Wednesday March 22

Stocks found their footing late in the session after a falling to start the day. The S&P 500 rose 0.2% t 2,348 and the Dow Jones was virtually unchanged at 20,661. The KBW Bank index fell fractionally while utilties gained 0.5%. Eric Rosengren and Loretta Mester spoke last night after markets closed. Rosengren cited the heating up real estate market while Loretta Mester said she was in favor of starting to unwind the balance sheet this year. Today the EIA report showed that crude oil inventories rose by 5 million barrels last week which is a large increase compared to a 200k barrel drawdown last week. The fact that markets stabilized after yesterdays selloff is an encouraging sign for investors. Tomorrow investors will be paying attention to whether the House is able to repeal Obamacare and the direction the voting takes could provide direction for the ease with which Trump will be able to pass his policies. Rates continued to rally. The two year Treasury yield fell 2bp to 1.24%. The ten year Treasury yield also fell 2bp to 2.40% after earlier falling as low as 2.38%. 2yr vs 10yr held at 1.16%. Rates in Germany rallied after a terrorist attack in the UK with the 10 year bund yield falling 5bp to 0.41%. USD rose 0.1% against EUR to $1.0802. USD fell 0.5% against JPY to Y111.14 as the yen experienced haven flows. USD was little changed against GBP to $1.2484. Oil prices were lower on the EIA data. WTI fell 0.2% to $48.14. Brent fell 0.5% to $50.73. The VIX rose for the second straight day to 12.74 still very low by historical standards.

Cerberus is looking to make a turnaround of Avon, the cosmetics company. Avon was founded 131 years ago and over the years it added products such as the crockpot, colorful measuring cups and spoon sets, as well as decorative bedding. Cerberus executives argue that those lines of business complicate the supply chain and take away attention and effectiveness of selling cosmetics which is the core business. In the years before Cerberus acquired Avon it had lost money for eight consecutive years. For a company that was once in the S&P 500 Cerberus paid $170mm for an 80% stake in the North American business which is now separate from the rest of the company. Cerberus also took a 17% stake in the parent company for $435mm. Cerberus aims to cut costs and sell assets that are tied to lines of business that are superfluous to the cosmetics sales. Cerberus will shed $90mm in costs annually and put $75mm into advertising, compensation, and digital systems. Avon was slow in moving into selling online and through social media. Competing with online retailers such as Amazon, Avon faces the challenge of convincing people to buy from them and wait for delivery when they can purchase at Amazon and have it delivered the next day. Cerberus executives will emphasize selling to aging women in middle America, which executives believe has been overlooked. They also want to start selling nutritional supplements which are also a growing area. Cerberus also has to take into account sales representatives, who in many ways function as independent entrepreneurs. Some representatives have voiced displeasure with the changes. However Cerberus is increasing compensation and getting rid of sales minimums which is popular with representatives.

Financial markets have been reconsidering some of their initial assumptions about the Trump trade. After the election stocks rallied, rates sold off, and the dollar strengthened as investors anticipated deregulation, fiscal stimulus, and tax cuts from the Trump administration. The extent to which those trades manifested seemed to be pricing in an ideal scenario under the Trump administration. Essentially investors priced in a high degree of certainty that Trump’s policies would pass, that they would pass as proposed, that they would pass in a short time frame, and that they would have a high degree of effectiveness once they were implemented. However the selloff yesterday and caution today reflects that those anticipations may have shifted. Republicans in the House of Representatives are trying to pass their healthcare plan, however they are running into resistance as conservatives and moderates can’t agree on whether or not to completely overhaul Obamacare. They will vote on Thursday however whether or not it will pass is in doubt. Even if it does pass it will have to make it through the Senate which also seems unlikely. While healthcare may not be on the top of the list of what’s driving the Trump trade, the early troubles and political tension there is with passing it could be a harbinger for future struggles passing other Trump policies. Steve Mnuchin has said that he wants to have a tax plan passed before August, and if that is the case any benefits to earnings won’t be manifested until 2018. And with tension holding up the healthcare topic the rest of Trump’s agenda is for the moment put on hold. Goldman Sachs estimates that if the corporate tax rate falls from 35% to 20% then the S&P 500 could rise as much as 10%. However if republicans are forced to make concessions and the tax rates falls to 30% then the S&P 500 would rise just 4%.

Alberto Gallo of Algebris Investment writes about some of the challenges and obstacles that the ECB faces in attempting to normalize monetary policy across the region. The first of its problems according to Gallo relates to timing. While some EU countries such as Ireland, Spain and the core countries are recovering nicely countries such as France, Italy, and Portugal have fallen behind. If the ECB raises rates too early it will prematurely impede any recoveries taking place in the countries that are still trying to catch up. Another challenge relates to interest rates. Right now in core countries inflation expectations are set to outpace bond yields by 50bp over the next 10 years using average numbers. That heavily penalizes savers. However if the ECB chooses to raise interest rates in order to benefit savers as well as banks, it risks hurting governments and corporations who need to borrow to invest and grow. Many market participants expect that the ECB will follow in the Fed’s footsteps regarding how it normalizes policy. The ECB itself has suggested that it will raise interest rates after quantitative easing has ended. However by maintaining quantitative easing while raising interest rates the ECB may better solve some of the challenges it faces. Continuing QE would allow the ECB to keep providing liquidity to specific countries and raising interest rates region wide at the same time. Gallo suggests that if the ECB tapers first then that could penalize countries such as Portugal and Greece since their yield spreads would widen out significantly with the absence of QE. Gallo suggests that if the ECB buys more peripheral debt while normalizing interest rates it would be a better option for the ECB. While Mario Draghi has suggested that the ECB will raise rates after ending QE, other members of the ECB have said that they don’t have to follow the same methods as the Fed.

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Wednesday March 22

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