Friday, July 13, 2012

Market Week Wrap-Up

- The first week of the June quarter earnings season saw relatively subdued trading and low summertime volumes. Risk-off sentiment dominated through Thursday morning, as global growth fears and nervousness about the sustainability of the euro zone bailout funds predominated. There were fears that China's Q2 GDP report could be much worse than expected, while in Europe the German Constitutional Court heard arguments about the legality of Germany's participation in the ESM bailout fund and fiscal compact. Safe haven flows continue to dominate fixed income markets on both sides of the Atlantic. The benchmark US 10-year yield closed below 1.5% for just the second time ever on Wednesday following a historically strong $21B 10-year reopening. In the euro zone, the core counties saw their yields continue to plummet, with yields on Austrian, Belgian, and French bonds all hitting record lows. Spanish 10-year yields briefly topped 7% before falling back roughly 50 basis points on confirmation and more details regarding its bank bailout plan. Italian 10-year yields popped back above 6% on Friday following a two notch downgrade at Moody's. China's Q2 GDP turned out to be more or less in line with expectations, although even at that it was still a 13-quarter low. Markets turned higher on Friday on relief that the Chinese data was not as dire as feared, plus a surge among financials driven by JPMorgan's solid quarterly results. For the week the DJIA gained less than 0.1%, the S&P500 rose about 0.2% and the Nasdaq lost 1.0%.

- JPMorgan disclosed that total losses to date from the London Whale debacle amount to $5.8B, $4.4B of which was recognized in the second quarter. The firm also warned that "certain individuals may have been seeking to avoid showing the full amount of the losses in the portfolio we are no longer confident that the trader marks reflected good faith estimates of fair value," casting more doubt on the bank's business practices. CEO Dimon insisted that the firm would only lose another $1.6-1.7B on the bad trades. Due to these issues, JPM restated Q1 result, cutting EPS to $1.19 versus the $1.31 previously reported. In Q2, the firm posted net income of $4.96 billion or $1.21 a share. Note that profits were bolstered by $2.1B from loan loss releases and $755M or $0.12/share by gains from DVA adjustments. The underlying tone of the firm's report was relatively positive and Dimon promised better news in Q3.

- In other equity news, Alcoa beat consensus estimates in its Q2 report, but failed to improve the weaker forecast for aluminum demand it issued earlier this year. Supermarket chain Supervalu declined nearly 50% after the firm disclosed disastrous profits for Q1 and suspended its dividend. In an interim update, Chevron's earnings forecast implied that profits would be a bit higher than expected thanks to improved refining margins and some better downstream performance. Gambling names were hurt by the very weak May Nevada casino revenue report. Las Vegas strip revenue in May was $475M, -18.2% y/y.

- The drought in the Midwest has made the agriculture a market focal point over this month. Wednesday's USDA crop report - the World Agricultural Supply and Demand Estimates (WASDE) - was a highly anticipated snapshot of conditions, although many analysts said the USDA would be conservative in reducing projected crop yields. Little conservatism was in evidence in the report: corn yields were slashed by 20 bushels per acre to 146 while soybean yields were cut to 40.5 bushels per acre from 43.9 prior. The unexpected revisions sent futures much higher in the immediate aftermath of the data. However, the surge topped out and futures turned around as the smart money stepped in to buy. Predicting crops is a tricky business, and some expect that the USDA could have to roll back these cuts next month if the drought breaks even somewhat.

- Europe was relatively quite this week for the first time in months. The most impactful news came from Germany, where the Constitutional Court heard arguments for and against the constitutionality of Germany's participation in the European Stability Mechanism (ESM). The court is not considered to be terribly pro euro, and in the past Chief Justice Vosskuhle has said that if Germany wants to move towards a fiscal union, a new constitution and referendum are needed. The court could first hand down an injunction next week, preventing German ESM participation from moving ahead while the court is still deliberating, with a final decision coming later. German press reports indicated that the court would not rule quickly on the matter; Der Spiegel wrote that the final decision would take months and might even take until 2013. Vosskuhle said he recognized that it was "not easy" for the court to decide whether to grant a temporary injunction or allow the treaty to take effect at the risk that it can no longer be halted if ruled unconstitutional at a later date. The fear is that an injunction itself will be considered to have gutted the ESM.

- In other Europe news, Spain's government passed a new round of austerity measures, including a mixture of spending cuts, reforms of government operations, competitiveness reforms and VAT tax increases. The new package aims to save an additional €65B over the next two and a half years, and was opposed by massive street protests in Madrid and other major cities. Commentators such as the UK Telegraph's Ambrose Evans-Pritchard and Paul Krugman warned that the additional measures could push the economy into a depression. For most of the week, the euro drifted lower alongside equity markets, with EUR/USD sliding from approximately 1.2320 to lows around 1.2170, before bouncing higher in Friday's relief rally. The EUR/GBP cross put in a new three and a half year low, breaking below 0.79 for the first time since late 2008, while EUR/AUD broke to fresh all-time lows.

Economic data out of China was in the spotlight from start to finish this week. The Sunday evening release of inflation data continued to support an increasingly aggressive policy stance by the PBoC, as June CPI rose just 2.2% y/y - the slowest pace of consumer price growth since early 2010. On Monday evening, China trade surplus came in at a 37-month high of $31.7B, however analysts were quick to point out the surplus was largely the function of much weaker than expected imports components which rose just 6.3% vs 11% expected. Weakness in domestic consumption and the manufacturing sector implied by slowing imports growth were on display late in the week, with China June retail sales coming in at a multi-year low 13.7% y/y and industrial production missing expectations by three-tenths at 9.5%. The news out of China was not all bad however, as Q2 GDP was close to consensus at 7.6%, spoiling some of the more bearish estimates around 7% from mainland research officials and boosting Asia-Pacific commodity FX as well as basic materials. Chinese lending data was also much better than expected, with new yuan loans rising to a 3-month high of CNY920B while offering some indication of the impact of recent PBoC accommodation taking hold.

Far east central bank presented some surprise policy decisions as the Bank of Japan was less aggressive than some hoped, while the Bank of Korea announced an unexpected rate cut. The BOJ increased its asset purchase policy component by ¥5T in T-bill operations but also cut its fixed-rate facility by the same amount, effectively keeping the total size of the package at ¥70T. JPY strengthened in the wake of the BOJ decision to keep more powder dry, with USD/JPY falling to a 3-week low around the ¥79 handle. Bank of Korea surprised with a 25bp cut to 3.00% - its first easing since early 2009 - in a likely reflection of concern over rising level of default in household loans. Later in the week, Bank of Korea cut its 2012 GDP forecast by half a percentage point to 3.0%, while also lowering 2012 inflation by the same margin to 2.7%.