Friday, June 24, 2016

UK Voters Fancy a Brexit, Global Markets Left in the Lurch Weekly Market Update: UK Voters Fancy a Brexit, Global Markets Left in the Lurch
Fri, 24 Jun 2016 16:08 PM EST

On Friday, the UK voted to quit the European Union after more than four decades of membership, upending global markets and sending the pound to its weakest levels since the mid 1980s. The stunning rejection of Europe's political and economic order prompted Prime Minister Cameron to resign, and global central banks were scrambling to ensure markets continue functioning normally. Asian equity markets cratered, with the Nikkei closing down nearly 8% on Friday and the yen surged, with USD/JPY briefly dipping below 100 for the first time in three years. The CAC fell nearly 8% and the DAX declined nearly 7%, while in the UK the FTSE was only off 2.2% as the surge in gold prices helped hold up the index - where many of the largest global gold miners trade. Gold surged to two-year highs around $1,325. The 10-year Bund yield dipped as low as -0.17%, while the German 30-year yield nearly went negative. The reaction in the States was a bit less harsh, but nonetheless share prices plunged and Treasury prices surged along with the US Dollar. For the week the Dow closed down 1.6%, Nasdaq -1.9%, and the S&P lost 1.6% to finish at a three month low.

The final results of the UK referendum show 51.9% voted to leave the EU versus 48.1% to stay in the union, with London and urban areas strongly favoring 'stay' and northern and more rural areas voting 'leave'. PM Cameron will step down within three months, saying the UK needs fresh leadership. "We should have a new prime minister in place by the Conservative party conference in October," said Cameron. Boris Johnson, former Conservative mayor of London and a leader of the 'leave' camp, appears to be in the front running to lead a new government. The framework of the UK's new relationship with the EU, including trade agreements, will be negotiated over a period of years. Scottish nationalist leader Nicola Sturgeon has said that the Scottish National Party will begin to prepare legislation to allow a new Scotland referendum to take place before the UK leaves the EU. Scotland decisively voted to remain in the EU with 62% voting for 'stay' compared to 38% for 'leave'.

Leading central banks firmly repeated their commitments to strongly support the normal functioning of financial markets. The Fed and other said they would activate existing swap lines to provide adequate liquidity in all cases. Bank of England Governor Carney said the BoE was ready to provide up to £250B of extra funds and foreign currency to stabilize markets and would consider additional policy action in coming weeks. The ECB warned of contagion risks and loss of confidence, with a potential spread to the banking system. The Fed and BoJ both face involuntary policy tightening as funds flee to the greenback and the yen. There is little hope that the Fed will be able to raise rates more than once this year, with a September hike looking less possible and even December a real question. With the yen dropping to parity with the dollar, the Bank of Japan will likely intervene in FX markets ahead of new monetary easing measures, even after Japan Finance Minister Aso said the threshold for an intervention remains very high.

There was little market-moving news beyond the Brexit vote this week. Fed Chair Yellen gave her semi-annual monetary policy testimony before Congress. Yellen offered very cautious remarks, warning that considerable uncertainty about economic outlook remains and that the Fed is concerned that slower productivity growth could continue for some time. Some analysts detect an even softer tone in Yellen's remarks, noting that she seemed to suggest the Fed is looking to see whether there is more improvement in the US economy, not when improvement may arrive. "Proceeding cautiously in raising the federal funds rate will allow us to keep the monetary support to economic growth in place while we assess whether growth is returning to a moderate pace, whether the labor market will strengthen further, and whether inflation will continue to make progress toward our 2 percent objective," Yellen said.

In the US, the June Markit Manufacturing PMI report suggested the healing has begun for the manufacturing industry. The May reading of 50.7 was the lowest in 6.5 years, making June's relatively anemic figure of 51.4 look pretty good. The annualized rate of May existing home sales rose to the highest level in nearly a decade. Strong sales contrasted with lower inventories and higher prices. May new home sales were slightly below the April rate, which was revised lower. Nevertheless, both the April and May reports show rapid growth in sales, with the latest three-month average of 553K up at an annual rate of +19% from the previous three months (Dec through Feb) and up 11% from the same period a year ago.

A spectrum of transport names offered guidance ahead of the June quarter earnings season. Canadian Pacific warned that revenue had declined 12% y/y in its second quarter due to lower-than-anticipated volumes in bulk commodities, such as grain and potash, the unexpected and devastating wildfires in northern Alberta and a strengthening Canadian dollar. United Airlines slightly improved its passenger unit revenue outlook for its second quarter. Executives also hinted that prior capacity reductions had reduced the airline's market share. Southwest reaffirmed its outlook for very modest RASM growth in its second quarter, but warned that RASM would face challenges in the second half of the year. Trucking names Werner Enterprises and Covenant Transportation both offered very soft earnings guidance, citing sluggish demand and higher labor costs.

Elon Musk confounded Wall Street once again and launched a bid for Tesla to acquire SolarCity. Tesla offered to buy SolarCity for 0.122-0.131 shares per share, in a deal valued at $26.50-28.50/shr or $2.5-3.0B in total. The premium was 20-30% over SolarCity's closing price, although it's worth keeping in mind that shares of SCTY have plummeted by 60% over the last year. Musk said he would like to build Tesla into a one-stop shop for electric cars, solar panels and home batteries. The rationale behind the deal would be for SolarCity to save big on sales and marketing costs, and gain access to new customers as part of Tesla, although analysts suggest the plan is nothing more than a bailout of SolarCity's sinking fortunes. Citron Research's Andrew Left warned that if the Tesla deal doesn't go through than shares of SolarCity would go to zero. Investors will scrutinize the deal very closely: Solar City CEO Lyndon Rive and Musk are cousins, and Musk is the biggest shareholder in both SolarCity (22.2% stake) and Tesla (26.5% stake).