Monday January 25

Falling oil prices once again drag down stock indices. The S&P500 fell 1.6% to 1,877 and the Dow Jones fell 1.3% to 15,885. Oil prices fell today as a result of recurring concerns of market oversupply and slowing China demand. Brent oil fell 5.2% to $30.50 and WTI lost 7.2% to $29.88. Short positions have fallen 8% on recent weeks and the number of investors who are net long oil increased modestly which could perhaps be a sign of the market bottoming out. Oil prices and the global economic outlook are making a dent in analyst expectations as earnings estimates for S&P500 companies have been cut for this year. Further easing is expected from central banks around the world including the BoJ possibly Friday and the ECB in March. The 2 year Treasury was flat at 0.87% and the 10 year yield fell 3 basis points to 2.02%. Haven assets rallied with the yen rising 0.4% to Y118.36 and gold prices increasing. The euro rose 0.5% against the dollar to $1.0852.

Once again Treasury prices are rising and yields are falling accompanying lower oil prices. The yield curve has been flatting as the spread between the two and ten year, or the yield premium) reaches 115 basis points which is the lowest level since 2008. This reflects low inflation and growth expectations. Prices have rallied this year as investors have shifted out of riskier assets such as equities and certain areas of the credit market. Lower yields also reflect the belief that the Fed won’t raise rates as fast as the dot plot suggests. The market for fed funds futures suggests a 31% chance of rates increasing in March, compared to the 56% probability assigned to this outcome last month.

The PBoC is faced with a policy challenge, it wants to ease credit to households and companies in order to maintain growth but it wants to keep the renminbi relatively firm. As a result of this policy dilemma the central bank will not use traditional measures such as lower interest rates or lower reserve requirements in order to ease monetary policy since these would have adverse outcomes on the renminbi. It wants to avoid further weakening of the renminbi since this sends a very bad signal to international investors about the state of the Chinese economy. The PBoC will use loan facilities to pump liquidity into the financial system, however this is a more temporary resolution. The Fed will be paying attention to uncertainty in China in subsequent decisions on whether or not to raise rates.

Bonds from the retail sector reflect the woes facing those companies. Private equity firms in the past used LBOs to finance takeovers of retail companies which have since struggled. Bonds from J Crew, Nine West, and Claire’s trade at 27, 32, and 60 cents on the dollar respectively. High levels of debt and unfavourable industry conditions are large headwinds to these companies as online retailers become more popular with consumers. Bain Capital, KKR, and Apollo are among the private equity groups that have held investments in retail companies for extended periods of time. The current market environment is not conducive to liquidation events such as a public equity offering.

Monday January 25

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