Friday, November 20, 2015

Markets Undeterred by Terrorist Attacks Weekly Market Update: Markets Undeterred by Terrorist Attacks
Fri, 20 Nov 2015 16:03 PM EST

The week began with investors largely looking right past headlines related to the disturbing Paris terror attacks. European indices made up all of their losses from last week and US equities returned to gains after last week's retreat. A second straight quarter of negative GDP put Japan back into technical recession, marking another setback for PM Abe's grand plans for reviving his country's economy. A chorus of commentary from US Fed officials book-ended the Oct FOMC minutes midweek, and largely cemented expectations US rates could very well begin going up next month, but that they will only be rising at a very tempered pace. In Europe, ECB President Draghi amped up expectations for more easing, while the PBoC cut short-term borrowing rates, to some extent fulfilling expectations that Beijing would do more to help the flagging Chinese economy. The US Dollar remained buoyed by the divergent central bank outlooks, resulting in a fresh 7-month low in the Euro. WTI crude blipped below $40 briefly but held that level into week's end, while copper saw another fresh 6-year low. For the week the DJIA gained 3.4%, the S&P rose 3.3%, and the Nasdaq rebounded 3.6%.

The minutes from the last FOMC meeting sent fresh signals that the Fed is more and more confident that it will raise interest rates at the December meeting as long as job growth and inflation trends don't take a turn for the worse. Most officials at the October meeting anticipated that December "could well be" the time for rate liftoff. "Most participants anticipated that, based on their assessment of the current economic situation and their outlook for economic activity, the labor market, and inflation, these conditions could well be met by the time of the next meeting," read the minutes. The US Treasury curve flattened following the minutes and stocks surged as markets appeared more comfortable that they can handle a gradual rise in rates.

Japan preliminary third quarter GDP was negative for a second consecutive quarter (-0.2% q/q), marking Japan's first technical recession since mid-2014 (the last one followed the increase in the consumption tax as part of Abe's Three Arrows reform). Corporate capex spending did the most damage, falling -1.3%, while the soft JPY boosted exports in the quarter to +2.6% from -4.3% prior and consumption was nearly flat at +0.5%. The negative print further boosted expectations for more BoJ easing or a supplemental fiscal budget to address the slump, although the BoJ maintained its stance at its policy meeting on Wednesday. The BoJ maintained its annual pace of monetary base expansion at ¥80T and also kept its overall economic assessment unchanged, while it slightly tinkered with its inflation outlook. USD/JPY marked an eight-week high after the GDP and BoJ developments on Wednesday, touching 123.65 before tightening up into week's end.

In a speech on Friday, ECB President Draghi made his case for more easing in December (the ECB Council meets on December 3rd). While the speech largely reiterated his past themes, Draghi added subtle changes that suggested even headline inflation moving towards target will not be enough. He said the ECB needs to be confident that inflation will not only converge to, but also stabilize around levels close to 2% over the medium term, adding inflation stabilization for the first time to ECB forward guidance. Analysts said his remarks suggest the ECB may sustain monetary stimulus even if oil prices push headline inflation above the 2% target. They also highlighted that German inflation hawk Weidmann took a different tack, called lower energy prices more of a stimulus than a deflation signal. The euro kept weakening and closed the week below 1.0650 for the first time since April.

A pair of US housing industry indicators stepped away from their recent highs. The NAHB index of homebuilder confidence declined slightly in November, to 62 from a revised reading of 65 in October. The October reading represented the highest level since late 2005, for a cycle high. Analysts were unsurprised, even as the reading missed expectations, calling the dip back to September levels a heathy correction that was in line with sales and mortgage applications readings. The annualized pace of housing starts fell 11% to a seven-month low in October, although it's worth remembering that October marked the seventh straight month of starts above 1 million units, the longest stretch since 2007.

Two more major US retailers got a thrashing this week despite reporting merely mediocre quarterly results. Target met expectations on the top and bottom lines, reported a good-not-great 1.9% gain in comps and slightly adjusted its FY guidance. Best Buy beat EPS expectations and boosted margins y/y. Investors frowned on initial FY16 guidance that called for nearly flat revenue and a modest decline in the operating income. BBY fell 8% at its worst after reporting, while TGT was off 6% at its worst. Both names recovered into week's end. Home Depot and Lowes saw strong gains on the week thanks to very good comp sales growth and more limited earnings and revenue outperformance.

Big name IPOs made a comeback this week with the initial stock offerings of Square and Match Group. Early in the week, reports said that the companies were being advised to cut their IPO prices to ensure early investors would be happy and indeed Match priced at the lower end of its $12-14/share initial pricing range while Square priced at $9/share, well below its $11-13/share initial range. With their modest pricing, both IPOs saw a big pop on their first day of trading, and each managed to trade above their respecting initial pricing range.

On Thursday, UnitedHeath Group cut its FY15 guidance and offered a slightly soft initial outlook for FY16. The CEO said the company had suspended marketing for Affordable Care Act exchanges and could exit the Obamacare individual health plan business altogether because it is losing money on the business. UNH's shares fell 6% in the session and the comments dragged down most of the sector. Analysts suggested bigger losses may be in the pipeline for other healthcare insurance names more exposed to flawed exchanges.

In M&A news, Starwood Hotels agreed to be acquired by Marriot for $12.2 billion, mostly in stock. Together, the companies will operate or franchise 5,500 hotels with a total of 1.1 million rooms, in around 100 countries. The already shaky $6.3 billion Staples/Office Depot merger was looking worse after the New York Post reported that the FTC might finally block the deal due to antitrust concerns. Shares of ODP were down 12% on the week. Railroad Norfolk Southern received an unsolicited offer from Canadian Pacific valued at $46.72/share in cash and 0.348 fixed share exchange ratio. Norfolk's board described the deal as low-premium and highly conditional but did not reject it out of hand, and CP's leadership indicated they may be willing to increase their offer. Recall that CP tried and failed to buy CSX last year.

The US Treasury implemented stiffer anti-tax inversion merger rules in an attempt to make overseas deals designed to avoid US taxes more difficult. The new rules restrict US firms from inflating the size of the new foreign corporate parent, and thereby avoid the current rule that requires the former owners of the US firm to own less than 80% of the newly combined entity. The move threw a monkey wrench in the ongoing merger talks between Pfizer and Allergan, but did not derail them. At the beginning of November, talks between the two companies were active, while this week reports suggested the deal could be priced as high as $150 billion, for the biggest drug industry deal in history. There were fears the deal might die under the knife of the new Treasury rules, although CNBC's Faber pointed out that the new rules apply to transactions where continuing ownership is in fact 60-80%, and under current talk Pfizer would own 59% of the combined entity with Allergan.