Although we don't believe in timing the market or panicking over daily movements, we do like to keep an eye on market changes -- just in case they're material to our investing thesis.
When an engineering or technological system gets sufficiently complex, unpredictable failures are certain to occur from time to time. And that's exactly what happened this afternoon when the Nasdaq stock exchange suffered a halt in the trading of all stocks that lasted for more than three hours.
None of this appeared to bother investors: The S&P 500 (SNPINDEX:^GSPC) rose 0.86% -- its best gain in three weeks -- while the narrower, price-weighted Dow Jones Industrial Average (DJINDICES:^DJI) was up just 0.44%. The Nasdaq's own Composite index beat both, with a 1.08% gain.
There was no hint of nervousness to be found in the CBOE Volatility Index (VIX) (VOLATILITYINDICES:^VIX), Wall Street's "fear index," which fell 7.4% to close at 14.76. (The VIX is calculated from S&P 500 option prices and reflects investor expectations for stock market volatility over the coming 30 days.)
More than three years after the May 2010 "flash crash," perhaps investors are becoming more accustomed to temporary failures in financial markets. If so, that's a healthy attitude, since similar problems are bound to recur in the future, quite possibly at an increasing frequency.
The case for Microsoft
A Nasdaq-listed stock, Microsoft (NASDAQ:MSFT), ended up being the biggest contributor to the S&P 500 and the Nasdaq Index's gains, as shares of the software giant rose 2.7%. The stock's rise was triggered by Nomura's Rick Sherlund, who upgraded it from neutral to buy (Sherlund is a former Goldman Sachs partner who was the "axe" -- the most influential analyst -- covering Microsoft.)
In his note, Sherlund writes:
Fundamentals are still on a slippery slope as tablets erode PC's, but stable enterprise business and strong cash flows could support a potential activist agenda for large share repurchase, substantially greater dividend and management succession plan.
We do not think fundamentals matter so much over the next 6 months. Rather, we see potential catalyst events that can potentially alter corporate governance at the company and benefit shareholders.
The "catalyst events" are the actions of activist investor ValueAct Capital, which owns 1% of Microsoft shares. ValueAct may pursue a proxy battle to obtain board representation. It has until August 30 to notify the company if it chooses this course. Of course, for long-term investors who are considering the shares, the fundamentals beyond six months are a critical issue. In an interview with CNBC today, Sherlund acknowledged that:
The harder thing [than financial engineering] would be, well, what do you do about tablets and smartphones? I'm not sure there's a quick fix for that, but I think that's a question you address down the road which is: How do you better structure the company?
However, he was quick to put this issue in context:
We think the downside is a lot more limited, [with shares trading] at about seven times free cash flow, on next year's estimate of free cash flow. The consumer business is where you worry most about tablets and smartphones. and, three-quarters of the business is enterprise and that's a lot more stable.
You can look at what could go right in the business by delivering Office for the tablet market and moving to subscription business -- there are a lot of good things that can happen fundamentally as well. I think we can isolate what the downside risk is and say their core cash flows are pretty stable.
Sherlund makes a compelling case for Microsoft shares, but not everyone agrees. Another activist investor, David Einhorn of Greenlight Capital, was glad to see ValueAct enter the arena, but he wasn't looking far into the future. In a letter to investors dated July 26, he wrote:
In 2006 we compared Microsoft to A-Rod, which was a compliment at the time. In 2013, the comparison is still apt, but it is no longer a compliment. Windows 8 appears to be a flop, and a decade of mismanagement has put Microsoft at risk of becoming a shrinking company. We were pleased when an activist gave the stock a boost, giving us the opportunity to exit.