Thursday, August 4, 2011

Morning Note

August 4, 2011

Equity futures are trading below fair value following yesterday's afternoon bounce which was largely attributed to oversold conditions and speculation that the Federal Reserve will announce further easing in the form of new asset purchases to prevent the economy from falling back into recession.

Sep WTI crude ($1.07) to $90.86

Natural gas +$0.03 to $4.12

Gold +$2.25 to $1662.99

10-year yield 2.597%
30-year yield 3.876%

Asian Markets

Asian markets were mixed with early gains following the US stock market recovery last night fading as the day wore on. There was currency intervention by the Bank of Japan which weakened the yen and enabled Japan's stock market to outperform, but the overall trend in markets was down.  Japan rose 0.2%, well below its intra-day highs after the above-mentioned intervention and after Finance Minister Noda said the central bank may follow up with monetary stimulus. China also rose 0.2% boosted by cement makers after the relevant ministry said the average cement price rose CNY57.24 y/y in June. Hong Kong failed to hold on to early gains, falling 0.5%. Australia dropped 1.3% and the currency fell also as investors fretted about the economic outlook going forward. Korea was the worst performer in the region dropping 2.3%. The refining sector plunged with increased worries of a global slowdown. The yen is trading at 79.65

European Markets

European equity markets opened higher aided by Wall Street's constructive close and solid earnings from heavy-weights including Unilever (UNA.NA) and ING Group (INGA.NA) before paring advances. Peripheral markets are amongst the regions leading gainers, the exception being Italy that moved into negative territory as indices retreated from early highs, with the FTSE100 also reversing gains. Both central banks left interest rates unchanged BOE 0.5% and ECB 1.5% with the focus on Trichet's post meeting news conference and any comments regarding the ECB's bond buying program.

Today's Economic Releases (Eastern Time)

06:00 Germany Factory Goods Orders y/y (Jun)
07:00 UK BOE benchmark interest rate decision (Aug)
07:45 Eurozone ECB benchmark interest rate decision (Aug)
08:30 US Initial Jobless Claims (30-Jul); consensus 406K
08:30 US Continuing Claims (23-Jul); consensus 3700K
09:45 US Bloomberg Consumer Comfort (31-Jul); consensus n/a
10:30 US EIA Natural Gas Inventories (29-Jul); consensus n/a
—:— US Chain Store Sales (Jul); actual ---; consensus ---

Today's Key Events (Eastern Time)

08:00 STEC Analyst Day
—:— American Association of Diabetes Education ~ AADE
—:— Credit Suisse Midsummer Latam Conference (one on ones)
—:— Monthly Retail Sales
—:— Needham with Sequans Communications

Company Specific News

ACM (AECOM Technology reports Q3 EPS $0.62 vs Reuters $0.61. Reports Q3:
Revenues $2.05B vs Reuters $2.08B)
ANDE (Andersons reports Q2 EPS $2.42 vs Reuters $1.72. Reports Q2:
Revenues $1.34B vs Reuters $1.15B)
ANR (Alpha Natural Resources reports Q2 EPS $0.96 ex-items vs Reuters $1.08. Reports Q2: Revenues $1.59B vs Reuters $1.51B)
ATK (Alliant Techsystems reports Q1 EPS $2.02 ex-items vs Reuters $1.99. Reports Q1: Revenues $1.08B vs Reuters $1.17B)
AUY (Yamana Gold reports Q2 adjusted EPS $0.25 vs Reuters $0.24. Reports Q2:
Revenues $573.3M vs Reuters $563.1M)
GM (Gildan Activewear reports Q3 EPS $0.77 vs Reuters $0.70. Reports Q3:
Revenues $529.8M vs Reuters $549.7M)
HCN (Health Care REIT reports Q2 FFO $0.90 vs Reuters $0.87. Reports Q2:
Revenues $381.1M vs Reuters $338.3M)
KFT (Kraft Foods reports Q2 EPS $0.62 ex-items vs Reuters $0.58. Reports Q2:
Revenues $13.88B vs Reuters $13.15B)
LEA (Lear Corp reports Q2 EPS $1.65 vs Reuters $1.29. Reports Q2: Revenues $3.68B vs Reuters $3.44B)
MDR (McDermott reports Q2 EPS $0.27 cont ops vs Reuters $0.32. Reports Q2: Revenues $849.8M vs Reuters $847.6M)

RIG (Transocean reports Q2 GAAP EPS continuing ops $0.47. Reports Q2:
Revenues $2.33B vs Reuters $2.33B)
WLT (Walter Energy reports Q2 EPS $2.36 ex-items vs Reuters $3.98. Reports Q2: Revenues $773.0M vs Reuters $914.5M)

Positive News
NOV (Navistar awarded $82.5M contract from the US Army)

Newspaper Article / Headlines

- Delcath Systems holds small part of a conference call to release Q2 results. GekkoWire reports: Results came without a press release or SEC filing. The conference call was cut off in the middle of the answer to the first question. The company said it would file an NDA response to the FDA’s Refusal to File letter for Chemostat this year. The company declined to give sales guidance for the EU, but said it would begin commercialization early next year. The company said it will publish Phase 2 results from the Neuroendocrine Tumors this fall in a peer-reviewed publication, but did not indicate when it would release data from the other three arms of the data

- Clal Insurance confirms to TASE that it has received $312M offer for its US operations. Sources tell Globes that the offer is likely from a foreign company. In a stock exchange announcement, Clal also said it is in talks to sell its UK operations.

Economic Times
India's Department of Industrial Policy and Promotion to circulate cabinet note calling for 51% foreign direct investment in multi-brand retail. A government official tells the Economic Times that appropriate concerns will be included. The proposal will probably: allow the ownership with a minimum investment of $100M. Give state governments final approval over whether such retailers will be allowed in their states. Limit stores to cities with populations of at least 1M. Require at least 50% of the investment to be in back-end infrastructure. Not require 30% domestic sourcing. Not require that 30% of turnover be from wholesale cash-and-carry sales to small traders. Not require retailers to file accounts with the Reserve Bank of India or the Foreign Investments Promotion Board

Financial Times
- Tesco to trial convenience store format in southern California. The FT,citing the company, reports that the trials will be as part of a plan to open 214 supermarkets on the west coast by the end of February the average size of around 3K sq ft will enable it to break into urban Los Angeles where larger sites are harder to find.
- Antitrust pressure eases on IBM in Europe. The Financial Times reports antitrust pressures have eased on IBM as a result of three companies dropping their respective antitrust complaints inEurope against the company. The complaints, filed with the European Commision, related to IBM tying its mainframe hardware and mainframe operating system together giving customers no opportunity to use a competitors' product. The article notes that a second probe has been initiated by the European Commision's own accord that focuses IBM's mainframe maintenance service

London Times
- Thomas Cook Group shareholders press chairman Michael Beckett to leave before scheduled February retirement. An analyst tells the Times that investors including 9.1% holder Lloyds Banking Group (LLOY.LN) thought that ex-CEO Manny Fontenla-Novoa would remain in charge, and they now think Beckett should step down early.

New York Post
Frederick's of Hollywood hires bankers to find buyer in Asia. A source briefed on the situation tells the Post that the sales pitch is the company's potential to be big in China, the Middle East, and other foreign markets. Analysts disagree on whether an Asian buyer would be interested in the company.

New York Times
- NYT discusses 'fracking'. The NYT reports that industry and regulators have long said the drilling technique has never contaminated water supplies as the drilling is well below the level of drinking-water aquifiers.
an old 1987 EPA report shows there has been a documented case and also that there may have been other instances but details have been sealed after energy companies settled with landowners.
- Fast-food chains flock to Russia. The NYT reports that there is plenty of demand in the country and avergae prices are higher than in the US.
- Luxury goods still selling well in the US, despite mark-ups. The article breaks no news but talks about levels of spending almost reaching pre-recession levels attributable to the stock market rally.

- Strong yen leads Nissan Motor to set goal of cutting exports from Japan by half by FY16 - Nikkei, seemingly citing "an official".
- Toyota Motor agrees to ¥13K/ton price increase from Nippon Steel (5401.JP) for steel sheets for April-September half. Without citing sources, the Nikkei reports that the percentage size of the increase varies by steel-sheet type, but some will rise 15%. The story also says that Nippon Steel has struck similar agreements with Nissan (7201.JP) and others.

- Investec approached Evolution Group regarding a takeover. SkyNews reports that Investec is interested in Evolution's wealth management arm. Recall it was reported earlier today that Evolution had received an expression of interest from an unamed third party.

South China Morning Post
- Coach hopes to list in Hong Kong in early fall. The SCMP reports that CFO Michael Devine, apparently speaking on yesterday's conference call, said the listing -- announced in May -- is "proving to be complex" as the company tries to answers all the questions that the Hong Kong exchange is raising. No specifics are provided.

Wall Street Journal
- White House courted banks before deficit deal. The WSJ reports that
according to people familiar with the situation, White House officials called bank contacts to ask them to contact key senators and congressmen to tell them that an agreement was crucial for the economy and business confidence. There has been bad blood in the past due to the new financial regulations but both sides may benefit from a thawing of relationships as Obama seeks funds for re-election and the banks try to settle mortgage foreclosure liabilities.
- WSJ is positive on Crocs. A "Heard on the Street" column says the company seems to have solved the problems that caused its shares to plummet from $70 in 2006 to less than $1 in 2009.
- WSJ is cautiously positive on Time Warner. A "Heard on the Street" column calls Q2 results respectable but unspectacular. But it notes that the stock is trading at a discount to CBS (CBS), Time Warner has ample opportunity to license its old series at an appetizing margin, and chairman Jeff Bewkes seems to have laid the groundwork yesterday to announce a new deal.

Kraft to split into two. Kraft (KFT) is to spin off its North American grocery business to its shareholders as part of a plan to split up into two companies: the grocery operations, which have revenue of about $16B, and a global snacks business with revenue of $32B. Kraft said a review showed that the businesses would benefit from being run independently, as they differ in their priorities, growth profiles and operational focus. Kraft also released Q2 earnings results that beat forecasts and it lifted its 2011 outlook. Q2 EPS rose 3.3% to $0.62 and revenue climbed 13.3% to $13.9B. Shares +2.7% premarket.
Japan acts to halt the yen. Just as Switzerland did yesterday, Japan today moved to stem the rise of the yen, which had become a safe haven from the eurozone and U.S. but had threatened the country's economic recovery from the March earthquake. The Finance Ministry sold over ¥1T ($12.6B), while the Bank of Japan said it would increase the size of its Asset Purchase Program to ¥50T from ¥40T and keep its interest-rate target range unchanged at 0-0.1%. The actions have so far worked, with the yen -3.5% vs. the dollar and -2.9% vs. the euro.
Spain sells bonds at higher rates. Spain has passed a key test in selling €3.3B ($4.71B) of bonds but at the cost of sharply higher interest rates following the recent market turmoil. The treasury sold €2.2B of three-year bonds at a maximum yield of 4.90%, up from 4.05% in a June sale. It also sold €1.1B of four-year bonds at a yield of 5.05%, up from 2.87% in an October 2009 sale. Still, yields of 10-year bonds fell in the secondary market to 6.022% in morning trading, while those of Italy fell below the psychologically important 6%. The auction came as the ECB met to set interest-rate policy amid hopeful talk it might revive a bond-buying program to calm the turmoil.
BOE leaves rates unchanged. As expected, the Bank of England has maintained its key lending rate at a record low of 0.5% and left the size of its asset-purchase program unchanged at £200B ($327.8B).
Hitachi, Mitsubishi Heavy to merge ops, or maybe not. Hitachi (HIT) and Mitsubishi Heavy Industries (MHVYF.PK) have denied they're in talks about merging some of their power and infrastructure operations despite Hitachi's president saying on TV a deal was in the works. Sources said the negotiations stalled after news of the discussions appeared in the media, although Nikkei has reported that the companies will soon set up a merger prepartion committee. Any agreement would mark a major step in reforming corporate Japan: a merger would help Mitsubishi and Hitachi to reduce costs, offset a soaring yen and gain competitive scale.
Rio Tinto plummets after H1 profit miss. Rio Tinto's (RIO) shares fell 7.7% premarket after the global miner's H1 net profit jumped 35% to $8.03B but missed expectations. Not even a $2B expansion of its existing $5B share buyback program, nor a $0.09 increase in its dividend to $0.54 a share, seem to have assuaged investors. Rio remained positive for the rest of 2011 and for 2012, but said risks included credit tightening in developing economies and debt problems in the U.S. and Europe.
Unilever profit rises 10%. Uniliver's (UL) H1 net profit rose 10% to €2.24B ($3.21B) from €2.04B last year and beat expectations as revenues increased 4.1% to €22.8B, with higher prices and increased sales in emerging markets offsetting weakness in Western Europe and North America. Underlying sales, a closely watched measure, advanced 7.1% in the second quarter, again above analyst predictions. Shares rose 6% in U.K. trading.
Dendreon plummets on weak Provenge sales. Shares in Dendreon (DNDNcollapsed 62% in AH trading after its Q2 report showed weak sales of its prostate cancer drug Provenge, prompting the firm to abandon its revenue guidance and cut jobs. Annual sales of Provenge, Dendreon's only marketed product, will likely be closer to $200M than the $350M-400M previously projected. The problem is that doctors find it difficult to get reimbursed. In Q2, Dendreon's net EPS loss narrowed to $0.79 from $1.04 a year earlier, while revenue jumped to $49.6M from $2.8M but missed expectations.
Pfizer wants to sell Lipitor over the counter. Pfizer (PFE) reportedly plans to introduce a version of its popular Lipitor pill that consumers could buy without a prescription. The move would allow Pfizer to generate new sales from the world's best-selling drug after it loses its patent protection in November. The FDA has rejected allowing OTC versions of similar cholesterol drugs, but Pfizer thinks regulators may be more open to the idea as budget-strapped governments in the U.S. and Europe look for ways to control rising healthcare costs.
Misys ends Fidelity talks. U.K. software company Misys (MUSJF.PK) has ended talks about being bought by U.S. financial data-processing firm Fidelity National Information Services (FIS), as the latter's revised offer "materially undervalued the company." A deal would have helped Fidelity reduce its reliance on the U.S., where it generates over 80% of revenue. Misys' shares plunged 17.6% in U.K. trading, leaving it with a £1B ($1.6B) market cap.
Pentagon preparing for $28B savings in 2012. The Pentagon expects to make savings of $28B in FY 2012 as the first stage in its role in implementing the debt deal. Over ten years, defense spending will be limited by $350B at least, although the department could be hit by an extra $500B of automatic cuts if Congress doesn't agree on a government-wide program of $1.5T in savings by December. Legislators friendly to the defense industry are vying to be appointed to the Congressional "super committee" that will formulate the plan.
Lloyds makes huge loss on insurance charge. Lloyds (LYG) swung to an H1 pretax loss of £3.35B ($5.3B) from a profit of £1.3B a year earlier, due to a one-time charge for selling faulty payment-protection insurance and because of bad loans in Ireland and Australia. Shares fell 5.5% in London, making any profitable reduction of the U.K. government's 41% stake an increasingly distant prospect.


Bank of America: downgraded DNDN
Brean Murray: downgraded WLT, DNDN
Caris: downgraded CLX
Citi: upgraded LAZ
Collins Stewart: upgraded EMC; downgraded DNDN
Cowen: downgraded DNDN
Craig Hallum: upgraded BID
CRT: downgraded HMA
Evercore: downgraded SKYW

Goldman Sachs: upgraded TIF
Jefferies: upgraded LHCG, ELON, SM
JP Morgan: downgraded ENTR
Keefe Bruyette: upgraded FICO
KeyBanc: downgraded WLT
Ladenburg Thalmann: downgraded EE
Morgan  Keegan: upgraded WXS; downgraded DVR
Needham: downgraded DNDN
Piper Jaffray  upgraded DVA, MCD; downgraded AGN
Raymond James: upgraded FTR, DVA, AMRS; downgraded RDC
RBC Capital: upgraded MRGE; downgraded DNDN
UBS: upgraded FIRE, BKI
Wedbush: upgraded THOR; downgraded NTSP
Wells Fargo: upgraded VTG; downgraded NCIT


Volatility- Past, Present and Future

A Look Back at Volatility by Episode

We have divided 2011 into four major “episodes”. During each of these episodes the market alternately under or overpriced volatility.

Episode 1: (MENA unrest) The vol market was late in pricing-in the risk related to a potential disruption in Saudi Arabia. When vol finally did start rising, the risk soon abated.

Episode 2: (Tragedy in Japan; Crisis at Fukushima) The combination of geopolitical risks and natural disasters pushed the VIX through 30 the only time this year. The rise in vol was never justified by a prolonged downturn in the market. 30-day realized vol never breached 17.

Episode 3: (Budgetary Battle in Washington, Sovereign Debt Crisis in Europe) Negotiation impasse in DC brings the US's worsening fiscal to the forefront of investors minds. The VIX rises above 25 for only the second time this year, but conveys no sense of panic. During the protracted (and ongoing) effort to devise a bailout for struggling peripheral EU members, implied vol rises steadily and accurately forecasts both a drop in equity prices and a rise in realized vol.

Episode 4: (Signs of an Economic Slow-Down) Worrying signs are emerging that US economic activity has started to slow. Volatility is elevated but betrays any sign of panic. The VIX stays under 25.

Hallmarks of Today’s Volatility Landscape

SPX implied Vol is elevated but not near “panic” levels. Despite a 7% drop in the SPX over the nine days starting 7/25 the VIX barely managed to breach 25. We believe the cross-current of compelling equity valuations with macro risks could explain the subdued reaction.

Skew has begun to flatten. Skew has been generally steep (negative) for most of 2011 reflecting the perception of greater downside vs upside risk. While still negative, it has flattened considerably since mid-July possibly a sign that the market now perceives more equal downside vs upside risk going forward.

The Vol term structure is Inverted. The recent equity market sell-off has kept a bid to short-dated options (especially puts). This supply/demand imbalance has led to an inversion of the vol term structure.

Macro Views and Option Strategies for Q4 and Beyond

Consumer stocks look vulnerable; Cheap vol makes downside puts in consumer ETFs attractive. We favor short exposure via puts or put spreads in consumer ETFs XRT and XLY where implied volatility looks particularly cheap as a function of realized (60-day implied/realized=1.01 & 1.14 respectively) 

Precious metals as a safe haven; Inverted skew in GLD & SLV makes call spreads optimal for upside exposure. We like positioning for further upside in both GLD and SLV while leveraging their steep skew structure via long call spreads.

Corn is best derivative play on Chinese growth/ increasing protein consumption; Buy cheap upside calls in CORN ETF. Implied vol in CORN (Tecrium Corn ETF) currently trades at a discount to realized. We favor outright call purchases here. 

Longer term, favor high-tech companies. Looking farther into the future, we like upside exposure to leaders in high technology who have a proven ability to innovate and re-invent themselves over time.

*Special thanks to Option Radar, BMO Capital, MEB Options, Bloomberg, Reuters, Optionistics, LiveVolPro, CBOE, AMEX, Option Monster, T.O.P. group, and all of the options desks and traders we work with to provide the option flow!

 No position at this time. Position declarations are believed to be accurate at time of writing but may change at any time and without notice.

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