Morning Note

June 24, 2011

Equity futures are trading mixed to fair value, pressured by unconfirmed rumors in Europe that Italian banks failed the stress test. Earlier today, Greek Finance Minister Evangelos Venizelos reached a deal with the EU and the IMF on additional tax rises and spending cuts. European Union leaders have formally appointed Mario Draghi to be the next president of the European Central Bank in October.

Yesterday after the close, Oracle (ORCL) and Micron (MU) traded lower after reporting earnings, which is helping to cause the relative underperformance in Nasdaq futures.

Libor fixings 

- Overnight Libor: Dollar: 0.128% vs prior 0.127% ; Sterling: 0.566% vs prior 0.567%; Euro: 0.875% vs prior 0.925%

- 1-month Libor: Dollar: 0.186% vs prior 0.186%; Sterling: 0.628% vs prior 0.628%; Euro: 1.270% vs prior 1.270%

- 3-month Libor: Dollar: 0.246% vs prior 0.247%; Sterling: 0.825% vs prior 0.825%; Euro: 1.472% vs. prior 1.469%

Fed reports balance sheet assets of $2.86T on Wednesday, +$28.8B w/w and +$512.4B y/y 

- Holdings of US Treasury securities were $1.6T on 22-Jun, +$26B w/w and +$825B y/y

- Holdings of mortgage-backed securities were $914.3B on 22-Jun, ($180M) w/w and ($214.3B) y/y

- Holdings of federal agency debt securities were $118.4B on 22-Jun, unchanged w/w and ($47.2B) y/y

August WTI crude +$0.47 to $91.49

Natural gas ($0.002) to $4.191

Gold ($2.05) to $1518.31

10-year yield 2.9196%

30-year yield 4.1679%

Asian Markets

Asia markets started strong and continued to rise through the day from a combination of factors: The drop in oil prices helped the region where most countries are net importers and have very few natural resources. The seeming agreement as to how to deal with Greece helped lift sentiment and the statement by Chinese Premier Wen Jiabao in the FT that inflation will now be under control. Short-covering was evident in the beaten-down sectors across the region. China initially fell but recovered strongly as the day went on, helped by Premier Wen's comments, taking air out of the idea that interest rates will rise more. Hong Kong led the region with airline and shipping stocks to the fore, all benefiting from the drop in oil prices. South Korea rose sharply as the oil price drop helped the KRW strengthen also and followed the regional pattern with airlines strong and refiners weak. Japanrose but was not as strong as the other markets as it had already had a good week. Australia lagged the region as the resource heavy index felt the oil price drop, but BHP Billiton (BHP.AU) rose 0.7% bucking the trend even though the company raised its cost and time estimates by 58% and six months respectively for the Worseley aluminum project and coal miners in Queensland resume their industrial action. Tech-heavy Taiwan fell as Oracle’s (ORCL) revenue miss hurt sentiment for tech stocks. Chip makers weighed on the index as chip prices fell for a seventh day, with Inotera (3474.TT) and Nanya Tech (2408.TT) both dropping over 6%.

European Markets

European equity markets trade higher, recouping much of yesterday's sharp losses, after EU leaders agreed on a €120B bailout package for Greece, assuming the austerity measures are passed by the Greek parliament next week. EU/IMF representatives in Athens approved Greece's proposed 5-year austerity package that included additional spending cuts and tax hikes. There has been little significant corporate or economic news. Reported EU leaders have given their backing to the appointment of Mario Draghi as next the ECB president following Trichet retirement in Oct, with formal endorsement expected in the Summit's closing communiqué. BOE's new Financial Policy Committee will release it's Financial Stability Report today with BOE's King holding a press conference at 10:30 (UK time). Germany Jun IFO business climate 114.5 vs consensus 113.5 and prior 114.2. The pound and the euro are trading at $1.6023 and $1.4304 respectively.

Today's Economic Releases (Eastern Time)

02:45 France Consumer Confidence (Jun); actual 83; consensus 84

04:00 Germany IFO business climate (Jun); actual 114.5; consensus 113.5

08:30 US Durable Orders (May); consensus +1.7%

08:30 US Durable Orders ex transport (May); consensus +0.4%

08:30 US GDP (second revision) (Q1); consensus +1.9%

08:30 US GDP Deflator (second revision) (Q1); consensus +1.9% 

Today's Key Events (Eastern Time)

09:00 MAP Pharmaceuticals Presents LEVADEX Data @ IHS

—:— American Diabetes Association ~ ADA

—:— American Orthopedic Association Annual Meeting ~ AOA

—:— BOE to release minutes of Financial Policy Committee meeting

—:— Capstone Investments with 3SBio

—:— CommunicAsia

—:— Deutsche Bank South Africa Conference

—:— Electronic Materials Conference

—:— Ernst & Young Asia Cleantech Ignition Session

—:— EU leaders summit

—:— GigaOM's Structure 2011

—:— IEEE Photovoltaic Specialist Conference

—:— International Headache Society Meeting ~ IHS

—:— Joint International Liver Transplant Congress

—:— OneMedForum

—:— Paris Air Show 

Company Specific News

Earnings

ACN (Accenture reports Q3 EPS $0.93 vs Reuters $0.90)

MU (Micron reports Q3 EPS $0.07 vs Reuters $0.16, revenues $2.14B vs Reuters $2.36B)

ORCL (Oracle reports Q4 EPS $0.75 ex-items vs Reuters $0.71; guides fiscal Q1 (Aug) non-GAAP EPS to $0.45-$0.48 vs Reuters $0.46, guides Q1 non-GAAP revenue growth to 9-12% y/y, which implies a range of ~$8.3B-$8.5B vs Reuters $8.29B)

M&A

SUG, WMB (Williams proposes to acquire Southern Union for $39/share cash, countering a competing offer from Energy Transfer Equity's (ETE))

Newspaper Articles / Headlines

21st Century Business Herald

- China Investment Co may take 5% in Sberbank. An insider tells 21st Century Business Herald that the parties have held preliminary discussions on an investment as Russia sells down its stake in the bank.

Barron's

- Barron's Weekday Trader is positive on Empresa Nacional Electricidad.  Barron's Weekday Trader is positive on EOC citing the company's market position in various fast growing South American countries, EOC's 4.7% dividend yield, the company's experienced managment team and strong cash flows. In addition, Barron's notes EOC's earnings are expected to grow ~10% in 2011 and ~9% in 2010 and the company's ADRs currently trading around 13x 2011 earnings.

Financial Times

- Aegon NV may make acquisitions overseas. CEO Alex Wynaendts tells the FT in an interview that now the company has repaid the Dutch state, they are free to make acquisitions pricing discipline will be key they will look at new markets but also in the US pension space.

- European banks have until 24-Jun for stress-test results. The FT reports that the European Banking Authority plans to release the results in mid July. StreetAccount notes the WSJ reported 2-Jun that the results were to be delayed until July.

- Regulators looking into US banks exposure to Greece. The FT, citing officials at different agencies, reports that Regulators have asked banks about both their direct and indirect exposures to Greece, including crredit default swaps and any contingency planning they have. Fed Governor Bernanke had mentioned this at this post FOMC press conference and said direct effects would be small. US banks have recently been reducing their exposure to some of the troubled European countries. Regulators are worried about the Federal Reserve's dollar swap lines with European central banks, due to expire 1-Aug and the Fed hasn't yet indicated if these lines will be extended.

- Aston Martin looking for partners on engines, reducing reliance on Ford. People close to the company tell the FT that Aston Martin recently approached Daimler (DAI.GR) and other German premium carmakers. The article says Daimler is considered the most likely partner, since the companies already have a relationship.

- US producers use 'fracking' technique to expand in the Permian basin. The FT reports that Chevron (CVX), Devon Energy (DVN), Apache (APA) and others are increasing drilling operations and buying more acreage in the area after using the technique, for extracting gas, to get oil from shale and other tight rocks. Apache seesm to be the most aggresive, having 25 rigs in the area vs year-ago 5 and with acreage sites being sold at double the value of six months ago Chevron has taken back its acreage and is drilling wells itself rather than letting partners do the drilling.

- States now turn on Google. The FT, citing people familiar with the investigations reports that AGs in California, New York and Ohio have begun reviews of Google's dominance in online search the inquiries are at an early stage.

Globe and Mail

- Canada looking at whether Foreign Account Tax Compliance Act regulations violate its laws. The Globe and Mail reports that FATCA's requirement that non-American banks collect social security numbers of their American clients and report their balances to the IRS might run afoul of Canadian privacy laws. FATCA, which has not yet been finalized, is scheduled to come into effect in 2013, and threatens a 30% penalty on banks' USincome and financial transactions to twist their arms into complying with it.

Handelsblatt

- China stopping Hong Kong Airlines from placing Airbus order worth almost €4B at list. Industry sources tell Handelsblatt that the country is blocking the ten-A380 order to protest European plans to subject non-European airlines to its emissions standards. The Chinese think the concept of allocating carbon-dioxide emission rights on the basis of 2006-9 emissions is particularly biased against them, as their air traffic has grown dramatically since 2009. A China Air Transport Association official calls the plan "unreasonable and illegal." The article notes that European and American airlines are also unhappy with the proposal.

Independent

- Qatar Investment Authority may bid for Sainsbury. The article gives no reason to believe the idea has any factual basis. The rumor is that QIA is again looking at Sainsbury's property portfolio.

London Times

- Tories not fond of Nick Clegg's idea to give away shares of Royal Bank of Scotland (RBS.LN), Lloyds Banking Group (LLOY.LN). The Times reports that Tories were annoyed by and dismissive of the idea, partially because of the way Clegg publicized it. Sources close to UK Financial Investments say that the idea isn't actually bad, but the government is unlikely to use it to offload its entire stakes in the two banks.

- Ladbrokes (LAD.LN) to make decision on Sportingbet "fairly quickly". An insider tells the Times that Ladbrokes will not let the talks drag on in the way that the ultimately unsuccessful 888 Holdings (888.LN) talks did. The Times calculates that Ladbrokes's rumored 70p/share offer values Sportingbet at £462M, but says the figure will become £560M after all additional shares are taken into account. Analysts tell the Times that Sportingbet is unlikely to seriously consider a bid that is not 80-90p/share

Los Angeles Times

- Starz (LSTZA) likely to want more money from Netflix to put Sony's (6758.JP) movies back online. People familiar with the matter tell the LA Times that the Starz-Netflix agreement has a cap on how many people can watch Sony movies online, and Netflix recently broke through the limit. People close to the talks expect the matter to soon be resolved.

A person with knowledge of Netflix's contract with Disney (DIS) says that Netflix can have up to 20M people streaming content online, after which Netflix needs to pay Disney about $0.20/additional subscriber/month.

New York Post

- KKR-led group near deal to buy Go Daddy for more than $1B. The article is light on detail, but sources tell the NY Post that Go Daddy is using adjusted EBITDA rather than EBITDA -- which is only half as large -- as its key metric.

- American Media buys US edition of OK!

New York Times

- Lawmakers try to dilute derivatives rules. The NYT reports that: The bipartisan effort argues that the rules could force some business overseas end-users don't seem to be excused from the rule that derivatives must be traded on an exchange.

South China Morning Post

- Husky Energy still considering secondary listing in Hong Kong. The SCMP cites Husky's CFO, speaking after the company's share offer yesterday; the context of his comments is not made clear.

Telegraph

- Cinven gives Aegis Group expression of interest in Synovate. Aegis is in talks to sell Synovate to Ipsos (IPS.FP) for about £520M; sources tell the Telegraph that Cinven wants to know if Aegis is willing to talk with anyone else. People familiar with the process say Aegis doesn't want to talk to anyone else for now, but other would-be buyers are positioning themselves if the talks should fail. "A number of people" wish Aegis was formally auctioning the business. Sources say GfK (GFK.GR) is also interested in buying Synovate.

Shanghai Daily

- China Mobile may roll-out iPhone in September. The Shanghai Daily, citing a blog by a marketing officer of China mobile, reports that a 4G version is likely to be available.

Times of India

- H&M in talks to enter India within 24 months. Industry sources familiar with the process tell the Times of India that H&M is talking with mall developers and corporates that have fashion interests. The article says H&M is likely to be concerned by Zara's (ITX.SM) "aggresive" pricing in India.

Wall Street Journal

- European regulators tighten rules for bank stress tests. The WSJ, citing a spokeswoman from the European Banking Authority, reports that the tests will now require banks to take 'haircuts' on their holdings of some countries government debt this will apply to holdings in their 'trading books' rather than their 'holding books'. The article notes that most banks keep their sovereign debt in the latter category.

- WSJ is negative on large food companies. A "Heard on the Street" column says that big brands are likely to face the same pressures that caused TreeHouse Foods (THS) to reduce guidance yesterday. As a result, the column thinks the larger companies are likely to give up their 10% premium to the market.

- WSJ looks at competing offers for Southern Union. The article basically summarizes the situation, but adds: Williams (WMB) CEO Alan Armstrong says Williams made an offer to SUG earlier this year, but "did not hear back anything affirmative." Armstrong gives no detail of the original proposal.

SUG would be liable for a $94.5M breakup fee if it chooses to sell to Williams (WMB) within the first 40 days of its agreement signing with Energy Transfer (ETE).

- WSJ is positive on EADS. A "Heard on the Street" column cites Airbus's performance at the Paris Air Show and says the company is worthy of trading at its premium to the sector.

- Vornado Realty Trust plays unusual role, buys $185M of junior debt in apartment complex at discount. People familiar with the matter tell the WSJ that the company has reached a deal to recapitalize a New York City apartment complex with Stellar Management, which is the complex's landlord's company.

Research

FBR Capital: upgraded DO

HSBC: downgraded COH, TIF,

Moody's: downgraded AIB

Ticonderoga: upgraded RJF, ART

UBS: downgraded BSX

Options

It Aint over Till its Over

- It is hard to believe, yet true, that 30-day close-to-close realized volatility in the S&P actually fell modestly yesterday versus Wednesday (14.46 to 14.33); a data point that neither reveals the magnitude of nor the anxiety associated with yesterday’s intra-day price swing. The factors used to determine the fair value of implied volatility are somewhat more astute in their approach. Despite the market closing down a mere 28 bps, the VIX, mindful of the intra-day swoon, refused to give up its gains and closed up .77 points at 19.29 (+4.16% on the day). Interestingly, the gain was limited to spot VIX as longer dated VIX futures (particularly June & Aug) fell in an apparent expression of easing concern out 1 to 3 months in the future.

When the Defensive Smell Offensive, Buy Put Spreads

- Looking at volatility changes across the sector spectrum, note the vol and skew is moving meaningfully higher in defensive/out-performing spaces such as utilities, consumer staples and REITs.  At 1.61, XLU’s 30-day Implied/Realized vol ratio now screens as the most expensive ETF in our universe; 60-day 25-delta put/call skew has reached a level not seen since March of 2011, a period which coincided with a 5.5% sell-off in the ETF (underperforming the mkt by ~1%). XLU just broken back below its 50-day MA and a DMI analysis shows the  -DMI line crossing up and through the +DMI line, a sell signal using that methodology.  We would look at capitalizing on the high skew and break down in technicals by purchasing the XLU Aug 32-30 put spread for $.43. (100% of XLU constituents report earnings by August expiration.)

- On Tuesday, we suggested buying the IYR July 60-55 put spread for $1.03. Outside of energy/materials, REITs were one of the worst performing industry-groups yesterday. That trade is now marked at $1.64 mid-market. We still like the idea, but at this point would implement it by purchasing the IYR July 58-53 put spread for $.87.

- Like XLU, the chart in XLP looks terrible with the ETF recently plunging below its 50-day moving average and the –DMI line crossing up and through the +DMI. We saw large bearish flow in the ETF yesterday and think companies are still feeling the pinch of commodity and wage inflation teamed with the inability to pass along those costs as they try to not lose market share to private label makers. We have also seen a significant uptick in pair-wise correlation among XLP constituents. Avg pair-wise correlation of .44 from the start of the year through April has jumped to .65 from start of May to present. This explains much of the steady increase in XLP realized volatility over the past 1.5 months. With 89% of XLP constituents reporting earnings before August expiration; we would look to buy the August 31-28 put spread for $.68

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 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.