Breakfast on Wall Street – 17 September 2013

MARKET COMMENTARY

The Dow Jones Industrial Average rose more than a hundred points yesterday to end at 15,494.78, up 0.77% or nearly 119 points. The rise in stock market futures over the weekend, due to the withdrawal of Larry Summers’ candidature for the Fed chief’s role, culminated in these gains for the market. Summers, one of President Obama’s senior advisors and a well-known policy maker is considered to be a hawk – and the post-crisis stimulus would have definitely been reduced at a faster pace under his leadership than that of any other candidate for the role.

The clear leader in the field now—Janet Yellen—is a known dove; who is more concerned about unemployment and growth than with inflation. This line of thinking led to the quantitative easing under Ben Bernanke and the markets are relieved that this paradigm will continue.

Following the Dow’s lead, the broader market index, S&P 500, was also up. The Index gained 0.57% to end at 1697.60. It has already gained 19% this year and is up 3.9% this month after a 3.1% drop in August. This has again brought the S&P 500 within 1% of its all-time highs of 1709.67. We ask the discerning investor to keep this in mind as they increase or decrease their equities investments.

The chart above shows how much the Index has gained when compared to its 2007 boom highs. The December 2007 high of 1561.80 was breached on May 4th, 2013, although since then the markets have been jittery, despite an upward trend. It has continued to cross technical resistances multiple times – but on significantly lower volumes. It is important to note that the equities markets are much thinner now than during the boom times of 2005-2007.

If the markets continue to perform and the risk-on trade remains on the table, there is a lot of money on the sidelines —that had moved away from the equities markets after the crisis—that might come back now. This will create another significant rally fueled by cautious investors.

We have seen September trading volumes move higher from its depressed levels in August. We expect the upward trend in the markets to continue till volumes keep increasing and the markets reach a new top.

As equities markets loosened up yesterday, bond yields tightened and the dollar fell further against emerging markets currencies. These are all signs of a risk-on rally based on the possibility of a dove taking over the Fed.

News from Syria seems stable now, despite evidence from the UN team of inspectors that sarin gas had been used in a Damascus suburb. But the peace process is on full steam and the likelihood of a US military intervention is low. This optimism was reflected in the oil markets, where futures on WTI lost 1.5%. We are bearish on oil due to a secular rise in supply across the board though we predicted a short-term rise in oil prices due to the conflict. This short-term rise has now played out and fundamentals are catching up with the oil markets. US oil production has been steadily rising over the past two years as the country has decided to move away from foreign oil. According the Department of Energy (DoE) the US now produces 7.2 million barrels of crude oil per day compared to a near flat 5.5 million barrels per day from 2009 – 2011.

Additionally, there is a record production of crude oil from Saudi Arabia, Mexico has opened its oil exploration and production industry to foreign private investment, emerging economies have slowed down and there is a move away from big cars in the US. Together, our equation points to weak fundamentals for crude and we predict a fall in prices over the coming weeks. Though there might be a strong resistance at the $100 per barrel level, we see crude oil breaching that level in the near future – unless any other conflicts show up in the Persian Gulf region. WTI futures closed at $106.59/barrel yesterday and are trading at $105.84/barrel as we write.

While the markets reacted positively to the news from the Fed, manufacturing data continued its dismal performance. Our modest retail performance forecast last week was based on poor manufacturing and employment figures and yesterday’s data confirmed our fears again. The economy still is not moving towards production at a pace with which it should. The cycle of low demand-low production-low employment-low demand is yet to be broken, despite the enormous stimulus from the Fed.

The Empire State Manufacturing Survey Index from the New York Fed came in at 6.29, significantly worse than the consensus expectations of 9.10. It is lower than the previous month’s print of 8.24. While not as bad as the Manufacturing Index, Industrial Production for August rose 0.4% – worse than the expected 0.5%.

The market lost some of its steam during the day on these data points, but it is still the Fed that is moving the indexes. Analysts expect a $5 billion reduction in total bond buying and it is our belief that if it is at the $5-$10 billion level, the market should not react. But, as is well known, traders tend to buy the rumor and sell the news.

THE LAST 24 HOURS

TWO EX-JP MORGAN TRADERS CONVICTED IN ‘LONDON WHALE’ SCANDAL

The U.S. district court in Manhattan has indicted two ex-JPMorgan traders, Javier Martin-Artajo and Julien Grout, for their involvement in the bank’s ‘London Whale’ scandal of May 2012. Both the traders were accused of artificially inflating the value of the securities to cover up a trading loss of $6.2 billion. The accused are indicted with five criminal counts for their involvement including securities fraud, wire fraud, conspiracy, making false filings with the U.S. Securities and Exchange Commission, and rigging books and records. Meanwhile, JPMorgan is in talks with the U.S. and European regulators for a civil settlement of $700 million.

SAUDI OIL OUTPUT AT A RECORD HIGH

The disruption in supplies of crude oil in crisis in Libya, together with the U.S. sanctions on purchase of oil from Iran, has led to a massive increase in Saudi Arabia’s oil production. The Gulf country is now pumping an additional 10.2m barrels of crude oil a day to meet the global demand. At present, the UAE, Kuwait, and Saudi Arabia are supplying 17.1% of the global crude oil demand, especially from developing countries like China and India. Even after the discovery of shale gas in the U.S, these Gulf countries, which have historically saved the global crude market at times of crisis, is at its maximum oil output since the 1970’s.

OBAMA STRONG ON REPUBLICAN STAND ON DEBT CEILING

The President Obama has made a strong stand against the Republicans and has asserted that he will not bargain over an extension of the U.S. debt ceiling at the upcoming debate, which is next on the Congress’s agenda. The Republicans are planning to coerce more spending cuts and to especially, withdraw funding for Obama’s flagship healthcare program. The President has said that he will not be bullied at the debate and he hopes that the Republicans will succeed in rising above politics to navigate the U.S. economy through its current economic scenario. The U.S. debt ceiling of $16.7 trillion will be exhausted by mid-October; in order to pay the Treasury bills and to avoid defaulting, the U.S. government will have to increase the debt limit.

U.S. AUTO SALES TO TOUCH THE 16 MILLION MARK BY NEXT YEAR

The U.S. auto market is set for a robust growth, as sales projections for new cars and light trucks is expected to reach 16.1 million by next year – a fifth straight year of growth and the fastest expansion since 1950 auto deliveries exceeded the 16 million levels in august for the first time in 6 years. The signs are encouraging for the U.S. auto industry as it aims to get back to the growth levels attained in the 2000’s.

VODAFONE SET TO ACQUIRE 76.48% OF KABEL DEUTSCHLAND SHARES

Vodafone has offered to buy 76.48% of Kabel Deutschland’s shares for 7.7 billion euro. In a strategic move, Vodafone is seeking to buy Kabel Deutschland to capitalize on the television and fixed-line services in Germany, the biggest mobile market in the European Union. Vodafone, which decided to sell of its stake in the U.S. operator Verizon Wireless for $130 billion last month, now wants to gain at least 75% in Kabel Deutschland as it will then be able to control the strategy and the cash flows of the German company. The deal is subjected to a review by the European Commission, which will be conducted on September 20.

UN REPORT ESTABLISHES THE USE OF SARIN GAS IN SYRIA

The U.N. concluded in its report that rockets filled with sarin gas were liable for the large number of civilian casualties on August 21 in Damascus. The report is based on interviews with survivors and witnesses to the attacks and physical samples collected from the rockets. The chemical bombings in Syria prompted the U.S. President to threaten a military intervention against the Assad government’s use of chemical weapons against his own civilians.

THE NEXT 24 HOURS

Despite some important data releases coming up today, all eyes will be on the Fed’s release tomorrow. We expect low volumes and some volatility in today’s market due to a cautious stance of investors.

Inflation data from the Consumer Price Index (CPI) —including the ex-Food and Energy data—will be released tomorrow. We still expect a low inflation level, which has already been seen from the Producer Price Index (PPI) last week. The US has a Capacity Utilization rate (released yesterday) of 77.8%. It depends on China for much of its manufactured goods. Our readers are well aware of the excess capacity problems plaguing that country. With this level of global excess capacity, we do not see the risk of inflation in the near term.

At 2PM tomorrow, the Fed will release its economic projections and its pace of MBS and Treasury purchases. We have published a report on the Fed’s bond buying that can be read on HOTW. It is a succinct analysis of quantitative easing and the economics governing it. We also provide some investment ideas based on the tapering of the easy money policy that will continue in the near future.

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