Closing Market Summary: Stocks Tumble with Interest Rates in FocusThe stock market ended an otherwise flat week on a sharply lower note as increasing interest rates spurred selling interest in the broader market. The Nasdaq Composite (-2.5%) settled in-line with the S&P 500 (-2.5%) and behind the Dow Jones Industrial Average (-2.1%). The three indices ended the week with losses between 2.2% and 2.4%.
Global markets tilted to the downside as participants responded to a negative set of economic data and news that North Korea carried out another nuclear test. However, the negative headlines failed to elicit a bid in the bond market. The counterintuitive move in bonds incited further angst regarding yesterday's policy statement from the European Central Bank and rising fed funds rate hike expectations.
The ECB released its September policy statement yesterday, holding its monetary policy stance steady. The central bank opted to keep its key interest rates at record lows while maintaining the size and scope of its asset purchases. Furthermore, ECB President Mario Draghi struck a hawkish tone, indicating that the Governing Council didn't discuss extending the asset purchase program at the latest meeting.
DoubleLine's Jeffrey Gundlach added to rate angst, stating after yesterday's close that it's time to get defensive on bonds. The bond fund manager argued that a shift in longer-term inflation risk will drive monetary policy going forward. On that note, Boston Fed President, and FOMC voter, Eric Rosengren struck a somewhat hawkish tone today, stating that there is a reasonable case for continuing on the gradual path towards interest rate normalization. Furthermore, Fed Governor Daniel Tarullo said that he wouldn't foreclose the possibility of a rate hike this year.
The benchmark index remained under heavy pressure throughout today's session, carving out a session low in the final hour of trade. All ten sectors ended with sharp losses as energy (-2.8%), materials (-2.9%), telecom services (-3.4%), and utilities (-3.8%) finished on the bottom of the leaderboard. Conversely, financials (-1.9%) and health care (-2.0%) ended with the narrowest losses.
The PHLX Semiconductor Index (-3.7%) finished well behind the benchmark index, retracing its August gain. The index rallied 4.5% in August, but has declined 4.1% thus far in September. Skyworks (SWKS 66.76, -4.67) finished at the bottom of the index. The iPhone supplier declined 8.6% since Apple (AAPL 103.13, -2.39) unveiled the iPhone 7 on September 7.
The commodity-sensitive energy (-2.8%) space finished in the red as crude oil ended its day lower by 3.7% ($45.88/bbl; -$1.78). However, WTI crude finished the week higher by 3.4%. The energy component was under pressure as participants dialed back the potential impact of yesterday's inventory report from the Department of Energy. In the sector, Williams Cos (WMB 30.04, -1.11) lost 3.6% after Enterprise Products (EPD 26.81, -0.44) announced that it is no longer pursuing a combination with the company.
Biotechnology displayed relative weakness in the health care sector (-2.0%), evidenced by the 3.3% loss in the iShares Nasdaq Biotechnology ETF (IBB 278.63, -9.40). Biogen (BIIB 296.10, -11.63) underperformed in the ETF after the stock was removed from the focus list at Goldman Sachs. Conversely, Gilead Science (GILD 78.08, -0.90) fell 1.2% after Gabelli issued a bullish note on the name.
The economically-sensitive financial sector (-1.9%) finished ahead of the broader market, benefiting from rising rate hike expectations and some steepening in the yield curve. The fed funds futures market indicates that the odds of a rate hike at the September meeting have increased to 24.0% from 18.0% in the prior session.
Treasuries ended sharply lower with the long end of the curve demonstrating relative weakness. The yield on the 10-yr note rose seven basis points (1.67%) while the yield on the 2-yr note ticked higher by one basis point (0.78%).
Today's participation was above the recent average as more than one billion shares changed hands on the NYSE floor.
Today's economic data was limited to Wholesale Inventories for July:
- Wholesale inventories were unchanged in July, as expected, following an unrevised 0.3% increase in June.
- The report won't have any material sway on economists' third quarter GDP forecasts since the reading was in-line with the consensus estimate.
There is no domestic economic data of note scheduled for Monday.
- Russell 2000: +7.7% YTD
- S&P 500: +4.1% YTD
- Dow Jones: +3.8% YTD
- Nasdaq Composite: +2.4% YTD
Full DoubleLine presentation attached
In his latest webcast to DoubleLine investors and the general public, the "new bond king" Jeffrey Gundlach, who had taken a one month sabbatical from public appearances after warning (hyperbolically as he explained yesterday) to "Sell Everything, Nothing Here Looks Good", said that the Fed is determined to show it is independent from market forces, and may hike rates even as investors bet they will not.
As a result, Gundlach said it’s time for fixed-income investors to prepare for rising rates and higher inflation by reducing the duration of their positions, moving money into cash and protecting against volatility. In his presentation titled appropriately "Turning Points" (presented below) Gundlach said that “this is a big, big moment,” predicting that “interest rates have bottomed. They may not rise in the near term as I’ve talked about for years. But I think it’s the beginning of something and you’re supposed to be defensive.”
"They want to show that they are not guided by the markets," Gundlach told Reuters in a telephone interview following the DoubleLine webcast. "The Fed wants to show, at some point, that they can’t be replaced by WIRP (World Interest Rate Probability). The only way they can do that is to tighten when WIRP is below 50."
However, by trying to prove its independence from the WIRP, the Fed might be "blowing itself up," Gundlach warned. The Fed will not hike in September if the WIRP is below 40 and the S&P 500 is below 2150, he said on the webcast, which we assume means that the market is in control after all.
Meanwhile, the economy continues to contract: Gundlach pointed out that the non-mfg ISM released earlier this week is at the lowest level since 2009, and it is almost on recession watch. "Clearly, it's a bad environment to be raising rates," yet some Fed members are talking about two rate hikes between now and the end of the year, Gundlach said. Gundlach said investors should get defensive with bonds, adding that he is sensing a "bond unfriendly turn" such as fiscal stimulus and that bond yields bottomed several years ago.
As a justification for his higher rates call, Gundlach stuck to his prediction that Republican Donald Trump will be elected the next U.S. president, and said both Trump and Democrat Hillary Clinton have advocated more spending on infrastructure, which would add fiscal stimulus to the economy, which as we have explained, simply means "more debt."
“This idea that fiscal stimulus may be coming seems to be getting sniffed out by the bond market,” Gundlach said. More debt spending may increase the cost of government borrowing by adding supply and making investors demand higher yields, he said. “People say, ‘How can rates rise?”’ he said. “That’s how they can rise and they’re sort of rising already.”
Gundlach told Reuters this summer that his firm went "maximum negative" on Treasuries on July 6 when the yield on the benchmark 10-year Treasury note hit 1.32 percent. The 10-year now yields around 1.60 percent. All told, Gundlach said he turned short-term negative on gold and gold miners but has not sold any of his firm's positions. He also said DoubleLine's bet on emerging-market debt over high yield "junk" bonds have paid off, given that EM has posted returns of more than 15.2% so far this year.
Gundlach's full presentation is below.
Fed's Kaplan (moderate, non-voter): case for rate hike strengthened in last several months - Q&A with reporters
- there's a cost to rates at this low level
- US economy does not look like it's overheating; ISM reports a little more negative than I expected Related ()
RTRS - EXCLUSIVE-EUROPEAN COMMISSION TO PROPOSE EXTENDING INVESTMENT SCHEME TO 2020, BOOSTING ITS SCOPE TO OVER 500 BLN EUROS -OFFICIALS
EXCLUSIVE-EU exec aims to boost investment co-funding scheme to 500 bln euros-plus - Reuters News
09-SEP-2016 16:47:12
BRATISLAVA/BRUSSELS, Sept 9 (Reuters) - The European Commission will next week propose extending an EU-wide investment-generating scheme by two years to 2020 and increasing its scope to at least 500 billion euros, European officials said.
In its current form the co-financing scheme - focused on infrastructure, energy, research and education - is using 21 billion euros of EU cash and guarantees to attract private investments for 15 times that amount up to 2018.
"The Commission will present an extension of the programme to ...trigger investments of a total of at least half a trillion euros by 2020," one official familiar with the project said.
After its first year, the programme is slightly ahead of schedule with already 116 billion euros of private investment generated.
In its most ambitious form, the proposal aims to double the investment generated to 630 billion euros if European governments contribute money.
It is to be presented by Commission President Jean-Claude Juncker in his state-of-the-union speech on Sept. 14, officials said.
Fed’s Eric Rosengren Sees ‘Reasonable Case’ for Gradual Rate Increases
Federal Reserve Bank of Boston president finds U.S. economy resilient despite drag from overseas
Federal Reserve Bank of Boston President Eric Rosengren said Friday that “a reasonable case can be made” for tightening interest rates to avoid overheating the economy.
Holding rates at their current low level for much longer risks making labor markets too tight, forcing the Fed to raise interest rates sharply, which could result in another recession, he warned in remarks prepared for a morning speech in Quincy, Mass.
“If we want to ensure that we remain at full employment, gradual tightening is likely to be appropriate,” he said. “A failure to continue on the path of gradual removal of accommodation could shorten, rather than lengthen, the duration of this recovery.”
Mr. Rosengren didn’t specifically say whether he supports raising interest rates at the central bank’s Sept. 20-21 meeting. But his remarks, which echoed a speech in China last month, serve as a warning against becoming too complacent.
Mr. Rosengren’s speech puts to rest any thought that a disappointing August employment report might dim his support for higher interest rates. Although he has previously been an outspoken advocate for holding interest rates low, the strength of the labor market and a steep rise in asset prices have caused the Boston chief to support tighter monetary policy.
The unemployment rate now stands at 4.9%, right around policy makers’ estimate of the lowest sustainable rate. Mr. Rosengren said continuing tightness in the labor market could push the unemployment rate below full employment in the next year, which would result in labor shortages.
The Fed last raised rates in December to a range between 0.25% and 0.5%.
Mr. Rosengren pointed to rising commercial real estate costs as an indication the economy may be reaching the point where low rates may be doing more harm than good.
And even though the Fed has yet to reach its 2% inflation target, Mr. Rosengren suggested the strong labor market would nudge up consumer prices, citing “modest evidence of the upward pressure on wages and salaries that would support inflation reaching the Federal Reserve’s 2% goal.”
Mr. Rosengren is among several Fed officials who say the time is coming to raise interest rates. This week San Francisco Fed chief John Williams said it “makes sense” to raise rates “sooner rather than later.” And Fed Chairwoman Janet Yellen in August said “the case for an increase in the federal-funds rate has strengthened in recent months.”
Some Fed officials, however, have been resistant to another rate increase, pointing to soft global growth and the central bank’s inability to push inflation up to the target. Fed governor Lael Brainard, who has been among the most vocal to make this argument, is scheduled to give remarks Monday that will be closely watched to gauge her willingness to go along with another rate increase at either the September or the December policy meeting.
Mr. Rosengren, in his Quincy speech, sought to counter those arguments. He said the U.S. economy has performed well despite the weak global environment, citing the strong stock market and low volatility measures.
He said disappointing economic growth numbers for the U.S. in the first half of the year are likely to rebound in the second half.
And Mr. Rosengren suggested the risks of running the economy too hot outweigh the risks of stifling inflation growth.
The Fed’s policy of holding down borrowing costs “increases the chances of driving the core inflation rate closer to the Federal Reserve’s 2% target, but it also increases the changes of overheating the economy,” he said.
DISCLAIMER This information represents neither an offer to buy or sell any security nor, because it does not take into account the differing needs of individual clients, investment advice. Those seeking investment advice specific to their financial profiles and goals should contact their Oscar Gruss & Son Incorporated sales representative. Oscar Gruss & Son Incorporated believes this information to be reliable, but no representation is made as to accuracy or completeness. This information does not analyze every material fact concerning a company, industry, or security. Oscar Gruss & Son Incorporated assumes that this information will be read in conjunction with other publicly available data. Matters discussed here are subject to change without notice. There can be no assurance that reliance on the information contained here will produce profitable results. A security denominated in a foreign currency is subject to fluctuations in currency exchange rates, which may have an adverse effect on the value of the security upon the conversion into local currency of dividends, interest, or sales proceeds. The value of securities and depositary receipts of foreign issuers that are denominated in United States dollars are also influenced by fluctuations in currency exchange rates. © 2016 Oscar Gruss & Son Incorporated. All rights reserved.FDML - The NY Post http://nypost.com/2016/09/09/gabelli-and-icahn-are-dueling-over-federal-mogul-shares/
reported this morning that Mario Gabelli "appears to be angling for $13/share"; Gamco owns 11M shares (6.5% S/O) which is ~36% of the share float excluding Carl Icahn (138.6M shares / 82% S/O). The $9.25/share offer is conditioned on a majority of the minority tender. A $7.00/share proposal was announced 2/29/16 and was further increased to $8.00/share on 6/20/16.
Gamco was an investor in Pep Boys (PBY) which initially had a definitive agreement to be acquired by Bridgestone Corp for $15.00/share and subsequently received a number of proposals from Carl Icahn, who ultimately acquired the company for $18.50/share in cash (note: Bridgestone had raised its offer to $17.00/share). Gamco owned ~3.3M shares (~6.1% S/O) of PBY.
FDML was trading in the $4-$5/share range in January-February 2016 prior to Carl Icahn making his initial proposal; the shares had traded in the $7.00-$8.50/share range during 4Q15 and had closed at ~$16/share at the end of 2014. The current $9.25/share deal price values FDML at 2017E multiples of 0.6x EV/Revs ($7.7B), 5.9x EV/EBITDA ($770M, 10% margin) and 7.4x P/E ($1.25 EPS).
The Gamco "ask" implies FDML valuation multiples of 0.67x EV/Revs, 6.7x EV/EBITDA and 10.4x P/E. A standalone comparable is AXL ($1.3B MC, $2.4B EV) which at $17/share has 2017E valuation multiples of 0.6x EV/Revs ($4.15B), 4.0x EV/EBITDA ($609M, 14.7% margin) and 5.4x P/E ($3.17 EPS). A 250bp margin improvement at FDML (12.5% EBITDA margin) and the current $9.25/share deal price implies adjusted 2017E valuation multiples of 4.7x EV/EBITDA ($962M) and 4.7x P/E ($1.99 EPS); a $13/share price implies multiples of 5.3x EV/EBITDA and 6.5x P/E.
FDML is a cyclical business (Auto Parts industry) with significant capex requirements as well as pension obligations; the single digit valuation multiples reflect those dynamics. Unlike PBY, Carl Icahn already owns 82% of the company and there is not a competing proposal (nor is there expected to be one). The Gamco statement suggests an attempt to squeeze some additional deal consideration with the leverage being the unaffiliated shareholder tender condition.
A 10%-20% bump gets a price of about $10.15-$11.10/share; the alternative is the FDML stock price trading at ~$7/share absent the Icahn deal offer. Gamco has some leverage in its large block of shares and the inefficiencies of Carl Icahn having full ownership of FDML. Net is that expect there to be a price bump contingent on Gamco tendering its shares into the tender offer.