Wednesday April 19

Stock prices fell as lower oil prices dragged down indices. The S&P 500 fell 0.2% to 2,338 and the Dow Jones fell 0.6% to 20,404. The reason for the large underperformance from the Dow was a 4.9% drop from IBM after a 13% drop in 1Q earnings given the company’s large weighting in the index. Energy shares lost 1.4% and were the biggest decliners in the S&P 500 today. Yahoo fell 1.2% after reporting stronger earnings but offering guidance saying it wouldn’t be able to close the Verizon deal by the end of the second quarter. Additionally the KBW Bank index was flat and utilities fell 0.5%. Economic data today showed that crude oil inventories fell by 1mm barrels last week for the second consecutive week of declines. Nevertheless oil prices sold off heavily as investors reconsider geopolitical developments in the area. Interest rates in the United States reversed course a little bit from the recent rally. The two year Treasury yield rose 3bp to 1.20%. The ten year Treasury yield rose 5bp to 2.22%. Accordingly 2yr vs 10yr bear steepened to 1.02%. The dollar was stronger on the day against peers. USD rose 0.2% against EUR to $1.0714. USD rose 0.4% against JPY to Y108.86. USD rose 0.5% against GBP to $1.2779. WTI fell 3.6% to $50.55 and Brent fell 3.4% to $53.03.

Morgan Stanley was the last large US bank to report 1Q earnings and results were strong which continued the trend set by JP Morgan, Citi, and Bank of America earlier in the week. EPS and revenue were both higher than expected and market progress from last year’s 1Q numbers. Morgan Stanley’s stock was up 2% late in the session. Fixed income trading brought in revenue of $1.71bn even in spite of difficulties in the past and some leadership changes. The results make Goldman Sachs the lone outlier that experienced underperformance this earnings season. It’s wealth management business produced strong results. Equity trading revenue was down 1.9% however compared to last year due to lower commissions on trades and the shift to passive managers that trade less frequently than active managers. Investment banking was strong in the first quarter as Morgan Stanley came in second behind GS in M&A mandates. Overall investment banking revenue rose 43%.

The IMF issued a report offering a word of caution for corporate leverage in the United States. The IMF is concerned about the ability of leveraged companies to refinance their debts if the Fed continues raising interest rates. According to the IMF debt servicing as a percent of total income is at the highest level since 2010. This comes as demand for credit is at a notable high, which has pushed credit spreads to multi-year lows. In March the spread between high yield bonds and US Treasuries touched 3.44% which was the lowest level since 2014. That encourages companies to issue more debt. Indebted, leveraged companies are making up a larger portion of total companies in recent years. The report did come across bullish on tax reform. According to one measure looked at by the IMF, companies’ abilities to cover interest expenses is at the lowest level since 2008 which makes them highly prone to changes in interest rates. Interest coverage ratios have dropped from around 7.25x in 2010 to less than 5.5x currently. The proportion of companies that the IMF ranks as weak or vulnerable has been on the rise from around 12% in 2013 to around 22% currently.

The French election has turned into a worse case scenario for investors. Whereas before investors were pricing in the probabilities of Marine Le Pen and Francois Fillon or Emmanuel Macron, Jean-Luc Mélanchon has been gaining a lot of momentum. With Le Pen on the far right, Mélanchon is on the far left and both have similar policies that both aren’t ideal in the eyes of investors. As a result of Mélanchon’s sudden rise in support investors have been pricing in increased political risk with the spread between 10 year Bunds and French bonds as wide as 0.73% compared to 0.57% in march. In the second round election investors still expect a mainstream candidate to garner the most votes. Le Pen is a euroskeptic and has advocated pulling France out of the eurozone, as well as higher spending. Mélenchon is also skeptical towards the eurozone but doesn’t necessarily want to leave, however he also supports higher deficit spending. That is bearish for French government bonds. The battle of extremes between Mélenchon and Le Pen would create volatility for investors. Mélenchon would not be good for France from a fiscal perspective as he advocates for raising vacation time to six weeks, a four day 32 hour work week, higher minimum wage, and a lower retirement age.

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Wednesday April 19

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