Morning in Arizona

Morning in Arizona
Rainbows over Canyonlands - Dave Stoker

The Headline Animator

Thursday, February 11, 2016

Risk Off

Financial Review

Risk Off

DOW – 254 = 15,660
SPX – 22 = 1829
NAS – 16 = 4266
10 Y – .06 = 1.64%
OIL – .17 = 27.28
GOLD + = 50.10

It’s a bad day for global stock markets.  Markets in Hong Kong opened for the first time this week and had their worst start to a lunar new year since 1994, falling 3.9 percent, adding to a 12% plunge since the beginning of the year. The MSCI Asia Pacific excluding Japan Index lost 2.2 percent. The Europe Stoxx 600 dropped 3.6%.

In her testimony to Congress yesterday, Federal Reserve Chair Janet Yellen was not certain whether she had the legal authority to cut rates into negative territory. Yellen on Wednesday said the crucial question confronting the Fed was whether the domestic economy is strong enough to keep growing modestly even as the global economy struggles. This is the question.

Today, Yellen headed over to the Senate Finance Committee and repeated her testimony from yesterday before opening it up for questions. Yellen said the cause of the market selloff is “not mainly our policy,” noting that the market was tranquil in the immediate aftermath of the increase in interest rates in mid-December. She doesn’t think the Fed will cut rates anytime soon. The key for the central bank is whether the negative shocks hitting the economy persist, Yellen said. The central bank will know more in a few weeks.

Bond investors are making it clear that they do not expect further rate hikes from the Fed, and the bet seems to be that the rest of the world will drag down the US, rather than the US economy serving as an economic engine for the rest of the world.

Futures traders are betting that the Federal Reserve will refrain from raising interest rates for at least two years as stocks and other risky assets plummet. The yield on the 10-year Treasury note dropped as low as 1.53%, the lowest level since August 2012, and close to the record low of 1.39%. The probability for one rate hike by December has dropped to about 10%, from 94% less than two months ago.

In Sweden, the Riksbank surprised analysts by cutting its main repo rate to minus 0.5 percent, from minus 0.35 percent this morning. Negative rates are breaking out all over the world. Yields on German government bonds that mature over the next seven years are negative. Swiss 10-year bonds offer negative yields and today the Swiss National Bank did not rule out even deeper cuts. And after the Bank of Japan moved to negative short-term yields earlier this year, the yield on the Japanese 10-year note fell into negative territory Tuesday.

And while paying a government to park your cash may sound like an automatic losing proposition, here’s something that might surprise you: buying an index of Japanese government bonds or Swiss government bonds has returned more than 6% so far in 2016. Remember, as rates go down, price goes up.

The idea behind negative rates is that it will force the banks to put money into circulation; they will lend money rather than pay to park money; the money will start to circulate through the economy, stimulating business and commerce. When interest rates turn negative, Europeans turn to cash.

The amount of cash across the euro zone rose to more than 1 trillion euros last year, with almost 30 percent of it hoarded in 500 euro notes. Cash in circulation is almost double the amount of 10 years earlier and has risen steadily throughout the debt crisis, a trend that reflects fears about the euro zone and its banks as well as exasperation with low returns on savings.

Even though there is more cash in circulation, it doesn’t mean it is actually circulating. The reality is that in a deflationary environment, people hold onto money because whatever you might buy today will be cheaper tomorrow. ECB data has shown that nervous individuals keep more of their money at home or in a vault.

CoCo bonds are getting hit hard, again. A lot of the recent worries with European banks have been centered on CoCo bonds, or contingent convertible bonds. These bonds automatically convert debt to equity when a bank’s cash reserves fall below a certain level.

So, in the event of a default, the holders of CoCo bonds no longer have a bond that pays interest, they now own stock in the bank that can’t pay interest on its debts. It is, essentially a bail-in. Today’s selling has run the yields on Deutsche Bank’s and Santander’s CoCo bonds to fresh highs (yields rise when prices fall), causing more concerns about Europe’s banks.

Deutsche Bank expects to write down the value of its Postbank by about a third, ahead of a planned sale of the retail unit as part of a strategic overhaul. The institution’s book value will be cut to $3.1 billion. Deutsche Bank shares are down around 35% since the start of the year.

Bank stocks across Europe are down, with the Bloomberg Europe Banks Index dropping 5.6%. Credit Suisse Group slid to a 27-year low as the bank grapples with a restructuring plan. Societe Generale missed fourth-quarter profit estimates, with earnings declining 35 percent at its investment bank.

Morgan Stanley will pay $3.2 billion to settle federal and state charges that it misled investors in residential mortgage-backed securities that later soured during the financial crisis. The case against the bank alleges that Morgan Stanley painted a rosy picture to investors about the quality of the residential mortgages it had securitized, even though the loans had material defects.

Puerto Rico’s Senate has cleared legislation that would enable the island’s main electricity provider to restructure almost $9B of debt. The bill now moves to Puerto Rico’s House of Representatives, which would need to approve it before Feb. 16, when the restructuring agreement between creditors and the electric utility, PREPA expires. A previous deal fell apart in January after the territory’s legislature had failed to pass the act by a previously agreed date.

Oil prices hit a 12-year low. West Texas Intermediate futures dropped to $26.13 a barrel, breaking below the $26.19 low from January to reach the lowest since May 2003. Supplies at Cushing, Oklahoma, the biggest US oil-storage hub, rose by 523,000 barrels to 64.7 million last week, according to government data.

The site is considered full at 73 million barrels. And at some point you have to wonder what happens when all the storage tanks are full. Shortly after hitting a low for the day, OPEC sent out a tweet from the United Arab Emirates Energy Minister saying: “OPEC is ready to cooperate on a cut, but current prices are already forcing non-opec producers to at least cap output”.

Well, that was good enough to push oil prices a little higher, and that in turn helped lift stocks, but not before the S&P 500 index hit an intra-day low of 1810 – taking out the intra-day low of Jan. 20 at 1812. We told you in January that after the S&P dropped below 1860 there really wasn’t any meaningful support for a while. Nine days ago I repeated that a drop below 1860 and it was Katy bar the door, or short the Spiders. Well today, we dropped through minor support at 1812 and broke it.

Next we look for confirmation. The next levels of minor support are a couple of hundred points lower around 1560, and we don’t have major support…, well we don’t want to talk about it right now. In other words, we could be looking at a very, very big drop if 1810 does not hold. Look for some support at 1810 along with some support for oil prices at $26. We might see a bounce, but if these levels don’t hold, it gets really dangerous.

Now, is OPEC serious about production cuts? No. And here’s why. Saudi Arabia just announced it will send ground troops to Saudi Arabia, supposedly to fight ISIS, but more to support Sunni rebels which are currently being pounded by Russia and Assad. The exact role of the Saudis in Syria has not been determined, and it might not pan out. Still, increased involvement would be in addition to the Saudi’s engagement in Yemen and Bahrain.

Now normally, military action in the Middle East would result in a fear premium for oil, but these are not normal times. No fear premium now, although it could come later if we see escalation that draws the Iranians into conflict. For now, it means the Saudi’s will have to pump oil at 100% to pay for their military excursions.

Jobless claims dropped by 16,000 to 269,000 in the week ended Feb. 6; that’s a 7-week low. The number of people continuing to receive jobless benefits dropped by 21,000 to 2.24 million. With staffing additions probably slowing this year as the labor market makes it tougher to attract skilled workers, employers are showing little appetite to reduce headcounts.

Boeing plans to cut jobs in its commercial airplane division (the company’s largest business), as part of cost reductions in the wake of market share losses to Airbus. But wait, there’s more…, The US Securities and Exchange Commission is reportedly investigating Boeing Commercial Airplanes’ accounting practices with respect to the company’s 787 Dreamliner and 747 jumbo jet programs.

Nearly one in five vehicles on U.S. roads is in need of repair of a safety issue serious enough to be involved in a federal government recall, according to Carfax. That means there are more than 47 million cars nationwide with open recalls, up 27% from a year ago. NHTSA data shows that in 2015 there were close to 900 recalls affecting a record 51 million vehicles.

PepsiCo reported better-than-expected quarterly net revenue as higher sales of snacks and non-fizzy beverages such as Gatorade in North America helped reduce the impact of a strong dollar. PepsiCo increased its annual dividend and increased its stock buyback program. However, the company forecast 2016 adjusted earnings below many analyst estimates, citing a strong dollar.

Rio Tinto, the world’s second-largest mining company, reported that in 2015 it earned half of what it earned in 2014, and changed its dividend policy so that they won’t increase automatically. The commodities that Rio Tinto produces have been getting crushed for about a year now; and it’s not just iron ore and copper. Rio Tinto owns the largest diamond mine and diamond production increased 25%, even as fewer people bought diamonds. So the good news is that diamond prices are down, just in time for Valentine’s Day.

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