Friday, July 11, 2014

Market Week Wrap-up  Weekly Market UpdateVolatility Picks Up, Correction Fears Rife 

- There was much talk about a looming equity correction among market participants this week. Global indices lost ground, very gradually in the US and most of Asia, and more dramatically in Japan and Europe. Trouble at a Portuguese bank midweek drove a brief rash of contagion fears that recalled the darkest days of the euro debt crisis, however the situation ended almost as soon as it had begun. Nevertheless, markets were reminded that unknown risks lurk everywhere as the Fed and the BoE gear up to exit easy policy even as the ECB struggles to deal with Europe's stubborn disinflation and flat growth trends. Alcoa rang in the June quarter earnings season with a strong quarterly report, and Wells Fargo offered a mixed report. For the week, the DJIA fell 0.7%, the S&P500 fell 0.9% and the Nasdaq declined 1.6%.

- Global markets were spooked on Thursday by problems at Portugal's largest bank, Banco Espirito Santo. Trading in shares of BES were suspended after a wealth management affiliate delayed a debt payment. The yield on Portugal's 10-year note surged to 4%, the highest since early April, and the yields on other peripheral Eurozone sovereign bonds pushed higher. Portuguese and EU officials rushed in to reassure markets that the situation was a one-off and the bank claimed to have plenty of capital on hand.

- Volatility trended higher this week, raising hopes that the dull-as-rain trading seen in the last month is over for now. After bottoming out at 10.28 last Thursday, a seven-year low, the CME's Volatility Index (VIX) ticked as high as 13.20, its highest level since mid-May. The volatility index is still 14% below its one-year average of 13.9 and has closed below that level for 49 days, the longest streak since 2007.

- Crude prices continued to slide, with the front-month WTI contract gliding from $103.70 to close out on Friday around $100.70. Brent futures dropped from $111.60 to close out the week around $107. In Libya, the National Oil Company lifted force majeure on recently regained oil ports, Es Sider and Ras Lanuf, and began discussions with OPEC about how to accommodate rising crude production. There has not been any real change in the situation in Iraq this week, with the fighting there causing little disruption to oil production.

- Wells Fargo was the first of the big banks to report second quarter results. The firm's numbers were mixed, reporting a 3% y/y increase in profits for the second quarter, although revenues ticked a bit lower and EPS was flat for the first time in years. The results reflect a decline in provisions for credit losses and slightly lower expenses, both of which helped offset a 39% y/y decrease in mortgage banking income. Mortgage originations were up over the first quarter but down more than 50% y/y. Executives said the pipeline of mortgage originations was better in the firm's third quarter, but still had not returned to pre-crisis levels.

- Commentary and numbers out of a spectrum of retail names this week suggest not all is well with the US consumer. Walmart CEO warned the hiring rebound has failed to lead to a rise in spending by Walmart's core of middle- and lower-income customers. Restaurant chain Bob Evans said that it sees consumer confidence adversely impacted by macroeconomic headwinds, including health care costs and unemployment. Home improvement supplier Lumber Liquidators guided Q2 lower, saying the demand it experienced following the tough winter did not carry into May and June. After mixed quarterly results, Family Dollar said its numbers reflected the economic challenges facing core lower- and middle-class customers. Finally the June same-store sales figures from L-Brands and Gap missed expectations.

- Airline stocks saw turbulent trading. Early in the week, Air France-KLM warned that rising competition from other airlines on long-haul flights, weak cargo demand and forex issues would reduce earnings more than expected. The slump in Air France's shares pulled major US airlines lower. Then on Wednesday United and American both issued positive second quarter updates. American hiked its Q2 pre-tax margin guidance and disclosed it has sold off its remaining portfolio of fuel hedging contracts, while United said its passenger revenue per available seat mile (PRASM) rose well above expectations thanks to better domestic and Pacific performance. United and American shares gained altitude on the guidance.

- Merger activity quieted down, with only a few deals in headlines. AbbVie raised its bid to acquire Shire, which has already rejected its prior takeover offer. AbbVie raised its cash-and-stock offer by 11%. Reynolds entered negotiations to acquire Lorillard. Imperial Tobacco is also in on the talks, looking to acquire certain brands to help Reynolds address anti-trust concerns. British American Tobacco, which holds 42% of Reynolds, is seeking to maintain an undiluted stake.

- Cable saw its first weekly decline against the dollar since May on signs that momentum in UK economic growth is starting to slow. The pound also fell against nearly all of its other major pairs. The May UK industrial production data slumped, seeing its biggest monthly decline in a year and a half, while June RICS and Halifax home price indices both surprised to the downside. As of July 4th, GBP/USD hit highs around 1.7180, the pound's best level since October 2008, and was back around 1.7110 as of Friday. EUR/USD remained trading in a tight range in the lower half of 1.36.

- US Treasury Secretary Lew travelled to Beijing this week to meet with his Chinese counterparts, who agreed to reduce but not end FX intervention. PBoC Chief Zhou has already signaled that he would like the yuan to reflect market forces, although the PBOC does not really have much independence from China's leadership. China Fin Min Lou Jiwei said that some FX intervention is still needed when China's recovery is not solid and money flows are unstable. USD/CNY exchange rate fell to a 3-week low of CNY6.1950 midweek.

- Initial economic data for the month of June out of China were generally less impressive than May figures but not particularly worrisome. CPI of 2.3% just missed the consensus estimate of 2.4%, as food component slowed to 3.7% from 4.1% and non-food remained unchanged at 1.7% y/y. First-half CPI is well contained below the 3.5% official target ceiling at 2.3%. Chinese trade balance was also lower than expected at $31.6B, with 7.2% exports growth undershooting the 10% forecast as shipments to Japan contracted by nearly 1%. Authorities do not appear concerned over the performance of trade however, expressing more willingness to tolerate renewed Yuan strength.

- In Japan, a 19.5% m/m drop in machine orders - the biggest on record - has renewed speculation the BOJ may be forced to undertake additional easing. Cabinet office has also lowered its assessment on machine orders to state the "increasing trend has been seen stalling", and investors will surely tune in to next week's BOJ policy statement to gauge the extent of its concern over the apparent impact of higher sales tax. The Nikkei225 underperformed regional indices, falling nearly 2% this week.