Financial Review

Off to the Races

Financial Review by Sinclair Noe for 01-04-2016

DOW – 276 = 17,148
SPX – 31 = 2012
NAS – 104 = 4903
10 YR – .02 = 2.25%
OIL – .11 = 36.93
GOLD + 13.50 = 1075.50
The Dow started the morning with a 467 point decline. An inauspicious start to trading in 2016 kicked off, or more accurately fell down, this morning in China. Traders in Shanghai reacted to growing tensions in the Middle East and a drop in one of China’s manufacturing gauges. Fresh manufacturing surveys revived concerns about Beijing’s economic slowdown. China’s manufacturing activity contracted for the 10th straight month in December – the official manufacturing PMI stood at 49.7 in December. The yuan, which began new extended trading hours today, also hit its lowest point in more than four years in both onshore and offshore trade.

 

The China CSI 300 Index dropped 5% and that triggered circuit breakers that resulted in a 30 minute halt in trading of all stocks. When trading resumed, the traders were scared and they rushed to exit their positions. In a matter of about 7 minutes the Index dropped to a loss of 7%, and the next round of circuit breakers triggered a halt to trading for the remainder of the day.

 

The benchmark Shanghai Composite index closed the shortened session down 6.85% while the broader CSI 300 index, encompassing the largest listed firms by market capitalization in Shanghai and Shenzhen, slid by 6.98%. The small cap CSI 500 index fared even worse, finishing the day down 8.27%.

 

From there, the bad vibes in the market spread; the Nikkei in Japan dropped 3.1% even as the yen rallied on a safe haven play; the Hong Kong Hang Seng China Enterprises Index dropped 3.7%%.The Stoxx Europe 600 Index fell 2.6%, capping its worst start of the year ever as almost 580 of its companies fell. The MSCI Emerging Markets Index lost 3.5%, its worst day since August, when China devalued its currency. Benchmark gauges in South Korea, Taiwan, Malaysia, South Africa and Poland lost more than 2%.

 

The first trading day of the year does not seem to have any predictive capacity to tell us the direction of trading for the rest of the year. It’s about a 50-50 chance that the market follows the first day of trading in the year. Still, today was a big drop and it makes us look at historic data. For example, in 1932, the market started the year trading down 6.9%; in 2001 the markets lost 2.8% on the first day of trading. We can include first day trading losses of under 2% in the 5 worst first days of trade including 1949, 1980, and 1983. Of the 5 worst, 2 came at the start of down years, and 3 came at the start of up years for the market.

 

Still you could be forgiven if you are concerned that today portends a theme in the markets. For global investors, China is a critical piece of the growth puzzle. As the second-largest economy, China drives demand around the world in commodities, consumer goods and other sectors. The government has been trying to increase growth through stimulus measures and it has moved aggressively to prop up the stock market with a series of policy actions. The latest economic data and the big drop in their stock markets cast doubts about whether those measures are working. We don’t know and we will only know in time, but if today is any indication we may be in for a boatload of volatility.

 

Two Fed chiefs came out today to say they’re not worried about China. Federal Reserve Bank presidents, Loretta Mester of Cleveland and John Williams of San Francisco, basically said a weakening economy in China had already been built into the outlook for 2016 by Fed officials. Mester said, “There’s going to be volatility in the markets, that’s kind of the nature of financial markets.” Williams said the Fed would have to continue with “significant monetary accommodation” to keep growth above 2%.

 

Saudi Arabia cut off diplomatic relations with Iran on Sunday, giving diplomats 48 hours to leave the country, after protesters on Saturday stormed and torched the Saudi Arabian Embassy in Tehran. The move was in response to Saudi Arabia’s execution of 47 prisoners, including a prominent Shiite cleric. Bahrain and Sudan joined Saudi Arabia in severing diplomatic relations with Iran. Bahrain is home to the US Navy’s 5th Fleet. The United Arab Emirates, meanwhile, recalled its ambassador from Tehran. So this is breaking down along religious lines between Sunni and Shia, but you might also suspect the timing involves Iran’s re-emergence as a major player in oil production.

 

Meanwhile, the first oil tanker of freely traded American crude oil launched Thursday from the Port of Corpus Christi, marking the end of a long-standing U.S. ban put in place in the 1970s. ConocoPhillips and NuStar Energy loaded the tanker with crude pumped from Eagle Ford.

 

AAA is projecting that gas prices will stay lower in 2016, estimating an average cost of $2.25-$2.45 per gallon. In 2015, the average price per gallon was $2.40 (Americans saved $540 on average). AAA also forecast that the national average would stay steady or drop another $0.10 in the coming weeks, and would not go above $3/gallon this year. Oil prices moved higher in early trade but closed slightly lower for the day.

 

Economic news today shows weakness in the manufacturing sector. The ISM manufacturing index slipped to 48.2% last month from 48.6% in November. Readings under 50% indicate more companies are shrinking instead of expanding. The ISM index has posted sub-50% readings for two straight months for the first time since an economic recovery that began in July 2009. An interview with ISM chair Brad Holcomb has been posted on this site. Meanwhile, Markit’s US manufacturing PMI fell to a 3-year low.

 

The Commerce Department reports construction spending sank 0.4% in November to a seasonally adjusted annual rate of $1.12 trillion. The October increase, originally reported as 1.0%, was revised down to 0.3%.In November, spending was 10.5% higher compared to a year ago. Private construction was down 0.2% during the month, but 12.1% higher for the year. As a side note, the Commerce Department is revising how it counts construction spending to include private residential improvement spending. That sounds innocuous, but the improvements category account for about one-third of private residential spending, or 13% of the overall total. In November, improvements amounted to a seasonally adjusted annual rate of $144 billion. And these revisions go back 10 years, so there could be adjustments to GDP numbers as well.

 

The Atlanta Federal Reserve cut its forecast for fourth-quarter growth for the fourth time in the past three weeks. The Atlanta’ Fed’s closely watched forecast model now suggests that gross domestic product grew a scant 0.7% from October through December. In mid-December, the Atlanta Fed was predicting a 2% increase in GDP. It’s since lowered its forecast after disappointing reports on manufacturing, exports, construction spending and consumer spending.

 

This Friday’s jobs report for December, the highlight of the economic data due in the first full week of January, is expected to show nonfarm payrolls expanded by about 205,000. Even with weakness seen during the summer, job gains in 2015 will top 2.5 million, making it the second-best calendar year for U.S. job growth in this millennium, after last year’s 3.1 million. The last time more jobs were created in a two-year period was at the height of the dot-com boom, in 1998-1999.

 

After a disappointing 2015 for stocks, it appears the upcoming earnings season will not provide relief. Once again weighed down by the energy and materials sectors, the S&P 500 is expected to see a decline in earnings of 4.7% from the year-ago period, according to estimates from FactSet. The only sectors expected to see any gain in fourth-quarter earnings are telecom, financials, consumer discretionary and health care. If fourth quarter earnings decline, it will mark the first time the index has seen three consecutive quarters of year- over-year declines in earnings since the first 3 quarters of 2009. The ongoing hope is that this will be one of those stock-market-earnings recessions that are able to avoid US economic recessions.

 

Nokia has officially gained control of French rival Alcatel-Lucent through a €15.6 billion-euro all-share deal after the French stock market authority declared the offer successful. The first day as an operationally combined group will be January 14.

 

Shire is in advanced talks to acquire Baxalta for $46.50-$48 per share, or about $32 billion in cash and stock, excluding debt. Final details of the transaction are still being negotiated, but the two drugmakers are likely to announce a deal this week. Baxalta would benefit from a lower tax rate if taken over by Shire, and the enlarged company would generate $20 billion in sales by 2020, with as many as 30 new drugs to launch over five years. Meanwhile, Baxalta agreed to pay Symphogen A/S of Denmark as much as $1.6 billion for the rights to develop and sell a handful of experimental cancer products that work by harnessing the power of a patient’s own immune system.

 

The Justice Department and the Environmental Protection Agency have filed a civil lawsuit against Volkswagen, Porsche, and Audi alleging Europe’s largest automaker knowingly sold nearly 600,000 diesel vehicles with “illegal defeat devices,” which allowed the cars to cheat state and federal emissions tests. The suit alleges violation of the Clean Air Act and could face up to $18 billion in fines. The Justice Department is also investigating VW for possible criminal conduct related to the devices; plus, as many as 12,000 VW, Audi and Porsche owners have signed onto a class action lawsuit.

 

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