Global markets retreated this week amid risk aversion caused by the Bank of Japan's (BoJ) surprising decision to forego additional monetary easing and lackluster U.S. corporate earnings.
Yen soars, Nikkei plummets after Bank of Japan (BoJ) surprise
Japan's Nikkei 225 Index fell more than 5%, with heavy losses coming Thursday after the BoJ's decision to hold its fire. Japanese policy makers have long insisted they would increase economic stimulus until inflation goals were met, but despite Japan's core consumer price index (CPI) falling 0.3% in March (the largest drop in three years), the central bank decided to pump the brakes on its controversial monetary policy experiment. As a result, on Thursday the yen rallied more than 3% against the U.S. dollar (its largest single-day gain since May 2010), hitting 18-month highs.
The following feature appeared in SkyBridge Capital's "Wall Street Weekly" newsletter, where every weekend we break down the most important stories from the world of finance, economics and geopolitics.
Japanese central bankers are perhaps beginning to realize the diminishing returns and limits of aggressive monetary policy. The Abenomics bazooka has been unable to stoke inflation while the BoJ's exchange-traded fund (ETF) purchases have already made it a top 10 owner in about 90% of Nikkei 225 stocks. While the BoJ's embattled Governor Haruhiko Kuroda maintained the central bank has "plenty, plenty of room to push down the negative rate," Thursday's inaction could represent a tacit acknowledgment of the unintended consequences resulting from negative interest rate policy (NIRP).
The market's violent response to the non-news also serves as a lesson in expectation management for central banks. The role of monetary policy is to smooth out business cycles by promoting steady inflation and healthy labor markets, but modern central bankers have taken an activist turn. If the market builds up tolerance to potent drugs, the effects of withdrawal process can become even more dangerous than the disease itself.
The U.S. Federal Reserve has done a much better job managing the transition from bailouts to quantitative easing (QE) to monetary tightening. The Fed's Federal Open Market Committee (FOMC) took its time before moving off 0% late last year and indicated this week it was in no hurry to further raise rates. The next "live" meeting for a rate hike is June, and while Chairwoman Janet Yellen was encouraged by improvement in the U.S. labor market, "Brexit" concerns mean the FOMC likely won't risk roiling global markets weeks ahead of the June 23rd U.K.-E.U. referendum.
The Bank of Japan (BoJ) sprung a dovish surprise on the market with its move to negative interest rates, which didn't have the desired effect on the yen or inflation. Now it has spooked the market with hawkish inaction. At the next meeting, we will find out whether Japanese officials are ready to go all-in to salvage a weak hand, or whether the time has come to accept sunk costs, lay down losing cards and begin acceptance of a new normal.
Technology sector's changing of the guard
This week was the busiest of the Q1 earnings season, with around one-third of S&P 500 companies reporting. The results were uninspiring, with corporate America on track for its fourth straight quarter of profit declines - the longest such streak since 2009. Of particular interest were earnings from U.S. technology giants, which appeared to usher in a changing of the guard within the sector.
WINNER - Facebook (FB). Facebook began its life as a social network and, after a clumsy initial public offering (IPO), drew inevitable comparisons to the deposed MySpace. However, exceptional growth has rendered the company's early struggles a distant memory. The platform has evolved into something much greater than a social network; it's now a vehicle of mass communication and news aggregation that is beginning to rival the scope of the internet itself. The company topped earnings expectations again this week thanks to faster-than-expected growth in mobile advertising revenue, pushing the stock up nearly 10% in early Thursday trading before the euphoria subsided only slightly. The company has amassed more than 1.6 BILLION active users and used its rapidly-appreciating share price as currency to make bold, forward-looking acquisitions. For now, Facebook appears impervious to the global economic stagnation plaguing more traditional companies. Like Alphabet did in its restructuring of Google, Facebook has also proposed a new class of voting stock that will allow Mark Zuckerberg to maintain control of the company while pursuing his plan to give away almost all of his shares.
WINNER - Amazon (AMZN). "Amazon will never grow into its revenue multiple. The company doesn't even make any money." Well, you can go ahead and put that once-popular narrative about Amazon to bed. Despite losing money quarter after quarter, the company often got a pass from Wall Street because of its propensity for heavy capital reinvestment. Now we see why. The company hasn't stopped spending heavily to grow its various lines of business, but now stacks paper, too. AMZN rallied 10% Friday after topping both bottom and top-line expectations, earning $513 million of net income while accelerating revenues to $29.13 billion. In the process, Bezos' net worth grew by $6 billion. Revenues for the Amazon Web Services cloud computing business grew a staggering 64%. Awe-struck analysts raised price estimates universally.
LOSERS - Apple (AAPL). It's hard to feel sorry for a company earning $5 billion in free cash flow every month, but that's what happened this week. Apple (AAPL) fell around 10% after posting its first-ever decline in iPhone sales and first revenue contraction in 13 years. Of particular concern was a nearly 30% drop in China iPhone sales. The company is reportedly working on plans for an iCar to revolutionize transportation the way the iPhone forever changed computing, but with that product likely years away Apple looks set to settle into life as a clunky dividend-paying value stock. Carl Icahn doesn't want to wait around, dumping shares he once said were worth $240 (Apple closed this week at $93.74).
LOSER - Twitter (TWTR). The puzzles of user growth and mobile advertising revenue solved by Facebook continue to perplex Twitter, which fell around 14% after another dismal quarter.
Welcome to Saudi Vision 2030
Last week we discussed Saudi Arabia's $2 trillion plan to wean itself off oil. This week we got more details as millennial Deputy Crown Prince Mohammed bin Salman (MbS) unveiled "Saudi Vision 2030." The kingdom will IPO 5% of the state-owned oil company, Aramco, which produces three times more oil per day and has ten times more reserves than ExxonMobil, carrying an estimated market value of between $2 and $2.5 trillion. The IPO will bring a major financial windfall to the kingdom, allowing it to create a larger and more diversified sovereign wealth fund, but also usher in unprecedented change in terms of transparency and corporate governance.
Not everyone is convinced the plan will work. While it will package and sell part of Saudi Arabia's crude exposure, the Aramco IPO will not instantly transform the kingdom's oil-based workforce and economy. It essentially represents a shift of balance sheets rather than the creation of new assets. The Saudis also want to become a major military technology supplier rather than importer. While possessing considerable military might, the kingdom domestically manufactures only 2% of its military equipment, relying heavily on purchases from countries like the Unites States.
Deputy Crown Prince MbS is also easing into rhetoric about social reforms, saying women in Saudi Arabia are perhaps being denied basic rights afforded them by Islam (like being able to drive). To meaningfully modernize Saudi society, though, he will eventually have to confront the strong fundamentalist Wahabbism influence within the kingdom's culture. There are concerns that bin Salman, who has ostracized technocrat Saudi diplomats, could be in over his head.
Oil's false dawn?
Oil prices continued to climb this week, with West Texas Intermediate (WTI) crude making 2016 closing highs at $45.99. The magic number for recovery in the U.S. energy industry is $50/barrel.
While beaten-down oil companies are not quite out of the woods, energy bonds have rallied so far they're no longer considered distressed. Some analysts are worried the bond market has gotten a little ahead of itself, with the recent rally perhaps representing a false dawn.
ExxonMobil lost its AAA credit rating this week, but bond markets had already priced in the downgrade. With rates universally low across the corporate credit spectrum, losing the AAA distinction has little material effect on ExxonMobil's borrowing costs. In fact, nobody really cares about the AAA rating anymore. Microsoft and Johnson & Johnson are the only two companies left with perfect credit ratings.
The great China debate
In a down week for global markets, there was actually decent news out of China. Data shows the Chinese economy is recovering faster than expected. Jim Chanos says shorting China is a once-in-a-lifetime opportunity, but one hedge fund manager is betting the likes of Chanos, George Soros and Kyle Bass are wrong - that China has already had its "hard landing" and is now on the road to recovery.
The International Monetary Fund (IMF) applauded China's efforts to tackle high corporate debt and bad loans. Despite China's central bank governor warning financial institutions face increasing credit risks, BlackRock CEO Larry Fink thinks there's only a 20% chance China's credit bubble bursts. The Chinese corporate world isn't taking any chances regarding a potential renminbi devaluation, using cheap funding to fuel a cross-border M&A spree.
Ant Financial, the financial technology arm of Alibaba being spun out for an IPO by the Chinese e-commerce giant, is quickly gaining clout in China's financial system. Its bloated $60 billion valuation stems in no small part from its close affiliation with government-affiliated investment vehicles.