Friday, June 29, 2012

Market Week Wrap-Up

The week commenced with investors eagerly anticipating two key events, the EU summit and a Supreme Court ruling on healthcare. Both had surprising outcomes. On Thursday the US top court upheld the constitutionality of the individual mandate, the backbone of President Obama's Affordable Care Act. The ruling provided a lot of political fodder for Washington, while overall market sentiment softened upon its release. With that out of the way, attention turned squarely back to Europe as the month and quarter end drew near. On Monday, Spain submitted its formal request for bank sector aid, and then European officials turned their attention to setting details of a growth pact to compliment the fiscal compact. Leading up to the opening of EU summit, expectations were being tamped down, particularly by German officials, who repeatedly vowed their staunch opposition to the notion of mutual liability, most notably to Eurobonds and deposit insurance. Late into the summit's first day President Van Rompuy confirmed that leaders had agreed on a growth agenda valued at €120B, or 1% of EU GDP. The surprise turn came later that night when EU leaders agreed to direct the firewall funds of the EFSF and ESM toward direct recapitalization of banks, reversing the German stance against it. Additionally and more importantly, countries not currently involved in bailout programs (Spain & Italy) will be allowed to access funds, and any ESM loans made to Spanish banks will not have creditor seniority. The potential for a break in the cycle of ever higher borrowing rates across Europe really goosed sentiment. European peripheral yields plummeted and the US 10-year yield moved below that of the German Bund for the first time since early February.
Investors aggressively piled into risk trades, and even some backtracking by German Chancellor Merkel had little effect after she reminded everyone that the ESM bank recapitalization plan would need unanimous approval and aid from the EFSF/ESM will always have certain conditions and could take up to one year. After trading below $80 for much of the week, crude futures rocketed up over 9% on Friday, and gold simultaneously gained over 3%, ending the week near $1600. The EUR/USD surged two big figures briefly approaching 1.27. Thanks to the huge rally on Friday stocks were up this week: the DJIA gained 1.9%, the S&P500 rose 2% and the Nasdaq added 1.5%, making it the best June for stocks since 1999.

The US Supreme court decision on Thursday held that the mandate at the center of President Obama's healthcare overhaul is constitutional as a tax (but not as a 'penalty' as it was framed by the Obama Administration). Chief Justice Roberts joined the left wing of the court to uphold the mandate, not based on the Commerce Clause but on the basis that Congress has the authority to set taxes. The court also ruled to limit Medicaid expansion but did not invalidate it. This decision was a real stunner as almost no one expected the law to be upheld in this manner. Almost every lower court rejected the tax argument and the key to almost every decision was the Commerce Clause. Republicans quickly reiterated calls to repeal the law and healthcare insurance industry groups said that major provisions (premium tax) in the healthcare reform law will have unintended consequences including cost increases. Some also argued that the law being upheld will inflame partisanship, making it harder to get a budget deal done heading into next year's fiscal cliff. Congress demonstrated some ability to compromise this week, however, passing the $120B highway transportation and student loan bill in both chambers on Friday.

Several drug names were in the news prior to the Obamacare ruling. Arena Pharma's lorcaserin weight loss pill was approved by the FDA for obese adults (i.e. body mass index of 30 or greater). The company will be required to conduct post marketing studies but because it was the first weight loss drug approved in more than a decade it brought buyers into the entire sector. Teva opened the week with surge after receiving a favorable court ruling in its copaxone patent infringement litigation with Momenta Pharma. The decision covers several patents, the last of which expires on September 1, 2015. Shares of Bristol-Myers and Pfizer moved lower after receiving a complete response letter from the FDA on the application for its eliquis stroke prevention drug, requesting additional information on data management and verification from the Aristotle trial.

Though it took a back seat to Europe and Obama care, the US housing market quietly had a good week. The data continues to point to a potential bottom as sentiment is beginning to brighten. Monday's May new homes sales registered a 25-month high while month's supply figures dropping to levels not seen since late 2005. The April S&P/CaseShiller house price survey showed the smallest y/y decline since Dec 2008. Also May pending home sales registered a 6-month high. After the data, the chief economist at the NAR commented that if housing starts do not rise in a meaningful way over the next two years due to the difficulty in getting construction loans, and barring an unexpected shift in the economy, the steady shedding of inventory could lead to shortages where home prices could get bid up close to 10 percent in 2013. Among the homebuilders, Lennar reported strong results that beat on the bottom line while coming up short of analyst revenue estimates. New home orders rose 40% though with average selling prices climbing and the cancellation rate dropping which has provided a boost for the sector.

Thursday's initial jobless claims were roughly in line with analyst expectations but remained elevated at 386K, further dampening the prospects for a recovery in the monthly payrolls data next week. The data followed a disappointing Q4 earnings report from Paychex, which cuts its FY13 revenue forecast. The payroll, human resource, and benefits outsourcing solutions provider is often viewed as a good barometer of the employment landscape.

Anheuser-Busch confirmed the purchase of the remaining stake in Groupo Modelo shares this week. The $20.1B deal represented roughly at 30% premium bringing the estimated total enterprise value north of $32B. The transaction is expected to close during Q1 2013 and financing has been fully committed.

Throughout the week cracks to the global economic growth story emerged. In their quarterly report the Brazilian central bank cut its 2012 growth forecast to 2.5% from 3.5%. German economic data was generally softer culminating in Friday's disappointing decline in May retail sales figures. Prior to that several large German companies provided commentary indicating they were not immune to Europe's woes. Chip maker Infineon guided Q3 revenues to be "slightly" lower on a sequential basis due to current global economic uncertainties. Siemens CFO said he expected some difficulty in meeting the lower end of its earnings guidance range due to slowdown in China and continued European uncertainty. Salzgitter also revealed it no longer expects to be able to achieve breakeven results for its steel unit this year which weighed on the entire group. By Friday, North American multinational corporations had joined the chorus. Nike shares plunged more than 10% after Q4 results were shy of consensus expectations on weaker margins, while Research in Motion fell nearly 20% as its Q1 Blackberry shipments plunged.

For much of the week the EUR/USD pair hovered in the lower end of its established range from mid-June, with the 1.2450 support seen as pivotal. The higher yields in the Spanish and Italian auctions coupled with weak Italian retail sales offset any benefits of a potential EU fiscal union deal at the upcoming summit. Growth remained a concern for Europe. The German engine showed signs of sputtering while peripherals faced renewed headwinds, exemplified by the Bank of Spain comment that its Q2 GDP contraction would be worse that Q1. Softer inflation data in Europe and weaker German employment figures boosted expectations for an ECB rate cut next week. Analysts are now calling for a 25-50bps cut in the main refi rate from its current historic low level of 1.00%. By Friday the EUR/USD pair exhibited it biggest one day gain in eight months following the EU announcement of its roadmap towards further integration. The EUR/USD moved off its Asian lows of 1.2433 and approached 1.27 by mid-morning before consolidating its gains throughout the European morning.

The USD/JPY currency pair maintained a firm tone despite the Japanese Lower House passing a national sales tax hike legislation and May inflation data disappointing expectations. While PM Noda had succeeded in pushing through his consumption tax increase proposal, the victory in the Diet may have political repercussions for his own party. Former DPJ leader Ozawa is expected to decide as early as Monday on whether he and some 50 of his supporters would bolt the DPJ in opposition to the legislation. Although the initial estimates suggest the number of departing lawmakers would be below the 54 threshold required for DPJ to maintain its lower house majority, the fracture may leave the ruling party in a far more vulnerable state. Meanwhile, Japan May core CPI data returned to deflationary territory, falling into negative territory for the first time in 4 months and potentially signaling yet another increase in the Bank of Japan asset purchase facility at its next meeting on July 12th. The concerns over Europe and cross currency flows caused the JPY to benefit from risk aversion throughout much of the week. But risk was back on during Friday's European session following Day one of the EU Leader Summit. The USD and JPY currencies were weaker against the European and commodity-related pairs.

Over in China, May industrial profits saw its third consecutive month of decline at -2.4% y/y, as attention shifts to the weekend release of the official manufacturing PMI data. Recall the HSBC flash PMI last week shocked to the downside, falling to a 7-month low 48.1. While the official PMI figures have stayed above the 50 threshold until now, analyst consensus appears to be on the side of a contraction this time - the first below-50 print since November of 2011.