Friday, May 18, 2012

Philly Fed, Initial Claims, Overall Market ... and FB

In this lengthy post, we discuss the Philly Fed business survey results, initial jobless claims, our thoughts on the overall market, and we also digress a bit and touch on Facebook (FB).

Philly Fed Business Survey
The Philly Fed business survey came in at -5.8 for May, significantly below estimates of 8.8.  It appears that the Empire State manufacturing data which came out earlier this week may have been an outlier.
Drivers for such disappointing Philly Fed survey results included the much faster delivery time which was impacted by much lower unfilled orders.  In addition, decline in number of employees and average workweek was not encouraging at all.
A couple of other things stood out in the report.  One was that the index for future capex (the next six months) in that region declined significantly to 5.3 from 21.7.  This basically indicates that businesses surveyed do not expect as much capex in the future as they did the previous month.  The other data that caught our attention was response to the question of what factors are forcing businesses not to hire aggressively.  In the current stormy political environment (which is expected given the upcoming elections) politicians usually say taxes, health care legislation, other regulations or policies, and lack of skilled workers are the biggest reasons why businesses are not hiring more.  Well, at least in the third Federal Reserve District, the biggest factor restraining hiring is the businesses' pessimism regarding topline growth in the future.  The next biggest factor was that companies wanted to keep costs low, which is expected given lack of sales growth.  Clearly, such data is not very encouraging.

Initial Jobless Claims
Seasonally adjusted initial jobless claims were again above expectations, and as we suggested before, the prior week's data was revised up.  In fact, YTD, every single week's jobless claims data has been revised up; 20 weeks in a row!

Overall Market
The equity market took another dump Thursday with the S&P 500 declining another 1.5% to 1304.86.  Since end of April, it has declined approx. 6.7%; and it is down 8.3% from its YTD high of 1422.38.  It is down 4.7% since we posted recommending transitioning to less risky equity sectors on 3/5/12.  That 1325 support level we touched on earlier this week was broken through on Wednesday.  Thursday's further decline was an indication that it could be well on its way to the 1290 level we suggested.  However, again, as mentioned earlier this week, the Facebook (FB) IPO could help create a dead-cat bounce Friday.
We haven't yet had a chance to go through FB's S-1 in much detail as we knew we wouldn't be able to get in on the action early enough.  However, we do have some hesitations regarding sustainability of FB's revenue model in the long-run.  The Company generates revenues from ads (based on number of impressions or click-throughs) and from fees that its payment platform charges businesses per transaction.  Consistent growth in ad revenues is in question.  We have already seen one major business, GM, pull its ads saying they do not pay off.  In addition, more and more FB users are on the mobile platform which creates some limitations for generating ad revenues.  Lack of screen space certainly further restrains FB to place ads on its mobile platform.  Also, we believe it is less likely for users to conduct click-throughs on ads they see on their mobile devices as compared to the ones they see on their laptops, PCs or Macs.
Although FB's user base continues to grow (for good reasons as the users love their experience on the FB platform), we could see the average revenue per user, ARPU, level off and possibly decline for the reasons mentioned above, which is not good news for the Company's topline growth.  We also note that FB's revenues from transactions, which in the March quarter made up 17.6% of total revenues, are heavily concentrated.  In other words, most of those revenues come from purchases of apps by users from one company, Zynga (ZNGA).  We are not saying that other developers won't contribute to FB's revenues, but right now the risk of client concentration is clear and present.  Also, surprisingly, we did notice seasonality in this young Company's revenues.  It appears that the March quarter is usually its lightest when it comes to topline, which could explain why they chose to go IPO after the March quarter.
Regarding FB, we are not saying that this Company will be a bust and no growth remains.  In fact, there is a lot of growth potential for FB, as many others will agree.  However, sustainability of such growth and some steps that may be necessary for this may backfire in the long-run.  Of course, the Company won't face such risk until a few more years down the road.  FB users have stayed on FB because of fewer ads and because it is free.  We just hope that with declining ARPUs in the long-run, FB won't have to consider creating a 'premium subscription' plan.  Once users get something for free or for a low price, the worst thing is to raise the price; something that NFLX has realized during the last 12 months.  We note there is significant growth potential in FB's transaction based revenues.  Then again, that space is pretty competitive with companies such as Amazon (AMZN) doing pretty well.   Unfortunately, we digressed a bit from our discussion of the overall market.  We’ll likely discuss FB in more detail once we have a chance to go through the S-1 filing and conduct some good ‘ol due diligence.
We did see some signs of a potential break of the positive correlation between gold and the equity market.  While the stocks went down further, gold spiked up a bit on Thursday.  This could be due to either that many believe commodities will still have value in bad times and/or that the macro environment is deteriorating so much that chances of further quantitative easing just may be increasing, which of course help commodities and metals such as gold.  Whether the divergence demonstrated on Thursday will last or not remains to be seen.  The gold ETF, GLD was up 2.2% on Thursday.  We must note that YTD GLD is up only .5% while S&P 500 is up 3.8%.  It’s a bit different Y/Y, with GLD up 5.6% and S&P 500 down 1.8%.
Overall, the economy is not growing as strongly as many expected and the Euro crisis continues to get worse.  For these reasons we still believe a little bounce off the lows might be short lived and 1290 for the S&P 500 is within reach.

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