Friday, October 21, 2011

Market Week Wrap-up

Trade The News Weekly market update: Market Week Wrap-up

- Volumes in US equity markets remained low this week as major indices reacted to a mixed batch of corporate earnings and a ceaseless stream of headlines about how the Europeans plan to structure their big financial backstop. France and Germany have struggled behind the scenes over the most appropriate way of levering up the pot of authorized funding for the EFSF, how to restructure Greece's debt, how to recapitalize the banks, and how to firewall Europe, and especially Italy, against the crisis. Few concrete final details have emerged, although it appears that despite the terrible state of Greece's austerity plans, there is no question that Athens will get its next tranche of aid in November. The big US banks reported dismal earnings for the third quarter, and Goldman Sachs actually took a loss. There were other high-profile misses, including Apple, but overall the tone out of corporate America has been relatively positive. On the data front, China's Q3 GDP data declined on a sequential basis for the third consecutive quarter, registering its lowest reading in two years, although the very gradual declines suggest that the Chinese government is so far managing an economic soft landing. In Europe, the German October ZEW index of economic sentiment fell for the eighth consecutive month. However some improved data in the US provided reasons to doubt the inevitability of a return to recession. The October Philly Fed survey registered its first positive reading since May, with a return to positive new orders as well. Data on the US housing market were also surprisingly positive. The October NAHB Housing Market Index hit its highest level since May 2010, thanks to modest improvements in buyer interest in select markets. More importantly, September housing starts increased at their highest annualized rate in eighteen months thanks to a 51.3% y/y increase in construction of multi-family units. For the week the DJIA gained 1.3%, while the S&P500 and Nasdaq each rose 1.1%. Chartists noted that on Friday that the S&P 500 had its best close in over two months, just 20 points shy of break even for the year.

- On Tuesday Goldman Sachs reported its second quarterly loss since going public back in the 1990s, citing troubles in its investment portfolio and declines in trading revenue. Investment banking revenues were down sharply on both a q/q and y/y basis, and there was a big net negative revenue figure in its investing and lending segment. Like JPMorgan last week, debit valuation adjustments (DVA) were a major factor in earnings out of Citigroup, Morgan Stanley, and Bank of America this week. Morgan Stanley reported headline earnings of $1.15/share, but after backing out the DVA gain, it only earned $0.02/share. With its shares down 50% YTD due to fears about the bank's exposure to peripheral European debt, Morgan Stanley reiterated that its net funded exposure was approximately $2B, or $5.7B before hedges. Bank of America's headline profit amounted to $0.56/share, but big asset sales and a DVA helped it cover up some fairly substantial losses, including a $2.2B pretax loss on private-equity assets and around $1.9B in charges related to mortgage litigation, disposing of the international cards business and other items. Net interest income fell to $10.7B from $12.7B a year earlier. Citigroup's earnings were only slightly higher than expected, after subtracting a $0.39 gain from the bank's debt value adjustment. Top-line revenue was in line, although the investment banking business saw revenue decline 12% y/y, hurt by declining underwriting and merger advisory fees.

- In other earnings, DJIA components AT&T, Coca Cola, GE, IBM, Johnson & Johnson, McDonalds, and Verizon all reported quarterly results that met or slightly exceeded expectations. GE saw solid double-digit profit growth, although investors were concerned that margins fell on a y/y basis, driven by a calm patch in the wind business. Coca Cola saw decent growth in volumes, although it warned that cost of goods sold was up 67% in the quarter, thanks to higher commodity costs. Shares of American Express fell despite the firm's good profit growth and excellent credit metrics, as expenses grew faster than revenue. J&J's decline in domestic sales was more than made up for by double-digit y/y growth overseas. AT&T did not impress investors with its soft postpaid subscriber additions and iPhone activations. Apple's shocking miss weighed down the tech-heavy NASDAQ index on Wednesday, with the miss attributed to potential new customers holding off on buying an iPhone in anticipation of the new model launch in October. Note that Apple's own forecast for Q1 lacked its typical conservatism, as executives reiterated their high hopes for the iPhone 4S. Microsoft reported decent results, although analysts were concerned that its Windows 7 franchise made very minor gains after three quarters of declining sales, in line with limp PC sales.

- Trading in US bond markets was fairly subdued this week as much of the focus remained on Europe. Early on hopes remained high and government borrowing costs in Europe continued to come down. Signs that European corporate bond markets were beginning to thaw further aided sentiment. But European sovereign spreads widened out as the week wore on and it became clear there would not be an overriding solution agreed upon by this weekend. The Italian 10-year touched 6% again and even French 10-year debt saw its yield blow out relative to the Bund. On Friday traders pushed money back towards riskier assets which sent Bund and Treasury yields higher. The US 10-year yield finished the week at 2.2% while the Bund closed at 2.10%.

- Finding themselves still far apart on a master plan for solving the euro zone crisis, European officials began the week with attempts to temper expectations for the summit scheduled for October 23rd, warning that hopes they would deliver a final solution to the crisis were overblown. By midweek the intensive talks between Germany and France over the best use the expanded EFSF were still at an impasse. To give themselves more breathing room, officials scheduled a second summit meeting for Wednesday, October 26th and said the Sunday summit would be used for further talks. Conflict over the best route to leverage the backstop breaks down as follows: France would like the EFSF to be given a banking license while Germany would like it to become an insurer that would back government bonds. There are problems with each approach, especially given that the ECB strenuously apposes giving the fund a banking license. In addition to the EFSF, conflict rages over how great a haircut private holders of Greek debt should ultimately take, with some saying participation in taking haircuts should be made mandatory (current proposals call for them to be voluntary). But ultimately, it's worth keeping in mind that the battle over the EFSF comes down to one fundamental question: is there enough money in Europe to prevent a run on the €1.9T Italian bond market?

- The threat of contagion was renewed by a Moody's report warning it might put France's ratings on negative watch in the next three months if the cost of bailing out banks or other euro zone members adversely impacts its budget. The spread between 10-year French and German government debt hit an all-time euro-era high of 120 bps this week, reflecting nervousness about France's ratings. This in turn pushed out spreads on EFSF debt, further exacerbating the situation and driving France to negotiate harder for an EFSF structure that is suited to protecting its ratings. EUR/USD has peaked above the 1.3900 level coming into the week, however the pair bounced around between this level and 1.3650 on conflicting headlines about the state of the European negotiations. By the end of the week the greenback was under pressure again on an uptick in overall risk appetite.

- USD/JPY remained basically locked within its 200 pip range for the 55th consecutive session but dealers noted the current environment was ripe for a stop hunt as they eye some massive dollar sell stops building below the 76 and 75 levels. The pair hit fresh life-time lows below the 75.95 level after markets were disappointed by Japan's formal plan to spend ¥2T on steps to ease the impact of the strong yen. With USD/JPY at its lower end of the recent range, the price action could bring the BoJ back into focus, and nerves will be on edge as intervention becomes more of a possibility.

- China released the balance of its monthly economic data that was largely in the same vein as its somewhat disappointing GDP figures. Q3 growth slowed to a 2-year low 9.1%, below 9.3% forecasted, while industrial production rose 13.8% y/y to break a string of two consecutive monthly declines. Debate over a "hard" versus "soft" landing scenarios in China attracted renewed focus in the commodity markets this week, as copper fell sharply mid-week before a modest recovery on Friday. A number of press outlets also saw a heightened concern over a brewing Chinese credit bubble, and a couple of analysts also noted an inflation discrepancy as measured by monthly CPI and quarterly deflator GDP figures indicating a lower probability of PBoC easing.

- In Australia, the RBA released its policy meeting minutes reiterating that inflation pressures appear to be more subdued over the medium term, deferring to the next set of quarterly inflation metrics for setting policy bias. Australia PPI and CPI will be announced on Sunday and Tuesday evening respectively, with estimates suggesting an easing in early November would be justified. New Zealand, on tap for a central bank rate decision on Wednesday, is widely expected to leave rates unchanged for the fifth time, even though RBNZ governor Bollard reiterated this week that it is not appropriate to keep easy monetary policy at a time of earthquake rebuild.

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