Friday, February 26, 2016

Oil Prices and Policy Stimulus Hopes Elevate Markets Weekly Market Update: Oil Prices and Policy Stimulus Hopes Elevate Markets
Fri, 26 Feb 2016 16:13 PM EST

Higher oil prices, soothing central bank/G20 commentary and better US economic data all helped European and US equities climb higher this week. On Friday, the S&P500 tested above the key 1950 level that has repeatedly provided strong resistance over the last several weeks as global markets looked to put the rough start to 2016 in the rear view mirror. Treasury demand remained noticeably firm into month end, especially in light of the improving risk appetite by investors and a string of stronger than expected US data later in the week. Sovereign bond prices did slip on Friday, but have still largely consolidated the safe haven bids seen here in early 2016, keeping the US 10-year around 1.75%. All three of the major indexes closed about 1.5% higher for the week.

Data out this week painted a somewhat confusing picture of the real condition of the US economy. The February preliminary Markit factory PMI reading told us what we already knew: US manufacturing faces very tough sledding. The survey sank to 51.0, its lowest reading since late 2012. But it was Markit's February preliminary services PMI that really freaked people out: the index sank into contraction at 49.8, and Markit Chief Economist Chris Williamson warned the survey data show a significant risk of the US economy falling into contraction in the first quarter. February consumer confidence fell to the lowest level in seven months, with notable declines in the present situation and future expectations components.

On the more positive side, the preliminary January durable goods orders came in at +4.9%, the strongest gain in nearly a year, more than reversing the -4.6% plunge seen in December. The revisions to fourth quarter GDP were a mixed bag, with the headline figure better but spending a bit lower. The second reading of Q4 US GDP defied expectations to the upside, rising to +1.0% from the +0.7% advance figure. Most of the revision higher was attributed to the volatile inventories and trade components. The January personal consumption measure remained very healthy at +2.0%, and personal income accelerated +0.5% from the flat December reading. Core PCE - the Fed's preferred ruler for measuring inflation - was surprisingly strong in January, rising to +1.7% from +1.5% in December, the fastest m/m acceleration seen since late 2012.

January inflation data out of the euro zone suggested the disinflation predicted by ECB Vice President Constancio last week was at hand. The total euro zone measure was a mere +0.3% y/y, while preliminary February readings from Spain, France and four major German states saw negative y/y readings. The readings further strengthened the case for more easing from the ECB next month, even as markets express more and more uneasiness with negative rate policies. The strengthening dollar seen over the prior two weeks continued this week, with the relatively strong US GDP and PCE data on Friday pushing EUR/USD back below 1.0950 and back into the range seen in December and January.

Expectations have been building for weeks if not months that Beijing would be forced to add additional stimulus of some kind in order to deal with the continuing Chinese slowdown. Guessing has focused on RRR cuts, more medium-term liquidity injections and possible fiscal policy moves. There were reports that PBoC staff were recommending the government increase the fiscal deficit to 4%/GDP from the 3%/GDP currently targeted in 2016, although finance ministry officials tempered these hopes. Until Thursday, the Shanghai Composite had remained more or less calm since late January. Tightening liquidity conditions, driven by a spike in short-term money market rates - the overnight repurchase rate spiked by 16 basis points to 2.12% - sparked a 6.4% decline in Shanghai. Interestingly, the sell-off did not travel to Europe and the US, with equities in both regions up sharply on Thursday.

Saudi Arabia, Russia and other major OPEC producers worked hard to consolidate support for the proposed oil production freeze agreement announced last week. Iraq remains non-committal, while Iran ramped up its negative rhetoric. Iran Oil Min Zanganeh called the plan "a joke," while various OPEC officials conceded that Iran might need individual attention in negotiations for a freeze. Parties to the agreement will meet in mid-March to negotiate a formal deal. On Friday, Brent tested as high as $37 and WTI briefly ticked above $34.50 for three-week highs, but by and large prices were well contained within the ranges seen through the month of February.

Cable made fresh seven-year lows every day this week, closing out Friday around 1.3850, forced lower by nervousness about the upcoming referendum on the UK's continued membership in the EU. Political jawboning and constant polling kept the subject of Brexit in headlines, but the biggest development was London Mayor and Conservative Party stalwart Boris Johnson backing the anti-EU camp. Citigroup suggested that Brexit risk rises to 30-40% from 20-30% prior with Johnson's endorsement. Polls were very tight: a BMD/Standard poll on the EU Referendum showed 44% of respondents opting to stay in the EU, while 41% wanted to leave, while a YouGov poll saw 37% in favor of staying versus 38% for Brexit.

Earnings season is winding down with reports from the largest US retailers. Decent results from Macys, Kohls, Best Buy and JC Penny helped boost the shares of a broad spectrum of retail names. Macy's topped its recent guidance for the quarter and offered FY guidance that was slightly ahead of expectations. Comps were down more than 4%, but again this slightly beat consensus views. Kohls raised its dividend and managed to deliver (barely) positive sales comps. Best Buy's comps were negative, although it also launched a big new buyback and raised its dividend. Lowe's and Home Depot both had positive quarters, aided by continuing strength in the housing market. Shares of Hewlett-Packard sold off hard after the firm disclosed ugly revenue declines with its first-quarter results.

After years of negotiations, fallen Japanese titan Sharp reached a deal to sell itself to Chinese firm Foxconn (formally known as Hon Hai Precision Industry) for around $6 billion. But then in a very rapid reversal, shares of Sharp gave up the 15% or so they had gained over the last month on talk the deal was finally closing when Foxconn said it would postpone the arrangement until it had clarified some "new material information" from Sharp, reportedly sizable undisclosed liabilities. Honeywell and United Technologies confirmed press reports that the two companies had discussed a potential merger deal but talks stalled given very significant regulatory hurdles and considerable customer concerns. UTX's CEO went as far as to appear on CNBC to say that a merger with Honeywell just "ain't going to happen." Honeywell confirmed that it had offered $108/shr in cash and stock, and would continue to pursue a combination. London Stock and Deutsche Boerse said they were holding talks about a potential merger of equals, which would create a combined group worth nearly $28 billion.