Weekly Markets Review 06-28-2010

June 28, 2010

"The Bible, the Koran, early Christianity, the Romans--everyone learned the perils of debt. What happened to that wisdom? Business schools." –Nassim Taleb
Major market indices were lower last week. The DJIA lost 2.94%, the S&P 500 dropped 3.65%, and the Nasdaq decreased 3.74%. Value stocks outperformed growth stocks. And the small cap index fell 3.27%. The 10-Treasury yield lost 11 basis points on the week, closing at 3.11%.
The Chinese leadership is finally giving into hints, winks, nudges and demands of other world leaders and letting their deeply undervalued currency rise. How much, and how soon will be up to the market to decide. It may not be game-changing, but it will have an impact on the value of commodities and other Asian countries’ currencies. Think of it this way: If the yuan rises by 5% vs. the dollar then oil, which is priced in dollars, becomes 5% cheaper. So they can buy more of it, and the price in dollars should go up. Pretty simple—in theory, anyway. That said, Chinese state-owned banks are aggressively buying dollars for the yuan, according to traders, Reuters reported June 22.
President Obama spoke at length about U.S.-China relations on Thursday, expressing approval of China's recent announcement that it would end its currency's two-year de facto peg to the U.S. dollar and allow more flexibility in its exchange rate going forward. Obama will meet with Chinese President Hu Jintao on the sidelines of the G-20 summit, and spoke optimistically and conscientiously in preparation for the talks. He said essentially that he approved of China's gesture but now would like to see substantial action to support it.
At a time when U.S. unemployment continues to allude improvement, powerful American senators have essentially told China that they must act now, or face consequences sooner than later. China has responded, but will a floating yuan really have a significant impact? Some argue that the currency could even fall—though most agree it is much overvalued.
Good news? Yes. But haven’t we simply blown out the candle while the house goes up in flames?
Our biggest problem remains our intractable debt accumulation policy, not Chinese currency policy. By the way, this is the very currency with which they have continued to fund our debt spree, serving as the world’s largest owner of U.S. Treasuries. Can the tenant really get away with berating the landlord? Until we face that fact and begin to do something more dynamic than stump speeches and pedagogy, we will be no closer to any solutions, nor any further from the storms on the horizon. Stay tuned…
Economically Speaking
*Going into the G-20 summit, nations are bringing with them starkly different viewpoints of the road to recovery. The U.K. is pressing for prosperity through austerity, and nations like China, Canada and Japan are heading in that direction as well. The U.S. would like to see nations scale back the pace of their austerity plans and is pushing for more stimulus measures, not less, to provide continued support for economic growth.
*White House Budget Director Peter Orszag reportedly plans to step down from his job in July, with sources saying Orszag had never planned on staying for more than two years. Orszag was instrumental in crafting the economic stimulus bill, and was part of Obama’s inner circle of advisers during the peak of the financial crisis.
*Purchases of new homes in the U.S. fell in May to a record low as a tax credit expired, showing the market remains dependent on government support. Sales collapsed a record 33 percent to an annual pace of 300,000 last month from April, less than the median estimate of economists surveyed by Bloomberg News and the fewest in data going back to 1963, figures from the Commerce Department showed today in Washington. The end of a tax incentive worth as much as $8,000 means the market will now be dependent on gains in employment, which are needed to lift incomes, brace confidence and contain foreclosures.
*The head of China’s National Audit Office, Liu Jiayi, said 18 provincial, 16 city and 36 county governments had accumulated combined debts of 2.79 trillion yuan ($410 billion) by the end of 2009, Xinhua reported June 23.
*Weak banks will be recapitalized if upcoming European stress tests reveal “pockets of vulnerability,” EU Economic and Monetary Affairs Commissioner Olli Rehn said June 24, Reuters reported. Rehn said he believes “the European banking sector is stronger and more resilient” than it is perceived to be.
*Orders for computers and machinery climbed in May, showing gains in global business investment and demand that will give the U.S. economy a lift. Bookings for goods meant to last at least three years, excluding autos and aircraft, increased 0.9 percent, the third gain in the past four months, according to figures from the Commerce Department issued today in Washington.
* China's net income rose to 1.54 trillion yuan ($227 billion) from a year earlier, the statistics bureau said on its website, and profits climbed 120 percent in the first two months, Bloomberg reported June 25. Sales increased 38 percent to 25.4 trillion yuan, according to the statement. Nonferrous-metal mining profits soared 330 percent in the January-May period compared to a year earlier. For coal mining, the increase was 81 percent.
* Lawmakers working into Friday’s early hours reached a final agreement on the financial reform bill. They agreed to a modified Volcker rule, allowing banks to invest up to 3% of their equity in hedge funds and private equity funds, and will mandate that banks separate much (but not all) of their derivatives activities. Banks and hedge funds will be disappointed by the inclusion of a $19B fee they will have to pay to cover the costs of financial reform. With the negotiations done, both houses of Congress will proceed with a vote on the full bill this week.
* Greece is preparing to sell, or put up for long-term lease, around 6,000 of its islands to help repay its debts, reports the Guardian. The areas for sale include part of Mykonos, one of Greece's top tourist destinations, and the island of Rhodes. Potential investors are said to be predominantly Russian and Chinese.
Equity Markets Review
*Corn Products International agreed to buy AkzoNobel’s National Starch business for $1.3B in cash. For Corn Products, the deal will create a new sugars-and-starch giant with $5B in revenues, and will be the company’s first major deal since its aborted attempt to sell itself two years ago. AkzoNobel plans to use the proceeds “for both selective acquisitions and organic growth.”
*JPMorgan is said to be in advanced talks to buy Brazilian hedge fund and private equity group Gavea Investimentos. The deal for Gavea could still collapse, but the fact that JPMorgan is pursuing the deal at all signals its confidence that the final financial reform bill won’t prevent banks from owning hedge funds. An announcement could come as soon as next month.
*News that Saudi Arabia’s central bank is holding nearly twice as much gold as previously thought helped lift the metal to a fresh high of almost $1,265 per troy ounce. Though analysts suggested that an accounting revision is partially responsible for the rise in Saudi Arabia’s holdings to 322.9M tons compared to the 143M tons reported in March, the disclosure comes as emerging economies are increasingly adding gold to their reserves and private investors are piling into the metal.
*A New Orleans federal judge lifted the six-month moratorium on deepwater drilling imposed by President Barack Obama following the largest oil spill in U.S. history. Drilling services shares jumped on the news.
* Boeing temporarily grounded a fleet of Dreamliner test planes after discovering a problem in the horizontal tail. Dreamliner spokeswoman Yvonne Leach said the problem was "regrettable but under control," and that the temporary grounding shouldn't further delay the already behind-schedule timeline for testing and delivering the planes. However, the company got some good news for a change, with the announcement that Air China will buy 20 of Boeing's 777-800 planes for $1.4B.
Weekly Sector Review
The sectors of the U.S. economy, as well as the S&P 500, have performed as follows:
Last Week’s Returns:
Information Technology… (4.46)%
Materials… (2.74)
Consumer Staples… (3.49)
Utilities… (4.26)
Consumer Discretionary… (5.33)
Financials… (1.50)
S&P 500… (3.65)
Industrials… (3.76)
Healthcare… (2.17)
Telecommunications… (2.70)
Energy… (5.90)
Observe & Report – Crisis in the Gulf
BP's oil containment efforts hit a snag last week when an underwater robot collided with the containment cap. Oil gushed unchecked from the leaking well for most of the day until the cap was put back in place late last night. The House Judiciary Committee approved legislation that would remove the liability cap for BP and Transocean, and has sent the bill to the full House for consideration, while New York state's pension fund has decided to move forward with a lawsuit against BP in what is likely to be just the beginning of a long string of litigious actions against the firm. Separately, Interior Secretary Ken Salazar introduced a new, more flexible drilling moratorium after the previous deepwater drilling ban was overturned in court. Finally, though it may be too little, too late to help BP's public image, it turns out that BP and other oil majors based their response plans to a potential Gulf spill on government data that was faulty; government models had put very low odds on oil hitting shore, even in a spill much bigger than the current one.
BP's cleanup and containment efforts in the Gulf of Mexico are now costing the company $100M a day, with total expenditures at $2.65B and rising. BP executives, government officials and meteorologists are all keeping a close eye on Tropical Storm Alex, which has regained strength in the southwestern Gulf of Mexico and could become this year’s first Atlantic hurricane within 48 hours, wreaking havoc on BP's containment efforts. Gulf Coast states are considering filing major claims against BP, and lawyers advising the states said they will ultimately seek multi-billion dollar payouts, eclipsing the $305M BP has thus far paid out to affected states. Meanwhile, concerns have arisen that the two relief wells BP is drilling may not work on their first attempt, leading to unanticipated delays in the containment process.
Sports, Culture & Politics
*Brazil’s foreign minister said that his country would step back from its role as a mediator on the Iranian nuclear dispute due to the unfavorable response Brasilia believes its efforts received from the United States. However, Brazil’s decision to step away from the negotiating table likely has more to do with other economic and political considerations.
*The Defense Department issued a statement June 22 from Defense Secretary Robert Gates that said U.S. commander of NATO-led forces in Afghanistan Gen. Stanley McChrystal “exercised poor judgment” in making comments critical of the Obama administration in an article for Rolling Stone magazine. According to the statement, Gates said McChrystal made a “significant mistake,” and said McChrystal has since apologized to Gates, as well as others named in the magazine article. Further, President Obama on June 23 accepted the resignation of U.S. Gen. Stanley McChrystal, commander of U.S. Forces-Afghanistan and the NATO-led International Security Assistance Force, in the wake of a controversial interview leaked late June 21. He has appointed Commander of U.S. Central Command Gen. David Petraeus as McChrystal’s replacement without clarifying the status of Petraeus as commander of CENTCOM. Further, the Taliban will continue its insurgency in Afghanistan regardless of a switch in NATO command after the White House sacked Gen. Stanley McChrystal, a spokesman said, The News International reported June 24. The Taliban does not care whether it is McChrystal or Petraeus, Taliban spokesman Yousuf Ahmadi stated by telephone. The Taliban position is clear, he said, to fight the invading forces until they leave.
*A federal judge on June 22 issued a preliminary injunction against the White House’s six-month moratorium on deepwater drilling in U.S. waters. The White House has filed an appeal at the U.S. Fifth Circuit Court of Appeals, and the Department of the Interior has said the moratorium will remain in effect. The question for U.S. President Barack Obama’s administration is whether the legal process will affect its ability to mitigate the oil spill’s negative political repercussions.
*The United States intends to deploy two Predator drones along the Texas-Mexico border, U.S. Homeland Security chief Janet Napolitano said June 23, AFP reported. The deployment is part of a new effort to reduce illegal immigration and organized crime. Currently, four drones patrol the border with Mexico in Arizona, and one patrols the U.S.-Canadian border in North Dakota. The Predators in Texas will patrol the border and nearby areas in the Gulf of Mexico.
*South Korean and U.S. troops will decisively respond to any future provocations by North Korea, according to U.S. Army Gen. Walter Sharp, even with outright war, Yonhap reported June 24. Realistic training and exercises enable troops to decisively engage across the entire range of military conflicts from cyberterrorism to North Korean provocations and aggressions, Sharp said at a ceremony held at Yongsan Garrison in Seoul.
*Venezuelan state oil company Petroleos de Venezuela SA is seeking the nationalization of 11 oil drilling rigs owned by U.S. company Helmerich & Payne, which is accused of trying to slow oil production, Bloomberg reported June 24.
* Australia's prime minister, Kevin Rudd, stepped down just before a leadership vote he was likely to lose, paving the way for Julia Gillard to become the country's first female prime minister. On the whole, Australian stocks took the news in stride. Analysts expect changes to be made to Rudd's controversial mega-mining tax, giving miners a lift.
* Tens of thousands of protesters took to the streets of Taipei on June 26 as Taiwan prepares to seal a major trade deal with Beijing, AFP reported. Opponents fear the move is a step toward Chinese control. The pro-independence Democratic Progressive Party (DPP), which organized the march, claimed 100,000 people turned out to demonstrate against the Economic Cooperation Framework Agreement (ECFA). The police put the number at 32,000. Taiwanese President Ma Ying-jeou urged the DPP not to "oppose ECFA for the sake of opposing it."
* Russian President Dmitri Medvedev said he was alarmed by U.S. assertions that Iran may have enough fuel for two nuclear weapons and warned that if confirmed Tehran may face new measures, Reuters reported June 28. The information must be checked, Medvedev said, adding that if the CIA information is shown to be true, the situation will become more tense.
* Sen. Robert Byrd, a Democrat from West Virginia, died today at the age of 92, after 51 years of service in the Senate. Democrats had been counting on Byrd to help secure the 60 votes necessary to approve financial reform legislation; if Sen. Scott Brown votes against the bill, as he suggested this weekend that he might, Democrats will be one vote short of closing debate and moving to final passage.
* Ten people were arrested June 27 for their alleged involvement in "deep cover" operations against the United States on behalf of the Russian Federation, the U.S. Justice Department announced in a news release. In total, 11 people have been charged in two criminal complaints with conspiring to act as unlawful agents of the Russian Federation within the United States, which carries a maximum penalty of five years in prison. Nine of the defendants have also been charged with conspiracy to commit money laundering, which carries a maximum penalty of 20 years in prison. The charges have been filed in the U.S. District Court for the Southern District of New York.
* For the second time in four years, Ghana has ousted the U.S. from the World Cup, beating the Americans 2-1 in yesterdays overtime contest.

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