Weekly Economic Review Mar. 25, 2016
Eugene Fama Economist
“Markets are efficient, but there are different dimensions of risk and those lead to different dimensions of expected returns.�
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Market Overview This week, equity markets experienced their biggest drop in 2017, threatening the post-Trump market rally. The S&P 500 fell 1.4%, which is the biggest drop experienced since the week before the U.S. November election. It is also the first time the S&P 500 has fallen over 1% in 109 trading days. Analysts suggest that the congressional battle over the American Health Care Act contributed to the decline, calling into question the administration’s ability to deliver on promised deregulation and tax breaks. The Dow Jones Industrial average also declined, falling 59.86pts, while the DIJA fell by 317.77pts. Concerns over the administration’s ability to deliver on campaign promises that triggered the 3-month rally were exacerbated by concerns over North Korea’s nuclear missile program due to a test launch earlier in the week. Simultaneous to the U.S. equity market decline, the Shanghai Composite was up 0.99% at the end of the week, bolstered by infrastructure gains. The Nikkei 225 index rose 0.93% on Friday due to a weaker Yen, but still lost 1.5% throughout the week as a result of uncertainty in U.S. markets. After the terrorist attack in London, and as a result of uncertainty in the U.S., European equity indices were mostly down over the course of the week. The European STOXX600 closed 0.2% down at the end of the week, while the FTSE100 dropped 0.05%. Only the Frankfurt, Germany DAX index rose throughout the week, gaining 0.20% by the week’s end.
Macroeconomic Overview U.S. economic data this week was mixed, potentially contributing to the stock market declines observed. New data suggests existing home sales fell 3.7% in February, while new home sales rose 6.1%. Jobless claims are now at a seven-week high of 258,000 after rising this week by 15,000. This comes as TransCanada was granted a permit for the Keystone XL pipeline, which could potentially create 3,900 construction jobs. The US CPI was up 0.1% month-over-month in February, which the U.S. Labor Department suggests matches expectations for the month. This represents the fastest increase in the CPI in five years, reflected by the Federal Reserve’s recent decision to increase interest rates. Oil prices are once again rising, with the WTI reaching $50 a barrel. There are some concerns that efficiency gains in hydraulic fracturing once again threaten to decrease the price of oil for oil producers. At the same time, the U.S. Energy Information Administration said U.S. oil stockpiles rose to 533.1 million barrels, representing an increase of nearly 5 million throughout the week. OPEC attempted to alleviate the decline in prices by cutting output by 1.8 million barrels in a deal brokered earlier this year, but an increase in capital investment by shale oil producers have decreased the effectiveness of this output cut. This week, the UK pound reached its highest level against the dollar as U.K retail sales increased. The EUR/USD is closing on yearly highs, with analysts expecting a bullish breakout of the pair. This comes as UK inflation rises, with a 2.3% annual inflation for February outpacing U.S. annual inflation of 2.2%. In addition, the U.S. dollar has weakened based on concerns over the administration’s ability to deliver on domestic spending and tax cut programs.
Fixed Income Overview Based on expectations of two more rate hikes by the U.S. Federal reserves, forecasts for the U.S. 10-year Treasury yield fell to about 2.90% in 12 months, with the highest expectations at 3.50%. This week, both intermediate and long-term Treasury bond yields finished lower, falling to their lowest level in 2 weeks. The 10-year Treasury yield currently stands at 2.4125%. There is increasing speculation that the relatively high returns on U.S. bonds will dissipate as the Federal Reserve continues to raise interest rates. On Thursday, gold futures ended down following a five-day run. Gold prices currently settled at $1,247.20 per ounce, following reaching the highest finish since March 1, 2016 on Wednesday. This is reflected by the decline in equity markets this week as a result of uncertainty in the Trump administration’s ability to deliver on economic growth promises. In addition to declines in U.S. medium and long-term Treasury yields, Eurozone government bonds fell lower this week. Spanish 10-year government bonds fell to a three-week low of 1.67%, while Italy’s 10year government bond yield has increased over concerns about its increasingly volatile political climate. This comes as doubts about Trump’s ability to increase U.S. inflation has pushed international bond yields lower.
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Industry Focus: Chemical Historically, chemical stocks have been characterized as growth-and-income holdings, well suited to investors seeking a broad exposure to the US’ manufacturing sector. And as the global economy continues to strengthen, many industry experts are becoming increasingly bullish of the chemical sector. “This is one of the most cyclical businesses on earth”, so as the world’s economy grows stronger so too will chemical companies tend to increase in earnings. Products within the chemical industry are mostly used as raw materials by companies within various manufacturing industries. Some of the major end markets include automotive (paints and plastics), residential/commercial construction (glass, wood, metals), agriculture (fertilizer, pesticides), commercial aerospace (carbon fiber composite), and general manufacturing customers. Two industry leaders within the chemical space gaining attention at the moment are Albemarle Corporation and FMC Corp. Albemarle primarily manufactures technologicallyadvanced specialty chemicals for use in various industries, notably lithium used for recharging batteries. With a large segment of its business tied into lithium manufacturing, Albemarle stands to gain considerably as the lithium business continues to flourish thanks to an increase in demand for hybrid and electric cars that is likely to continue growing. FMC is a large, diversified chemical company based out of Philadelphia serving the agriculture, consumer and industrial end markets. FMC’s largest revenue segment comes from agriculture sales, where FMC manufactures a wide array of pesticides and herbicides. Within the agriculture division, FMC gets a large amount of its sales through Latin America—which may present an opportunity as Latin America’s economy strengthens.
Transaction Highlights EU regulators expected to clear DOW Chemical and Dupont merger In the late months of 2016, the possibility of this merger remained largely unclear as regulators around the world scrutinized a deal which would combine the two biggest chemical makers in the US. And EU regulators were right to have antitrust concerns, as this $71bn merger between Dow ($65bn market cap) and DuPont ($64bn market cap) would create the world’s largest chemical company on earth under a new entity called DowDuPont. The major concern within the EU was that this new entity would spend less on crop-protection research and thus reduce global crop yields. However, recent news has stated EU antitrust regulators are set to clear the merger. The European commission reportedly could announce its approval of the merger as soon as this Monday (3/27) or Tuesday (3/28). The EU antitrust enforcer has currently set a deadline at April 4 for the Dow-DuPont deal. Tesoro and Western Refining Stockholders approve a merger deal Tesoro Corp. and Western Refining Inc. took one step closer to sealing a merger this Friday, as stockholders from both companies voted in approval of Tesoro’s acquisition of Western Refining in San Antonio, Texas. Additionally, at a separate stockholders’ meeting on March 24, Tesoro stockholders approved issuance of needed shares of Tesoro common stock in connection with the acquisition. Tesoro and Western Refining signed their $4.1bn merger agreement on Nov. 17, 2016—and one completed, this will make Tesoro a 3,000-plus station operation. The total deal is valued at $6.4bn, including the assumption of approximately $1.7bn of Western Refining’s net debt and a $605mm market value of non-controlling interest with Western Refining Logistics LP. Under the terms of the agreement, Western Refining’s shareholders can expect to receive 0.44 shares of Tesoro for each Western Refining share they own, equivalent to $37.30 in cash per share of Western Stock.