Friday December 23 Daily Market Primer

US stocks slipped in lackluster trading ahead of the Christmas holiday.  The market is on track for a very good December if nothing goes wrong, with the Dow up over 4% for the month.   Big retailers didn’t help yesterday, with Bed Bath & Beyond down 9% on an earnings decline, Nordstrom down 6%, and Gap down 5%.  Treasury yields are creeping back up over the last few days, and the 10 year is 2.54% this morning, and oil seems to like a low 50s price, for now. Stocks fell in Asia and are up slightly in Europe, as investors breathed a sigh of relief on big bank settlements with the US, and S&P futures are pointing to a down Christmas Eve-Eve.

	LAST	CHANGE	% CHANGE
DJIA	19,918.88	-23.08	-0.12%
Nasdaq	5,447.42	-24.01	-0.44%
S&P 500	2,260.96	-4.22	-0.19%
Russell 2000	1,362.66	-12.53	-0.91%
Global Dow	2,533.29	-2.50	-0.10%
Stoxx Europe 600	359.75	-0.07	-0.02%
Nikkei 225	19,427.67	-16.82	-0.09%
UK: FTSE 100	7,068.17	4.49	0.06%
CBOE Volatility	11.57	0.14	1.22%
Australia: S&P/ASX 200	5,627.90	-16.00	-0.28%
China: Shanghai Composite	3,110.15	-29.40	-0.94%
Hong Kong: Hang Seng	21,574.76	-61.44	-0.28%
Europe Dow	1,554.00	-3.28	0.24%
India: S&P BSE Sensex	26,040.70	61.10	-0.21%
France: CAC 40	4,836.00	1.37	0.03%
Germany: DAX	11,435.02	-21.08	-0.18%
Italy: FTSE MIB	19,283.20	161.94	0.85%
Spain: IBEX 35	9,351.60	18.00	0.19%
U.S. 3 Month	0.508	0/32
U.S. 2 Year	1.206	-0/32
U.S. 5 Year	2.03	1/32
U.S. 10 Year	2.537	4/32
U.S. 30 Year	3.108	12/32
Germany 2 Year	-0.79	0/32
Germany 10 Year	0.262	0/32
Crude Oil	52.31	-0.64	-1.21%
Brent Crude	54.41	-0.64	-1.16%
Natural Gas	3.548	0.015	0.42%
S&P GSCI	389.41	-2.55	-0.65%
E-mini S&P 500	2256.5	-2.25	-0.10%

Everything is relative, and it’s a relatively good legal outcome for Duetsche Bank, which announced a settlement last night of $7.2 billion with US authorities over mortgage backed trading during the financial crisis. This amount is half of original the demand from the US of $14 billion.  Only $3 billion of the settlement is in cash and the rest is in the form of customer relief, including loan modifications.   Credit Suisse was also part of the deal, settling for $5.3 billion.  Barclays, which you’ll remember bought the international business of Lehman Brothers after the bankruptcy, did not join the settlement and will fight awhile longer.     Deutsche Bank has has already reserved for most of the legal costs, and the stock rose 3.3% in Frankfurt.  How does a $7 billion settlement stack up with other financial institutions that got in trouble in the credit crisis?  In August of 2014, Bank of America reached the largest mortgage related settlement with the Justice Department for a whopping $16.6 billion. 

UK GDP was revised up to .6%.  Mr. Trump has been Tweeting again, playing defense contractors Lockheed Martin and Boeing against each other and expressing the need to “greatly expand” the US nuclear arsenal.  It was good for uranium miners yesterday, but some policy analysts are nervous. 

Friday Factoid: Purchasing Power Parity

With the US dollar on a tear since the election, I thought it might be a good time review the drivers of exchange rates.   There are two main theories at play, Purchasing Power Parity and Interest Rate Parity.  In case you don’t have your college economics books handy, we will start with this summary of Purchasing Power Parity.

Time to get those Eurotrips planned... The USD/EUR exchange rate touched its lowest rate in twelve years this week, trading at $1.0388 this Tuesday. Investors are anticipating the dollar continues to strengthen relative to the Euro helped by divergent central bank monetary policies, hawkish comments from the Fed after the .25bps rate hike last week, and increase demand for the dollar as we look forward to repatriation of corporate cash and potential Trump “U.S. first” trade policies.

YTD USD/EUR Price Movements

In addition, WSJ also found that more money has left the Eurozone financial markets this year than any time in the bloc’s history. Between Eurozone investors buying assets outside of the Eurozone and foreign investors selling their Eurozone assets, a total of €528.8 billion has left the Eurozone markets as of end of September putting further downward pressure on the currency and appreciation in the USD.

This recent change in exchange rates makes it a good time to brush up on the theory of Purchasing Power Parity (PPP). PPP states that a good or service should be the same price across borders because any arbitrage opportunity would be exploited by consumers and/or speculators and drive prices back to an equilibrium point. The Economist magazine puts out an annual piece to track PPP known as the Big Mac Index where they track a price of a McDonald’s Big Mac across the globe to see where it is over/undervalued relative to the price of a Big Mac in the U.S. based on current exchange rates.  

Here’s the 2016 Economist Big Mac Index ranking countries from most overvalued to most undervalued:

Applying this to the current USD/EUR exchange rate, one could hypothetically purchase Big Macs in the Eurozone at a lower price and sell them to consumers in the U.S. at a higher rate, thus exploiting price inefficiencies and profiting. Eventually, others would catch on to this trade and the increased demand for the lower priced Euro Big Mac (Royale with cheese?) would drive the price up to a point where it costs the same as a Big Mac in the U.S.

The PPP does not hold up well in the short-term due to other factors affecting the exchange rates, but over the long-term it does a better job of predicting exchange rate movements.

So, in theory, the depreciation of the Euro relative to the USD should ultimately benefit the Eurozone as more foreign money flows in to purchase goods and services due to the lower exchange rates. This in turn would strengthen the Euro relative to the USD as purchasing power parity drives the exchange rates back toward equilibrium.

   

We will cover Interest Rate Parity in a future factoid.  The Daily Market Primer will take next week off for the Christmas-New Years break.  Happy Holiday’s everybody, here’s the news:

Deutsche Bank and Credit Suisse settle

Deutsche Bank AG said in statement this morning that it has reached a $7.2 billion settlement with U.S. authorities following an investigation into its dealings in mortgage-backed securities. The total is far below the $14 billion originally demanded by the Justice Department but still is higher than many expected. Also this morning Credit Suisse Group AG agreed to pay $5.28 billion to settle a similar case. Shares in both banks rallied in European trading. The deals settled a major point of uncertainty.

Barclays fights on, Paschi lives on

Barclays Plc, however, failed to come to an agreement with U.S. authorities to end the probe into its part in the sale of mortgage-backed securities, which were described as "craptacular" by a consultant who reviewed the loans. The two sides will now face each other in court. In Italy, meanwhile, the government will step in to rescue Banca Monte dei Paschi di Siena SpA after the lender failed to raise the 5 billion euros ($5.2 billion) it needed from the market.

U.K. GDP revised higher

Third quarter U.K. GDP growth was revised higher to 0.6 percent, with consumption driving the expansion. In a separate report, the Office for National Statistics said that the country's current-account deficit widened as Britain posted its worst trade performance in three years. In the U.S., new home sales data and University of Michigan Consumer Sentiment are due to be released at 10:00 a.m. ET.

Markets quiet

Overnight, the MSCI Asia Pacific Index dropped 0.2 percent in light trading. In Europe, the Stoxx 600 Index was 0.1 percent higher at 4:57 a.m. ET as banks propped up the market in a session with volumes about a third lower than the 30-day average. S&P 500 futures were flat.

Italy has reached a deal to save its banks. The Italian government has agreed to a 20 billion-euro ($20.9 billion) fund to aid its struggling banking system, Reuters reports. Monte Paschi, the world's oldest bank, requested a bailout just moments after a deal was completed. Bitcoin is zooming higher. The cryptocurrency is up 5.1%, or $44, to $905.50, bringing its year-t0-date gain to 117%. Bitcoin trades at its best level in three years. "Fallen angel" debt had its best year since 2003. Bonds issued by companies that were unexpectedly downgraded by credit rating agencies have generated a 37% total return in 2016, more than double the total return for the broader high yield market, according to Goldman Sachs. Putin says the Russian economy is on the mend. Speaking at an annual year-end news conference, Russian President Vladimir Putin said the economy is slowly healing as the capital flight fades and wages pick up, Reuters, reports. The US is suing Barclays over mortgage-backed securities. The Department of Justice is suing the bank and two former executives, saying more than half of the $31 billion worth of packaged mortgage loans defaulted during the financial crisis, a person familiar with the matter told Reuters. Twitter has had a rough week. The stock has tumbled 12% over the past week after a slew of top executive departures. Stock markets around the world are lower. China's Shanghai Composite (-0.9%) trailed in Asia and Spain's IBEX (-0.4%) lags in Europe. The S&P 500 is set to open up 0.2% near 2,262. US economic data flows. New home sales and University of Michigan consumer confidence will be released at 10 a.m. ET and the Baker Hughes rig count will cross the wires at 1 p.m. ET. The US 10-year yield is down 1 basis point at 2.54%. US markets are closed on Monday. US stock markets are open a full day on Friday, but the US Treasury market will see an early 2 p.m. ET close. Shootout in Milan The man suspected of carrying out the truck attack on a Christmas market in Berlin has been killed in a shootout in Milan, an Italian official said. Anis Amri was stopped by police during a routine check at about 3 a.m. and started shooting. The police returned fire, killing him. We report that the path the 24-year-old Tunisian took to Europe has laid bare multiple failings in the continent’s security apparatus, including poor cooperation between governments, porous borders and lack of biometric data to identify people who use false identities. The rise of Islamic State and Germany’s decision to throw open the door to refugees has left security services overwhelmed as they try to track threats among new arrivals. Overtaxed security agencies dropped 24-hour surveillance of Mr. Amri this year when they failed to find enough evidence to make him a high-priority target. Billions More The Obama administration scrambled to resolve its remaining crisis-era megabank mortgage cases, striking multibillion-dollar settlements with Deutsche Bank and Credit Suisse over toxic securities while separately filing a lawsuit against Barclays alleging more than $30 billion in fraud-tainted sales. U.S. authorities settled with Deutsche Bank for $7.2 billion Thursday. Early Friday, Credit Suisse said it had agreed to pay about $5.3 billion to close the matter. The dramatic back-to-back announcements show the urgency among senior Obama appointees in the Justice Department to resolve the outstanding probes of precrisis conduct at major banks before those officials leave office in mid-January amid uncertainty about whether Donald Trump’s administration will show any interest in pursuing the cases. Deutsche Bank and Credit Suisse shares rose 4% and 2%, respectively, on Friday morning. Shares in Barclays dropped less than 1% as investors digested the potential uncertainty of a protracted legal battle with the Justice Department. The Price Is Right President-elect Trump’s pick to run the Health and Human Services Department traded more than $300,000 in shares of health-related companies over the past four years while sponsoring and advocating legislation that potentially could affect those companies’ stocks. We report that Tom Price, a Georgia Republican, bought and sold stock in about 40 health-care, pharmaceutical and biomedical companies since 2012, including a dozen in the current congressional session. In the same two-year period, he has sponsored nine and co-sponsored 35 health-related bills in the House. His stock trades are likely to be a significant issue during his Senate confirmation hearings. Ethics lawyers in both parties have advised lawmakers against trading even if it is legal. Meanwhile, Mr. Trump on Thursday rounded out his senior White House team and said in a cryptic tweet that he supports an expansion of U.S. nuclear-weapon capabilities.

Trump says nuclear arsenal must be "greatly" expanded.

EU's nightmare year ends with Le Pen risk haunting investors.

Bitcoin surges above $900.

Jamie Dimon on Trump, taxes, and a U.S. renaissance.

The year in money.

If you're so smart, why aren't you rich?

Eleven ways to stop winter weather delays from ruining your travels. U.S. Economy Approaches Year’s End on Lackluster Note Tank Car Maker Controlled by Carl Icahn Suing Railroad Regulators Syrian Army Says Government Has Full Control of Aleppo Violence Bolsters Erdogan’s Plan for More Presidential Power in Turkey Multibillion-Dollar Jet Deals With Iran Will Test Trump Policy Platinum Partners Fraud Case Has Investigators Casting Wide Net

Well! This year didn't quite turn out as people expected. A year ago, all of the talk in markets had to do with the oil crash, high-yield debt, and China. Today the risk landscape seems mostly dominated by politics. That's always how it is. You never know in advance what the big stories are going to be. So to say that the big events in 2017 will probably be things that nobody sees coming doesn't even rise to the level of pseudo-insightful. But one thing that makes this moment especially interesting is the speed with which ideas and ideologies can travel from the fringes to the mainstream. This week we got the news that UC-Irvine economist Peter Navarro will be leading a new trade advisory council within The White House. Navarro is a hardcore China trade hawk who, we can assume, would pursue a trade strategy far outside the economic mainstream. In a statement announcing Navarro's appointment, Trump said “I read one of Peter’s books on America’s trade problems years ago and was impressed by the clarity of his arguments and thoroughness of his research." It's not just Navarro's stock that's on the rise. Whether it's a rethink of the U.S. relationship with Vladimir Putin (to one more favorable), the Universal Basic Income, or getting rid of physical cash... All kinds of concepts and ideologies that seemed to be relegated to the fringe are now entering normal discourse. This is what made 2016 different: not the surprise political developments, but the intense attacks on mainstream ideology. Expect that to continue next year.

Source: Bloomberg, BI, WSJ, CFAI Fin. Newsbrief