Friday, March 1, 2013

Market Week Wrap-up Weekly Market Update: Markets Weather Political Follies in Washington and Rome

- Trading in global markets was highly volatile this week. The indecisive outcome of the Italian parliamentary elections has left Italy in limbo without a government, threatening a full-blown return of the euro crisis just as it seemed that the European Union had gotten the situation under control. Later in the week, a round of dire European February manufacturing PMI data suggested that the economies of the EU member states were stabilizing at a very low level, or in the case of Italy were actually getting worse. In the US, much of data was quite good: the US February ISM manufacturing index rose to 54.2, its highest level since June 2011, beating expectations, and the new orders sub-index was near two-year highs. The second reading of US Q4 GDP was lower than expected but came in hair better than the first reading, rising to +0.1% from the initial -0.1%. In China, there were reports that the government would institute a package of measures to help curb the overheating home prices. Note that the new government will be seated next week. There was much hoopla late in the week about the DJIA climbing to within striking distance of all-time highs. For the week, the DJIA gained 0.6%, the S&P 500 added 0.2% and the Nasdaq rose 0.3%.

- Anxieties about the Italian parliamentary elections were more than borne out by the results this week. Initial exit polls on Monday suggested that Bersani's center-left coalition had won a decisive victory, however the messy reality showed Bersani had not achieved a margin of victory that would let him form a government without the support of either Berlusconi's center-right coalition or Beppe Grillo's Five Star Movement. Both Berlusconi and Grillo have repeatedly refused to join in the formation of a government, although Grilllo seemed to hint he might support a left-wing government once it was in office. By the end of the week, Berlusconi was calling for a new election. Data released this week emphasized Italy's desperate need for a stable government as the January unemployment rate rose to 11.7%, the highest level since the series began in 1992, and 2012 final GDP came in at -2.4%.

- President Obama and the Congressional leaders failed to replace the sequester cuts with a more reasonable package of budget reductions. There was endless political sniping by Speaker Boehner, Senate Majority Leader Reid and Obama, but in the end nothing was accomplished. The current continuing resolution that provides the government with funding expires on March 27, although there have been reports that talks are happening between the two sides to extend this date until September in order to provide space for negotiations to replace the sequester. If no deal is struck, there is the possibility of a government shutdown and a bruising political battle. On Friday, President Obama conceded that in may take weeks or months to reach a deal to replace the sequester cuts with more targeted measures.

- In other Washington news, the Senate Finance Committee backed President Obama's nominee to head the Treasury, Jack Lew, overlooking the perks he got from previous employers and clearing the way for a full-Senate confirmation vote. Fed Chairman Bernanke provided semi-annual testimony before the Congress. He reiterated his standing opinions, offering little new. He defended QE, saying the benefits of asset purchases clearly outweigh the costs and urged the Congress to replace the sequester cuts with more nuanced and gradual spending reductions.

- Despite the DJIA's run toward fresh all-time highs, Treasury yields have remained near the lowest levels of the year. Investors eager to start the "great rotation" in earnest continue to be cautioned by safe haven flows prompted by the still uncertain situation in Europe and Bernanke's insistence that rates are not going up anytime soon.

- The earnings focus was on retailers this week. Shares of JC Penny fell about 20% following its disastrous Q4 report, which one analyst called the worst quarterly results by a retailer in history. The bleeding continues apace, with comps down nearly 32% in the quarter. CEO Johnson admitted that mistakes had been made and said a new promotional strategy would be adopted. Target's results were weak, with sales comps barely above flat in its Q4 and the outlook for full-year comp flat with last year. Gap, Limited Brands, and TJX had decent Q4s, but like other retailers their guidance for the current quarter and the FY was weak.

- Ahead of Apple's annual shareholder meeting this week, there was plenty of speculation about what the company might do with its cash hoard. Greenlight Capital's David Einhorn has been pushing the company to return the cash to shareholders, and at the meeting Apple CEO Cook acknowledged discontent among holders and promised that the company was working on ways to reward shareholders, although he offered no concrete measures.

- The euro was hammered by the events in Italy, and on Friday EUR/USD momentarily nosed below its January lows. Recall that the pair's January trading range has marked either the high or the low for remainder of the year in ten out of the 13 years since the euro's launch in 1999. The January 2013 range is 1.3711 to 1.2994. The optimistic early Italian exit polls on Monday had sent EUR/USD above 1.33, but the pair bounced around between 1.3030 and 1.3160 once the political trench warfare began in Rome. Friday's awful European PMI data sent EUR/USD as low as 1.2970, although it managed to close out the week above 1.30.

- Cable plumbed 2.5-year lows through the end of the week on fears that the UK really was headed for a triple-dip recession. The PMI data suggest that the UK economic contraction is worsening rather than getting better as the Cameron government holds the course on fiscal consolidation programs. GBP/USD fell below 1.52 early on in the week and only found support right at 1.50 after the PMI numbers on Friday.

- USD/JPY headed even higher on Monday after reports suggested that PM Abe had settled on Haruhiko Kuroda as the new BoJ chief. Kuroda is said to support Abe's policy of inflation targeting and monetary easing. However the risk-on tone that returned after the initial Italian election results came in helped strengthened the JPY on Monday and sent USD/JPY to its lowest levels since late January, just above 90. The pair floated back above 93.50 by week's end.