Friday, November 25, 2011

Market Week Wrap-up

Market Week Wrap-up

- European debt contagion got further out of hand this week, as investors liquidated assets, took refuge in dollars and USTs and markets sank lower. Coming into the week, a chorus of voices were sounding the alarm about the impact of the European crisis, further inflaming sentiment: Moody's warned that higher borrowing costs would be credit negative for France, Germany's BdB Banking Association warned that German local governments are already having trouble financing themselves and Goldman Sachs cautioned that sovereign risk is "spreading like wildfire." In the US, the Congressional supercommittee tasked with developing deep, structural reforms to the budget failed to come to an agreement. The result was expected, although it further damaged confidence. JP Morgan came out a cut their outlook on commodities to underweight and noted policy failures in the US and Europe have darkened the six-month outlook. With the EFSF bailout fund clearly faltering, markets were also reacting to the sense that officials do not have the proper tools to halt contagion. Indeed, German party officials warned that Germany did not have a 'bazooka' plan to deal with the crisis. The IMF proposed new liquidity lines, up to 24 months in scope, allowing nations to borrow against a multiple of their IMF quota to finance balance of payment needs, however analysts panned it as too little, too late. The European Commission floated several preliminary ideas for creating a euro bond system, although Germany, Finland and the Netherland's continue to categorically rule out euro bonds. The situation took a marked turn for the worse after a very disappointing German 10-year bund auction on Wednesday morning; in the auction,the Bundesbank was forced to buy 39% of the €6B on offer, leaving the sale "technically uncovered." Global growth fears were further exacerbated by a sub-50 reading in the November HSBS flash PMI reading for China and the revision lower in the second reading of US Q3 GDP. US Treasury prices were bid throughout the week from safe haven flows, though gains were modest spreads between US and European interest rates widened. The US 10-year yield remains below 2% and for the first time in more than 2-years the German Bund's yield exceeds that of the US Treasury's by more than 30 basis points. For the week the Dow was off 4.8%, the NASDAQ declined 5% and the S&P 500 lost 4.7%. This was the worst performance by the leading US indices during the Thanksgiving week since the market began observing the holiday in 1942.

- In US equity news, there were two notable mergers announced this week. Biotech firm Pharmasset agreed to be acquired by Gilead Sciences for $137/shr in cash, an 89% premium to the firm's prior closing price. The transaction is valued at $11B. Pharmasset is conducting clinical trials on promising hepatitis C medicines. Property and casualty insurer Alleghany signed a definitive deal to acquire reinsurer Transatlantic Holdings for $3.4B in cash and stock, for an implied deal value of $59.79/shr. This new offer values Transatlantic at nearly $5 more per share than Validus' latest offer, which may help Transatlantic prevent Validus' hostile takeover. In earnings news, investors were not enthusiastic about Hewlett-Packard's Q4 results. HP only just met expectations in the quarter, while its earnings forecast for Q1 and FY12 was strikingly weak, and the firm refrained from offering revenue guidance. Deere was a rare bright spot: the company firmly beat earnings and revenue targets in its Q4 report and offered a very bullish forecast for 2012, including very strong double-digit revenue gains for both the year and the first quarter.

- The triple whammy of the European debt crisis, US budget policy gridlock and global growth fears drove FX trading this week. Risk-off sentiment eventually benefitted the greenback and the yen, although the euro held up to a certain degree on Monday and Tuesday as markets watched the US Congressional supercommittee go down in flames. In the early part of the week the EUR/USD maintained a hold above 1.3450, despite the evident contagion and a very poor Spanish 3- and 6-month bill auction featuring yields at 14-year highs, well above 5%. The failed German 10-year bund auction on Wednesday sent EUR/USD definitively below the pivotal 1.3370 channel-line support area. Note that on Tuesday, CLS Bank International, the backbone of the FX trading settlement system, said it was evaluating various contingency scenarios in which the euro zone breaks up. 

- As the week drew to a close a combination of risk aversion and ECB comments sent the Euro to fresh 7-week lows against the USD and JPY pairs. The rating agencies continue to be active with sovereign downgrades with Portugal and Hungary cut to junk status by Fitch and Moody's while S&P cut Belgium's rating as well in the last 24 hours. The Franc0-German-Italian press conference failed to inspire any initial compromise by Germany on the issuance of joint euro bonds to help stem the debt crisis in Europe. Chancellor Merkel stuck to her guns in her opposition of such bonds.

- Kokusai Asset Management was said to have sold entire holdings of Spanish and Belgian government bonds in flagship fund. EUR/JPY cross hit six-week lows as its tested below 103.20. The big upswing in USD/JPY on Tuesday was said to have been due to some decent Japanese exporter interest at the 77.30 area, although the pair drifted back below 77.00 eventually. The pair nearly broke 77.60 on Wednesday after the failed German auction, and ended the week near that level after reports circulated that the BoJ said that have sent survey to major banks regarding fx intervention assistance. Also of note commentary out of the S&P expressed real concern regarding Tokyo's ability to make progress on lowering its debt levels weighed on the Yen, sending USD/JPY above ¥77.50. JGB yields have also risen, with 10-year at a 3-week high above 1%. Concurrently, constraints from the Thailand flood and recent strenth in the Yen saw Japanese economy slip back into deflation, as y/y core CPI fell into contraction for the first time in 4 months. Cabinet officials remained cautious yet defiant, with Dep BOJ Gov Yamaguchi stating financial market condition are still severe, but also attributing Yen strength to safety.