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Monday, February 08, 2016

Honey for Bears

Financial Review

Honey for Bears

DOW – 177 = 16,027
SPX – 26 = 1853
NAS – 79 = 4283
10 Y – .11 = 1.74%
OIL – .80 = 30.09
GOLD + 15.50 = 1190.00

This was just an ugly session from the start. The Dow opened about 200 points down and then trickled lower; at one point down more than 300 points. The S&P 500 index broke down through the key level of support at 1860 that I warned you about in January and again last week, taking out the August 2015 lows and the October 2014 lows.

The S&P 500 not only took out support from January, but now we look to minor support at 1815, and then, well there isn’t really any support. In other words, the charts look very dangerous here.

And if you prefer fundamentals over technicals; this is what FactSet had to say in its recent report: “For Q4 2015, the blended earnings decline is -3.8%. If the index reports a decline in earnings for Q4, it will mark the first time the index has seen three consecutive quarters of year-over-year declines in earnings since Q1 2009 through Q3 2009.”

The difference this time versus 2009 is that valuations are much higher. FactSet data show expectations for first-quarter per-share earnings have collapsed to a decline of 5.5% as of today. Back in September, that forecast was for growth of 4.8%. By the end of December, it had fallen to growth of just 0.8%.

Chinese stock markets are closed for trade all week to celebrate the Lunar New Year, providing little direction for European stocks at the open. However, data out over the weekend showed China’s foreign-exchange reserves fell to the lowest level in more than three years last month, in another sign of capital flight as the yuan weakens.

European stocks opened lower, extending last week’s losses. The Stoxx Europe 600 index had its lowest close in more than 15 months; banks in the Stoxx Europe 600 Index have dropped about 39 percent since a peak in July. Their slump this year is the worst of any other industry group.

Oil prices kicked off the week in the red. Data on oil demand in the world’s two largest markets, the U.S. and China, has taken a sharp turn lower. U.S. demand for oil products in January fell 3.9% compared with January 2015. In China, although overall oil demand was flat in December and an improvement on November’s outright decline, it still represented the second weakest reading for the year.

Meanwhile, hopes about an agreement between producers within and outside of the Organization of the Petroleum Exporting Countries to cut output and support prices have also faded in recent days. A meeting between Saudi Arabia and Venezuela on Sunday ended without any plans for a production cut. Iran plans to sell 300,000 barrels of crude oil a day to European customers now that Western sanctions are lifted. And within the next few months, Iran wants to ramp up production to 500,000 barrels a day, with the remainder going to Asia.

Chesapeake Energy, the natural gas driller that’s been cutting jobs and investor payouts to conserve dwindling cash flows, lost more than half it stock market value today after a report that it hired a restructuring law firm. The company’s bonds led losses among high-yield debt. Chesapeake’s notes due March 2016 (about $500 million in bonds) tumbled to a record to 74.5 cents, from 95 cents last week, while its bonds maturing in 2017 fell to an all-time low at 34 cents.

Exchange-traded funds that hold US junk bonds slid to their lowest levels in almost seven years. BlackRock’s iShares iBoxx High Yield Corporate Bond exchange-traded fund and SPDR Barclays High Yield Bond ETF both fell to the lowest levels since 2009. In high yield, energy, communications and health care fared the worst. Banks and insurers in Europe led a surge in the cost of insuring corporate bonds to the highest levels since 2013.

European financial firms are taking a beating amid fears of “a chronic profitability crisis that makes it impossible for banks to build up barely-adequate capital bases. None of the fresh wave of selling stems from new news, but the list of negatives is long. Fears surrounding non-performing loans and other deep-rooted issues in the Italian banking sector have driven nerves, while a slew of weak earnings from large banks such as Credit Suisse and Deutsche Bank have added to concerns. The worst of the lot is Deutsche Bank, Germany’s biggest, down about 10% today, and down 40% year-to-date, as its credit default swaps spiked to their highest levels since 2012.

Bank credit default swaps, or contracts that offer protection against the risk of a bond defaulting, have also surged in price, indicating intensifying fears for financial groups’ credit. Deutsche bank’s 5-year senior CDS has jumped 11bps today to a three-and-a-half-year high of 212bps, up from 134bps just over a week ago. The cost of protecting the company’s subordinated debt from default for five years using credit-default swaps has more than doubled since the end of 2015, rising to 438 basis points, a four-year high, from 187. That is just a very, very big selloff.

And what makes it crazier still, is that it looks like Deutsche Bank has more than sufficient reserves set aside for its debt and the interest on its debt, exclusive of operating results. But for now that doesn’t matter; share price has dropped, which increases expectations for more turmoil, which pushes the cost of hedging, which frightens shareholders, who then sell, pushing prices even lower. If it all sounds a bit over-done, it is, but it still demands we pay attention.

And the situation is not unique to Deutsche Bank, which is just one of the extreme examples. Basically all the banks are seeing their credit default swaps trading at the highs of the year. And here in the US, the large cap financials are down almost 12% year-to-date. That means there has been some panic selling. Today, the mega-banks, including Bank of America, Citi, and Wells Fargo all moved to new lows intraday or at the close.

The KBW Bank Index, which consists of 24 banks, is approaching 2008 and 2011 lows relative to the S&P 500. So, the question of the day is: Are the large cap financials cheap or is the rest of the market still overpriced? We may need more time to answer that one, but for now the big banks distress is honey for the bears.

If Congress does not act soon, Puerto Rican officials say major defaults are likely this spring. They are trying to make their case for a law that would allow a broad restructuring of the territory’s multibillion-dollar debt. The officials also said they knew that any legislative help would come at a stiff price: Puerto Rico would have to submit to a federal control board, something viewed by some on the island as colonialist-style interference.

Argentina has offered to pay about $6.5 billion in cash to U.S. holdouts that refused debt restructurings after its 2001 default, implying a haircut of about 25% on the amount bondholders say they are owed. If accepted by all the holdouts, which are led by billionaire Paul Singer’s Elliott Management, the deal would clear the way for Argentina’s return to the international capital markets.

Washington is vowing to ensure the United Nations Security Council imposes serious consequences on North Korea after it launched a space rocket in a purported satellite program widely considered to be a cover for developing ICBMs. The latest launch, which follows North Korea’s Jan. 6 nuclear test, may kick off a rapid buildup of American missile defenses in Asia.

Apollo Education Group, the parent company of the University of Phoenix, will be taken private as it is acquired by a group of investors for $1.1 billion. The investors will pay $9.50 in cash per share, which is 30% above the company’s trailing 30-day volume weighted average stock price. Tony Miller, chief executive of The Vistria Group, one of the investors, will become chairman of the board for the Apollo Education Group once the transaction is completed. The other investors included Apollo Global Management, LLC and Najafi Companies.

The agreement arrives weeks after the company reported a decline in revenue and another round of layoffs at the for-profit college. Phoenix, like other for-profit schools, has been battered by poor enrollment, government investigations and heightened federal regulation.

Chipotle closed its more than 2,000 restaurants today for a few hours to address employees about the food-borne illnesses that have led to lawsuits and a federal investigation. Chipotle used the event to review new food safety protocols and explain the steps the company is taking to improve food safety.

Ford is planning to build a new assembly plant in Mexico to sharply increase output from the country, representing the latest shift of investment abroad by a Detroit automaker following the signing of a costly new labor deal. Ford expects to add 500,000 units of annual Mexican capacity starting in 2018 (more than double what it built in 2015), by constructing a new assembly complex in San Luis Potosí and expanding an existing factory near Mexico City.

You don’t see this every day…Credit Suisse CEO Tidjane Thiam has asked the company’s board to reduce his bonus, days after the Swiss bank reported a fourth-quarter multibillion-dollar loss that sent its share price tumbling. Thiam, who joined the bank in July, did not indicate the size of the cutback, but said his was the largest bonus reduction within the management team.

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