TheChek News Flow

Closing Market Summary: Small Caps Lag While Blue Chips Display Relative Strength

The stock market ended the Thursday session on a defensive note despite showing early strength. The S&P 500 lost 0.1%, while the tech-heavy Nasdaq (-0.4%) fell nearly 60 points from its session high. Also of note, the Russell 2000 (-1.0%) settled below its 200-day moving average after failing to retake that level during the session.

Today's affair proved to be a bit of a rollercoaster ride as equities grinded higher in the morning, but rolled to fresh lows during the afternoon before climbing off those lows into the close. Fittingly, the areas that fueled the early advance (biotechnology and high-growth names) were the same spots that paced the afternoon slide.

Equity indices climbed through the first 90 minutes of action with the four top-weighted sectors setting the pace. Consumer discretionary (+0.3%), financials (+0.2%), and technology (+0.1%) continued their outperformance throughout the session, while the health care sector (-0.5%) swung from a position of relative strength to that of weakness when biotechnology reversed from its session high. The iShares Nasdaq Biotechnology ETF (IBB 223.35, -4.13) lost 1.8%, ending just above its 200-day moving average (223.00) after being up as much as 1.6% during the first half of action.

Elsewhere, momentum names like Facebook (FB 56.76, -0.63), FireEye (FEYE 27.45, -1.20), LinkedIn (LNKD 145.07, +1.70), and yelp (YELP 53.29, +0.55) gave an early boost to the technology sector before sliding into the close. Facebook and FireEye ended lower, while LinkedIn and Yelp gave up a good portion of their early gains. Similarly, consumer discretionary components Netflix (NFLX 321.66, +1.12) and Priceline.com (PCLN 1108.00 -23.74) also slumped from their intraday highs. Shares of Priceline.com could not stay out of the red as the company's cautious guidance overshadowed its earnings beat.

Staying on the momentum/earnings theme, Tesla (TSLA 178.59, -22.76) tumbled 11.3% following its quarterly report that featured a bottom-line beat on deliveries that were on the low end of analyst estimates.

Once again, the underperformance of high-beta names took place against the backdrop of relative strength among blue chip issues. The price-weighted

Dow Jones Industrial Average eked out a modest gain of 0.2%, narrowing its week-to-date advance to 0.2% versus a 2.7% drop for the Russell 2000 since last Friday.

Even though equities did not display weakness until the afternoon, the foreign exchange market was signaling caution for the better part of the day. Specifically, the Japanese yen surged to a session high less than an hour after the New York open and continued inching higher into the afternoon. The dollar/yen pair dove into the 101.55 area, ending the session just above yesterday's low of 101.44.

Similarly, Treasuries jumped to highs in the morning, but fell from those levels in reaction to a dismal 30-yr auction that saw a below-average bid/cover ratio of 2.09x (12-auction average 2.39x). Despite the early-afternoon dive, the 10-yr note ended in the green, adding one tick with its yield at 2.61%.

The intraday reversal did not invite unusually strong participation as less than 700 million shares changed hands at the NYSE.

Economic data was limited to just one report:

* The initial claims level fell to 319,000 for the week ending May 3 from an upwardly revised 345,000 (from 344,000) for the week ending April 26. The consensus expected the initial claims level to fall to 325,000. As expected, the recent volatility surrounding the

Easter holiday period is coming to an end. Initial claims are likely to stabilize between 320,000 and 330,000 as labor conditions improve moderately. The continuing claims level fell to 2.685 mln for the week ending April 26 from a downwardly revised 2.761 mln (from 2.771 mln) for the week ending April 19, while the consensus expected a decline to 2.750 mln. 

Tomorrow, the Wholesale Inventories report for March and the March Jobs Openings and Labor Turnover Survey will both be released at 10:00 ET.

* S&P 500 +1.5% YTD  * Dow Jones Industrial Average -0.2% YTD  * Nasdaq Composite -3.0% YTD  * Russell 2000 -5.5% YTD

Wellcome Trust raises ‘concerns’ over Pfizer bid for AstraZeneca

Britain’s biggest medical research foundation has told the government it has “major concerns” over Pfizer’s £63bn offer for AstraZeneca, as the Wellcome Trust became the latest powerful voice to weigh in over the mooted deal. Sir William Castell, the chair of the world’s third largest charitable foundation, and Jeremy Farrar, director of Wellcome Trust, outlined their concerns in a private letter to George Osborne last Friday as the US drugmaker made its opening offer for the UK firm.

Sir William told the UK chancellor that AstraZeneca was “critical” to the UK’s science base and raised doubts over Pfizer’s commitment to investment in Britain. “Pfizer’s past acquisitions of major pharmaceutical companies have led to a substantial reduction in R&D activity, which we are concerned could be replicated in this instance,” said the letter, seen by the Financial Times. Wellcome’s £16bn charitable endowment is a bedrock of UK science, pouring more than £750m a year into biomedical research. It works closely with industry, including a new genetic research partnership with GlaxoSmithKline, the UK’s biggest drug company. Sir William’s intervention comes as Pfizer mulls whether to return with a higher offer after AstraZeneca last week refused to enter takeover talks. Ian Read, the US company’s chairman and chief executive, is due in London on Tuesday to face questions over the proposed deal from MPs. The value of Pfizer’s latest cash and share offer has slipped since it reported disappointing first-quarter results on Monday, pushing down the value of its stock by as much as 6 per cent before it recovered slightly on Thursday. Pfizer proposed that AstraZeneca shareholders would receive 1.845 shares in the combined company and 1,598p in cash, valuing the deal at £50 per share before the recent dip in Pfizer’s stock, making the total offer now worth £60bn. Shares in AstraZeneca closed up 1.8 per cent at £46.80. In early afternoon trading, shares in Pfizer were slightly up at $29.13. Some big shareholders in the UK company have said they would want a higher price and a larger proportion of cash before backing a deal. Pfizer must ensure that at least 20 per cent of the shares of the combined group stay in UK hands if it is to redomicile itself in the country for tax purposes, meaning there is a limit to how much cash it can offer. Political headwinds have added to the challenges for Pfizer after a hardening in the government’s attitude to the proposed deal. The opposition Labour party is pressing prime minister David Cameron to extend the government’s takeover powers to intervene in what would be the biggest foreign takeover of a UK company. The government insist it is to “keep all options open” while pressing Pfizer for stronger assurances over jobs and investment. “We know the research communities have anxieties about Pfizer. The issue is what you do about it,” said one government official involved in the discussions. “Do you tear up the rulebook over takeovers and start all over again with a different regime, or do you negotiate in a hardheaded way with Pfizer?” Sir William said it was “critical” that the government holds Pfizer to commitments the US drugmaker made to keeping 20 per cent of the companies’ combined research and development workforce in the UK for at least five years following a takeover. “The company has not always honoured similar undertakings made following past acquisitions,” he wrote. The Wellcome Trust also urged the government to ensure that Pfizer does not transfer AstraZeneca’s oncology activities to its site on the US west coast.

BofA Warns, Big Trouble In Small Caps If This Line Is Crossed

US equity price action warns of trouble, BofAML's Macneil Curry warns. Since the start of this year, Tuesdays have consistently resulted in positive returns for US equities; but this week's failure to follow through with that pattern, coupled with the Russell 2000’s first close below the 200-day moving-average since November 2012, warns of trouble ahead.

Indeed, the Russell is dangerously close to completing a 4 month "Head-and-Shoulders Top". A close below 1099 is needed to complete the pattern, exposing significant downside to 1057 (5-year trendline), ahead of 988/975 (Head-and-Shoulders obj.).

‘Event-driven’ hedge funds leap into lead after rush to invest

When a hedge fund manager makes a paper profit of $1bn in a single day, it attracts attention. Bill Ackman’s 9.7 per cent stake in Allergan, the maker of Botox injections, rose by that much last month when he revealed he was working with Valeant Pharmaceuticals on a hostile bid for the company. It was a trade that attracted wide comment from lawyers and rivals for its unusual structure and its audacity, but for investors it was simply the fact of such a large profit that caught the eye.

It was another example that a creative hedge fund manager can make his own profits, no matter what is going on in the wider market, and the best justification yet for the headlong rush to put money into “event-driven” hedge fund strategies over the past year. The activists, such as Mr Ackman and peers including Dan Loeb and Barry Rosenstein, whose goal is to cajole companies into corporate activity, have generated most of the headlines, but the phenomenon has been seen across the whole category of event-driven funds. These include managers who make bets around mergers and acquisitions, for example, or even around regular events such as earnings or share buybacks. In all, event-driven funds attracted $29.6bn in new money last year, more than any other hedge fund category, and a further $4.1bn in the first quarter of 2014, according to data provider Hedge Fund Research. Assets under management are more than double what they were in 2008. These funds have outperformed the hedge fund industry as a whole in all but two quarters since the start of 2011 – making them even more popular – and even as the industry has suffered two rocky months, turning in negative returns overall, event-driven funds have stayed profitable. The question, as equity market valuations get more stretched and investors become more nervous about a correction, is whether the boom in event-driven funds will prove to be a bull market phenomenon, or whether these managers go on to prove they have found the holy grail of hedge fund investing, uncorrelated returns. SkyBridge Capital, a fund of funds, has 40 per cent of its portfolio allocated to event-driven strategies, and although it has dialled back investments with managers who are the most correlated with the stock market in recent months, founder Anthony Scaramucci says he still believes activists in particular have further to run.

“Every 30 years in the modern era, corporate America has had to go through a period of slimming down and restructuring,” says Mr Scaramucci. “In the 1980s, it was driven by the corporate raider, now it is the activist. Every 30 years, the companies get fat, they get clubby.” Some of the most conservative event-driven strategies of recent years have lost their allure as more and more funds have crowded in, according to Barry Gill, portfolio manager at UBS O’Connor. These plain vanilla strategies include short-term bets around specific triggers such as earnings, usually made up of betting in favour of one stock and short selling a rival. “The more capital, the lower the returns, since there are lots of people with similar ideas and ways of thinking about the world,” says Mr Gill, adding that the bias towards using mid and small-cap stocks has exacerbated losses in this subsector in recent weeks as small-caps have sharply underperformed. If these conservative strategies are played out, and activism is halfway through its cycle, Mr Gill says, the next bright spot within event-driven strategies is merger arbitrage. A boom in US merger and acquisition deals appears to be spreading to Europe, not least via Pfizer’s $100bn-plus bid for AstraZeneca, giving traders numerous options to bet on the outcome of the battle and on the likely shifts in the two companies’ shares and bonds. A recent rise in European deals has prompted hedge fund investors to seek funds with exposure to the region, and for hedge funds themselves to look to hire more managers who are able to trade such situations effectively. A recent report by Lyxor Alternatives, a France based fund of hedge funds, referred to an “M&A frenzy”, arguing that the European merger cycle would mean a large number of opportunities would open up for managers. Andrew Garthwaite, chief global equity strategist at Credit Suisse, argued at a recent conference in London organised by the bank on event-driven investing that M&A activity tended to lag the broader stock market by a year, meaning Europe was now primed for a fit of takeover activity. The bank’s hedge fund investor survey, which polled over 500 respondents representing $1.16tn in hedge fund assets, showed demand from investors for event-driven strategies almost doubled from the year before. Mr Scaramucci says: “I think we’re in the first or second inning in this trade, and I predict we’ll have more money to allocate to these strategies in the future.”

ECB's Draghi Talks Up a Summer Storm

Mario Draghi's strategy of talking dovishly while keeping monetary policy unchanged has run out of road.

The president of the European Central Bank on Thursday heavily hinted at action in June, saying the governing council was "comfortable" with that idea, subject to new information that will be available by then. But what exact course of action the ECB might take then isn't clear.

Mr. Draghi certainly caught the market off guard. He kicked off Thursday's news conference with remarks that were almost identical to those he made a month ago. That helped push the euro up to within a whisker of $1.40. But then he dropped several bombshells, saying the exchange rate was cause for "serious concern" in the context of low inflation; that the ECB wasn't resigned to tolerating low inflation; and that policy makers were "comfortable with acting next time" subject to new staff forecasts on growth and inflation. The euro promptly tumbled over a cent against the dollar, and stocks and euro-zone bonds rallied.

Mr. Draghi's reversal raises many questions. First, if there is a consensus to act, why wait? Second, how much has the ECB's thinking changed since March? Back then, a forecast for inflation of just 1% this year and 1.7% by late 2016 was judged as allowing monetary policy to remain on hold. True, the June forecasts are likely to show lower inflation for this year—so far it has averaged 0.7%—but may also show higher economic growth. And it is medium-term inflation that policy will be able to influence, not the data unfolding in the coming months.

Most important of all, what might the ECB do in June if it does decide to act? The focus on the strength of the currency suggests that a cut in interest rates combined with a negative rate on the cash that banks deposit at the ECB might be in the cards. ECB officials have previously suggested that this would be the first course of action.

But the ECB's newfound unwillingness to tolerate low inflation points to a potentially bigger response: Mr. Draghi on April 24 said that a worsening of the medium-term outlook on this front could lead to asset purchases, or quantitative easing. However, he said the context for doing so might be a broad-based weakening of demand or a big positive supply shock—neither of which seem to have materialized. QE remains a drastic policy step, and it isn't clear the ECB has worked out what to buy, or how.

Markets will comb speeches from ECB officials in coming days for further guidance. Previously, less obvious hints at ECB action have been followed swiftly by talk about the practical difficulties involved. Mr. Draghi's comments Thursday, however, will make it very difficult to row back now.