Weekly Market Update: Global Markets Shanghaied Again
China's yuan revaluation experiment seemed to end as rapidly as it began, just in time for the Chinese stocks to resume stomach-churning declines. On Tuesday, the Shanghai Composite saw its biggest slide since late July, dropping 6.2%, prompting the PBoC to engage in a series of massive liquidity injections. Equity indices around the globe followed China lower: the S&P500 had its worst week in almost four years dropping 5.8%, the Nikkei lost 5.7%, and the Euro Stoxx 50 fell 7.2%, while many emerging market stock and bond markets saw even worse losses. With China looking very sick, commodities saw more big losses: copper fell for the seventh straight week and WTI crude racked up its eighth straight weekly decline falling below $40 a barrel, its longest losing streak since 1986. Investors poured over the minutes from the July 28-29 FOMC meeting but no conclusive bias for or against rate hikes could be divined from the document. With uncertainty and tensions building in every corner of global markets, the 10-year UST yield gradually slipped lower, losing another 15 basis points to end the week below 2.05%. TIPS breakeven spreads in Europe and the US declined to levels not seen since January as freefalling commodity prices and global growth concerns showed up in various market inflation gauges. EUR/USD rose more than three big figures to 1.1370, approaching two-month highs, while the greenback lost ground to the Japanese Yen and Swiss Franc too. Emerging market currencies continued to get throttled on a host of political and economic worries. Gold prices surged 4% aided by risk averse flows, namely equity market selling. On Friday, the DJIA traded down by as much as 500 points intraday, and the VIX volatility index rose to its highest level since last October (during the Ebola scare), the last time the S&P 500 broke below its 200 day moving average.
The Chinese have put Beijing's big rescue efforts to the test, pushing the Shanghai Composite down to match its July 8th low and erasing the 14% gain seen over recent weeks. On Tuesday, the Shanghai index sank 6.2%, and then saw mid-single digit percentage losses on Thursday and Friday, finishing the week down 11.5%. Some blamed slightly better July housing market data for setting off the current slide lower, reasoning that a bottoming housing market might encourage the government to hold off on more stimulus. On Thursday, the PBoC did inject another CNY120B in 7-day reverse repos through open market operations, bringing the weekly total to a 6-month high of CNY150B, but that only elevated fears of massive investment outflows from the mainland following surprise devaluation. On Friday, there was also the first major Chinese economic data release for August: the Caixin flash manufacturing PMI widely missed expectations to come in at 47.1, the lowest level since March 2009 and also sixth straight month of contraction. Meanwhile, local press featured several reports suggesting Beijing policymakers are debating slashing China's growth objectives further in the next 5-year plan to 6.5%.
The FOMC minutes left market participants somewhat confused and revealed no clear sign in favor of a September rate hike. There were very dovish bits: "Some participants expressed the view that the incoming information had not yet provided grounds for reasonable confidence that inflation would move back to 2% over the medium term and that the inflation outlook thus might not soon meet one of the conditions established by the Committee for initiating a firming of policy." Conversely, there was also some quite hawkish language: "Most members viewed the incoming data as reinforcing their earlier assessment that, although inflation continued to run below the Committee's objective, the downward pressure on inflation from the previous decreases in energy prices and the effects of past dollar appreciation would abate."
Fed governors Kocherlakota and Bullard - both non-voters - addressed policy in speeches out ahead of the minutes. Kocherlakota summarized the dove case that the Fed needs to hold rates near zero well into 2016 to help boost inflation toward the target level. Bullard reiterated his support for a September rate hike and said the FOMC needs to be prepared to increase rates faster to counter bubbles as low rates may be fueling excessive risk taking.
The July US core CPI reading fell short of expectations and declined slightly from the June reading. Analysts cited a 5.6% decline in airfares for the shortfall, although they also cautioned that the airfare component of the PCE index relies on PPI data, which were flat this month, suggesting that the fall in core CPI may not show up in the PCE data.
The US housing market kept improving in July, with housing starts and existing home sales back at highs last seen in early 2007, although data also suggested that affordability was becoming a bigger problem. Housing starts rose to an annualized rate of 1.21M units in July, up from the revised 1.20M unit figure for June. The 782K total for single family starts was the highest print since December 2007, while multifamily starts actually declined by double-digits from June. July existing home sales were 5.59M units and the June figure was revised slightly higher. Median existing home prices were up 5.6% y/y in the month, leading the NAR to warn declining affordability could begin to slowly dampen demand, despite the strong growth in sales since this spring.
WTI crude tested below the $40 mark on Friday after weekly Baker Hughes rig data showed another uptick. Brent finished out the week around $45.50. US statistics out this week compounded the impact of China on broader commodity prices. The weekly EIA inventory report showed US crude stocks returned to builds ahead of refinery maintenance season in September (the API survey dissented, finding a fourth straight week of crude drawdowns). In a separate report out on Thursday, the API said that US crude output climbed 8.8% from a year earlier to 9.52 million bpd in July, the highest level in decades. Analysts believe the low of $32 for WTI reached at the height of the 2008 crisis is now within reach.
The June quarter earnings season wrapped up with reports from the leading US retailers. Walmart disclosed its third consecutive quarter of disappointing numbers and cut its FY view for the second time this year. Management blamed higher costs and margins pressure for its disappointing earnings performance, pointing the finger at higher wages and lower profitability in the US pharmacy business. Rival Target beat earnings expectations and raised its FY outlook, however guidance for current-quarter same-store sales was a bit weak. Home Depot met expectations and raised its FY view for the second time this year. Discount apparel retailer TJX Companies beat expectations and raised its FY guidance, and disclosed sales comps up 6%, double the expected gain. Apparel name American Eagle Outfitters beat top- and bottom-line expectations on an 11%-comp sales gain.
The steep declines in Disney over recent weeks continued, as analysts and talking heads continued to discuss the death of cable TV and its implications for media stocks. In a bearish research note out midweek, Bernstein said markets are now valuing ad-supported TV as structurally impaired assets and warned that TV advertising is undeniably in secular decline, with affiliate fees at increased risk. According to Bernstein, US TV businesses are now heading towards valuations more resembling things like satellite TV, publishing and AOL.
Valeant announced a deal to acquire Sprout Pharmaceutical for $1.0B in cash, just two days after the FDA approved Sprout's Addyi, the first treatment for female hypoactive sexual desire disorder. There are real concerns about the drug, which was rejected twice by the FDA over concerns about its effectiveness and side-effects. Valeant said it would pay $500 million upfront and make another installment next year for privately owned Sprout. In other deal news, Liberty Interactive agreed to acquire online retailer Zulily for $2.4 billion in cash and stock, more than a 45% premium to the prior closing price.
After two straight quarters of expansion, Japan's economy contracted again, albeit by a slightly smaller margin than expected. Q2 GDP fell 0.4% q/q and shrank 1.6% on an annualized basis. Declines in key components of corporate CapEx and Private Consumption were particularly notable as both missed expectations. Exports also contracted over 4% after rising 1.6% in Q1. Japan's cabinet officials attributed the decline to weaker external demand, particularly out of the US and China. Soft domestic consumption was written off to inclement weather and higher auto taxes. The Nikkei225 ended the week down over 5.5%, with the selloff exacerbated by the safe-haven bid in Japanese Yen, as USD/JPY pair fell two and a half handles below ¥122.