Weekly Market Wrap

Equity indices gapped lower this week in the face of growing risk aversion, with traders disregarding robust corporate earnings and a strong first reading of US GDP. The Shanghai Composite dropped below 3,000 for the first time since late 2008, while the DJIA closed within 44 points of 10,000 and commodities traded off hard. On Friday, advance GDP showed the US economy grew faster than expected in Q4, at an annualized rate of 5.4%. If the GDP reading holds up upon revision, GDP in the final quarter of 2009 would be higher than at any time since September 2003. Housing data was mixed: the November S&P/CS index gained for the sixth consecutive month, although the move up was modest. Meanwhile, December new home sales fell nearly 8% m/m (following an 11% m/m decline in November), prompting Yale Economist Robert Shiller to reiterate that he believes home prices could be faltering yet again. President Obama gave his first State of the Union speech on Wednesday, offering a trenchant defense of his first year in office while also admitting certain mistakes had been made. The President promised to double US exports over the next five years and make job creation a primary focus, and also said $30B in repaid TARP funding would be redirect to loans for small businesses. Ahead of the speech, the Congressional Budget Office released predictions for a $1.35T deficit for this year as the economy continues to slowly recover from the recession. After a flurry of Washington drama last week (full of implicit threats to Fed policy independence), the Senate handed Ben Bernanke a second term as Fed chairman in a 70 to 30 vote. For the week, the DJIA lost 1.1%, the Nasdaq dropped 2.6% and the S&P 500 fell 1.7%.

Dow components Johnson & Johnson, DuPont, 3M, Procter & Gamble and Travelers all beat earnings estimates by respectable margins. Full-year EPS guidance ranges were largely in line with expectations. AT&T and Verizon met expectations and both telecoms saw big increases in wireless subscriber additions on a q/q basis. DJIA industrial names Boeing, Caterpillar and United Technologies offered strong quarterly results. On the other hand, full year EPS forecasts at Boeing and Cat were weaker than expected. Chevron's results were surprisingly mixed: earnings missed expectations while revenue was way ahead of the consensus view. The firm's upstream revenue was up by nearly 30% on a q/q basis, but the downstream operation racked up a substantial loss due to weak demand and excess supply.

Leading tech names Microsoft, Apple, Amazon, Yahoo, Qualcomm, SanDisk and Juniper Networks all exceeded or greatly exceeded earnings expectations. Apple's launch of the widely anticipated iPad tablet computer dominated the newsflow in the tech universe, and Apple stock jumped $10 when CEO Steve Jobs announced the new product would start at an affordable $499. Exceptional demand for Microsoft's new Windows 7 operating system led to very strong top-line growth for the company. Traders should note that results from Apple and Microsoft were inflated to a certain degree by the adoption of new deferred revenue recognition accounting rules. Motorola offered in line results, while competitor Nokia's operating profit was twice the expected amount. Both firms expect very strong growth in smartphone sales this year.

In other earnings, ConocoPhillips and Valero topped expectations, and COP crushed revenue targets. The outlook is not bright for integrated oils: Valero warned that there is too much inventory and spare refining capacity in the industry for margins to rebound quickly. Benefits administrator WellPoint offered excellent quarterly results, although its full-year forecast was a little soft. Ford's revenue results blew out expectations. CEO Mulally said Ford would be profitable on a pre-tax basis this year reiterated that the company would be fully profitable next year. Steel maker Nucor returned to profitability after two quarters of losses, with earnings more than twice the expected amount. Nucor's CEO warned that real demand is in for a long, slow recovery. Competitor US Steel reported a larger than expected loss.

Nowhere was investor's diminishing risk appetite more apparent than in commodities. Following a roughly 3% move lower last week the CRB index declined another 4% this week. Softs continue to trend lower led by more steep declines in wheat and corn prices. Economically sensitive commodities moved through some key levels attracting more pronounced media attention. Front month crude now trades with a $72 handle and has closed the week below its 200-day EMA for the first time since last March. March copper finished the month down 8% while silver is off 4% in January. Concerns about China are weighing on industrial metals and March cooper is now below its 90-day EMA and testing the first Fibonacci retracement level just above $3 working up from the late 2008 lows. February Gold closed below its 90-day EMA for the first time since last summer making new multi-month lows below $1075.

US bond markets felt the push and pull of key economic data, new supply, the FOMC decision on Wednesday and the deepening sense investor risk aversion. Treasury yields were ultimately unable to make much headway one way or the other as tailwinds from Fed Governor Hoenig's FOMC dissent, $118B in coupon supply and the surprisingly strong first reading of Q4 GDP was more than offset by the underlying risk aversion. The US benchmark 10-year yield looks to finish the week lower than where it began and roughly 10 basis points from the move up towards 3.7% made post FOMC decision. Volatility has been even more dramatic at the short end: the 2-year yield is also down nearly 10-basis points from mid-week highs made above 0.9%.

Another week of intrigue in European sovereign debt markets has driven bond and currency markets, with claims, denials and counter-denials sending peripheral debt on a roller coaster ride to the upside. Greece's 10-year spreads rose from the Bunds+300 bps area on Monday to as wide as +400bps midweek when press reports of a €25B debt sale to the Chinese government were strenuously denied. Spreads regained ground as expectations for some form of assistance grew stronger, culminating in a report from the French press. Le Monde speculated that France and Germany were preparing a bailout that could be presented in Brussels on Feb 11 when various heads of states are scheduled to meet. Subsequently a chorus of EU officials, including Economic commissioner Alumina and Commission President Barroso, as well as French Finance Minister Lagarde, issued carefully hedged support for the country. Meanwhile, the Greek finance minister issued another series of pledges and promises. By Friday 10-year Greek paper offered yields 360+ basis points above Bunds.

Greece was not the only hotspot within the EU. A preliminary look its 2010 budget failed to inspire much confidence that Portugal will be able to avoid the concerns surrounding the likes of Greece and Ireland. Portugal's 10-year spreads from Bunds rose another 13 basis points on the week and at Bunds+118 has nearly doubled in the last month. Spanish officials were much more forthcoming when presenting details for how they plan to tackle uncomfortably high debt levels, but nevertheless 10-year spreads there too widened 12 basis points by week's end.

The greenback continues to benefit handsomely as European peripheral spreads move out to their widest levels against the 10-year Bund since the launch of the euro back in 1999. George Soros summed up the current situation aptly, noting that the Greek debt problem shows up the shortcomings of Euro Zone structures and the inherent weakness of not having a single Euro Treasury. Sovereign issues were also fueled by rating agencies. Moody's commented that Portugal needed a credible deficit reduction. Spain, Poland and Portugal all released budget proposals during the week, revealing the scale of the challenges ahead for their respective economies. Spain, for instance, is targeting about €50B in spending cuts by 2013, which amounts to nearly 5% of GDP. Standard & Poor's downgraded its outlook on Japan's AA sovereign rating and also released a reported indicating that it no longer considers Britain among the 'most stable and low-risk' banking systems.
Verbal Intervention also played a minor role in the dollar's strong performance. ECB Chief Trichet reiterated his view that he agrees with US authorities when they state that a strong dollar is in best interest of US and added it corresponds to the overall interests of the global economy, Europe and 'currencies that do not float.' The road ahead for the firmer USD would not be one-way street. Obama's State of the Union pledge to support exports made some traders wonder whether a stronger dollar might not suit the administration's plans double exports

There was talk of an Eastern European option barrier at the 1.40 EUR/USD level that initially curbed the dollar's upside momentum. However, a more optimistic outlook by the FOMC on US growth prospects saw this psychological level give way, with EUR/USD moving out to the 1.39 handle, last seen in July 2009.

Across the pond, the UK unconvincingly moved out of recession with a +0.1% GDP reading that undershot expectations, with many wondering what will sustain the recovery as the BoE is likely to hit the pause button on quantitative easing in February. BoE Governor Sentence commented that the BoE must be ready to adapt policies to changing circumstances since goods deflation would not hold down the UK inflation rate. He noted that the impact of sterling was feeding into CPI and that spare capacity might be lower than expected. If the combination of above-target services inflation and rising import prices persisted, Sentence believes it will be difficult for the MPC to keep inflation on target. GBP/USD ending the week hovering around the 1.60 handle.

The yield on the US 2-year note encountered extreme volatility, whipsawing between 0.83% and 0.93% all week long. USD/JPY moved in lock step with fluctuating US yields. S&P's comments inspired promises of fiscal discipline from both Finance Minister Kan and his deputy Noda, all of which drove a reversal in fortunes for the yen. JPY took on a soft tone at the end of the week, attributed to Toshin fund launches and month-end rebalancing flows.

On Tues, Japan December Exports rose for the first time since Sept of 2008 by 12.1%. The reversal for the export-heavy economy lifted shares of companies with substantial overseas exposure and prompted the chief Japan economist at Barclays to suggest that economic growth is likely to accelerate towards the end of this year, reducing the need for the BoJ to take further easing measures. That was ndeed the case for Japan's central bank in the prior session. With a number of economists calling on the BOJ to take a more pro-growth path by either expanding the size of its emergency-loan program or raising the monthly JGB buying, policymakers did neither, instead upgrading the current year GDP outlook to -2.5% from -3.2% and next year's view to 1.3% from 1.2%. In the same session, S&P was less upbeat, noting that the Japanese government's diminishing economic policy flexibility may lead to a downgrade unless measures can be taken to stem fiscal / deflationary pressures. To that end, CPI figures in the final trading day in Tokyo saw a second consecutive increase and a 7-month high in headline and core levels of inflation in evidence of Japan making progress of clawing out of deflationary depths.

Australia's headline Q4 CPI figures topped estimates by a decimal point at 2.1% y/y and core levels printed in line at 3.2% - still above the central bank target band of 2-3%. The quarterly inflation data, seen as a 'make-or-break' event for next week's RBA decision, solidified analyst expectations for a fourth consecutive 25bp hike on Monday evening, as overnight swaps showed the likelihood of tightening rising to 75% from around 65%. PM Rudd spoke after the CPI release, warning that interest rates may increase. Several analyst reports also suggested confirmation of RBA tightening by the CPI data, including BofA/Merrill Lynch, who said the CPI is 'just enough' above consensus to confirm the hike.

The Reserve Bank of New Zealand left interest rates unchanged at 2.50%, but reaffirmed its plans to begin raising rates in 'mid-2010'. Governor Bollard shrugged the disappointing Q4 CPI released last week that showed the first contraction since Q4 of 2008 by noting that inflation remaining comfortably within the target range and that household spending is increasing as the economy recovers. Later in the week, Kiwi data continued to deteriorate however, as December building permits showed the first m/m decrease in 6 months, suggesting there is still plenty of room for improvement in Kiwi economy for its central bank to join Australia's tightening cycle.

Trade The News Staff
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