Closing Stock Market SummaryThe S&P 500 dropped 2.4% on Friday in a risk-off session amid the continued rise in new coronavirus cases and industry-specific issues for the banks and social media companies. The Dow Jones Industrial Average (-2.8%), Nasdaq Composite (-2.6%), and Russell 2000 (-2.4%) also fell more than 2.0%.
All 11 S&P 500 sectors closed in negative territory, with the financials (-4.3%) and communication services (-4.5%) sectors falling more than 4%. The utilities sector declined the least with a 1.0% decline.
The U.S. hit another daily record for new coronavirus cases, prompting hotspots like Texas and Florida to scale back their reopening efforts. The reduced reopening activity threatens to undermine consumer sentiment and personal spending, the latter of which rebounded 8.2% m/m in May (Briefing.com consensus +7.0%).
Unfortunately, the market was also burdened by other developments. Banks were pressured by the Fed's decision to require them to suspend share repurchases and cap dividend payments in the third quarter (out of an abundance of caution), while more companies suspended ad spending on Facebook (FB 216.08, -19.60, -8.3%).
Verizon (VZ 53.16, -1.12, -2.1%), Unilever (UN 54.51, -0.32, -0.6%), and Honda Motor (HMC 25.33, -0.92, -3.5%) joined the growing list of companies that paused spending, which was a wake-up call for companies that derive revenue from advertising in how they handle misconduct within their platforms.
Facebook shares fell 8%, but Alphabet (GOOG 1359.90, -81.43, -5.7%) and Twitter (TWTR 29.05, -2.32, -7.4%) also took it on the chin.
In other developments, Nike (NKE 93.67, -7.73, -7.6%) missed top and bottom-line estimates, Cisco (CSCO 46.31, +1.09, +2.4%) was the lone Dow component to close higher amid news that the Trump administration is thinking about helping the company in 5G development, and the yearly rebalancing of the FTSE Russell indices happened at the close.
Quarter-end rebalancing might have played a part in today's decline, too, as investors re-allocated money into bonds. The 2-yr yield was unchanged at 0.16%, while the 10-yr yield declined four basis points to 0.64%. The U.S. Dollar Index was little changed at 97.45. WTI crude declined 0.7%, or $0.26, to $38.49/bbl.
Reviewing Friday's economic data:
- Personal income declined 4.2% m/m in May (consensus -6.0%) following a 10.8% increase in April while personal spending surged 8.2% (consensus 7.0%) after declining 12.6% in April. The PCE Price Index and core-PCE Price Index, which excludes food and energy, were both up 0.1% and slightly ahead of consensus estimates.
- The key takeaway from the report is that the personal savings rate, as a percentage of disposable income, remains exceptionally high at 23.2%. Granted that's down from 32.2% in April, but a high savings rate means less spending activity, which means less economic growth.
- The final University of Michigan Index of Consumer Sentiment for June slipped to 78.1 (consensus 78.8) from the preliminary reading of 78.9. The final reading for May was 72.3, so the sentiment level is still higher than the prior month.
- The key takeaway from the report is the contention that consumer attitudes and demand will be influenced by the progress -- or lack thereof -- against the coronavirus.
Looking ahead, investors will receive the Pending Home Sales report for May on Monday.
- Nasdaq Composite +8.7% YTD
- S&P 500 -6.9% YTD
- Dow Jones Industrial Average -12.3% YTD
- Russell 2000 -17.4% YTD
China Message to U.S.: Crossing ‘Red Lines’ Could Put Trade Deal at Risk
Beijing quietly tells Washington that ‘meddling’ in Hong Kong, Taiwan and other matters could jeopardize Chinese goods purchases under the Phase One trade deal
Beijing has begun quietly delivering a message to Washington: U.S. pressure over matters China considers off limits could jeopardize Chinese purchases of farm goods and other U.S. exports under the “Phase One” trade deal.
Chinese leaders have accused Washington of meddling in areas such as Hong Kong, where China is imposing a sweeping national-security law, and Taiwan, which Beijing considers as part of China. On Thursday, the U.S. Senate passed by unanimous consent a bill that would put sanctions on Chinese officials, businesses and banks that undermine Hong Kong’s limited autonomy from Beijing.
During a meeting with Secretary of State Mike Pompeo last week in Hawaii, China’s top diplomat, Yang Jiechi, listed such actions, according to Beijing’s official account of the meeting, as well as China’s “strong dissatisfaction” with a bill President Trump signed last week mandating sanctions against Chinese officials and entities deemed responsible for mass detention of Uighur Muslim in China’s northwestern Xinjiang region.
While Mr. Yang reiterated Beijing’s commitment to carrying out the trade deal, he stressed that both sides had to “work together,” said people familiar with the conversations. A Chinese official said that meant “the U.S. side should refrain from going too far with meddling.” The official added, “Red lines shouldn’t be crossed.”
Mr. Pompeo didn’t give any ground, said those briefed on the talks. ”I articulated that day just exactly what I articulated here this morning,” Mr. Pompeo said at a forum in Copenhagen last week. “America is engaging in a response to [the] Chinese Communist Party and aggression in a way that America has not done for the past 20 years.” A State Department official said Mr. Pompeo traveled to Hawaii expecting “a fresh perspective and concrete actions,” but wound up disappointed. “We got more of the same. Yang offered nothing inspiring.”
Shortly after the diplomats met, Chinese leader Xi Jinping’s point man on U.S.-China trade negotiations, Vice Premier Liu He, followed up. He suggested that Beijing’s ability to carry out the trade deal required the U.S. to ease off pressure on other fronts. “The two countries should create conditions and atmosphere, and eliminate interference, to jointly implement the Phase One agreement,” Mr. Liu said in written remarks to a high-profile financial forum held in Shanghai on June 18.
According to some Chinese officials, by using words like “atmosphere,” Mr. Liu was delivering a reminder to the U.S. of growing hard-line sentiment in China and the difficulty its leaders will have at home justifying massive purchases of U.S. goods amid a firestorm of Washington criticism.
“You can’t keep asking us to buy your stuff and at the same time keep beating up on us,” said Mei Xinyu, an analyst at a think tank affiliated with China’s Commerce Ministry. “That’s not how it works.”
Beijing has committed to boosting its purchases of American agricultural and manufactured goods, energy and services by $200 billion over two years, a more rapid and sustained pace than at any time since China joined the World Trade Organization in 2001. In 2017, before the trade war, the U.S. exported $130 billion in goods to China. While China has recently stepped up its purchases, it remains a long way from meeting the targets, say trade analysts.
To some business officials who have closely tracked the trade talks, the Chinese warnings remind them of the spring of 2019. The U.S. side then was confident that it was about to conclude a deal and misread the political situation in Beijing, where opposition was growing. In May 2019, the deal fell apart, the U.S. responded with tariffs and threats, and it took another seven months to cobble together a less sweeping agreement.
“The hawks in both countries are quite strong,” said a U.S. business executive with close ties to the Chinese leadership. “This is a way for the Chinese to remind the Americans in a diplomatic manner that they aren’t operating in a vacuum.”
Neither is the Trump administration, which regularly boasts about the trade deal but also faces pressure from Congress over its handling of the coronavirus outbreak and its assertion of power over Hong Kong, among other issues. Within the administration there are different viewpoints.
On Wednesday, national security adviser Robert O’Brien excoriated Mr. Xi, the Chinese leader, calling him an heir to Joseph Stalin whose Communist party seeks “total control” over its people’s lives and tries to spread its influence globally.
The White House must contend with a Congress that acts with rare bipartisanship when it comes to criticizing China. The legislation passed Thursday has drawn objections from Trump administration officials concerned it could hobble their diplomatic interactions with Beijing.
With the U.S. presidential election approaching, the White House is closely monitoring Chinese purchases. Mr. Trump says the trade agreement is on track. “The China Trade Deal is fully intact,” he tweeted on Tuesday, after White House trade adviser Peter Navarro seemed to suggest otherwise. “Hopefully they will continue to live up to the terms of the Agreement.”
“Not hearing China threats,” a senior U.S. economic official echoed. “They have picked up their game on trade lately.”
The president hasn’t pressed as hard as some in his national-security team want on Taiwan or Xinjiang. A new book by former national security adviser John Bolton claims that Mr. Trump showed a willingness to play down sensitive issues in return for Mr. Xi’s help with his re-election.
The president has denied those allegations and his administration has begun a campaign to depict the U.S. as an ideological foe of China. Mr. O’Brien said in his Arizona speech that others in the administration will shortly be making the case why China should be opposed. The speech was planned before the release of the Bolton book, said an administration official.
Other national-security officials say that Mr. Trump is of two minds when it comes to Taiwan. They say he veers from being rankled by China’s insistence that Taiwan is off limits to annoyance that Taiwan is an obstacle to better economic relations with China.
But Beijing still runs the risk of overplaying its hand, as happened many times during the trade negotiations in the past two years. For example, from the start, Chinese negotiators recognized that farm purchases—especially soybeans—had been at the heart of Mr. Trump’s demands on China, and sought to use that to its advantage. But repeated failures to follow through with promised purchases led to tariffs upon tariffs from the Trump administration.
And the administration has worked before with China to keep the deal alive when endangered.
Following months of pro-democracy protests in Hong Kong, the U.S. Congress late last year passed legislation mandating an annual review of Beijing’s treatment of the autonomy of the former British colony.
Mr. Trump, whose trade team was in the midst of negotiating the Phase One trade deal, picked the night before Thanksgiving to sign the bill into law and, according to people familiar with the matter, his aides briefed the Chinese government on his plans. Trade negotiators on both sides forged ahead.
Now that Wirecard has been proven once and for all to be a massive fraud and is rapidly dying away into oblivion, many of us — and you, we’re sure — have been thinking about where the next big corporate scandal might come from.
Mirabaud Securities, the equity research house whose analyst Neil Campling stood out for being the only person to put a price target of zero on the German payments processor, have been thinking about this too.
They’ve come up with 20 warning signs that they are looking out for in trying to determine the next “Big Disaster”. They are as follows:
1. Massively promotional CEO who actively looks for publicity and spends a lot of time courting Wall Street/investors etc and is very media savvy
2. Huge CEO/Senior Management compensation package NOT tied to cash flow or Earnings but just to Sales and/or the stock price, creating the possibility of egregious wealth creation if the stock goes up a lot. Huge pledging of collateral by the CEO in return for margin loans to fund a billionaire lifestyle
3. Management compensation generally way out of line with peers despite notably less profitability
4. Glossy future projections that have a habit over a long period of being proven to be too optimistic
5. Questionable product quality, ie defects (boon??) or debatable technological leads over similar products
6. Some evidence of self certifying, whether it be through strange international subsidiaries or not having an Auditor or experiencing unusual and slightly sudden end of quarter surges in revenues, up to and including the last day
7. Unusual or unverified and large Receivables in a business where the product is exchanged for cash up front
8. Evidence that the company is existing on a shoestring, not paying Suppliers, Employees, Landlords etc
9. Unusual margin progression, with SG +A going down over time despite a rising global footprint, or GM's staying flat despite much lower ASP's over time, for instance.
10. High levels of Gross Debt. Cash balances not matched by notable Interest Income thereby suggesting they are fraudulent
11. High employee turnover, especially in the LEGAL and FINANCE areas. Co-founders or Board members leaving.
12. Aggressive pursuit via paid third parties and/or “heavies” of any critics or people who have too many questions, which in any case are “boring”
13. Dislike of Hedge Funds
14. Possible Narcissistic Personality Disorder on the part of the CEO. Additional points if he/she uses Twitter a lot
15. Large cabal of outcasts/weirdos/bloggers/Twitter groups who have been saying for years that everything is amiss but just get a lot of criticism because the stock keeps going up ergo they must be idiots
16. Slowing top line growth rate despite all the hoopla and supposed “growth stock” status. Evidence of competitors rapidly eroding unsustainably high market share.
17. Loss making. Ideally never made a profit but likes to pretend it did or failing that, that it will for sure in 2-3 years due to highly questionable new products. But the 2-3 years gets pushed out constantly
18. Extensive use/exclusive use of NON-GAAP Accounting and occasional bridging to get from a Net Loss to a (small) Net Profit via poorly explained one-offs/Other Items/unusually large Credits of some kind in a desperate attempt to get into an Index by illicit means
19. Weak Board, preferably also small and ideally in hock in some way to the CEO, who therefore do his/her bidding. Helps if some of them are related physically to the CEO.
20. Gullible media, gullible analysts and dozens of paid bloggers who produce Price Targets out of nowhere based on “Option Value” or put another way products that are at least 5 years away from having any material impact.
We’re having some trouble here. We kind of have the feeling that Mirabaud has someone in mind, but we can’t for the life of us think of a large listed company that ticks these boxes. We are stumped.
EY failed to ask for Wirecard bank statements for 3 years
Auditor of insolvent payments group under fire for failing to detect fraud
EY failed for more than three years to request crucial account information from a Singapore bank where Wirecard claimed it had up to €1bn in cash — a routine audit procedure that could have uncovered the vast fraud at the German payments group.
The accountancy firm, which audited Wirecard for a decade, has come under fire after the once high-flying fintech company filed for insolvency this week, revealing that €1.9bn in cash probably did “not exist”.
People with first-hand knowledge told the Financial Times that the auditor between 2016 and 2018 did not check directly with Singapore’s OCBC Bank to confirm that the lender held large amounts of cash on behalf of Wirecard. Instead, EY relied on documents and screenshots provided by a third-party trustee and Wirecard itself.
“The big question for me is what on earth did EY do when they signed off the accounts?” said a senior banker at a lender with credit exposure to Wirecard.
A senior auditor at another firm said that obtaining independent confirmation of bank balances was “equivalent to day-one training at audit school”.
OCBC declined to comment. A person briefed on the details told the Financial Times that Wirecard has no banking relationship with OCBC and that the fintech’s former Singapore-based trustee does not have an escrow account with the bank. The lender did not receive any query from EY in relation to Wirecard between 2016 and 2018, the person added.
The Big Four accounting firm had issued unqualified audits of Wirecard for a decade despite increasing questions over suspect accounting practices from journalists and short-sellers.
An “out of country” team at EY is reviewing the work carried out by its German auditors, according to a person close to the firm.
The German accounting watchdog FREP is probing Wirecard’s balance sheet, and Germany’s auditor oversight body APAS has begun looking into EY’s work. EY declined to comment on the regulatory investigation and details of its work. FREP and APAS declined to comment.
The accounts at Asian banks play a pivotal role in Wirecard’s accounting fraud that culminated in the group filing for insolvency on Thursday.
According to the company’s former management, the accounts were used to settle transactions with partners who acted on Wirecard’s behalf in countries where it did not have its own licences to process electronic payments. Yet it is now unclear if the accounts — let alone the money allegedly deposited there — ever existed.
Wirecard had told its auditors that the money moved late last year from OCBC to banks in the Philippines, where supposedly there was now €1.9bn deposited.
A special audit by KPMG could not obtain original documents from the banks to prove deposits existed. EY was told this month by the banks that paperwork it had previously seen on the Philippine accounts was “spurious” and they did not exist.
The head of audit at a rival accounting firm to EY said: “It is beyond the realms of reality that EY wouldn’t have had [the bank balance confirmations] unless they did a very poor audit. Cash is easy to audit. If investors can’t trust the cash number, what can they trust?”
In a statement issued on Thursday, EY said that there were “clear indications that this was an elaborate and sophisticated fraud, involving multiple parties around the world in different institutions, with a deliberate aim of deception”. The company argued that “even the most robust audit procedures may not uncover this kind of fraud”.
Hansrudi Lenz, professor of accounting at Würzburg university, told the Financial Times that it was “not sufficient” for an auditor to rely on account confirmations that were provided by third parties. “The auditor needs to have full control over the delivery of account confirmation,” he said, adding that this was stipulated by procedural guidelines.
Germany’s small shareholder lobby group SdK on Friday said it filed criminal complaints against the EY auditors who signed Wirecard’s accounts between 2016 and 2018, accusing them of violating professional duties.
Accounts published by Wirecard showed that five different EY partners signed its accounts over the past five years. Among them is Andreas Loetscher, who co-led EY’s audits into Wirecard between 2015 and 2017 and a year later joined Deutsche Bank as chief accounting officer.
Deutsche Bank said: “There are many open questions with regard to Wirecard. We highly appreciate our work with Andreas Loetscher. Moreover . . . the presumption of innocence of course applies to him as well.”
EY is already facing a class-action lawsuit in Germany brought by Wirecard investors. Wolfgang Schirp, a Berlin-based lawyer who is working on the case against the audit firm, said: “It is frightening how long Wirecard was able to operate without being objected to by the auditors. We have been monitoring Wirecard since 2008 and have collected very extensive material. It was always clear that something was wrong.”
Akshay Naheta, a SoftBank executive who led an investment in Wirecard last year, attacked EY on Twitter last week. “I’m totally baffled by the lack of competence and responsibility displayed by E&Y,” he wrote. “As an organisation that is meant to protect all stakeholders — creditors and shareholders — in companies, both public and private, they have materially failed in their fiduciary duties.”
For years EY has said it wants to expand its roster of clients on Germany’s DAX 30 index as it audits fewer companies than its rivals KPMG and PwC. EY earned nearly €10m for its audits of Wirecard over the past decade.
The Wirecard fraud is one of several international accounting scandals that have emerged on EY’s watch this year, including at NMC Health and Luckin Coffee.
Gapping down
In reaction to disappointing earnings/guidance:
- APOG -3.9%, NKE -3.1%
Other news:
- SOLY -18.6% (stock offering)
- DBVT -17.6% (provides operational and business update; to immediately initiate restructuring plan to extend cash runway
- TBIO -7.7% (prices offering of 12,506,811 shares of its common stock at $22.00 per share)
- CYH -6% (to sell Florida hospital)
- FRG -3.9% (announces 3.5 mln share offering)
- DHT -3.5% (files for $850 mln mixed securities shelf offering; also files for offering by selling shareholder)
- GPI -1.8% (provides Q2 operational update; US operating profits are improving faster than anticipated)
- FB -1.1% (CNBC reporting that VZ will pull ads from FB until FB comes up with solution)
Analyst comments:
- IRBT -2.6% (downgraded to Underperform from Neutral at BofA/Merrill)
- FRPT -2.3% (downgraded to Sell from Neutral at Citigroup)
- PHAT -2.1% (downgraded to Sell from Neutral at Goldman)
- XLNX -0.8% (downgraded to In-line from Outperform at Evercore ISI)