Friday, January 8, 2016

China Fears Spoil the New Year Weekly Market Update: China Fears Spoil the New Year
Fri, 08 Jan 2016 16:05 PM EST

Global stock markets experienced one of the worst first trading weeks of the year ever, pummeled by China's ham-fisted attempts at stock market and currency reform. The S&P500 ended the first five days of 2016 down by 6%, while the DJIA erased 6.2% over the same period. Both the DJIA and the Nasdaq are now in correction, 10 percent off their 2015 highs. Weak Chinese data and the PBoC's attempts to shore up the economy by accelerating the devaluation of the yuan shuttered Chinese equity trading twice, creating panicked reactions in various global equity markets. Gold and government bond prices held up relatively well with investors turning away from risk assets, but oil prices continued to sink.

The selloff got underway on Monday after Chinese regulators implemented new circuit breaker rules for mainland equity markets, including a halt in trading for the day if the index fell 7%. That morning, the official China December manufacturing PMI dropped slightly to 49.7, marking its fifth month in contraction, while the unofficial Caixin manufacturing PMI dropped to 48.2, for its tenth month in contraction. The data gave traders the excuse they needed to test the new rules, and the Shanghai Composite was halted after dropping by 7% in afternoon trading. Shanghai appeared to stabilize somewhat on Tuesday and Wednesday, then on Thursday it only took 29 minutes after the open of cash equity trading for the Shanghai index to tank 7% and trigger the circuit breaker. The yuan fixing was blamed for Thursday's slide.

For eight straight sessions through Thursday, the PBoC weakened its yuan reference rate, dropping it to 6.5646 on Thursday, the weakest rate against the dollar since March 2011. Thursday's fix was significantly weaker, -0.5% from the prior day, the biggest margin of decline since the August devaluation. The move prompted concerns that the central bank's continued efforts to weaken the yuan will spur massive investment outflows from the mainland. The PBoC set the rate a bit higher on Friday. There were unconfirmed reports that the PBoC heavily intervened in markets throughout the week in an attempt to control the declines in the yuan. China's defense of the yuan had managed to stabilize the currency for almost four months following the notorious August devaluation, although the effort led to the first-ever annual decline in the nation's FX reserves, seen in data out on Thursday.

Traders dumped emerging market currencies while factoring the ramifications of a weaker yuan. The Mexican Peso and South Africa Rand hit fresh lifetime lows against the dollar. The Turkish Lira hit a three-month low and the Brazilian Real gained a foothold above four to the USD while its close ties to the Chinese economy were scrutinized. With oil trading in the low $30's and copper testing 2.00/lb., other commodity-backed economies saw their currencies fare very poorly as well. USD/CAD broke out above the 1.40 mark reaching levels not seen in more than a decade. The Aussie Dollar fell roughly 3 big figures against the Greenback to trade below 0.70 for the first time since early October.

Relations between Saudi Arabia and Iran reached an all-time low after the Saudis executed 47 militants, including Nimr al-Nimr, a Shiite cleric and activist on behalf of the Shiite minority. Protests erupted in Iran and throughout the Shiite world. In Tehran, a mob burned down the Saudi embassy, leading Riyadh (and many of its Gulf allies) to cut diplomatic ties with Iran. With crude at more than a decade low, the Saudi budget deficit hit an unprecedented 15% of GDP, forcing the government to dip heavily into its reserves. In response, the Saudis said they might attempt to IPO the state oil company, Saudi Aramco. Analysts suggest that even if the Saudis sell a small stake, the listing could easily surpass that of Alibaba, whose $25 billion IPO is the largest on record. Aramco could be worth anything from $1 trillion to upwards of $10 trillion, which would make it the most valuable company in the world by a long shot.

WTI and Brent marched in lockstep from around $38 to test towards $32 on Thursday afternoon. There was a brief move higher on Monday due to the Saudi/Iran dustup, however the Gulf tension was no match for global market turmoil. Traders ignored big drawdowns in the DoE and API crude inventory reports, as well. After fears about China and emerging market growth, the strong dollar appeared to be the other major catalyst holding down oil prices. The greenback at its weakest remained above the low levels seen in November and early December, however EUR/USD lunged back below 1.0750 early in the week, marking one-month lows.

The US December jobs report was surprisingly strong, capping off a good year of employment growth. Non-farm payrolls far exceeded expectations, rising by 292K versus 200Ke. The blowout in the ADP report earlier in the week had hinted at a good showing on Friday. Unemployment remains at 5%. Wages were the only sour note in the report: average hourly earnings were flat in December compared to the prior month and rose 2.5% against the prior year. Both numbers missed expectations.

Automakers reported total industry sales of nearly 17.5 million for 2015, for the industry's best sales year ever. Fiat and Ford reported December US sales results that fell a bit short of expectations, while GM's December sales met consensus estimates. Fiat and Ford also reported that total 2015 sales were the best they'd seen in a decade. US-traded ADRs of Volkswagen sank sharply after the US government filed a lawsuit seeking penalties as high as $80 billion - more than the company is worth - and faulted the German carmaker for a lack of progress fixing cars with rigged engines.

Shares of Apple were under pressure this week after press reports warned that the company was expected to reduce the output of its iPhone 6s and 6s Plus devices by about 30% between January and March. Apple was said to be cutting back production in order to allow iPhone dealers to work their way through inventories that have piled up at retailers in markets ranging from China and Japan to Europe and the US amid lackluster sales. Several prominent firms cut price targets and ratings on Apple in the wake of the reports. Then on Thursday, Apple component suppliers Cirrus Logic and Qorvo cut their forecasts for the current quarter.

In other tech news, the Consumer Electronics Show in Las Vegas took place this week, with the usual assortment of flashy tech baubles on display. Smartwatches got the main billing, with investors frowning on the new FitBit Blaze watch. Amazon also got a great deal of attention for entering the semiconductor business and selling its own branded chips to other companies.

In merger news, the big story was Shire getting very close to success in its long-running pursuit of Baxalta. Back in August, Shire had proposed an all-stock deal at around $45/share for Baxalta, valuing it around $30 billion. Baxalta chose not to even enter negotiations back then, but this time around an offer as high as $48/share with a cash component up to 40% of the deal appears to have gotten their attention. ON Semiconductor got a new competitor in its pursuit of Fairchild Semiconductor. China Resources Microelectronics Limited offered $21.70/share, above ON Semi's $20/share bid, and Fairchild's board determined it to be a superior offer.