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Gold Rebounds; GDP Report Disappoints

Market Digest – Week Ending 4/26

Despite a week of mixed news, most asset classes ended in the black. Broad equity indices were up with foreign stocks and domestic small cap leading the way. Gold rebounded from last week’s fall, climbing 4% through Friday. Commodities also increased. While Treasuries trended lower for most of the week, Friday’s disappointing GDP report pushed down yields and left prices in positive territory. The Dollar strengthened versus the Euro.

Weekly Returns:

S&P 500: 1,582 (+1.7%)

MSCI ACWI ex-US: (+2.6%)

US 10 Year Treasury Yield: 1.66% (-0.04%)

Gold: $1,458 (+4.0%)

USD/EUR: $1.303 (-0.2%)

Major Events:

  • Monday – Official charges are brought against the surviving Boston bomb suspect, including detonating a weapon of mass destruction.
  • Tuesday – A fake tweet citing explosions in the White House erased $136 billion from the S&P 500 in a matter of minutes—markets quickly rebounded after discovering the Twitter account was hacked.
  • Tuesday – Apple reported its first quarterly profit decline in over a decade. The company increased its dividend and planned share repurchases.
  • Wednesday – US durable goods orders fall more than expected on weaker demand for aircraft and defense products.
  • Thursday – The White House told Congress it now believes with “varying degrees of confidence” the Syrian government used chemical weapons in its civil war.
  • Friday – First quarter US GDP growth of 2.5% missed expectations on slowing business investment and government spending.
  • Friday – In an attempt to ease air traffic delays, the House passed a bill providing greater budget flexibility to the FAA.

Our Take:

Apple’s quarterly results are the most anticipated release of earnings season. Did they beat expectations? How many iPhones did they sell? What news of their product pipeline? All relevant questions for the Apple investor—even more so given the stock’s fall from grace over the last six to seven months. But perhaps more interesting than future product releases was the announcement of its first ever bond offering. This seems odd at first. After all, the company did report cash and available-for-sale securities of almost $145 billion at the end of the quarter. Why would they need to borrow?

The answer is simple: it’s cheap. Central banks have driven interest rates to historical lows. This allows companies such as Apple to borrow funds and immediately boost shareholder value through dividends and share buybacks. Specifically, Apple is increasing its dividend by 15% and adding another $50 billion in planned share repurchases through 2015. Borrowing allows the company to avoid repatriating overseas cash and paying a large tax bill. But there are other reasons, such as the earnings yield (the inverse of a company’s PE ratio). This metric represents the amount of earnings received per share of stock—it is a better way to assess the relative cheapness of equities versus bonds. So with Apple’s astonishing forward PE of 8.3x (according to Yahoo! Finance), the company can borrow at a couple percent and buy back shares yielding 12 percent! This is immediately accretive to earnings per share. Moreover, adding debt increases leverage and lowers the firm’s total cost of capital.

Others are catching on. Microsoft issued close to $3 billion in new debt this week, including its first ever Euro bond offering. According to estimates, it will cost the firm less than one percent over comparable 30 year Treasuries—even less for shorter maturities. LVMH Moet Hennessy Louis Vuitton and Nestle also joined this week’s group of bond issuers. All of this bodes well for stocks. Companies can more cheaply finance growth opportunities, return cash to shareholders like Apple, or fuel another surge in M&A.

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