Friday, January 6, 2012

Market Week Wrap-up

Market Week Wrap-up

- The new year in markets began where the old year left off, with investors focused squarely on Europe. US and European markets were closed on Monday for the New Year's holiday and opened higher on Tuesday, thanks to some better Germany employment and Chinese PMI data, plus a strong US ISM manufacturing report. However S&P's threat to downgrade the sovereign ratings of leading euro zone nations, especially France, continue to cast a long shadow and have curtailed greater risk appetite in the market. Rumors that the S&P downgrades were imminent contributed to equity downdrafts all week. In addition, there were reminders of weakness in Italy and Spain, as yields on the 10-year debt of both nations remained elevated (the Italian yield exited the week above 7%). Italian bank UniCredit was forced to sell new shares at a steep discount to shore up its credit base, driving big declines among European banking names. In addition, there were reports that the Spanish region of Valencia would delay a bond payment. On Friday the US December non-farm payroll report came in at +200K and the private payrolls number was +212K, topping both consensus estimates and the November numbers (+120K and +140K, respectively). These totals are still not near the levels many analysts say are needed to begin really replacing the jobs lost over the last several years, but the upward trend of new job growth is encouraging. There was a flurry of new developments at the Fed. In the minutes of the Dec 13th FOMC meeting, the Fed disclosed that it would provide a Summary of Economic Projections (SEP) four times a year starting in January. Later the Fed's Bullard said the FOMC is very close to implementing an inflation target. The four recent Fed dissenters rotated off the FOMC (hawks Fisher, Plosser and Kocherlakota, and the dove Evans), to be replaced by a more dovish slate of voters (Pianalto, Lacker, Lockhart and Williams). Chairman Bernanke commented that it would be appropriate to bring foreclosed homes into the rental market to help dampen downward price movements. Note that there were also rumors that the White House was planning a large-scale mortgage refinance plan, which was later denied. Late Friday, however, Freddie Mac announced that the FHFA had directed it to extend forbearance to unemployed borrowers for up to 12 months, which could affect up to 10% of delinquencies on mortgages administered by Freddie. Front-month WTI crude spent most of the week above the $100 handle as the Europeans prepared fresh sanctions against Iran, which held naval exercises in the Strait of Hormuz and generally rattled its scimitar. Brent hit $113. For the week the DJIA gained 1.2%, the NASDAQ rose 2.7%, and the S&P 500 tacked on 1.6%, thanks largely to big gains on the first trading day of the year.

- Another group of companies discloses troubling pre-earnings guidance this week. Barnes & Noble slashed its FY12 outlook to a fairly large loss. The change was due primarily to a shortfall in the expected sales of NOOK ebook readers coupled with more investment in the technology as management lays plans to spin off the NOOK business. Eli Lilly offered a grim look at 2012, warning that both its earnings and revenue totals would disappoint market expectations. Executives further warned about patent expirations on some of the company's largest products, most notably the antipsychotic Zyprexa and the antidepressant Cymbalta. Refiner Tesoro said it would report a big loss in its Q4 and slashed its FY11 outlook. Contributing to the net loss was an extremely weak margin environment in California and the collapse of the WTI-Brent spread. Alcoa announced that it would close or curtail 12% of its total aluminum smelting capacity, with a charge to Q4 earnings of $0.15-0.16. The company also said it would accelerate actions to reduce the escalating cost of raw materials.

- The December same-store sales (SSS) were on the whole better than expected, however promotional discounts ate into profits and many firms lowered guidance for the final quarter of the year. The discount chains TJX and Ross Stores attracted thrifty Christmas shoppers and beat comparable store expectations by wide margins. Meanwhile, the Gap continues to bleed away sales, reporting its sixth straight month of y/y same store sales contraction. Interestingly American Eagle Outfitters, which abandoned providing monthly SSS reports, said its comps were up 12% in the Nov-Dec period. AEO also slashed its Q4 guidance by about 25%, citing promotional activity. Target had a very bad month, with comps dropping to +1.6%, their lowest level since spring. Target also cuts its Q4 guidance, on softer holiday sales. Department stores also generally outperformed expectations, with the notable exception of Kohl's, whose comps were in the red for the second consecutive month.

- US Treasury yields finished the week above where they closed out 2011, but the selling was subdued considering the better US jobs data. The benchmark 10-year yield briefly topped 2% following both the ADP and non-farm payrolls figures, but weakness emanating out of Europe kept an underlying bid in US government paper. Corporate issuance was particularly robust with more than $12B in paper coming to market, for the most active week since last summer. Banks on both sides of the pond were aggressive in their efforts to get out ahead of more than $230B in US corporate debt roll-overs coming due in 2012 (this compares to $195B in 2011). According to data from Barclays, approx €794B of European sovereign bonds will need to be issued in 2012 (above the long-term average, but less than 2010's record €952B in sovereign issuance). The Independent reported that the world's top economies will need to roll over a combined total of $7.6T in 2012, with Japan requiring the most at $3T and the US needing $2.8T.

- Currency traders cannot tear themselves away from the deepening crisis in Europe, where everyone is nervously waiting for the rating agencies to pull the trigger. Absent the looming sovereign downgrades, there was the potential for more risk appetite, in the form of some slightly improved final December manufacturing PMI data in European and Asian nations, plus the good showing in the December US employment data. As the first week of the year rolled on, dealers became keenly aware of a breakdown in the risk on/weak dollar trend -- typically throughout 2011 the dollar was sold on any return of risk appetite, however this correlation appears to be falling apart as investors have bought the greenback on any sign of overall strength.

- EUR/USD began 2012 with an updraft taking the pair back above 1.30, from the 2011 year-end closing level of 1.2970. However, the continued focus on the sovereign situation hammered the euro in the back half of the week, as pessimism and the shifting dynamic with the dollar sent the pair down to 1.2700 level last seen in August of 2010. In a sign of the stress, the ECB deposit facility continued to hit record highs, closing the week with a whopping €455B parked in the facility. With the prospective of weeks and months of further consultations over Europe's new fiscal integration plans ahead even as yields on Spanish and Italian debt remain elevated, there is plenty of pessimism. The Centre for Economic and Business Research (CEBR) began the year by forecasting that the euro would lose a member in 2012. Reports that the Spanish region of Valencia was late in making a bond payment also highlighted these concerns. The EUR/JPY cross continued to hover at 11-year lows, unable to sustain any momentum above the 100 level. The cross tested 98.30 by the end of the week.

- Europe's emerging economies were also in focus this week. In Turkey, the central bank is maneuvering to aid a soft landing for the nation's cooling economy while also warding off the shocks from Europe. The Turkish Central Bank was selling elevated amounts of USD for TRY in order to support the lira throughout the week. After ratifying a new law that weakened its central bank, Hungary's government took heat all week from both markets and European Union officials. In addition, there were growing questions about the nation's ability to finance itself in public markets. This week the forint was testing fresh record lows against the euro, approaching the 325 level on Wednesday, before backing off again. The yield on 10-year Hungarian sovereign paper hit its highest level in two and a half years, testing above 11.20%, while 5-year CDS hit fresh all-time highs above 725bps.

Notable economic data out of Asia was limited to Australia's November trade report, which showed continued deceleration in basic materials shipment activity. Coming in at a 9-month low surplus of A$1.38B, the trade report's components also revealed a 4-month low in exports to China and a 7-month low in the exports of iron ore. The Reserve Bank of Australia is not meeting this month, while fixed income markets are pricing in a slight probability of another cut in February.