Saturday, April 12, 2014

Weekly Wrap-Up | The April Correction; Markets reacting bearishly this week

Markets were all over the place this week, with the end of the week resulting in global equity indices melting and bond yields contracting.  So...what happened?

Many media outlets said there was no real catalyst for the sell-off; however a quick review of some of the more bearish developments over recent days paints an ugly picture for risk assets:

What Happened this Week:
·       No extra easing from the Bank of Japan;
·       No stimulus from Beijing;
·       ECB easing not a sure bet and likely a long way off;
·       FOMC members reeling in fed fund futures expectations;
·       fifty thousand Russian troops camped out on Ukraine's eastern border as armed pro-Russian instigators barricade themselves in government buildings;
·       A second consecutive month of disappointing Chinese trade data;
·       Brutal contractions in mortgage issuance at JPMorgan and Wells Fargo;
·       Sky-high P/E ratios among momentum stocks.

The Result:
·      All three major US indices are below their 50-day moving averages, and the Nikkei225 index is down 7.3% on the week.
·      Europe did not suffer as much, although equities were weak on Friday.
·       For the week, the DJIA fell 2.3%, the S&P500 dropped 2.6% and the Nasdaq tumbled 3.1%.

- The Fed minutes displayed an FOMC that was struggling to build consensus and craft a message that would keep the markets from getting ahead of themselves even while inevitable rate hikes creep closer. Several members were concerned that the market might misconstrue the upward drift in the dot chart (which charts where FOMC members sees the fed funds rate over the next three years), given several members moved their dots up a notch despite soft recent data. Several participants noted that the shift in the position of the median dot overstated the extent of the shift in the FOMC's view. More dovish sentiment was found in the line that the FOMC anticipates keeping the target rate below levels viewed as normal in the longer run, even after employment and inflation get close to the mandated levels.

- The Nasdaq led the charge higher on Tuesday and Wednesday, and then led the slide lower in the second half of the week, slipping below the psychologically important 4000 level on Friday afternoon. The usual suspects were complicit in the Nasdaq's big slide on Thursday and Friday: NFLX, TSLA, AMZN and FB fell 6-8% a piece, while BIIB was down 8%, emblematic of the biotech implosion. Twitter shares sank 10% on the week.

- Alcoa unofficially kicked off the US earnings season with a mixed first-quarter result. Alcoa topped earnings expectations but missed on the revenue line. Alcoa reaffirmed that global aluminum demand growth would be flat y/y at +7%, although it also hiked its demand growth forecasts for the aerospace and auto industries, and more generally asserted that global end-market growth remained solid.

- The first quarter headline results out of banks JPMorgan and Wells Fargo contrasted sharply. JPMorgan's earnings fell 28% y/y and the firm missed estimates for the first time in over two years (it was only its fifth miss in the last ten years). Wells Fargo beat earnings expectations in its first quarter, on a healthy y/y gain in net profit. However both firms saw big weakness in mortgage originations: JPM's issuance slid nearly 70% y/y while WFC's new home loans were down nearly two-thirds y/y during the quarter. JPM said that mortgage production would be negative in Q2 - driving a loss for the business unit - and also negative for the year.

- The IPO market was a major theme, as up to 16 companies were planning to begin trading this week making it the busiest week for IPOs since before the financial crisis. The equity correction dented enthusiasm for the new issues, and about half of the planned IPOs were put on hold due to volatility. The two biggest IPOs that did go forward - Ally Financial and hotel chain La Quinta Holdings - priced shares cautiously, below the top end of projections initially given to investors. La Quinta gained as much as 7% on Wednesday, but was only about 2% above its opening price by Friday, while Ally was about 2% below its opening price. The best performing opening was fast casual restaurant chain Zoe's Kitchen.

- Online commerce giant eBay reached a deal with Carl Icahn to end his proxy battle. In exchange for appointing Icahn's man to the board (he originally wanted two), Icahn has agreed to withdraw his PayPal spinoff proposal and will sign a confidentiality agreement, ensuring that further conversations about enhancing shareholder value stay private. eBay's CEO observed that the proxy battle was not helping shareholders or innovation, while Icahn called the deal a "win-win."

- March same-store sales were mostly in the red, as continuing bad weather kept consumers at home, although the declines were generally not as bad as projected by consensus expectations. As usual, the big outlier was Costco, where a healthy +6% comp beat expectations. In retail earnings, discount retailer Family Dollar missed top- and bottom-line expectations, cut its FY14 outlook and warned it would lower prices on a wide range of items.

- WTI crude futures saw strong gains this week, rising to $104.44 from around $101 on Monday, coming within a few cents of a fresh multi-year high. Several factors were at work. Ukraine tensions have ratcheted up since armed pro-Russia protestors seized administrative buildings in several eastern cities. In its March monthly report, OPEC disclosed that output declined 626K bpd on the month to 29.61M bpd. The weaker dollar also helped strengthen the contract. Brent was stable around $107 most of the week after Libya finally reached a deal with protesters to reopen occupied oil terminals. Note that the Brent-WTI spread is at its lowest level since last September.

- Greece sold its first bonds this week since March 2010, just weeks before the markets lost confidence in Athens and forced its first bail-out. This week Greece raised €3 billion in five-year bonds at a yield of just under 5% in a heavily oversubscribed issue. The yield on the Greek ten-year fell below 6%, although many pointed out that is still much too high to be affordable for a country forecast by the IMF to grow by only 0.6% in 2014 and experiencing deflation. While the Greek leadership insists there will be no need for a third rescue package, on Friday Eurogroup Chief Dijsselbloem said Athens might require a bailout program after the summer was over.

- Eurozone officials were very loquacious this week on the subject of possible non-standard measures to deal with slowing deflation. The overall tone from the ECB was that the governing council is not ready to initiate QE, although contingency plans are being made. Weidmann emphasized that extraordinary measures would be have many conditions and should target banking sector. ECB Vice President Constancio echoed his boss Draghi by again saying that April data might show inflation returning to growth, obviating the need for measures. ECB's Nowotny suggested that a decision on QE should not be taken until the June meeting. IMF Chief Lagarde said it would only be a matter of time before the ECB launched a program. EUR/USD was a one-way trade all week, as the pair held support around 1.3700 early on and then traded up to 1.3900.

- The BoJ policy statement on Tuesday dashed any hopes for a fresh round of QE later this month to help offset the rise in consumption tax that went into effect on April 1st. The BoJ maintained its economic assessment for the eighth time in a row, stating that the "economy is recovering moderately" and only made a passing reference to "fluctuations" related to the sales tax. Kuroda's press conference sealed the bank's passive stance, indicating the BoJ does not believe additional easing is warranted at this time and that conditions remain sufficient to achieve the 2% inflation target in the specified 2-year time frame. Already weighed down by falling US treasury yields and general risk-off sentiment, USD/JPY hit three-week lows below ¥101.50. In turn, Nikkei225 collapsed approximately 7.3% this week to its 6-month lows below 14,000. Year-to-date, the Tokyo market is down about 15%.

- China reported its second consecutive disappointing trade balance, only this time around the government was unable to blame seasonality around the Lunar New Year. Although March trade recovered from the deficit seen in February with a surplus of $7.7B, both imports and exports fell, spoiling expectations of a modest y/y increase. The authorities acknowledged softer conditions in Q1 but also remained optimistic that exports would rebound in Q2. Separately, March CPI came in line with consensus at 2.4%, reversing a trend of five consecutive months of slower price growth and allaying investors' concerns about the threat of deflation following the 13-month low of 2.0% in February. China premier Li addressed the Boao Forum on Thursday, reiterating the state council would sacrifice its 7.5% GDP target to achieve stable employment. Li also announced that Beijing would not undertake significant stimulus measures to deal with short-term market volatility.

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