Friday, July 22, 2016

Markets continue rally on solid data and corporate earnings Weekly Market Update: Markets continue rally on solid data and corporate earnings
Fri, 22 Jul 2016 16:04 PM EST

Political developments and quarterly earnings were the main focus this week, although incessant speculation surrounding foreign, Central Bank intervention swung investor risk sentiment. Thursday broke a string of record closing highs on the DJIA and S&P500, but by Friday the S&P was back at all-time highs. The Republican Party gathered in Cleveland to officially nominate Donald Trump as their presidential candidate, while in Turkey an attempted coup by the military was put down, adding to the endless turmoil in the Middle East. Crude prices retreated back below $45, marking six weeks of contraction after key benchmarks topped out above $50 in early June. About a fifth of the S&P500 have reported quarterly earnings, with average profits a bit lower y/y and revenue a shade higher. While tech and financials have been generally impressive, consumer discretionary stalwarts have hit a wall, and Starbucks CEO went as far as to cite deteriorating global conditions - terrorism, and Brexit included - as driving a cooling in consumer confidence. After another solid swath of US economic data, US Treasury prices moved marginally higher, but yields largely consolidated just below the recent one-month highs. For the week, the DJIA gained 0.3%, the S&P500 rose 0.6% and the Nasdaq added 1.4%.

Fresh off its big election win last week, the government of Japan PM Abe has been crafting yet another huge stimulus program to revive the domestic economy and slay deflation. Three years of Abenomics, promises of sweeping legislative reform and negative rates have failed to do the job, and this week press reports suggested Abe's people are designing a fiscal package valued up to ¥20-30 trillion ($186-280 billion) - well ahead of the ¥10T discussed in the immediate aftermath of the election, given that some of the government guarantees and other off-budget measures will run into 2017 and beyond. There has been plenty of talk that the Bank of Japan will also pursue additional measures, and Kuroda has repeatedly said the BoJ is prepared to push rates lower, although the most recent speculation has fixated on the possibility the bank might pursue direct financing of government fiscal measures, widely referred to under Bernanke's formulation as "helicopter money." Kuroda strongly pushed back against that idea again this week, reiterating that there is neither the need for or the possibility of helicopter money, having already emphasized several times that the approach would be illegal under Japanese law. The yen pushed out to six-week lows around 107.60 on speculative press reports about helicopter money, but Kuroda's denials pushed USD/JPY back toward the 105 handle on Friday.

Top Chinese planning agency NDRC forecasted China 2016 CPI to be around 2% - well below the 3% official target - and GDP in a range of 6.5-6.8%, compared to the official 6.5-7.0% forecast. The agency warned that China was still facing increasing difficulties in stabilizing growth with investment and the possibility of overheating home prices. Fitch released a report that cautioned measures by policymakers in Beijing to reduce debt-servicing costs were fueling the ongoing credit boom, warning that "risks of asset quality and liquidity shocks to the banking system will continue to grow the longer that total leverage grows." Fitch estimates that total loans to the private sector have almost doubled since the 2008 crisis, reaching 243% of GDP in 2015, likely to rise to 253% by the end of 2016.

An attempt by a faction of the Turkish armed forces to overthrow the government of President Erdogan late last Friday rattled investor sentiment coming into the week. The coup attempt saw violent confrontations in the Turkish capital of Ankara and in Istanbul and produced a sharp reversal in risk assets, but the uprising was contained and the market impact was fairly limited. Erdogan's government has detained thousands of military officers suspected of treason and dismissed tens of thousands of teachers and civil servants in a wide-ranging purge of those believed to be sympathetic to Fethullah Gulen, a US-based cleric and political oppositionist being blamed for the coup. Turkey declared a state of emergency for three months and tensions with the US are rising as the government demands the extradition of Gulen.

The first big batch of post-Brexit European economic data showed minimal impact on the Continent from the UK vote. France and Germany preliminary July Markit composite PMIs beat expectations. Meanwhile, the UK July Markit composite PMI sank into contraction and saw its lowest reading in seven years. The new UK government has gotten to work with minimal snafus, although given his gaffe-filled record the appointment of Boris Johnson as foreign secretary has raised some eyebrows. Prime Minister Teresa May reiterated her government would not invoke Article 50 to leave EU before the end of 2016. Cable remained in a fairly tight range after the volatility of the prior two weeks, with GBP/USD bouncing around between 1.3315 and 1.3065.

The overall tone of the June quarter earnings reports has been lukewarm, with banks and tech showing real pockets of strength and revenue levels seeing very modest growth. Bank of America, Goldman Sachs and Morgan Stanley managed to beat expectations, but all three had some problems in the quarter, with lower ROE levels on falling interest rates. Both GS and MS saw lower y/y revenues. In tech, Microsoft is seeing very strong growth in its cloud business, offsetting the declines in the Windows unit. IBM's revenue and earnings declined less than expected (although IBM's revenue has now fallen for 17 straight quarters). Qualcomm saw very good gains on strong outperformance.

Airlines got hit by problems in Southwest's earnings. Higher fuel prices are looming on the horizon for the industry, and while Southwest's quarterly numbers were good, the firm's outlook for Q3 anticipates fuel costs rising back above $2/gallon for the first time in a while and RASM in contraction. Results from American and United Continental beat expectations, although both firms said RASM levels would be lower in the second half of the year. Germany's Lufthansa also had a mixed earnings report, and predicted weakness in Q3 unit revenues.

Industrial firms Honeywell and General Electric had mixed results. GE reported lower quarterly profits and revenue in its core industrial business, weighed down by its underperforming oil equipment division. Honeywell cut its 2016 sales forecast amid sluggish global growth and lower demand for energy-related products. Meanwhile, General Motors raised its FY outlook and posted record second-quarter earnings, beating analysts' estimates by a wide margin as truck sales increased in North America and its European business managed a small profit.

The Department of Justice sued to block the Anthem-Cigna and Aetna-Humana mega mergers. US Attorney General Lynch warned that US consumers would suffer if the Big Five health insurance names became the Big Three and said her department would vigorously enforce anti-trust laws. Press reports early in the week hinted about the development, forcing shares of all four firms lower, although the confirmation of the DoJ's suit and statements issued by the firms promising to vigorously defend the deals helped the stocks regain all their losses. In other M&A news, after years of takeover speculation and a 70% decline in its stock price over the last half a decade, Joy Global agreed to be acquired by Japan's Komatsu for $28.30/share in cash, in a total deal valued at $3.70 billion. Japan's Softbank reached a deal to acquire UK technology company ARM Holdings for £17/share in a £24B deal, as the Japanese telco conglomerate aims to capture opportunities in the IoT market.