Earnings MRK and AAPL

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The market remains in an elevated state, and it seems like there is no other direction for it to go. There is some faint talk of a Taper in December or January; however, most that believe in the possibility of the Fed Tapering have pushed their expectations into March of next year. For now the Federal Reserve’s printing presses are humming along at a rate of $85 billion a month and I, for one, believe that it is likely that they could INCREASE their asset purchases before they consider any Tapering. Corporate earnings have been mixed and there is great news coming out of the energy and technology sectors, while weaker top-line revenue seem to be the repeated story for those that are reliant on the domestic consumer. There are now some news stories trickling out about another housing bubble building, but I don’t think it is nearly as concerning as some would make it out to be. Primarily because it is segmented to certain demographics that can afford to take unrealized losses and ride out any volatility. If there was an underlying concern, it remains the sanguine view of inflation and national solvency in the long-term.

Earnings: Merck and Apple

Courtesy of wikipedia

Merck (MRK) reported earnings which were a little concerning. Over the credit crisis we had seen the big pharmaceutical companies in a race to take over under-valued or struggling competitors. In a business like pharmaceuticals the risk considerations are immense, when weighted by time to market, FDA approval, R&D, and generic erosion. A success couldn mean billions in revenue that can last for well over a decade, but for each success there are 100′s of millions in capital investment accompanied by failures. The whole process means that a quintessential consideration is time to market. If it takes too long, a company can face significant competition. So the credit crisis actually created an opportunity for many of the big pharmaceutical companies. Many saw their stock drop, but not because they were failing, but because investors needed CASH. The old saying, “Tossing the baby out with the bath water” was especially true in this sector. Merck, Johnson & Johnson, Pfizer and others went into a buying spree. One of the biggest was Merck’s acquisition of Schering-Plough. There are certainly huge advantages in acquisitions; buying patents, existing revenue, future pipelines, and even production facilities. Merck almost doubled its revenue in its acquisitions. However, there are the risk and cost factors with any acquisition. Some of those risks can show their ugly head months or even years later. The two concerning issues are always liabilities (class action lawsuits) and a dying pipeline. Companies need to stand ready to rebuff lawsuits, while at the same time continue to keep the pipeline primed with new drugs waiting for approval. No doubt 2009-2011 were boom years for these big companies as they could buy up pipelines and revenue. Those days are now over and they are back to the old game of managing risks, spending on R&D, and ramping up those pipelines. It’s a slog and uphill battle; one big dud can bring dismal results to the quarter. The big Pharmas must always march forward, by either acquiring new companies or developing their own. The shelf-life and risks of current drugs are limited; soon they will all face legal disputes and generics.

After reading through Merck’s earnings this morning it seems clear to me that they are in that pinch period where they are seeing competition and a decline in sales and/or revenue in their existing offerings, while at the same time their pipeline is not primed with any strong differentiation. That is not to say this stock will come crashing down or that their future isn’t bright. My concern with Merck is that they are in that lull phase in which we may see stagnation for a couple of quarters before they can either push something new out the pipeline or acquire something that brings new revenue in the door.

The company reported $1.12 billion or 38 cents a share to the bottom line, which is down from $1.73 billion from last year this time. The company did beat expectations when you exclude special items and costs; however, much of that came from cost cutting and not from growth. Sales on one of their most popular drugs, Januvia (for diabetes), had seen a boom in the 2010-2012 period, but saw sales decline over the last quarter and that means they need to start ramping up that pipeline soon. The stock is down in the pre-market about 2%

What to expect from Apple?

Apple (AAPL) is going to release earnings after the close today and it will certainly set the tone for the market tomorrow. What should we expect? If history is any measure, they always set the bar very low. The company is notorious for setting very low expectations relative to reality. That game worked for years, but the game has backfired recently as it has become expected that Apple ALWAYS beats earnings expectations. There is no such thing as an up-side surprise anymore, because an up-side surprise is expected. I guess it can’t be a surprise if we expect it. While I am a believer of the “under promise / over deliver” mantra, Apple has taken that to an extreme.

Apple has gone through some transitional pains for sure. First, it was the management transitional pains; there were rumors of infighting and a couple of top managers left the company. Next, there were the stumbles in some product releases (which thankfully didn’t hurt sales). Then, there was sales debacle in China, which hasn’t panned out as expected. Then, the lackluster launch of the iPhone 5c and 5s (which thankfully again didn’t hurt sales). Now it is facing the dogged tenacity of an activist investor, Carl Icahn, which first seemed like a love-fest with a couple of public tweets between Tim Cook and Carl Icahn; however, that relationship (as expected) has now turned sour. In my humble opinion, Apple is currently relying too much on a die-hard fan base, which has helped masked some rather big stumbles. For if you have a legacy product and a cult following, you can afford to trip and fall a few times. However, we forget Apple’s history; there was a dark time for Apple when they booted Steve Jobs in favor of an old school, business-type CEO. The company was then rescued by none other than their biggest rival, Microsoft, which poured in $150 million and the eventual return of their task-master, innovative leader, Steve Jobs. For if it wasn’t for Microsoft and Steve Job’s return, I wonder if Apple would even be around today – it most likely would have been gobbled up by some other technology company.

So, the question before us today is that we have a company with a ton of cash on its books, a solid existing pipeline of products, and a talented staff. The question is can it be managed properly and can that prior, successful business model, which was willing to take HUGE RISK in order to define new markets and face competition, carry on with the tenacity that Jobs was willing to bring? I am not so sure, certainly they have a huge advantage of their brand, cash on the books, existing products, and an army of fan boys. That is a foundation on which to build success; the question is which General do you want managing this company? So far Tim Cook seems like a nice guy, but I don’t want a nice guy running the business. You need someone young, hungry, and willing to take risk. Tim Cook is no Steve Jobs, but he is also no Elon Musk, Mark Zuckerberg, Jeff Bezos, or Larry Page. I see Tim Cook and I see another Steve Ballmer (Microsoft CEO) who will just keep the company going along in a conservative fashion. Ballmer sure didn’t sink the Microsoft ship, but he didn’t really take any risks or drive the company in a passionate and tenacious way. Ballmer is finally being shown the door and if Microsoft brings on a young talented risk taker, similar to a Musk, Bezos, or one of the many other “disruptors” – we could see Microsoft dominate as Apple stumbles along. If you want a conservative and a nice guy, then Tim Cook is your man. My concern is that Tim Cook is just that, a conservative and nice guy.

Apple CEO Tim Cook

We expect them to beat expectations, but in order for Apple to really surprise they need to knock it out of the park above the whisper number. They can do that and I expect them to; however, unless they do something new, exciting, defining, risk taking, and/or innovative, then Apple will just turn into another Samsung-type company. The problem with that is that Samsung can outplay Apple in that game every day of the week. Apple needs to be the “disruptor” and innovator in order to keep ahead of the pack, because others will eat it for lunch. The Apple Cult Fan boys can only carry the company for so long, as we saw back in the 1980′s-90′s era.

How many more quarters of up-side surprises does the company have in it with conservative Tim Cook at the helm?

Support & Resistance

INDU 15,500
We remain at this level and I think we could push up to 15,700 if we see a strong showing after the close from Apple, which can bring optimism to the entire market. I would look at short-term support at 15,400.

NDX 3250+
Today we could be in a holding pattern, waiting for the Apple’s earnings. This will surely drive HUGE volatility into the after-market futures action. I think we could see this index at 3500 or 3250 very quickly in the after-market trading session as Apple releases earnings. Even more, don’t expect an initially up or down move to last, we could see quick reverses – so don’t get sucked into an initial move.

SPX 1700+
While Apple will drive the NDX, it will also have an impact on the S&P 500 index. This index looks likes it wants to climb higher and Apple could be the knee jerk move to send this index higher tomorrow or pull back down to 1720 (the near-term support).

RUT 1080+
The RUT has stalled at the 1120 area, waiting. It doesn’t look as robust as the other indices. No doubt that a big drive higher in this index has been the Federal Reserve’s massive QE printing machine, forcing any investment into equities for a lack of alternatives. That will continue, but also expect some short-term pullbacks. Look at 1180 as a near-term support. The one-week stall at this area means that we need another boost of optimism to drive more order flow into the broad based market.

Oh Yeah, forgot the Fed was meeting.

While this week will most likely be defined by Apple’s earnings, which will flood the airwaves and business rags, the Federal Reserve is also meeting. I don’t expect anything out of the Federal Reserve meeting. They will certainly not even HINT at taper after their last public relationship debacle. I mean if they do, it will be nothing more than another embarrassment. They would rather put that whole thing behind them.

There is a small probability of an upside surprise, the Fed could announce a ramp UP in their QE printing and certainly use the government shutdown as an excuse to do so. If the Fed makes any hints of increasing their money printing scheme, it will drive the equity markets and bonds higher (yields lower). That’s a low probability; however, certainly a higher probability than any announcement of tapering.

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