AAPL Earnings After The Bell On Thursday
Apple stock is down 6.7% since January 18th because investors are worried about iPhone X sales. The worries stem from the report that the company cut its supplier orders. Initially it was reported that Apple cut iPhone X orders by 20 million which was half the initial estimates. However, a supplier called Fujita said the cuts aren’t that large. We’ll find out the truth on Thursday when Apple reports. The billion dollar question is if the $1,000 price of the iPhone X caused customers to skip buying one despite the advanced OLED screen which has a high screen to body ratio, the better sound, the face recognition, and the animojis. We will see if the decision to heavily market animojis was a good idea. This isn’t a toy. It’s a $1,000 device. Some consumers might think that feature is superfluous. Orders for the iPhone 8 and 8 Plus weren’t cut. It would be a disaster for Apple stock if the iPhone 8 and 8 Plus sales don’t make up for the disappointing iPhone X sales.
The chart below shows the latest sell side earnings estimates for Apple. As you can see, 14 analysts lowered their projections and 15 increased their estimates. While analysts likely won’t respond to the rumors about the order cuts, the stock clearly has. If the report is true, Apple stock will decline sharply on Friday. I’m not optimistic about this report because of the expensive iPhone X. Apple also had negative headlines during the past few weeks because the company slowed down the iPhone 6 and iPhone 6s devices after their batteries drained below a certain level. Apple was criticized for not being transparent about this as many fear the company is trying to mess with old devices to get people to upgrade more often. This caused Apple to offer cheaper $29 battery replacements. The fact that the company has sold out of batteries in recent weeks instead of iPhone X’s is concerning.
The chart below shows some of Apple’s financial metrics along with labels for when the recent iPhones were released. As you can see, the levered free cash flow divided by marginal costs decreased since right after the iPhone 6s was released. That’s a bad sign. The forward twelve month dividend adjusted earnings yield, trailing dividend adjusted twelve month earnings yield, and average dividend adjusted earnings yield have also declined. The stock price has rallied partially because of hope that the recurring revenue from the services business will stabilize earnings. However, Apple still needs to sell iPhones to have people buy services on them. Regardless of services revenues, the stock will still live and die by iPhone X sales results.
Fed Maintains Rates
As expected, the Fed kept rates the same at the January FOMC meeting. It was Yellen’s last one, so the odds of a surprise were long despite the excessive stock valuations. Many analysts and commentators thought this was a hawkish statement even though there was no rate hike. Before I review the meaning of the statement, let’s review the meeting’s effect on asset prices. The S&P 500 sold off 1.5 hours before the meeting; it rallied after the statement was released to close up 0.05%. There was bias to the upside in stocks on Wednesday because they sold off the prior two days. January ended being the best month for stocks since March 2016.
The 10 year bond yield spiked into the meeting and then collapsed about 5 basis points afterwards. It closed at 2.7050%. The 2 year bond yield barely moved, closing at 2.1406%. This means the difference between the 10 year and 2 year is 56.44 basis points. The hawkishness was felt in the Fed funds futures as the chance of a rate hike in March increased by 9.4% to 80.3%. The number of rate hikes in 2018 barely moved as the market shows there’s a 60.1% chance of at least 3 rate hikes.
Looking at the wording of the statement, the Fed eliminated the point about the hurricane related economic fluctuations. This change is simply about updating the situation, so it’s neutral. The household spending language was changed from “expanding at a moderate rate” to “solid.” That’s hawkish because it means the Fed has more confidence in the economy. Secondly, the fixed business investment went from “picking up in recent quarters” to “solid.” This is a moderately hawkish change. The unemployment rate went from “declining further” to “staying low.” It’s interesting to see a statement 2 days before the monthly labor report. Once the unemployment rate goes up year over year, stocks must be sold.
The Fed said “inflation continued to run below 2%, but market based measures of inflation compensation have increased in recent months.” The Fed is referring to the breakeven inflation rate. The 10 year breakeven inflation rate has been in a strong uptrend. On Tuesday, it hit 2.10% which is the highest point since September 2014. I’m still not worried about inflation, but the Fed mentioning it is a hawkish move. If inflation accelerates between now and the March Fed meeting, the Fed will say it’s concerning which will imply 4 or more rate hikes. That could send down risk assets. We’re still far away from that occurring. I’d guess the breakeven inflation rate would need to increase 20-30 more basis points for the Fed to raise rates 4 times.
The final change in the statement is the Fed went from saying “inflation is expected to remain somewhat below 2% in the near term” to saying “it will move up this year.” This isn’t surprising to me because I expect inflation to move up. Most investors and economists expect inflation to move up. The reason this seemingly innocuous point is such a big deal is because the forward guidance has become hawkish. We haven’t seen any hawkish rate hikes in this cycle. March might be the first one. That could cause a sharp flattening in the yield curve. This meeting was a prequel to the first hawkish policy in over a decade.
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