Stocks Lower as Tech Rebound Fizzles

Charles Schwab: On the Market

Posted: 12/5/2017 4:15 PM EST

Stocks Lower as Tech Rebound Fizzles

 

U.S. equities finished lower, with an early rebound for tech stocks losing steam in late-day action, while attention has shifted to the looming likely highly-contentious reconciliation process for tax reform. Treasury yields were mixed but little changed despite reports showing services sector output remained solid and the trade deficit widened more than expected. Crude oil prices moved higher and gold was lower, while the U.S. dollar also gained ground.

The Dow Jones Industrial Average (DJIA) fell 109 points (0.5%) to 24,181, the S&P 500 Index lost 10 points (0.4%) to 2,629, and the Nasdaq Composite declined 13 points (0.2%) to 6,762. In moderate volume, 885 million shares were traded on the NYSE and 2.1 billion shares changed hands on the Nasdaq. WTI crude oil inched $0.15 higher to $57.62 per barrel and wholesale gasoline gained $0.03 to $1.72 per gallon. Elsewhere, the Bloomberg gold spot price decreased $9.39 to $1,266.79 per ounce, and the Dollar Index—a comparison of the U.S. dollar to six major world currencies—was 0.2% higher at 93.38.

Toll Brothers Inc. (TOL $47) reported fiscal Q4 earnings-per-share (EPS) of $1.17, compared to the $1.19 FactSet estimate, as revenues rose 9.0% year-over-year (y/y) to $2.0 billion, versus the projected $2.1 billion. The luxury homebuilder's Q4 deliveries came in below expectations. TOL issued full-year revenue guidance that had a midpoint just above estimates. Shares fell.

AutoZone Inc. (AZO $710) posted fiscal Q1 EPS of $10.00, compared to the forecasted $9.78, with revenues increasing 4.9% y/y to $2.6 billion, exceeding the projected $2.5 billion. The auto parts retailer said its Q1 same-store sales rose 2.3% y/y, north of the expected 0.9% gain. Shares were modestly higher.

Services sector growth slows but remains solid, trade deficit widens more than expected

The November Institute for Supply Management (ISM) non-Manufacturing Index (chart) declined to 57.4 from October's unrevised 60.1 reading, which was only the fourth time in its history above 60 and the highest level since August 2005. The Bloomberg forecast called for a decline to 59.0. A reading above 50 denotes expansion. New orders fell 4.1 points month-over-month (m/m) to 58.7, business activity dipped 0.8 points to 61.4, and employment decreased 2.2 points to 55.3. Prices declined 2 points but remained elevated at 60.7. Non-manufacturing activity accounts for a large majority of U.S. economic output and the ISM said respondents' comments indicate that the economy and sector will continue to grow for the remainder of the year.

This report joins a host of global PMIs that continue to suggest global growth could continue to underpin the world stock market rally. Schwab's Chief Investment Strategist Liz Ann Sonders points out in her latest article, I Melt with You: Anatomy of a Market Melt Up, we believe it's been the actual fundamentals that have driven the calm surge in stocks with all 45 OECD countries growing. Liz Ann adds that coupled with the start of a sharp turn-for-the-better in U.S. corporate earnings and you have the recipe for yet another leg up in the ongoing secular bull market. However, she cautions that melt ups can be fun while they’re underway; but they don’t tend to end well, and it’s tricky to time the inevitable failure, concluding that discipline is more important now than it’s been in quite some time.

The final Markit U.S. Services PMI Index was revised to 54.5 in November from the preliminary 54.7 level, versus expectations of an upward adjustment to 55.2, and below October's 55.3 level. A reading above 50 denotes expansion and the release is independent and differs from ISM's report, as it has less historic value and Markit weights its index components differently.

The trade balance (chart) showed that the deficit came in at $48.7 billion in October, compared to estimates of $47.5 billion. September's deficit was upwardly revised to $44.9 billion. Exports were flat month-over-month (m/m) at $195.9 billion, while imports rose by 1.6% to $244.6 billion.
Treasuries were mixed to little changed, as the yield on the 2-year note increased 1 basis point (bp) to 1.84%, while the yield on the 10-year note was flat at 2.35% and the 30-year bond rate lost 1 bp to 2.73%.

The U.S. dollar modestly extended yesterday's gain and Treasury yields remain near the top end of the range traded at this year as the markets continue to digest the weekend's Senate tax reform bill passage and prepare for the expected competitive reconciliation process between the House and Senate as they try to find compromises on some key differences of their bills.

Schwab's Vice President of Legislative and Regulatory Affairs, Michael T. Townsend notes in his latest commentary, Tax Bill Passes Senate, Clearing Key Hurdle, reaching consensus between the two chambers won’t be easy; there are significant differences between the two bills that will need to be resolved. The conference process will begin this week and Republican leaders are optimistic that a deal can be struck within a matter of days. Complicating matters, the two chambers also must find time this week to avert a government shutdown and approve legislation that extends funding to keep the government open and operating. With regard to the tax bill, until the agreement is finalized, there is little for investors to do. But a year-end conversation with your financial advisor is always a good idea, and a discussion of the potential impacts to your tax situation as a result of the legislation would be prudent.

An initial look at job data for November will likely headline tomorrow's economic calendar ahead of Friday's November nonfarm payroll report, with the ADP Employment Change report expected to show private sector jobs increased by 190,000 following October's 235,000 increase. Final Q3 nonfarm productivity and unit labor costs will also be released, with the former forecasted to be upwardly revised to a 3.3% quarter-over-quarter (q/q) increase from the preliminarily-reported 3.0% and the latter to be adjusted downward to a 0.2% q/q rise from the 0.5% posted originally. MBA Mortgage Applications will also be released.

Europe dips on mixed data and Brexit uncertainty, Asia mostly lower

European equity markets finished mostly lower even as technology issues rebounded with a softer-than-expected eurozone retail sales report slightly more than offsetting Markit's data showing eurozone output from the manufacturing and services sectors continued to show solid growth. The euro saw some pressure versus the U.S. dollar, with the markets continuing to grapple with the prospects of U.S. tax reform and yesterday's failed Brexit talks putting some uncertainty regarding if negotiations can move forward. Talks are expected to continue this week, and the British pound traded lower compared to the greenback. Bond yields in the region were mostly lower and financials moved to the downside. Volatility has shown some signs of ticking higher as the markets assess the global market rally this year and in his article, Schwab's Chief Global Investment Strategist Jeffrey Kleintop, CFA, tackles the question, Are Stocks too Expensive?, noting that although world stock market valuations are above average, similar valuations have produced double-digit gains over the following 12 months during the past 50 years. Jeff concludes that valuations support a globally diversified portfolio offering the best diversification benefits in 20 years.

Stocks in Asia finished mixed after the U.S. markets gave back most of their gains late yesterday as the recent pressure on the technology sector persisted and an early boost from the weekend's Senate tax reform bill faded. Japanese securities declined, with the yen gaining ground, while those in Australia were also lower after the Reserve Bank of Australia expectedly held its monetary policy stance steady including leaving its benchmark interest unchanged at 1.50%. Mainland Chinese stocks and listings in Hong Kong fell, despite a report by Caixin showing growth in output in the nation's key services sector accelerated. Meanwhile, markets in India declined modestly and stocks in South Korea were slightly higher. The markets have shown some signs of pausing from this year's strong global rally that has been fueled by the broadest economic growth in a decade, which Schwab's Jeffrey Kleintop, CFA, says is expected to continue in 2018 as discussed in his article, 5 Reasons Investors Should Give Thanks.

Reports from around the globe tomorrow will include GDP from Australia, manufacturing orders from Germany and CPI from Switzerland.

Financial Review

Honey for Bears

Sinclair Noe — February 8, 2016

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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.