FT : Investors hedge against a European stock market downturn

Investors hedge against a European stock market downturn
Activity in options market indicates nerves over this year’s rally

Cautious investors are snapping up derivatives that would protect them if this year’s rally in European stocks crumbles, in a sign of mounting concerns that slowing economic growth will weigh on markets sitting close to record highs.

Traders have been buying an increasing number of put options, which provide insurance against a slide in prices, relative to calls, which pay out if the market rises. In so doing, they betray an “underlying nervousness” about European stocks despite their recent run, said analysts at Bank of America.

The ratio of puts to calls tied to the blue-chip Euro Stoxx 50 benchmark has risen to its highest level in BofA data stretching back a decade.

The index — which includes luxury goods group LVMH, chip equipment maker ASML and industrial conglomerate Siemens — has risen 14 per cent since January to its highest level since 2007. The eurozone economy sank into a mild technical recession in June after two consecutive quarters of contraction.

“Fundamentally, we’re still in a place where [Europe’s] growth outlook isn’t amazing,” said Abhinandan Deb​​​, head of global cross asset quant investment strategy at BofA Global Research. “People are uncomfortably long [Europe]. They’re long because they need to participate, but the fundamental conviction isn’t there. No one wants to chase this market so close to its high.”


Alexandru Bohotin, head of European index options trading at Optiver in Amsterdam, said he had seen more demand for “downside protection” from investors in European stocks, particularly as investors have begun to reallocate to equities after being underweight most of the year. “They’re protecting their portfolios through buying puts, which is what’s driving up metrics like put/call ratios,” said Bohotin.

Other investors point out that a recent slowdown in activity across Europe’s hitherto resilient services sector also bodes poorly for local stock markets.

S&P Global’s eurozone services purchasing managers’ index, a measure of activity in services, fell for a second month running in June to 52, indicating continued expansion, albeit at the slowest pace since January. 

The slump in service sector momentum may soon begin to weigh on European equities, which have pushed higher so far this year — defying many investors’ expectations — even though the European Central Bank has ratcheted up interest rates at unprecedented speed to combat inflation. 

Services account for roughly 70 per cent of economic activity in the euro area with the services PMI viewed as a strong leading indicator of stock price performance because of its high correlation with services activity.

“The whole bounceback of share prices in Europe after last winter was due to this rebound in services. People thought and still think that the economy remains resilient,” said Tomasz Wieladek, chief European economist at T Rowe Price. 

However, “[services PMI] will probably go down significantly as part of the natural monetary policy tightening cycle and that’s something that markets are not prepared for,” he said, adding that the euro area services PMI has been “highly correlated” with European share price moves over the past three years.

>>> Weekend Papers Summary

Weekend Papers Summary

NEW YORK TIMES
-In Hollywood, the strikes are just part of the problem. The entertainment industry is trying to figure out the economics of streaming. It’s also facing angst over a tech-powered future and fighting to stay culturally dominant.
-Medical device makers have bankrolled a cottage industry of doctors and clinics that perform artery-clearing procedures that can lead to amputations.
-Suspect in Gilgo Beach killings led a life of chaos and control. The 59-year-old architect was painstaking in his Manhattan career. At home in Massapequa Park, he left neighbors discomfited.
-The Gilgo Beach victims were always more than escorts. The author of a book about the murders writes that more than a decade after the women went missing, attitudes toward them seem to have changed.
-‘Not for Machines to Harvest’: data revolts break out against AO. Fed up with AI companies consuming online content without consent, fan fiction writers, actors, social media companies and news organizations are among those rebelling.
-It’s a few weeks before the release of Claude, a new A.I. chatbot from the artificial intelligence start-up Anthropic, and the nervous energy inside the company’s San Francisco headquarters could power a rocket.
-South Korea reels from monsoon rains as floods and landslides kill 26. At least 10 people were missing after the deluge, and rainfall was expected to intensify in the next few days.
-Russia is doing ‘everything’ it can to stop counteroffensive, Zelensky Says. President Volodymyr Zelensky of Ukraine secured new weapons pledges this week from allies, but it was not clear when they would arrive.
-After suffering heavy losses, Ukrainians paused to rethink strategy. Early in the counteroffensive, Ukraine lost as much as 20% of its weapons and armor. The rate dropped as the campaign slowed and commanders shifted tactics.
-Turmoil in Florida’s new State Guard, as some recruits quit. Some said the force, which was commissioned by Gov. Ron DeSantis and billed as a natural disaster relief organization, had become too militarized.

THE FINANCIAL TIMES
-The Pentagon’s annual funding bill is set to become the focus of a political showdown after Republicans inserted “anti-woke” social provisions into the legislation. The bill — known as the National Defense Authorization Act — is normally shielded from the bitterest partisan bickering and often passes with support from both political parties. But on Friday, Republicans in the House of Representatives passed their version of the legislation, worth $886bn, by adding measures designed to curb abortion rights, diversity training and medical care for transgender patients in the military.
-Joe Biden and the Democratic party raised $72M in the second quarter to spend on the US president’s 2024 re-election campaign as they raced to gain an early financial edge over Republican rivals for the White House.
-A week after Yevgeny Prigozhin’s Wagner group’s mutiny failed in June, the warlord’s online media empire announced it would shut its doors and “depart the country’s news agenda”. But since then Prigozhin’s notorious troll army has kept up its frenetic posting rate online, while the former caterer has remained in Russia — even meeting Vladimir Putin in the Kremlin — despite a deal to leave for exile in Belarus.
-Cautious investors are snapping up derivatives that would protect them if this year’s rally in European stocks crumbles, in a sign of mounting concerns that slowing economic growth will weigh on markets sitting close to record highs. Traders have been buying an increasing number of put options, which provide insurance against a slide in prices, relative to calls, which pay out if the market rises. In so doing, they betray an “underlying nervousness” about European stocks despite their recent run, said analysts at Bank of America.
-Three of the largest US banks reported a surge in profits from charging more for loans, as the Federal Reserve’s series of interest rate rises fattened their bottom lines. JPMorgan Chase, Citigroup and Wells Fargo collectively earned $49B in net interest income in the second quarter, the difference between what the banks pay for deposits and earn from loans and other assets.
-Elon Musk claimed on Friday that his new artificial intelligence company, xAI, could be trusted more than OpenAI and Google to build safe AI systems when computers become smarter than humans. However, discussing his AI plans on Twitter two days after launching the company, he did not shed light on how xAI’s work would differ from rivals that are years ahead or the kind of services it hoped to create.
-Hackers tied to Russia’s spy services have hijacked a Polish diplomat’s advertisement to sell his BMW, spreading malware in an attempt to infiltrate foreign embassies’ networks in Ukraine. The Kiev-based diplomat emailed an advertisement about his 2011 BMW 5 series car to dozens of other embassies this spring. Within two weeks, the hackers had repurposed the advertisement, dropped the price and laced the notice with malware, according to researchers at Unit 42 — part of Californian cyber security firm Palo Alto Networks.
-Wealthy borrowers in the UK with large interest-only mortgages face a punishing jump in payments — leaving them potentially paying thousands of pounds a month more — as they come off fixed-rate deals in a rising interest rate environment.

NY POST
-Suspected Gilgo Beach serial killer Rex Heuermann was caught on video strolling down a Midtown sidewalk in the moments before plainclothes cops swooped in to arrest him, footage shows. Heuermann, 59, appeared oblivious as he walked along, with a messenger back slung over his shoulder. Suddenly plainclothes officers can be seen stepping in front of, then surrounding the architect and taking him into custody, according to footage obtained by WABC. The takedown occurred close to Heuermann’s Fifth Avenue office Thursday night. Heuermann appeared in court Friday afternoon and pleaded not guilty to three counts of first-degree murder and other charges related to the deaths of three women over 10 years ago. The life-long suburbanite, who was emotionless in court, was also named the prime suspect in a fourth killing.
-The US Virgin Islands said it wants JPMorgan Chase to pay at least $190M to resolve a lawsuit accusing the largest US bank of ignoring the disgraced late financier Jeffrey Epstein’s sex trafficking. In a Friday filing in federal court in Manhattan, the territory said it wants JPMorgan to pay a $150M civil fine, and give up at least $40M from its 15-year relationship with Epstein. It also wants JPMorgan to pay compensatory damages suffered by Epstein’s victims, as well as punitive damages.

FT : Quant funds move into unfettered pink sheet stock trading

Quant funds move into unfettered pink sheet stock trading
Computer-driven hedge funds and proprietary traders attracted by off-exchange market’s improved liquidity

Computer-driven investment firms are increasingly trading over-the-counter US stocks, attempting to bring modern algorithmic strategies to a realm traditionally seen as one of the riskiest corners of equity investing.

So-called quant hedge funds and proprietary traders are being drawn towards this corner of the market by a combination of improved liquidity and the increasing difficulty they face making money in the large-cap markets they have previously focus on, say investors, market makers and exchange executives.

“It’s sort of at the sweet spot of what an investor like us thinks we can do,” said Seth Weingram, senior vice-president at Acadian Asset Management, which specialises in systematic strategies and runs a microcap strategy that includes OTC stocks. “It’s the least efficient part of the equity universe, and we are really interested in less efficient market segments.”

Over-the-counter stocks are shares in companies that are not listed on mainstream exchanges such as the New York Stock Exchange or Nasdaq. More than 12,000 stocks trade on the US’s main over-the-counter network, which is operated by OTC Markets Group. 

Those 12,000 companies range from dollar-denominated versions of big foreign stocks such as Nestlé, to smaller domestic groups drawn by cheaper listing costs, to highly speculative shell companies or bankrupt businesses that have been kicked off mainstream exchanges.

Earlier this month the Financial Times reported that traders had spent hundreds of millions of dollars on shares in defunct retailer Bed Bath & Beyond since it was delisted from Nasdaq in May, even though analysts consider it worthless and another company has bought the rights to its name.

While measuring quants’ share of trading in OTC stocks is difficult, hedge funds and proprietary traders account for a much bigger share of OTC Markets Group’s recent customer growth than in the past.

Such firms are still a relatively small part of the wider investment landscape, but made up 40 per cent of new customers paying for access to OTC Markets’ data over the past two years. In the first half of 2023, the percentage increased to 50 per cent. 

“Anyone with a broker relationship can pick out single securities or specific situations they might want to trade, but once they’re buying the real-time data, it indicates they’re putting it into a larger programme or strategy,” said Matt Fuchs, OTC Markets executive vice-president for market data.

OTC markets used to be known as the “pink sheets”, named after the coloured paper on which quotes were published. They were popular with retail traders but expensive to trade and notoriously risky, and were prone to “pump and dump” scams.

In total, investors traded some $507bn worth of OTC stocks last year — down from the peak of the meme stock craze in 2021, but still more than 50 per cent higher than 2019.

The increased liquidity has made it easier for algorithmic strategies to work. Meanwhile, with most big fund firms still spurning the space, competition from other institutions remains low.

“Trading volumes are much, much smaller . . . there’s not as much competition as in traditional standard developed parts of the equity markets,” Weingram said. 

The Composite index of OTC stocks has risen 45 per cent since the end of 2018, compared with 51 per cent for the S&P 500 and 49 per cent for the Russell 2000 small-cap index. However, proponents say there is more opportunity for active managers to add value in the smaller-cap space than in more efficient large-cap indices.

PGIM Quantitative Solutions, the systematic trading arm of the $1.3tn asset manager, started a quantitative microcap strategy last year. “In terms of adding [outperformance] we’ve seen much more opportunity compared to other strategies . . . it’s hard to add value if you’re benchmarked against the S&P 500,” said managing director and chief investment officer George N. Patterson.

PGIM is among firms that have been pitching such strategies to clients as an alternative asset class comparable to private equity, which can be used to diversify portfolios and reduce correlation with major markets.

However, some investors remain sceptical.

“You look at a company and ask is there value here or is it smoke and mirrors, and there’s more smoke and mirrors than value in the OTC market,” said Scott Sheridan, the chief executive of Tastytrade and co-founder of Thinkorswim, retail-focused options trading platforms.

He said while there was always the potential for a lottery ticket — an obscure stock that dramatically increases in value — that is rare, as it is for companies that trade OTC to grow and then list with regulated exchanges. “This isn’t like the minor leagues in baseball. There’s a reason these companies aren’t trading listed.”

“We have less than zero interest in OTC. There are so many pump and dumps,” Sheridan said. He added that there were risks for institutions, given the regulator environment. “With pink sheets, you’re asking for the regulators to come in and ask why you’re trading this.”

PGIM’s Patterson acknowledged investors still “have to be careful and pay attention to managing costs”, but insisted OTC was “not the same space it used to be 10 years ago”.

He added: “The risk is not outsized compared to, say, certain emerging markets strategies or lots in the hedge fund space. I think it’s a lot less risky than crypto.”

FT : Elon Musk claims more trust can be put in his xAI than OpenAI and Google

Elon Musk claims more trust can be put in his xAI than OpenAI and Google
Tesla boss gives rambling 90-minute talk about his artificial intelligence plans after launching rival company this week

Elon Musk claimed on Friday that his new artificial intelligence company, xAI, could be trusted more than OpenAI and Google to build safe AI systems when computers become smarter than humans.

However, discussing his AI plans on Twitter two days after launching the company, he did not shed light on how xAI’s work would differ from rivals that are years ahead or the kind of services it hoped to create.

xAI was launched this week with a mission to “understand the true nature of the universe”.

In a rambling, 90-minute discussion that drew more than 30,000 listeners on his social media site, Musk talked at length about whether aliens exist and why superintelligent machines might decide not to destroy humanity, but said of xAI’s work: “We’re just starting out here, this is really embryonic.”

xAI has joined a race to build machines with human-level intelligence, known as artificial general intelligence, or AGI. Earlier this year, Musk was one of the signatories to a letter calling for a six-month delay in the development of advanced AI to allow time for more focus on safety.

“I’ve really struggled with this AGI thing for a long time and I’ve been somewhat resistant to making it happen,” he said. “But it really seems that at this point it looks like AGI is going to happen so there’s two choices, either be a spectator or a participant. As a spectator, one can’t do much to influence the outcome.”

Musk said he first got involved in AI, as a founder of OpenAI, after deciding that Google co-founder Larry Page “just wasn’t at the time taking [AI safety] seriously enough”. He left OpenAI before it embarked on a series of breakthroughs in large language models that led to the launch of ChatGPT late last year.

The Tesla and SpaceX entrepreneur said that OpenAI had become “voracious for profit” and that, as public companies, Google and Microsoft were subjected to “all these ESG [environmental, social and governance] mandates and stuff that push companies in questionable directions”.

“As a company that’s not publicly traded, xAI is not subject to market-based incentives, or the non market-based, ESG incentives,” Musk said. “We’re a little freer to operate.”

FT : UK regulators open door to quick Microsoft-Activision deal

UK regulators open door to quick Microsoft-Activision deal
New timetable from Competition and Markets Authority means $75bn transaction could be closed within weeks

UK regulators have opened the door for Microsoft and Activision Blizzard to close their $75bn video games deal within as little as six weeks, as the companies scramble to restructure their agreement to satisfy competition concerns.

Meanwhile, the US Federal Trade Commission failed late on Friday in its last-ditch attempts to prevent the deal from closing in the US. Its request for a preliminary injunction to block the deal pending a separate action was denied by the Ninth Circuit Court of appeals, the day after a similar injunction request was denied by a federal court in San Francisco. The actions left approval in the UK as the only hurdle left for the companies in their efforts to seal the deal.

The UK’s Competition and Markets Authority on Friday said it would push back a July 18 deadline for it to block the deal until August 29, after receiving a “detailed and complex submission from Microsoft”. The company argued that the agency should re-examine its conclusions due to “material changes in circumstance and special reasons”.

That timetable could allow Microsoft to complete the merger more quickly than the CMA had suggested earlier this week, when the agency said a restructured deal would trigger a new investigation, likely taking several months.

The CMA’s move to reopen deliberations about its final decision, which is unusual so late in the regulatory process, revives the potential for Microsoft to resolve the watchdog’s concerns about competition in the cloud gaming market. The CMA did not provide details of Microsoft’s submission, which was made more than a month ago.

The extension comes as Microsoft explores ways of restructuring its cloud gaming business in the UK to appease the CMA, which ruled in April that combining the maker of Xbox consoles with the creator of hit games including Call of Duty and Diablo would give it “the ability to undermine new and innovative competitors”.

The UK competition regulator’s objections are seen as the last big legal hurdle facing the world’s largest video games deal, after US courts earlier this week sided with Microsoft to reject an initial attempt by the Federal Trade Commission to block the merger.

The merger agreement between Microsoft and Activision Blizzard is due to expire on July 18, which would allow either company to walk away from the deal and triggering a $3bn break fee. However, after this week’s legal victory in the US courts and a potential lifeline in the UK, people close to the companies say they are likely to agree an extension to the deal early next week.

“Things are moving quite quickly,” said one person close to the negotiations.

One potential concession to the CMA under consideration by Microsoft is a move to sell cloud streaming rights to its catalogue of games to another provider in the UK, according to people familiar with the discussions. The arrangement might see Microsoft in effect exit the cloud gaming market in the UK or hand over operations of a games streaming platform for its Xbox console to a third party.

Microsoft has sounded out potential investors and operators about such a deal, which might assuage the CMA’s concerns that the Xbox maker would have too much control over the nascent market for cloud gaming.

Bloomberg earlier reported details of the cloud discussions. Microsoft and Activision Blizzard declined to comment.

Gareth Sutcliffe, analyst at Enders Analysis, said that such a deal would be “really clunky” for consumers but “might be a way around the CMA”. “Microsoft will be running the numbers for a UK carve-out that will please the CMA,” he said. “They would be looking at least-worst options.”

Barron's : The Yen, the Yuan, and the Dollar: How China and Japan Could Shore Up

The Yen, the Yuan, and the Dollar: How China and Japan Could Shore Up Their Economies

When the People’s Bank of China talks, markets listen. Even when it kind of mumbles.

China’s central bank leaked guidance a few weeks ago that it was unleashing state-owned banks to sell dollars to defend the yuan. That stabilized the Chinese currency after a 5% slide over the previous three months.

Beijing’s throat-clearing got investors thinking about Japan following suit. The yen has bounced 4% against the dollar after a 9% slide. This week’s soft inflation report from the U.S. could add to this momentum, hinting at an end to the Federal Reserve’s interest-rate hikes.

So are the reserves-rich Asian giants marshaling a counterattack against the almighty dollar? Not exactly. The Bank of Japan ’s prime interest rate is 0.1% and China’s 3.55%, compared to the Fed’s 5.25%.

No amount of dollar sales will drive a sustained rally against that basic arithmetic. Intervention can end the one-way bets against the yuan and yen, though, and maintain a measured decline rather than a rout. “Speed always kills with currency moves,” says Edward al-Hussainy, senior currency analyst at Columbia Threadneedle Investments. “They can intervene so that the moves are less disruptive.”

China and Japan both have reasons to welcome a weaker currency. It could support their world-beating export industries, and neither is much worried about importing inflation. Too weak a currency, on the other hand, risks popular discontent as consumer imports become too expensive. “Last year we got a big jump in import prices, and people hated it,” says Masamichi Adachi, chief Japan economist at UBS.

Similarities between the No. 2 and No. 3 economies end there. China is grappling with an underwhelming recovery from last year’s zero-Covid lockdowns. It needs a growth accelerant to whittle down enormous youth unemployment, among other pressing problems.

The classic means to achieve that would be by cutting interest rates, which would further weaken the yuan. “Their key point of tension is between measures to support the economy and increasing pressure on the currency,” says Michael Hirson, head of China research at 22V Research.

Japan is enjoying its best economic mojo in quite some time. Inflation is rearing its head, which is a good thing over there; wages and home prices are both rising for the first time in decades; foreign investors are pouring in. The iShares MSCI JapanEWJ –1.20% exchange-traded fund (ticker: EWJ) is up 14% this year despite the slumping yen. The Chinese equivalent, iShares MSCI ChinaMCHI –1.71% (MCHI), has lost 5%.

Investors expect the Bank of Japan to support the yen a bit at its next meeting July 28—lifting its cap on 10-year government bond yields, the so-called yield curve control, from 0.5% to perhaps 1% annually. That should suck domestic buyers back in, as the return becomes competitive with hedging costs on dollar investments, Adachi predicts.

The moderate measure could keep the yen above the 150-to-the-dollar level where the government intervened (successfully) last autumn. Current value is around 138.

Actually raising interest rates is less likely, says Ayako Fujita, chief economist at JPMorgan Securities Japan. More than 70% of Japanese mortgages are written with floating rates, and small businesses borrow at less than 1% annually on average. “Policy makers are very much afraid” to risk this equilibrium, she says.

With inflation tentatively entrenching itself around 2% and credit still nearly free, “real rates have never been so negative” in Japan, she says. Throw in expansionist fiscal policy and you get “perfect conditions for asset price inflation,” Fujita concludes.

Investors might want to grab that while they can in Japan. China still has some tensions to work through.

Barron's : Deal Makers Are Ready for M&A Activity to Ramp Up

Deal Makers Are Ready for M&A Activity to Ramp Up

There may not be many deals in the offing right now, but Wall Street seems to be betting that conditions are about to become more favorable for deal makers.

Look no further than the recent stock moves of investment firms such as Apollo Global Management APO –0.32% (ticker: APO), which set a record high on Friday. Despite a tepid climate for mergers and acquisitions, some investors believe that deal activity has hit a bottom, and that future quarters will be busier.

“We’re not grinding down anymore, but rather it seems to us more that the market has found a base,” Oppenheimer analyst Chris Kotowski wrote in a recent note. “The next move in activity is more likely higher rather than lower.”

His bullishness isn’t just limited to Apollo; he also recommends shares of Blackstone (BX), Carlyle Group (CG), GCM Grosvenor (GCMG), Hamilton Lane (HLNE), KKR (KKR), Blue Owl Capital (OWL), and P10 (PX). So far this year, the asset managers in Kotowski’s coverage group, many of which grew from a private-equity core, have outperformed the S&P 500 by three percentage points, though the group is coming off a 2022 in which it lost 30%.

But if these firms feel confident enough to strike on a deal, they’ll have the wherewithal to do so. Kotowski found that for every $1 an investor pays for the asset manager, the firms he covers are sitting on an average of $2.15 of “dry powder” in private equity and real assets. With the macroeconomic outlook still uncertain, private-equity investors can put money to work at more appetizing valuations.