Financial Market Commentary

After test driving an iPad for two days, I am generally unimpressed. It’s clunky. If you’re expecting the “internet in your hand” feeling touted by Apple, you’ll be disappointed. My advice is to wait for further developments, by Apple and competitors, before buying.

The main reason the iPad is clunky is that it seems as if everything worth doing has to be done through an “app.” There’s far less of the direct feeling of the internet than was advertised. I had to download the WordPress app to write this blog. When I accessed my WordPress account through Safari, I did not have full functionality. And the WordPress app I’m using right now is extremely limited.

Same for Yahoo Mail — it had to be synced with the iPad email system to work at all. I was not able to fully use Yahoo mail through Safari on the iPad, which seems, frankly — ridiculous. Another problem is that there’s no way to log out of your iPad email app, so anyone you loan your iPad to will have access to your email, unless you completely disconnect the feed, which is cumbersome.

The dumbest thing about the iPad is that it doesn’t play Flash videos. There’s a CNBC app where you can watch a small number of videos — very small — but you can’t browse the guest list and watch the video interviews of the pros you follow. Lack of Flash interferes with many other applications. Want to watch those fantastic lectures from Harvard and Yale at AcademicEarth.org? Sorry — they’re in Flash. (But you can watch all the YouTube you want.)

Next let’s discuss disk size. The iPad is about four times the size of an iPod — so why does it have barely over a third of the hard drive space (and that’s in the largest version)? Was this so hard for Apple to figure out? They sell 160 GB iPods, and they actively encourage users to sync their iPad like an iPod. What did Apple think would happen when users tried to fit 160 GB of music and videos onto a 64 GB iPad? It forces the user to engage in a long, tedious process, deciding what to sync and what not to sync. As big as the iPad is, I have to think they could have squeezed the same amount of memory as the iPod on board.

Also disappointing is the lack of a USB port. You can’t just copy files as on a PC or Mac, and manually manage your directories.

Overall, the iPad is a work in progress. I recommend that potential buyers wait and see what Tablet 2.0 brlngs. You’ll probably get a lot more value in a year, 18 months at the most. This was the rule with the iPhone, and it’s likely we’ll see similar price cuts and enhancements with future versions. I also expect future tablets will be designed more like laptops and less like phones.

Friday’s weak job number took about 300 points off the Dow, and another 100 on Monday.  The national employment situation mirrors other factors weighing on the market, such as sluggish sales growth, which received more attention from the media in last year’s news cycle. A year ago many analysts were hedging their outlook for stocks with a caveat along the lines of

Earnings may be growing but revenues need to follow, because sustainable earnings growth based on cost-cutting alone is not sustainable.

As late as February 2010, well-read blogs like Pragmatic Capitalism were warning about this divergence between earnings and revenue growth. Although the idea is based on commonsense reasoning, now that revenue growth is not materializing on schedule, we’re hearing less and less about this thesis. I propose that overoptimistic expectations regarding revenue growth also help explain why the market needed to regurgitate the faulty logic used to justify the quick move from Dow 10,000 to Dow 11,000.

Using data from the US Census Bureau:

Notice how dramatically the events of Fall 2008 disrupt the time series of Real Retail Sales. Real Sales Ex-Auto in December 2009 was equal to its December 2006 value. Other severe recessions, such as post-September 2001, did not induce such a profound shock to the series.

The next graph shows year-over-year growth (plotted monthly), and a 1-year moving average of growth.

The 1-year moving average of year-over-year growth equals -2.5%, well below the trend average of 4.7% (5.4% measured from 1993-2007). We would therefore need the unusually high sales growth we’ve experienced recently to continue for another 2 years to pull us back to trend — something that only happened during the credit-fueled spending binge of 2005-2006, and the stock bubble years 1998-1999.

It seems unrealistic to count on sustained, above-average revenue growth to provide support for vigorous growth in corporate earnings in 2010-2011. It’s become increasingly apparent that, even at Dow 10,000, stock valuations reflect optimistic expectations vis-a-vis the fundamentals the economy will be able to generate.

Herb Greenberg examined the sustainability of corporate free cash flow on CNBC (June 7), concluding that “companies have cut to the bone . . . and if business does not improve . . . don’t count on cash flow to continue on its hot streak.” Just as top-line revenue growth drives profits, it drives changes in free cash flow as well.

Earlier on June 7, Benjamin Pace of Deutsche Bank cited “strong earnings growth” as the reason stocks should be trading closer to 16 times forward earnings, rather than their current multiple of 12-13. In fact, 16 times forward earnings is slightly above the historical average (stocks tend to trade for 15-16 times current, not forward, earnings). Pace’s thesis that stocks merit above-average multiples, given the current environment, is a tough sell.