Weekly Market Update: Markets Exhausted by VW, Biotechs, and China Worries
After the chaos of August, global equities have moved sideways in September as the Fed holds rates steady, Beijing keeps propping up its economy and Europe makes baby steps toward growth. The week saw plenty of dramatic corporate stories (Volkswagen's Dieselgate, Glencore's slide lower, biotech drug pricing) and mixed data (better European PMIs, better US GDP, more bad Chinese numbers), but there was an absence of catalysts that would break markets out to the upside or the downside. Meanwhile, major media was distracted by the theatrics of overlapping US state visits by Pope Francis and China President Xi, not to mention the resignation of House Speaker Boehner and the diplomatic maneuvering leading up the UN General Assembly. For the week, the DJIA slipped 0.4%, the S&P500 lost 1.4% and the Nasdaq tumbled 2.9%, weighed down by biotech names.
Fed officials worked to shape expectations after the FOMC left rates on ice last week. Chair Yellen disclosed that a large majority of voting members, including herself, still expects rates to rise this year, although St. Louis Fed President Bullard warned that there might not be enough new data by October to convince the committee to raise rates at that month's meeting. Lacker justified his dissent at last week's decision by saying that further delay of liftoff would be a departure from past Fed behavior and that the softness in inflation was merely the transitory impact of low oil prices. Regarding the market volatility justification for last week's hold, moderate Lockhart said the FOMC is not concerned about markets per se, but rather about how tighter financial conditions could create headwinds for US growth. Dove Williams again argued that a little more patience was needed before raising rates.
The Fed's big hold raised expectations that the ECB might be forced to expand its QE program, a feeling that was exacerbated by weak euro zone August CPI and the September consumer confidence and ZEW readings. ECB governors Nowotny, Praet, Weidmann, and Jazbec were out with remarks downplaying the speculation, and Mario Draghi reiterated that while he was prepared to adjust the size, composition and duration of QE if needed, there was no need to do so right now. EUR/USD has been highly volatile over recent weeks, with the pair spiking late last week to 1.1460 then tanking to 1.1105 on Tuesday, a level it tested again late in the week.
Norway's central bank (Norges) unexpectedly cut its key interest rate by 25 bps to an all-time low of 0.75% and said it may ease policy further. This follows on the heels of the last rate cut just three months ago, after which the central bank said it may need to cut again if oil prices didn't recover. Obviously, there has been no recovery in oil prices. Analysts note that oil companies in Norway have cut 20,000 jobs this year, driving unemployment to ten-year highs. USD/NOK rose to highs around 8.47 in the wake of the rate decision from below 8.30 prior, to its highest levels in 15 years. Norges Governor Olsen warned that the possibility of another rate cut in the next 12 month is greater than 50%.
On Tuesday, the Asian Development Bank lowered its forecast for China 2015 GDP to +6.8% from +7.2% prior. Chinese officials immediately responded by reiterating their 7% target growth rate for the year, however commodity prices moved notably lower, taking materials names lower along with them. The September Caixin/Markit flash PMI reading was weaker than expected (47.0 v 47.5e), dropping to a 78-month low and marking its seventh straight month in contraction. Note that Japan's September preliminary manufacturing PMI remained in expansion but fell to 50.9 from 51.7 in August, with survey respondents citing the decline in sales volumes from China.
Materials names were hit hard by weak Chinese economic data as well as the grim stories out of Caterpillar and Glencore. Cat slashed its FY15 revenue forecast for the second time this year and announced a restructuring program that will see it shed 10,000 jobs by the end of 2018. Additionally, the firm warned that its FY16 revenue would decline 5% y/y, its fourth consecutive year of lower sales. Goldman Sachs published a note this week casting doubt on the ability of Glencore to maintain its BBB investment-grade bond credit rating, given the dynamics of its recent equity raise and debt reduction efforts. Shares of Glencore have been on the wane since the spring, and this week they fell ~25% and dipped below 100 pence for the first time ever. The backdrop for this group continues to be a deflationary price environment. Oil prices remain mired in the mid $40's while copper fell back to a 1-month low below $2.30. In a sign of the times a report emerged on Friday that Airbus was demanding price cuts of up to 10% from its A320 suppliers.
Under intense pressure from conservative GOP members, House Speaker John Boehner said he would resign from Congress at the end of October. A government shutdown was looming as conservatives pushed Boehner to delay passage of continuing funding resolutions over issues related to Planned Parenthood and the Iran nuclear deal, however there is a feeling that Boehner's departure ensures a short-term funding resolution will be passed in the days ahead. In the medium term, there are concerns that a more conservative speaker may revive prior attempts to use the upcoming debt ceiling issue to force a shutdown, possibly later in the fall, with negative implications for the US economy and Fed policy.
The US housing market remained robust in August, while price gains appear to have eased somewhat. New homes sold at an annualized rate of 552K in August, topping expectations and marking the highest level since early 2008. Existing home sales declined to an annualized rate of 5.31 million units from the July rate of 5.58 million, missing expectations. Median prices of new homes were only up 0.3% y/y, while median existing home prices fell to their lowest level in a year. Both Lennar and KB Homes beat expectations in their third quarter reports, with double-digit gains seen in orders disclosed by both firms.
The revelation that Volkswagen manipulated diesel emissions on selected US and European car models knocked shares of the giant automaker down 35% this week. Volkswagen said it would set aside a €6.5 billion provision to deal with the charges and warned FY15 guidance would be adjusted as necessary. CEO Martin Winterkorn stepped down, asserting that he had no knowledge of the misconduct but that VW needs a fresh start. He will be replaced by Porsche chief, Matthias Mueller. In response to the scandal, the EPA said it would enact stricter emissions testing across the industry, and a host of agencies in Europe and the US said they had begun investigations of Volkswagen. There were press reports of excessive emissions from a BMW model, sending shares of BMW down more than 6% on Thursday and raising momentary fears Diesel-gate would spread to other auto makers, however it appears that Volkswagen was alone in its attempt to deliberately cheat.
Biotech stocks saw sharp declines in response to the Turing Pharmaceuticals fracas. Privately held Turing acquired toxoplasmosis treatment Daraprim earlier this year, and the firm quietly announced plans to raise the price on the obscure, 68-year old drug by 5,000%, to $750 per pill, up from $13.50. After weeks of social media debate on the development, the story was covered by the New York Times last weekend, prompting presidential candidate Hilary Clinton to spotlight plans to tackle "price gouging" in the drug market. The media circus led Turing to dial back its price hike, but broader biotech stocks saw losses on fears that regulators might reduce exclusivity periods and enforce stricter pricing caps. The iShares Nasdaq Biotech Index (IBB) lost over 10% on the week, and entered bear market territory at over 20% off of its recent peak.
There were few M&A deals announced this week. The biggest story was Atmel's deal to be acquired by Dialog Semiconductor for $4.6B in cash and stock. Dialog is heavily exposed to Apple and Samsung, and with Atmel the company will be able to expand its presence in the internet of things. Shares of Office Depot and Staples lost ground on press reports that the FTC would block the merger following a similar rationale as the Federal judge who blocked the Sysco/US Foods merger back in June.