Fed jawbones. Low rates keep stocks inflated. Oil continues to slide. Construction spending falls. ISM manufacturing falls. Mortgages near all-time lows. Verizon-Fleetmatic. Tesla-SolarCity. Didi Chuching-Uber China. Glaxo-Alphabet Verily. Pfizer-Bamboo. Ready for Rio.
Financial Review by Sinclair Noe for 08-01-2016
DOW – 27 = 18,404
SPX – 2 = 2170
NAS + 22 = 5184
10 Y + .04 = 1.50%
OIL – 1.58 = 40.02
GOLD + 2.00 = 1353.40
Chances of a rate cut are being pushed out. New York Fed President William Dudley declared, describing Friday’s GDP growth figure of 1.2% as “sluggish.” Although he said it was “premature” to rule out monetary policy tightening in 2016, he added that negative shocks were more likely than positive ones due to the unknown fallout from Brexit, a strong dollar and because it was safer to delay a move with rates so low. Federal Reserve Bank of Dallas President Robert Kaplan said a rate increase at the next policy meeting in September is still possible, but the markets just aren’t buying it. Following Friday’s disappointing GDP data, fed fund futures suggest there’s a 35% probability that the next Federal Reserve interest-rate hike will happen in December. That’s down from the 49% probability that markets were pricing in before last week’s Fed meeting.
You have to wonder what some of these Fed policymakers are looking at; the economy is not very strong; it isn’t falling apart – sluggish might be the way to describe it; corporate earnings have been declining for 5 consecutive quarters – a trend that is considered and earnings recession and rarely ends well; especially considering that stock prices, near records, are not cheap. Sometimes it feels like the only thing keeping stocks propped up is low rates. Bonds have risen sharply in value, and their yields, which move in the opposite direction, have plummeted. That has made stock prices look cheap and dividends generous. The average dividend for the Standard & Poor’s 500-stock index is about 2.1 percent – much higher than the yield on a 10-year Treasury note. Many investors have moved to stocks in search of a better deal.
Another factor, the strong dollar, has made stock sectors that are fairly impervious to exchange-rate shifts especially attractive. When foreign earnings in, say, euros or pounds translate into fewer dollars, American stocks with predominantly domestic revenue streams usually benefit. That’s why many American utility and phone company stocks, which both pay high dividends, have been soaring – up more than 20% year to date.
The 10 year Treasury note, the benchmark, is trading near historical low rates; the average yield on the 10 year note since 1965 has been 6% – now it trades around 1.5%. Fed policymakers are saying they are still considering rate hikes but the markets are telling a different story. More than $13 trillion in government bonds around the world carry negative yields; you lose money on those bonds. And so US Treasuries look good, even at 1.5%, but these low rates won’t last forever, and as rates go up, bond prices go down. And stock valuations at these levels only make sense in a low interest rate environment; if rates rise, stock prices could fall fast. It might take a while, but this is setting up for a nasty turn at some point. And that’s why we keep a close eye on the Fed.
U.S. construction spending fell for a third straight month in June with spending on nonresidential construction dropping by the largest amount in six months. Construction spending fell 0.6 percent in June following declines of 0.1 percent in May and 2.9 percent in April. Nonresidential construction declined 1.3 percent, the biggest setback since December, while residential activity was unchanged in June. Spending on government projects fell 0.6 percent, the fourth straight decline, with both federal and state and local construction activity down.
The Institute for Supply Management (ISM) said its index of national factory activity slipped 0.6 percentage point to a reading of 52.6 last month. A reading above 50 indicates an expansion in manufacturing, which accounts for about 12 percent of the U.S. economy. Manufacturing remains constrained by the strength of the dollar and an oil price plunge, which have hurt exports and undercut business spending. Although the ISM index has remained above expansion territory for five consecutive months, hard data on manufacturing has been generally weak and business spending has been soft. Last month, manufacturers reported declines in new orders, export orders and order backlogs. Factory employment also fell, though production increased.
Oil fell below $40 a barrel in intraday trading, after its biggest monthly decline in a year as U.S. producers increased drilling and crude and fuel stockpiles remained at the highest seasonal level in at least two decades. Drillers boosted the number of active rigs for a fifth week, the longest run of gains since last August, according to data from Baker Hughes Inc. Gasoline demand usually peaks during the summer months. Saudi Arabia cut prices to Asian customers as the country continues to fight for market share. The persistence of the supply overhang is upsetting industry expectations, with producers including BP, Royal Dutch Shell and Exxon Mobil reporting second-quarter earnings last week that were worse than estimated.
The national average 30-year fixed home mortgage rate in the U.S. fell to 3.36 percent, matching the record low first reached in December 2012, according to Bankrate.com. Would-be home-buyers and homeowners looking to refinance existing mortgages at lower rates have benefited from a drop in U.S. Treasury yields since U.K. voters decided in June to leave the European Union. A comparable Freddie Mac mortgage gauge watched by the industry is near a record low, at 3.48 percent.
Verizon Communications has entered an agreement to acquire Fleetmatics Group in a deal valued at $2.4 billion. Fleetmatics – based in Ireland – is a mobile workforce solutions company offering businesses the software and means to track and analyze data from their vehicles and, or drivers. The deal, which Verizon expects to close in the fourth quarter, will see the mobile, cable and internet company pay $60 per share in cash, which represents a 40% premium to Friday’s closing price.
SolarCity board members approved a $2.6 billion buyout from Elon Musk’s Tesla Motors in the solar industry’s biggest deal to date. Tesla agreed to pay $25.37 a share in stock for the largest U.S. rooftop solar company. The agreement allows SolarCity to solicit competing takeover offers through Sept. 14, the companies said. The vote will now go to Tesla and SolarCity shareholders. Tesla’s offer represents about half of SolarCity’s value a year ago. Both companies have been burning through cash but they claim they can achieve positive cash flow later this year. We’ll see.
Didi Chuxing is buying Uber China. China’s largest ride-hailing service is buying Uber China for $35 billion. The terms of the deal say Didi will invest $1 billion in Uber global at a valuation of $68 billion and Uber China’s investors will own 20% of the merged Chinese company. Uber burnt about $2 billion to date in China in order to catch up with Didi, which had a two-year head start. As of two months ago, it was still much smaller when measured for daily completed rides. Uber is currently in over 60 Chinese cities, while Didi is in more than 300. So, Uber is raising the white flag in China. It probably didn’t hurt that Didi had partnered with Apple and Alibaba, a couple of tech powerhouses. Side note: Didi in Chinese means little orange, which is their corporate symbol. What is it about tech companies named after fruit?
A federal judge has thrown out a verdict requiring Apple to pay VirnetX Holding Corp $625 million for infringing four patents relating to Internet security technology, causing VirnetX’s share price to plunge 44% this morning. The judge said it was unfair to Apple that two VirnetX lawsuits had been combined into a single trial. He ordered that both cases be retried separately, with the first trial beginning on Sept. 26.
GlaxoSmithKline is teaming up with Alphabet’s Verily Life Sciences unit to develop bio-electronic medicines, or treatments that use miniature electronic devices to modify how impulses are transmitted around the nervous system. The pair will spend up to $700 million over seven years on the venture, called Galvani Bioelectronics, provided they succeed in hitting various milestones along the way.
Pfizer has acquired privately held gene therapy developer Bamboo Therapeutics in a deal worth up to $645 million to boost its presence in the treatment of rare diseases. Research into gene therapy, which aims to insert corrective genes into malfunctioning cells, goes back a quarter of a century but the field has experienced multiple setbacks and been plagued by safety concerns. However, the discovery of better ways to carry replacement genes into cells is building optimism. The U.S. Food and Drug Administration has yet to approve any gene therapies but Europe has approved two – a treatment from GlaxoSmithKline for a rare immune disorder in babies and one from uniQure for a serious blood condition.
U.S. authorities have issued subpoenas to Goldman Sachs for documents related to 1MDB, the Malaysian investment fund at the center of an international corruption scandal. Goldman received the orders earlier this year from the DOJ and SEC, which also want to interview current and former bank employees in connection with the inquiries.
Brazil’s interim President Michel Temer has expressed confidence in Rio de Janeiro’s ability to pull off a successful Olympics (beginning this Friday). Around 85,000 security personnel are expected to be deployed during the Games, the largest contingent for a mega event, to guard the half a million visitors expected to descend upon Rio. From my experiences in Brazil, the Olympic Games won’t be perfect, there might be problems, but it will be great.