After Hours Gainers:

Companies trading higher in after hours in reaction to earnings: DY +9.4%, SLH +7.9%, UPIP +3.9%, LCI +2.9%, NMLB +1.9%

Companies trading higher in after hours in reaction to news: OSK +11.6% (announced the U.S. Army has awarded the company a $6.7 bln Joint Light Tactical Vehicle contract), SQNM +7.0% (entered into clinical research collaboration with the University of California, San Diego Moores Cancer Center), SRPT +3.0% (announced the FDA has filed the NDA for eteplirsen for the treatment of Duchenne muscular dystrophy; NDA given priority review with PDUFA date of February 26, 2015), MGA +1.9% (co obtained an issuer bid exemption order to make private agreement purchases of its common shares from an arm's length third-party seller), TRI +1.8% (to purchase up to 10 mln of its common shares through private agreements with four arm's-length third-party sellers)

After Hours Losers:

Companies trading lower in after hours in reaction to news: RIG -9.8% (to propose cancellation of third and fourth installments of dividend; Co was previously paying a $0.15/quarter dividend), ISR -5.0% (filed for $20 mln mixed securities shelf offering), NOR -4.3% (co has effected a 1-for-7 reverse stock split of its common stock)

Akzo Nobel, ARM, BMW, BNP, Centrica, Credit Suisse, Diageo, Engie , IAG, Intesa, KPN, LafargeHolcim, LVMH, Norsk Hydro, Philips, Prudential, Publicis, SAP, Telenor and TDC

 

Ajay Kapur – Asia/GEM equities overall

 

-       -ve on Asian equities, -ve on GEM equities. Valuations aren’t that great & neither are earnings. As Fed withdraws liquidity it will hurt.

-       Prefers to look at EV/EBITDA over P/E since EM companies have taken on a lot of debt, especially in China but elsewhere too. EM currently at 7.5x EV/EBITA (vs 4.2x in 2008, & 5.8x in Sept 2011).

-       One P/B, EM currently 1.2x trailing P/B. In ’08 it was 1x. General rule of thumb is market bottoms at 1x P/B for EM. Therefore by EV/EBITDA or P/B more downside left for EM equities

-       On debt: Fed balance sheet expanded from $1T to $4.4T since QE began. This has led to EM FX reserves to grow $2.7T since beginning of QE. Monetary base up $3.6T. Lot of the expansion has gone to EM property markets, bond markets and some into equities.

-       QE translated into EM primarily via debt markets. Corp bond issuance: +$1.4T, bank lending: +$1.3T i.e. total +$2.7 trillion over past 5 years. This is double the preceding 5-year period. (Therefore EV/EBITDA)

-       EM earnings: just awful. Start of the year consensus has EM earnings +10-15% for the year but looking at last 4 years quite clear this is wishful thinking. EPS fell 3% in 2012, grew 1.2% in 2013, fell 8.2% last year. For 2015, consensus still has EPS growing 2-3% but this should turn –ve.

-       EBIT margins: down to 9% vs 17% in 2006 (vs US where EBIT margins are at new highs near 13%). Therefore there is a reason EMs are cheap

-       What to look at/what will turn the tide – 1)Turnaround in Chinese monetary conditions (referenced a BBG Monetary Conditions index for China here which closely tracks EMs in general and cyclicals in particularly). 2)A delay in a Fed rate hike will postpone the pain if nothing else. If they don’t do Sept then case can be made for a short-term tactical buy on EM equities 3)Valuation adjustment – EV/EBITDA needs to come down 6-6.5x. 3)A capitulation in sentiment on EMs. We may not be far away on this. 4)Pick-up in inflation, which again correlates well with EM equities

 

David Cui – China strategist. (warning: this one was a little *HELMETS ON* time)

-       Continue to sell into any rallies on Chinese equities. Govt is struggling to hold the market up and will ultimately give up. (these comments were made yesterday afternoon. This story appeared late Asian hours today: http://bloom.bg/1ESXdL6 followed by the PBOC move on rates).

-       A failure to stop an equity rout has significant implications for the market, the financial system and broader economy

-       We’re a long way from the trough. Don’t buy till the Chinese govt panics. This could happen either via a massive QE program or physical stimulus. Even then rally will be short-lived unless coupled with large-scale bad debt write-off and a wholesale recap of the financial system + serious reforms

 

3 Key Points

1.    Why govt is failing to stem the equity slide – valuations, leverage, reputation. Ex-banks, A-shares are trading at an average trailing P/E of 28x on rapidly deteriorating ‘E’. EV/EBITDA is even worse given debt.[Side point here: Median EV/EBITDA for A-shares at 21x, was 32x at peak. This is vs 11x in the U.S. and 8x in Japan. Even worse is the ROE. A-share ROEs are at 11%, & this juiced by significant leverage. Ex-leverage, one is looking at ROE’s of 7-8%, putting China only above Greece in terms of ROE. It is a terrible deal for the govt to keep buying A-shares

2.    Cui estimates that about ~10T RMB worth of shares at least partially funded by leverage (this also lends credence to the fact that we’re still seeing margin trades unwinding in the A-share market). This is about ½ the free float. For margin financed positions to break even market needs to go higher. So unless the govt is willing to buy out a significant portion of the free float SHCOMP needs to drop to level that can be justified by fundamentals. This is roughly 40% below where it currently sits (!). If govt remains buyer of last resort as it has done over last few weeks it keeps denting reputation of the RMB.

3.    When the dust settles the damage will be felt quite broadly. Financial services contributed 0.5 pct points to Q1 GDP. This can safely be written off. There will be –ve consequences on consumption. Net effect of the ups/downs on the A-share market has been a transfer of wealth from those in their 30s & 40s to the rich who managed to cash out. This will hurt future purchases of cars, mobile phones, tourism. This is not expected to be too severe though

4.    Most importantly, & probably underappreciated by most is potential shock to the financial system (background: this has been Cui’s long-standing argument) – If A-shares continue their decline won’t be long before the equity base of brokers, trust cos & other shadow banking financial institutions is wiped out. Govt credibility has been hurt quite badly. 1^st time in recent memory, Cui says, that there are doubts about govt’s ability to manage things smoothly

.

What does the govt do next?

-       PBOC to cut interest rates (Cui said once in Q3, happened today already), and 100 bps in RRRs through the year (50bps done today). Quicken infrastructure projects etc. This is not enough, govt is behind the curve.

-       Risk of financial crisis breaking out is high and Cui says there are 2 options. Firstly,  the Japanese way – more stimulus, take on private bad debts on its balance sheets. This would likely result in a sharp rebound followed a prolonged selloff. Not attractive. Secondly, the U.S. way. – write off significant portion of bad debts, recap the financial system. This will likely be met by a sharp selloff because of the dilution risk but if these steps are taken couple with reform then we can think about finding a genuine trough in the market.

 

Lastly a chart from me:

 

 

 

The stock market ended the Tuesday session on a lower note despite starting the day with a sharp spike. The S&P 500 lost 1.4% after being up 2.9% while the Nasdaq Composite surrendered 0.4% after being up 3.6%.

The market began the day with a broad-based spike after most global stock markets rebounded during overnight action. Interestingly, the rebound did not include China's Shanghai Composite as the index lost 7.6%. That being said, the focus will be on the index tonight considering the People's Bank of China cut its main lending rate 25 basis points to 4.6% and lowered its reserve requirement ratio 50 basis points to 18.0% this morning.

The PBoC rate-cut announcement took place well after Asian markets ended for the day, and the news was met with a spike in S&P futures. Once the trading day began, the S&P 500 rallied through the first two hours of action, but returned into the middle of its trading range during the afternoon, and fell to lows during the final 60 minutes of the session.

In some ways, the selling during the final hour resembled action observed on Monday morning as liquidity dried up notably and bid-ask spreads widened past typical levels. The S&P 500 surrendered nearly 40 points during the final hour, pulling all sectors into the red. Interestingly, the utilities sector (-3.2%) ended at the bottom of the leaderboard as the rate-sensitive group suffered from higher yields intraday and extended its losses during afternoon selling.

More notably, heavily-weighted sectors like financials (-1.7%), industrials (-1.6%), and health care (-1.4%) ended in the red while consumer discretionary (-0.4%) and technology (-1.2%) surrendered their gains after being up more than 3.0% apiece.

The late afternoon tumble occurred after the Treasury market closed for the day, but 10-yr note futures rallied after the cash close. The benchmark instrument settled on its low with the yield up 13 basis points at 2.13%, but safe-haven demand drove the yield to 2.09% after the cash close.

Interestingly, the CBOE Volatility Index (VIX 37.08, -3.66) ended on its high, but still finished the day well below yesterday's settlement despite the late swoon.

Once again, corporate news was relegated to the backburner, but investors did receive a couple earnings reports this morning. Best Buy (BBY 32.95, +3.68) soared 12.6% after beating earnings and revenue estimates while Toll Brothers (TOL 35.08, -2.98) lost 7.8% after missing earnings and revenue estimates.

Economic data included Consumer Confidence, New Home Sales, Case-Shiller 20-city Index, and FHFA Housing Price Index:

• The Conference Board's Consumer Confidence Index increased to 101.5 in August from an upwardly revised 91.0 (from 90.9) while the consensus expected an increase to 93.1
  • The August jump in confidence wiped away all of the discomfort from July and returned the index past June levels (99.8) to the highest mark since January 2015
• New home sales increased 5.4% in July to 507,000 from a downwardly revised 481,000 (from 482,000) while the consensus expected an increase to 511,000
  • After starting the year on a tear, new home sales have settled into a range of around 500,000 per month since March
• The Case-Shiller 20-city Home Price Index for June rose 5.0% against a 5.1% increase expected by the consensus
  • This followed the previous month's increase of 4.9%
• The FHFA Housing Price Index for June rose 0.2%, which followed a revised increase of 0.5% in May (from 0.4%)

Tomorrow, the weekly MBA Mortgage Index will be released at 7:00 ET while July Durable Orders (consensus -0.6%) will be reported at 8:30 ET.

• Nasdaq Composite -4.9% YTD
• Russell 2000 -8.4% YTD
• S&P 500 -9.3% YTD
• Dow Jones Industrial Average -12.1% YTD