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.

Financial Review

Bueller? Bueller?

Sinclair Noe — October 9, 2015

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DOW + 33 = 17,084
SPX + 1 = 2014
NAS + 19 = 4830
10 YR YLD – .01 = 2.10
OIL + .14 = 49.57
GOLD + 17.40 = 1157.40
SILV + .16 = 15.93

World shares were green across the board after details from the Fed’s minutes cast further doubt on the prospect of a rate rise this year. European stocks broke a one-month high for their best weekly gain since late January on renewed hopes central banks will keep monetary policy loose for longer. Overnight, Asian equities and currencies also moved higher following yesterday’s gains on Wall Street (the Dow ended above 17,000 for the first time since August, while the S&P 500 closed well past its 50-day MA of 1,995).

Oil prices traded above $50 a barrel this morning, with a gain of nearly 9% this week; for the biggest weekly gain in 6 years.

Investors are now positioning themselves for corporate earnings season, which picks up steam next week with most of the nation’s largest banks reporting their results, as well as big companies including; Intel, Netflix, UnitedHealth and GE. Earnings are expected to be down roughly 5.5 percent from a year ago, according to FactSet, mostly because of the drop in commodity prices. Now there is a game on Wall Street where analysts set the bar very low and then celebrate when a company stumbles over it. However, if the index reports a decline in earnings for Q3, it will mark the first back-to-back quarters of earnings declines since 2009. In other words, the last time we had consecutive quarters of negative earnings growth, the US economy was in a recession.

Yesterday the Fed published the minutes of the September FOMC meeting; most of the attention was on the policymakers’ decision to leave interest rates unchanged for now; they’re worried about global economies and inflation running below their target of 2%; they think we are at or near full employment. Generally the tone was dovish. The current Fed has talked about raising rates for about a year.  Now we have the Fed saying future interest rate increases will be “data dependent.” Also in the minutes, we saw economic projections and they are basically calling for 2% GDP growth. Slow, sluggish – get used to it.

Emerging market currencies have had a strong week. The Indonesian rupiah was the leader with a 9.2% gain against the dollar, followed by the Russian ruble, with a 7.3% gain. The Malaysian ringgit gained 6.4%, and the Brazilian real was up 4.8%. This does not mean emerging market currencies are in a bull market; for now, it’s just a bounce.

If you follow all the data the Fed is looking at, you would stay quite busy; there are at least 30 economic reports that must be monitored in order to get a clue as to what the Fed’s next move will be. The quick and easy monitor is the dollar index, because the greenback affects just about every tradeable market: inflation, manufacturing, exports, trade balance, jobs, and more – in one handy chart. The dollar index is just a hair under 95. It has traded from a high of 98.7 in August to a low of 92.5 (also in August).

The dollar index has been in a downtrend since September 25, and this is why we have seen a bounce in oil (probably a greater cause than rig counts and demand, or Russia’s moves in Syria.) This is why the commodity indices have had a nice little rally in the month of October. Emerging-markets currencies have been battered over the past year by the expectation that the Federal Reserve will soon raise interest rates, but as the dollar has experienced a recent dip, the emerging currencies have bounced.

The trend lines on the dollar index suggest resistance around 97.5 and support, right about where we landed today; any further breakdown could see the dollar index testing the 92.5 lows. If we see a bounce, or even some sideways action here, then we look for the support and resistance trend lines to cross in the final week of the month, which is coincidentally, when the Fed FOMC holds its next meeting.

Today, New York Fed President William Dudley and Dennis Lockhart of the Atlanta Fed each said they expected a policy tightening in 2015 despite some recent red flags.

In a brief press conference yesterday, Rep. Kevin McCarthy announced he would not seek the nomination as House Speaker, saying he was still short of the support needed to be an effective speaker. Rep. Jason Chaffetz of Utah, current House Oversight chairman, and Rep. Daniel Webster of Florida were running against McCarthy. Rep. Darrell Issa of California says he’s considering jumping into the race for House speaker; Issa says he would support Paul Ryan of Wisconsin, the Chair of the House Ways and Means Committee; Ryan has said he does not want the job. Anybody else? Anybody? …Bueller?

Meanwhile, Congress faces another deadline to lift the debt limit on Nov. 5; today John Boehner acknowledged that getting enough votes to pass a debt-limit increase would be difficult. And another potential government shutdown threat looms in December when the current stop-gap spending bill expires.

U.S. import prices declined 0.1 percent. A surge in value of the U.S. dollar last year, fueled by expectations a strengthening U.S. economy would lead to higher interest rates, has been a factor pushing down inflation, evident by declines of non-oil import prices. The smaller than expected decline in import prices might lay a bit of groundwork for an eventual interest rate hike by the Federal Reserve because a smaller downward push on inflation from imports could alleviate the Fed’s concerns that inflation is too low.

In a separate report, the Commerce Department said wholesale inventories rose 0.1 percent in August, boosted by larger stocks of computers and professional equipment used by businesses. Inventories are a key component of gross domestic product changes. The component of wholesale inventories that goes into the calculation of GDP – wholesale stocks excluding autos -rose 0.1 percent. At August’s sales pace it would take 1.31 months to clear shelves. An inventory-to-sales ratio that high usually means an unwanted inventory build-up, which would require businesses to liquidate stocks. That in turn could weigh on manufacturing and economic growth.

Glencore is slashing its zinc production by a third in reaction to a 30% plunge in the commodity’s price over the past few months. The company will cut 500,000 tons of zinc production, 4% of the world’s total supply. Glencore is the world’s biggest miner of the industrial metal.

Chipmaker Intel is set to get the go-ahead from EU antitrust regulators for its $16.7 billion offer for Altera. A decision is scheduled by Oct. 14.

PC sales dropped sharply again in the third quarter. IDC estimates global PC shipments fell 10.8% year-to-year to 71 million units, a drop nearly as large as the second quarter’s 11.8%. Sales have been declining for so long — 14 consecutive quarters — that it is becoming harder to remember a time when PCs ruled the tech world. However, the market’s four biggest players all grabbed share from smaller firms with less scale. IDC calculates market leader Lenovo’s unit share rose 130 basis points year-to-year to 21%, HP’s increased 110 basis points to 19.6%, Dell’s jumped 120 bps to 14.3%, and Apple’s climbed 60 basis points to 7.5%.

Apollo Education Group, the parent company of The University of Phoenix has released information that the Department of Defense has suspended the university from recruiting military students. University of Phoenix, the largest for-profit college in the US, has brought in $1.2 billion in GI Bill money since 2009 and received $20 million in tuition assistance from the Pentagon last year alone. That outsized share of the market, in addition to alleged predatory tactics at the school to lure in military personnel, resulted in an investigation into the school earlier this year. Though the order to stop military recruitment at the University of Phoenix is not yet permanent, it is likely a distressing development for the school, as well as the larger for-profit college industry.

Combining two vaccine components from Crucell Holland and Janssen Pharmaceutical, Johnson & Johnson is beginning clinical trials of a preventive Ebola vaccine regimen in Sierra Leone. Is the Ebola outbreak finally over? For the first time since the disease was reported in March 2014, the World Health Organization reported no new cases over the past week. According to the WHO, this is part of a trend: The number of cases in West African countries has remained below 10 per week over the past three months, but that doesn’t mean the virus can’t surface again. A total of 11,300 have died since the start of the epidemic.

According to the International Monetary Fund, 6.5 percent of global gross domestic product currently goes to energy subsidies. The United Nations Environmental Program has just published a report calling for a $6 trillion cut of public and private investments in high-polluting energy by 2030. The agency estimates the world’s governments and private institutions should be investing $5 to $7 trillion annually on things like infrastructure improvements, clean energy, sanitation and agriculture, starting now, in order to meet the U.N.’s 2030 goals for reducing the pollution that causes climate change.

The 2015 Nobel Peace Prize was awarded today to Tunisia’s National Dialogue Quartet for its efforts to bring democracy to the country. The National Dialogue Quartet is made up of four organizations: the Tunisian General Labor Union; Tunisian Confederation of Industry, Trade and Handicrafts; Tunisian Human Rights League; and Tunisian Order of Lawyers. The Tunisian revolution, which forced the country’s long-time president to step down in what was called the Jasmine Revolution, led to uprisings against dictators in other nations including Egypt, Libya and Syria in what became known as the Arab Spring. Today, Tunisia is the only country in the region to make genuine progress transitioning to a democracy.