Weekly Market Update: The Correction That Wasn't
Market volatility reached epic levels this week. By Wednesday afternoon, the S&P500 had given up than 4% on the week after a series of unfortunate events hammered risk assets, drove liquidation and raised fear the dreaded correction had arrived. However most of the gap was filled in the second half of the week as the soothing possibility of more central bank easing emerged. On Wednesday, the withdrawal of Ireland's exotic tax avoidance laws, which inspired AbbVie to cancel its $54 billion merger with Shire, slammed many US hedge funds that were long Shire in an arbitrage trade. The same day, talk that the Greek anti-euro, anti-bailout opposition had strengthened its influence drove a massive sell-off in European peripheral debt, further hurting many US hedge funds that were long the instruments. On top of that the Ebola scare reached a fever pitch with false alarms across the US, though only one additional case was confirmed. The combined effect was risk asset liquidation, driving the VIX index above 30 for the first time in nearly two years. Commenting on Wednesday's market action, Goldman Sachs' CFO said investors were "shooting first and asking questions later." Then on Thursday, the ECB said it would adjust haircuts on bonds used as collateral for loans to Greek banks and Fed Governor Bullard said the FOMC should consider delaying the end of the QE taper this month to help stem the slide in inflation expectations. Both announcements helped propel a move higher, aided by some better US data late in the week and a round of mostly solid earnings reports.
For the week, the DJIA dropped 1%, the S&P500 fell 1% and the Nasdaq lost 0.4%. The Nasdaq briefly entered correction territory on Wednesday, joined by the Japanese Nikkei Index on Friday, while the S&P500 reached 9.5% off of September's high before rebounding. The market stampede was even more jarring in the bond market, as the US 10-year dove 43 basis points between last Friday's close and the height of the fear on Wednesday before closing back at the key 2.20% level on Friday.
The data out on Wednesday suggested the global slowdown may be finally catching up with the US economy. September US retail sales were negative (-0.3% v -0.1%e; Control Group: -0.2% v +0.4%e), with the key control group, which is used to help calculate GDP, way off expectations. That was the first negative reading for the series since January, when severe winter storms depressed the series temporarily. September PPI producer prices were softer than expected, teeing up a soft CPI reading. The New York Fed's Empire manufacturing index was well under expectations, with the new orders component turning negative.
In Europe, markets tested Mario Draghi's "whatever it takes" position after developments in Greece provided an opportunity for attack. Peripheral bonds sold off hard late on Tuesday and into Wednesday after a poll in Greece showed the anti-bailout, anti-euro party Syriza with a 6.5% lead over the governing New Democracy party, well ahead of the 1.4% lead seen in the last round of polls. There is a presidential election in Greece in February, which could be followed by early parliamentary elections. Greece's bailout is officially over in little more than a year, but PM Samaras would like to end it early in order to get ahead of his Syriza opponents, who talk often about getting Greece out of the eurozone. The rush to end 1% bailout government financing and jump into public markets, at a rate more around 7% (or the prospect of Grexit) drove the stampede out of Greek debt and a big drop in the stock market, both of which shocked wider European equities and sent peripheral debt spiking higher.
The Irish government confirmed that it will eliminate its notorious "double Irish" tax structure, just a few weeks after the US Treasury said it would put up roadblocks to tax inversion deals. The first victim of the changes was the $54 billion AbbVie/Shire merger (Shire is headquartered in Ireland). The implosion of the deal was cited as one of the factors deepening the sell-off on Wednesday. Many hedge funds had long Shire/short AbbVie arb trades riding on the merger and Shire shares lost over 20% as the deal unravelled, pummeling the funds and forcing liquidation. Recall that back in July, AbbVie's CEO said the tax benefits were an advantage in the Shire acquisition but were not the central rationale behind the deal. AbbVie will have to pay Shire $1.6 billion to break their engagement.
European governments are wrangling with 2015 budget planning and the process is exposing many of the very stresses that have prevented the Eurozone from escaping the long reach of its crisis. Budgets proposed by France and Italy both abandon pledges to bring deficit-to-GDP ratios into compliance with the 3% treaty limit. Last Friday S&P cut France's sovereign outlook, and on Wednesday Fitch put France's AA+ sovereign rating on negative watch. German Chancellor Merkel said there could be no exceptions to the EU deficit rules even as French President Hollande demanded flexibility, setting up another axis of tension in the EU.
The German government cut its GDP growth forecasts for 2014 (from 1.8% to 1.2%) and 2015 (from 2.0% to 1.3%), bowing to the reality of the European economic slowdown. Berlin insisted it would not change course on policy or austerity despite the worsening outlook. Merkel said that the government would still pursue its balanced budget goals.
The two cases of person-to-person Ebola transmission in the US appeared in Dallas, Texas. Two nurses who helped care for Thomas Duncan, the Liberian man who died last week, tested positive for the disease. There was widespread consternation on reports that the second nurse was cleared to travel to Ohio and back by air while also beginning to feel certain symptoms, including fever, associated with the disease. There was a cascade of Ebola scares in Ohio, San Diego, aboard a Caribbean cruise ship and other locations from people who had unknowingly travelled with the second nurse, although as of now there are still only two Ebola cases in the US, the nurses.
The growing rift in OPEC pummeled oil prices this week, and front-month WTI crude sank below $80 for the first time since June 2012. Persian Gulf states were said to be targeting crude prices around $70 with the aim of making US shale production uneconomical, and were said to be opposing any OPEC production cuts at the November meeting due to fears they could permanently lose market share. Non-Persian Gulf OPEC nations plus Iran pushed for the organization to adopt a production ceiling of 30M bpd. Venezuela called for an emergency OPEC meeting, but its demand largely fell on deaf ears. The IEA Monthly Report trimmed global oil demand growth forecasts for 2014 to their lowest level in five years and also trimmed its 2015 demand forecast. The IEA said any more crude oil price declines would require lower demand or supply cuts.
Wall Street banks had largely good news in their quarterly reports. Goldman Sachs reported excellent third-quarter results and raised its dividend nearly 10%. Revenue was up 25% y/y and net income rose a whopping 60% y/y. Morgan Stanley had similarly strong results. JPMorgan's profits were slightly lower than expected, but compared favorably with the loss seen a year ago. Bank of America either reported income of $168 million or a small loss in its third quarter, depending on how the bank's massive $5.8B DoJ fine for mortgage issues is counted. Shares of Citibank soared after the bank said it would exit stagnant business in 11 countries and modestly topped expectations in its third quarter.
Shares of railroad CSX gained after reports asserted that the company had rebuffed a merger proposal from Canadian Pacific last week. If a deal were reached, the companies would have a combined market value of $62 billion. Big regulatory obstacles stand in the way of a merger - the US Surface Transportation Board has a history of intervening in mergers over fears that the industry would end up with just two North American transcontinental railroad systems.
Overall volatility also whipped around currency trading this week, although there appears to be a slight strengthening trend in the euro as the single currency rises off the record lows seen in the first week of October. EUR/USD came into the week around 1.2610 and after the excitement on Wednesday appeared to be consolidating around the 1.2800 level. Meanwhile, the yen also strengthened, with USD/JPY declining from highs of 107.70 to lows around 105.5 on Thursday, before closing out the week around 106.65.
The Shanghai Composite fell 1.4%, the biggest weekly decline in four months, as the mainland index turned increasingly less immune to the global market rout amid a set of mixed economic figures. September Trade Balance hit a 5-month low of $31B, even though the y/y increase in imports and exports marked 7- and 19-month highs respectively. New Yuan Loans were also more encouraging at CNY857B - a 3-month high and well above the CNY746B consensus. Inflation indicators were still decidedly subdued however, as 1.6% CPI marked a near 5-year low while PPI of -1.8% was down on the year for the 31st consecutive month. Monetary authorities are taking notice with further incremental liquidity injection measures. On Tuesday, the PBoC lowered the offering yield on its 14-day repo by another 10bps to 3.4%. On Friday, the PBoC also announced an additional CNY200B injection directly into the banking system targeting 20 joint-stock Chinese banks. The balance of key China economic data for September along with Q3 GDP will be released early next week, followed by the October HSBC flash manufacturing PMI on tap for Thursday.