Weekly Market Wrap Up

With the DJIA closing above 10,000 for two consecutive sessions this week, traders have a lot to be enthusiastic about. The October Empire manufacturing survey crushed expectations, rising to its highest level in five years. Weekly initial jobless claims fell to their lowest level since early January and continuing claims dipped below 6M, prompting none other than Former Fed Chairman Greenspan to say that US firms may have cut too many workers. A smaller-than-expected decline in September retail sales indicated more incremental improvements in consumer sentiment. Signs of normality were seen in bond markets, as an ongoing rally in both stocks and government bonds may be giving way to the historical inverse relationship between the two asset classes. The dollar suffered as investors took on risk, spot gold marched even higher, hitting record levels above $1,070 mid-week and NYMEX crude pushed out to fresh one-year highs above $78 level in the wake of a surprising gasoline draw in the week DoE inventory report. But troubling signs were not hard to find. Terrible earnings reports from Bank of America and Citigroup reminded everyone that the banks are far from normal. Shares of Goldman are down over 2% on the week despite the bank crushing consensus expectations in its quarterly report. And it's best to keep in mind that the exit strategy is growing nigh. For the week, the DJIA increased 1.4%, the S&P 500 rose 1.5% and the NASDAQ Comp gained 0.8%.
Last Sunday Fed Governor Bullard expanded on his analysis of US employment trends, after he seemed to break ranks with other Fed members and speculate where the unemployment rate might top out. The previous Friday, Bullard had said he "hopes" unemployment can "remain below 10%," and that job growth might resume in 2009 and 2010. On Sunday, Bullard said unemployment may go into double digits and that high levels of unemployment are a "measure of stress" in the US economy. This contrasts statements from other Fed governors, who have avoided commenting on where peak unemployment may be and instead focusing what level unemployment might fall to next year.
Meredith Whitney foreshadowed the bad week for the banks on Tuesday when she cut Goldman Sachs to a Neutral from Buy; many investors took the call as a vote against the entire sector. Goldman's results actually beat consensus estimates, although earnings fell short of a widely reported whisper number, heightening a sense of disappointment. Goldman's CFO noted that his firm was getting "a bigger share of a smaller pie." JP Morgan also beat top and bottom line estimates, citing broad-based strength across its businesses. But JP Morgan's Jamie Dimon didn't shy away from mentioning the challenges faced by the industry, warning that corporate lending is still around all time lows and credit lines continue to be drawn at very light levels. Ward of the state Citigroup racked up its eighth consecutive quarterly loss, although the loss was a bit smaller than expected and executives took pains to point out that the bank added the smallest amount to its loan-loss reserves in two years. The biggest surprise came from Bank of America, which lost $2.4B, shocking investors with a per share loss more than four times the expected amount, not to mention revenue that was more than $1B lower than the consensus view. Executives blamed the loss on more asset writedowns at Merrill Lynch and Countrywide, and net charge-offs, net losses and nonperforming assets were all higher on a sequential basis. On the conference call, outgoing CEO Ken Lewis said total credit losses may have peaked this quarter but warned that net loss levels would remain high in 2010.
Major DJIA components General Electric, Johnson & Johnson and IBM also disappointed investors this week. GE's revenue missed consensus estimates, although executives took pains to highlight the fact that GE's $174B backlog is at all-time highs and cancellations are very low. The losses continue at GE Capital, however. JNJ also missed top line expectations. On the conference call, the CEO said JNJ continues to cut costs and warned that the consumer business continues to feel the impact of the crisis. IBM may have beaten estimates, but revenue hardly grew on a sequential basis and remains well below year-ago levels. Dow component Intel outperformed the consensus view, although executives warned that overall enterprise spending remains weak.
In other earnings news, Google's quarterly report was relatively strong, garnering the sultan of search multiple price target upgrades on Wall Street. Cell phone giant Nokia surprised investors with a quarterly loss and a modest miss on the top line, thanks to a writedown at its networks unit and sequential declines in smartphone sales. Medical device maker Baxter missed top and bottom line estimates, blaming lower margins and FX impact. Southwest Airlines beat earnings estimates on an adjusted basis, although it still racked up a small quarterly loss when taking into account one-time charges for its fuel hedging portfolio and employee buyouts.
Merger news was dominated by deals falling to pieces this week. Friday was the "put up or shut up" deadline set by the UK takeover panel for a consortium to make a binding offer for UK transportation name National Express. No offer was forthcoming. UK miner Xstrata walked away from bidding for competitor Anglo American this week as well, also after the UK takeover panel told the company to make an offer or give up on the acquisition. Back in the US, Live Nation and Ticketmaster are negotiating with regulators to come up with concessions that would allow a merger, although numerous US officials, principally Senator Schumer, have said the transaction will not happen. Actual deals did manage to come together, with Cisco announcing it would acquire the mobile telecommunications operator Starent for $35/share, in a deal valued at $2.9B. In addition, Pfizer closed its acquisition of Wyeth.
In fixed income trading, long-dated treasuries have borne the brunt of equity market strength. Despite a slight pullback on Friday, the yield on the 10-year Note is well on its way back above 3.40% and the 30-year Bond tested 4.30%, a noticeable increase of almost 40bps in just over two weeks. The short end remains the exception, where yields are lower. One overlooked byproduct of recent USD weakness has been the effect on short-dated treasury yields. The market continues to be abuzz with reports of Southeast Asian central bank buying in the short end as monetary authorities deposit dollars bought to maintain currency pegs in treasuries. The result is a much steeper yield curve, with 2s10s probing 250bps for the first time in almost a month.
Much attention was paid to the contribution fixed income trading made to the bottom line at JPMorgan and Goldman Sachs. Citigroup didn't fare as well, with some analysts noting the much larger percentage of assets concentrated in very short-term debt as well as concerns going forward about the discontinuation of the government guarantee for paper. It was another week where high quality companies raised money in a variety of different currencies. Goldman Sachs announced a 10-year bond offering in Euros while Bank of America raised 2¥ in Uridashi bonds. Anheuser-Bush/Inbev raised $5.5B in a multi-part offering while Deere did a smaller two-part sale.
The dollar extended its losses this week thanks to more reserve diversification and selected corporate earnings. Highlighting the reserve diversification issue, a Barclays analyst report said that nations which report currency breakdowns placed 63% of their new cash into euro and yen pairs this summer (the report also noted that 1999 reserve levels showed USD at 63% of holdings). Emerging market central banks have been notably more aggressive in shifting out of the dollar into other G10 currencies. However, ECB Chief Trichet warned that the euro was never designed to be a global reserve currency, while the ECB's Noyer cautioned that SDRs were not the right replacement for the dollar and the Chinese Yuan would only make for a workable reserve after it becomes fully convertible. Top Japanese Currency Advisor Gyohten weighed in, saying that cooperation between Japan, China and US was needed to stabilize the dollar. German Economic Minister Guttenberg commented that the weak dollar was not a concern for Germany since it would help the Euro Zone keep oil prices lower. Looking ahead, the Euro Zone finance ministers meeting (EcoFin) next Monday could be the key focus going into the weekend.
EUR/USD approached the key psychological resistance level of 1.50 and sovereign names seemed to put in a floor under the 1.4680 level for the time being. Dealers still believe the 1.50 level is a target, although plenty of option barriers are lurking ahead of that key level. Note that 1.50 has been cited by German companies as a "threshold of pain" for exports. The greenback hit 14 month lows against the Swiss, Canadian and Australian pairs, as well as the euro. UK inflation data kept the door open to the possibility of additional BoE quantitative easing, helping sterling maintain a broadly weaker tone against the majors at the start the week. A Centre for Economics and Business Research (CEBR) report noted that UK interest rates would stay at 0.5% through 2011, and would not rise to 2% before 2014. GBP/USD fell below 1.5770 to test its lowest level since May and sharply reversed back to 1.64 before the end of the week. Some dealers noted the downtrend line from Aug 2008 is currently around the 1.65 area and seem to take advantage of sterling strength in rallies.
JPY-related crosses weakened over the course of the week and Japan's Fin Min Fujii tried to clarify his recent remarks on the currency front. Fujii noted that he never committed to either a "strong yen" or "weaker yen" as a positive for the Japanese economy. MOF Chief Currency Advisor Gyohten commented that cooperation between Japan, China and the US helped the USD/JPY move above the 91 as the week ended.
The week in Asia echoed much of the cautious optimism seen in US markets. The Bank of Japan left overnight call rates unchanged at 0.10% as expected and also raised its economic assessment for the second consecutive month. In a unanimous decision, BoJ saw financial conditions showing signs of improvement on rising exports and production. Conspicuously absent from the decision was any alteration of the timeline for corporate bond or commercial paper buying, which is set to expire at the end of December. However, later testimony from BoJ Governor Shirakawa's left little reason to doubt the sun is setting on quantitative easing, as he insisted the need for corporate debt purchases is receding. Shirakawa also said that ending this program does not necessarily signal the beginning of the exit strategy.
Over in Australia, the central bank retained its hawkish bias in the wake of last week's rate hike. RBA Governor Stevens signaled an end to the period of economic weakness, noting that overall the downturn was fairly mild and the feared economic risks failed to materialize. Going forward, Stevens said policymakers cannot delay withdrawing stimulus, steering the target of RBA policy to a sustainable expansion. Following these comments, Aussie bond markets have begun pricing in about a 35% chance of a 50bps rate hike at the next RBA rate meeting.
Ahead of the pivotal Q3 GDP report next week in China, fresh signs of economic recovery emerged from the September trade report. While the overall trade balance came in below estimates at $12.9B, both export and import components saw relative rates of decline fall to multi-month lows. Imports were particularly striking, with contractions falling to 12-month lows, portending a more sustainable internally-driven bounce.
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