Monday, November 2, 2009

Weekly Market Wrap

The relative aimlessness of last week's trading was replaced by a decidedly negative tone this week. Investors displayed skepticism ahead of the advance Q3 GDP data, with equity indices giving up ground for three days in a row. The data surprised nearly everyone on Thursday morning (+3.5% v +3.2%e), not the least Goldman Sachs, which had predicted a 2.7% reading ahead of the data. Markets gained on Thursday, but further dissection of the GDP data provided little confidence. Almost half (1.7%) of the pickup in GDP growth came from "motor vehicle output" (hello, cash-for-clunkers), while inventories added +0.9%. IMF Chief Strauss-Kahn called yesterday's US GDP figures an encouraging sign but warned that the crisis will continue as long as unemployment continues rising. Before the GDP release, PIMCOs' Bill Gross published his November investment outlook, warning darkly that GDP needs to stabilize at around +4% for the FOMC to raise rates. Trading on Friday was hairy, as the leading US equity indices dropped precipitously and the VIX hit its highest levels since July. For the week, the DJIA fell 2.7%, the S&P 500 declined 4% and the NASDAQ Composite gave up nearly 5%, and ending down for the month for the first time since February.

As earnings season rolls on, lower oil prices and tighter margins had a big impact on the big bruisers of the global oil industry in the third quarter. Exxon and Royal Dutch Shell fell well behind their closest competitors: both missed consensus estimates for earnings and revenue. Exxon execs said the firm's refineries are mostly running at capacity and complained that the refining business remains "very challenging." British Petroleum was the clear winner among the big oil names, as it crushed top- and bottom-line expectations by wide margins. Chevron and ConocoPhillips beat earnings expectations on a more modest basis.

Positive quarterly results were seen from leading US steelmakers. US Steel racked up its third consecutive quarterly loss, although it was smaller than expected, and revenue was a bit ahead of expectations. Executives remained cautious about the future, warning that the firm will likely see another quarter of operating losses in Q4. AK Steel and Schnitzer Steel did significantly better than expected in Q3, with both firms coming in ahead of top- and bottom-line forecasts. The WSJ published cautious commentary on the steel sector in the wake of these earnings, however, noting that steel inventories are starting to rise, buyers are becoming more cautious and pricing is not increasing as quickly as many had hoped.

Manufacturers reporting results from the September quarter generally met or exceeded earnings expectations, although there was a marked dearth of impressive revenue performance. Conglomerate Textron destroyed earnings forecasts and guided to the upper end of its prior FY09 earnings range, earnings from engine manufacturer Cummins and electronics manufacturer ITT Industries were ahead of the consensus view, and auto component maker Johnson Controls was in line with the street. It's worth noting that the September durable goods numbers returned to growth after August's decline, although it was nothing compared to July's impressive gains. Also note that the Richmond Fed and Milwaukee NAPM manufacturing indices were both notably lower than expected.

Quarterly results from telecoms Verizon and Sprint Nextel came in at the opposite end of the scale, as Verizon racked up yet another quarter of sequential revenue gains and met earnings expectations, while Sprint's losses are only getting bigger. But the retreating American consumer is having an impact on both companies: Verizon saw big sequential declines in new FiOS customers and moderately higher churn. At Sprint, 545,000 precious wireless subscribers jumped ship in the quarter and both post- and pre-paid churn was up sequentially.

They say healthcare is a recession-proof business, and Q3 results from Aetna, WellPoint and Coventry Health make you believe it. Bottom-line results from Aetna and Coventry were ahead of consensus expectations, while WellPoint crushed earnings targets. In a now familiar refrain, revenue at all three was more or less in line. Executives at the firms touched on their fears about unemployment levels and uncertainty stemming from the vicissitudes of healthcare reform. On its post-earnings conference call, a WellPoint executive said the company does not expect employment levels in the US to improve until late 2010, warning that unemployment would continue to weigh on enrollment levels. And with Senate Majority Leader Reid coming out in favor of the public option this week, healthcare reform will certainly remain a potential issue for the industry. Note that Aetna postponed its shareholder meeting until next year so that it can discuss the eventual outcome of the reforms.

The US government bond markets came though yet another record week of new supply relatively unscathed. Yields made a brief run toward the upper end of their recent ranges only to retreat thanks to renewed risk aversion and month end buying. It is certainly noteworthy that after Thursday markets will no longer being artificially supported by the Fed after quietly completing its $300B in purchases.

Next week's fixed income trading will be dominated by key policy announcements from the Fed, Bank of England and ECB. The accompanying statements could allow for the possibility of a divergence in exit paths opening the door for interesting moves in cross market spreads. With the US now out of recession October employment data due on Friday also looms large. USD 3 Month Libor appears to have reached a floor at 0.28603, where it has fixed all week. Note that Norway's Norges raised deposit rates by 25bps to 1.50% as expected this week, becoming the first European central bank to tighten monetary policy (it also warned there would be more rate hikes in the future). On Friday, ECB sources indicated deliberations on exit strategy suppose that an early rate hike might prevent a new bubble, but issues in the financial sector's recovery could delay exit strategies.

Currency markets began the trading week with the dollar near 14-month lows against the euro, prompting dealers to speculate whether higher US yields would turn out to be a dollar positive factor. But the weakness didn't last, and the dollar reaped the benefits of the risk aversion that began with the unexpected decline in October's US consumer confidence and continued throughout the week. FX price action was highly correlated to equity markets, and dealers said reserve managers were very active participants, chasing liquidity for diversification purposes.

EUR/USD tested the key 1.5050 level once again but failed to make fresh highs thanks to the weakness in equity markets. The pair bounced off the 1.47 level but failed to hold its gains into the week's close following comments from the ECB's Noyer who said that problems would stem from USD and Sterling weakness. GBP/USD had a better week following on the heels of a dismal GDP report last Friday, and the pair bounced off the 1.6250 levels to test 1.66 before paring its gains. The weaker than expected US New Home Sales data continued to suggest that any dollar recovery remains wobbly at best and Friday's US personal spending exhibited its first sequential decline in five months as the nation's savings increased to an annual rate of $355.6B to 3.3% v 2.8% prior (Aug).

On the verbal intervention front, the dollar managed to shake off Chinese press reports that the PBoC was looking to add EUR and JPY to reserves. People's Bank of China governor Li brushed off the press commentary, noting that currency reserve diversification would be a long-term process and insisting that diversification should not lead to short-term FX volatility. In addition, the PBoC forecasted that the Chinese GDP growth would exceed the 8% target in 2009. Japanese Finance Minister Fujii said a weak yen was good for exporters and reiterated that he has never endorsed a stronger yen. The ECB's Noyer echoed these sentiments, saying a weak USD might hurt EU recovery. The ECB's Liikenan said a strong dollar policy was justified.

Financial sector concerns continue to hamper equity sentiment. Apart from concerns over Irish Banks' need for renewed capitalization, there was speculation that Lloyds, RBS and Northern Rock would be broken up and sold off in pieces. The US Treasury held talks with GMAC about a possible third cash infusion, adding to the $12.5B it has received to date. The IMF painted an optimistic on pending Asian region recovery and noted that Asia was leading the world out of recession. A better US Q3 GDP reading formally ended the recession but several officials including Obama IMF's Strauss-Kahn reiterated that job recovery was still uncertain with payroll data only a week away (the last positive reading was seen back in Dec 2007).

Down under, central bank decisions further underscored uncertainty over the trajectory of economic recovery. The Reserve Bank of New Zealand kept rates unchanged at 2.50%, in line with a unanimous consensus view. However, the accompanying statement saw RBNZ planning to maintain current interest rates until the second half of next year - well beyond expectations for the timing of eventual tightening. The comments helped sink NZD to three-week lows against USD and ten-week lows against AUD. Moreover, the RBNZ stated that the New Zealand housing market has reversed some declines but saw only a very gradual increase in household spending. The New Zealand September trade balance showed a narrower deficit driven by lower import volumes, confirming cautious view on domestic consumption.

The Bank of Japan left interest rates unchanged at minimum 0.1% as widely expected, but did confirm month-long speculation that the extraordinary policy of commercial paper and corporate bond buying would expire as planned at the end of December. Bank of Japan did note it would continue to accept low-rated debt as collateral until Dec 2010, extend limitless lending by 3 months to March 31, and also preserve the monthly government bond purchases at ¥1.8T. Furthermore, policymakers said low rate policy would be maintained for a while even though financial conditions were increasingly showing signs of improvement. With growing debate over the need for the corporate asset program to be extended going into this decision, Japanese Yen strengthened firmly following the BOJ decision.

Trade The News Staff Trade The News, Inc.

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