserved. Weekly BusiNess RepoRt Weekly BusiNess RepoRt Domestic and International Headlines "strategic transformation" and "return to prof- itability." It's hard to say whether he really believes that, but one thing is certain—the creditors do not. thiNk ChiNa's deBt load is high? you doN't kNoW the half of it There have been many alarming stories over the past few years with respect to China's unsustainable debt load, which threatens to quash the country's steep growth trajectory. According to a report issued by S&P Global Ratings, conditions may be even more dire than known. As could be expected, the Communist Central Government in Beijing controls how much Chinese provinces and other local gov- ernments within the country can spend. To skirt these restrictions, however, these entities have been turning to local government financ- ing vehicles, or LGFVs. These are off-balance sheet debt loads hidden from the world's rating agencies, but they are very real, nonetheless. According to research done by S&P Global Ratings, these higher-interest loans might have an aggregate value of 40 trillion yuan, or nearly $6 trillion. How big is that number? The offi- cial government debt of China currently sits at roughly $7 trillion. In other words, China's real debt load is approximately twice as much as the Communist government acknowledges. Furthermore, China's GDP sits at just $11 tril- lion—roughly half that of the US. Perhaps this debt could have been "man- aged" into the near-term future, except for one huge x-factor: President Trump's trade war with the nation, fomented by unfair trade practices and Chinese theft of US intellectual property. In short, just as Ronald Reagan hastened the demise of the Soviet Union with his Star Wars program, Donald Trump is forcing China's grave debt crisis into the open. China's growing anger at the American president is displaced; they should, instead, be focusing on the house of cards they built with reckless fiscal policies. "Made in China 2025" may be a catchy slogan and a source of national pride, but it is beginning to look more and more like a fictional tale. aNalysts misread—aNd theN overreaCt to—a Big ChaNge iN aPPle's rePortiNg Analysts were breathlessly awaiting the report. Would Apple's (AAPL $150-$207-$233) quar- terly earnings release be a catalyst for a tech stock rally after October's drubbing, or would it add fuel to the fire and liquidation sale? (The other FAANG names had all fallen nearly 25% from recent highs.) In what has become a common occurrence, Apple ended up beating on both top line revenues and bottom line profit, and then pro- ceeded to tank. The company's 7% share price drop wasn't so much about the numbers ($14.3 billion in income on $62.9 billion in revenue— both better than expected) as it was about what CFO Lucas Maestri announced in the post- report conference call. Maestri said that, beginning in the next quarter, Apple would stop reporting its unit- sales numbers for the iPhone, iPad, and Mac lines, but it would give a deeper look into the services numbers. We saw that as perfectly understandable, considering the explosive growth of Apple services like iTunes, the iCloud, and the App Store, not to mention the compa- ny's soon-to-be-released Apple TV subscription service. This annuitized stream of income is precisely what the company should be focused on—more so than the hardware. Jugheaded cynics saw this as a red flag that Apple is concerned about a slowdown in hardware sales, and that the company was try- ing to cover up the facts going forward. This is Apple, not Enron. Tim Cook doesn't hide from the numbers, nor does the company sugarcoat them. And wouldn't this mythical downturn be reflected in the sales and income figures? Nonetheless, the "notice me" anti-Apple crowd scared investors into the 7% sell-off. Undoubtedly, Apple will respond to this short-term weakness in the stock price with more share buybacks, as is typical for Cook. What are the shares worth? Suffice to say that AAPL has a PE of 20 (pretty impressive for a tech company), while darling Amazon's (AMZN) PE floats around 100 (down from 200 in June). Additionally, Apple is one of the few stocks on which we will not place a stop loss order. aNother stroNg joBs rePort aNd Wage groWth makes a deCemBer hike likely There are three big issues moving/spooking the markets right now: the midterm elections, global trade, and domestic rate hikes. On the third front, a couple of glowing Friday reports made all-but-certain another rate hike this December. In fact, as soon as the numbers were released, the major indexes fell substantially on rate fears. The first report was the October jobs num- ber. The US economy added 250,000 new jobs for the month, exceeding by about one-third what had economists had predicted. Every sin- gle sector of the US economy, in fact, added new hires. Education and health services led the way with 44,000 new jobs created. The unemployment rate remained at 3.7%, its low- est level since Neil Armstrong landed on the moon. That was the first sign that the Fed would probably pull the trigger in December, but the second sign was about twice as big: average hourly earnings rose yet again. Over a one-year period, wages for American workers have now grown an average of 3.1%, the fastest clip in nearly a decade. That is what spooks the Fed— the inflation that often comes along with wage growth. We could shoot holes in that argument by reasoning that technology, among other factors, is at work to keep inflation muted this time around, but the Fed probably isn't open to that argument. So, if we do see another quarter-point hike in December, the federal funds rate would rise to 2.5%. Barring any economic catastrophe in 2019, Fed Chair Powell seems intent on rais- ing that to at least 3.25%, meaning three more hikes next year. Can the economy withstand that? Take a look at the chart and see where we are right now with some historical perspective. Yes, the markets will throw fits around each hike, but the volatility should be short-lived. The economy can handle 3.25% rates. As for the argument that the recovery is so long in the tooth, that is an easy one: the first several years were kept muted by high taxes, endless regula- tory hurdles, and an anti-business White House. Off-balance sheet (OBS) financing Anyone who has ever leased a car is famil- iar with OBS financing. In practice, this amounts to financing a purchase or project, while keeping the liability off of the balance sheet. Enron is a classic example of the dan- gers of OBS financing, as the firm levered up to unsustainable levels hidden from view. teCh hardWare, storage, & PeriPherals eCoNomiCs: Work & Pay gloBal strategy: asia

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