Draghi’s offer to resign raises fragmentation risks in the Eurozone; Fedspeak provides a temporary reprieve to markets

What’s happening in markets?

Draghi’s resignation offer sent European stocks tumbling while U.S. equities recovered after less hawkish Fedspeak

Italian prime minister Mario Draghi’s offer to resign after losing support from Five Star Movement, a key coalition partner, heightens the risk of political instability in Italy when the Eurozone is in the midst of an energy crisis and runaway inflation, and probably an incoming recession.  The Italian 10-year government yield jumped as much 30bps to 3.41% before stabilized to end the day at 3.25%, 14bps higher in yield. FTSE MIB Index (SPMIB.I) ended the day 3.4% lower. Euro Stoxx 50 was 1.7% lower. The 10-year German Bund vs Italian BTP spread widened to 207 bps as the the fragmentation risk of the Eurozone increased. Being dragged down by European bourses and larger than expected headline PPI (June PPI +11.3% YoY vs consensus 10.7% and May 10.8%), U.S. stocks plunged in early hours with S&P500 (US500.I) and Nasdaq 100 (USNAS100.I)down as much as 2%.  Later in the day, Fed governor Waller and St. Louis Fed president Bullard said they were going for a 75bp hike on the July FOMC meeting.  Their remarks reduced the odds for a full percentage point increase in the Fed fund later this month and sent U.S. stocks higher to finish the day well off intraday lows.

Money woes hit US stocks; and earnings season has only just began

S&P 500 (US500.I) fell for the 5th day (down 0.3%) dragged down by banks, while Nasdaq 100 (USNAS100.I) closed steady, boosted by chip makers catching some bids. JPMorgan (JPM) and Morgan Stanley (MS) quarterly results missed expectations (as we at Saxo expected)- which dragged down banking shares, adding to their sour performance this year, (with banks shares down 24% from their highs). We think given borrowing is falling, bad debt are increasing as we forewarned- and rate rises are set to get steeper  - the picture is likely to get darker for big banks 

The biggest bank in world JPMorgan (JPM) hints corporate America did it tough in Q2 and expects a ‘hurricane’ ahead

If JPMorgan results were anything to go by, their results were weaker than expected, and its outlook - grimmer than markets forecast; However as we’ve been writing for some time, we expected disappointing numbers all round. JPMorgan CEO previously warned an economic ‘hurricane’ is coming. Q2 investment banking fees fell 54% (more than expected) and the group added $428 million to the pile of cash put aside for potential bad debts/defaults. It also suspended share buy backs to preserve cash - given its outlook will be darker. This sentiment reflects what we can expect from investment banking ahead. And we think if the US Fed rises rates by 1% on July 26 and continues to hike over the coming months, then credit/borrowing will aggressively continue to fall. Stock valuations will also be pressured too, further hurting investment banks. Essentially we don’t think you can bank on banking stocks turning around, until the Fed changes stance. Citi and Wells Fargo’s results will be watched closely on Friday.

Australia’s share market (ASX200) is down 0.8%, today, down 1.1% this week, weighted by tech, while coal stocks support the market

Tech names are down the most this week hitting new lows; with the risk of a short sharp recession, and rate hikes denting confidence in the sector. EML Payments shares fell the most this week, 21% after the CEO left, while celebrity endorsed family tracking app, Life360 fell 14% - both stocks are down over 60% this year. Meanwhile, today, the iron ore price (SCOA,SCOQ2) fell to a new low, weighing on the biggest miners after the commodity price fell below $100 for the first time since December 2021. Iron ore has now fallen 54% from May 2021, suggesting the biggest profit line items for BHP (BHP), Rio Tinto (RIO) and Fortescue Metals (FMG) in the 2022 financial year will be deeply negative.

Chinese property developers, banks and internet companies traded weaker on adverse news headlines

Hang Seng Index (HSI.I) fell 1.2% and Hang Seng Tech Index (HSTECH.I) fell about 1% and 2% respectively in the morning session.  CSI300 (000300.I) was little changed. Chinese property and bank names were lower on concerns about the deterioration in the quality of mortgage loan portfolios and the woes of uncompleted housing construction projects in China.  Buyers of 235 stalled housing projects have told banks that they would stop making mortgage instalment payments.  Alibaba (09988:xhkg) plunged nearly 4% after the WSJ reported that executives from the Alibaba’s cloud division had been summoned by Shanghai authorities regarding a reportedly huge data security breach of a Shanghai police database hosted at Alicloud. 

What to consider?

Draghi handed his resignation but Italy’s president asked him to stay

After failing to solicitate supports from coalition partner, Five Star Movement, in a crucial household support bill, Italian prime minister Mario Draghi handed resignation to president Mattarella yesterday.  Although Draghi can still push through the bill but he announced to step down following the former prime minister Conte led Five Star Movement from his national unity government.  After an hour-long meeting with President Mattarella, Draghi agreed to address the parliament on Wednesday July 20 to avoid a snap election.  

Power bills to surge in Australia, and Europe with Coal hitting new highs

China’s Q2 GDP data was weak but June activity data showed signs of recovery

China’s Q2 real GDP grew 0.4% YoY, and declined 2.6% QoQ, much weaker than the median (+1.2% & -2% respectively) from forecasts in Bloomberg’s survey. However, there were quite a few economists calling for even worse numbers and the whispering numbers circulating among traders were even weaker.  Since Q2 included the horrible month of April in which much of the country was put under partial or full lockdown, market participants tend to look past this lagging indicator and focus on the strength of recovery since late May when cities across the country gradually reopened. Retail sales, industrial production and fixed asset investment rose 3.1%, 3.9% and 5.8% respecting in June.  The performance of retail sales was better than expectations. The 13.9% YoY rise in auto retail sales was particularly notable. 

Potential trading and investing ideas to consider?

Rio Tinto and BHP face further pressure; Rio guides for a darker outlook. We also don’t think we’ve seen the bottom for these two giants shares

BHP (BHP) shares fell 3.5% to AUD$36.11 (a level not seen since December 2021) after iron ore tumbled below $100 on China putting its GPD target out of reach. BHP is also being sued $7 billion over the collapse of its dam in Brazil. The legal firm against BHP also secured extra funding to fight the ESG Case. That could add further headwinds to BHP costs, which are mounting amid higher wages and energy costs. In other news; Rio Tinto (RIO) shares fell 2.3% to ASUD$93.73 today after reporting quarterly production numbers  (weaker than expected). Copper output missed expectations. And as we anticipated, Rio admitted its outlook is weakening due to slower economic growth ahead, plus it sees China’s covid outbreaks lingering. Iron ore and alumimum demand is tipped to slow in Q4 and add further weight to commodity prices. 

Reorientation of attention to the woes in the housing market and regulatory risk in the internet industry

In spite of the recovery of activity data in June, investors are likely to reorient their focus to the lingering woes in the Chinese housing market and the potential regulatory risks of data security and anti-monology over the mega-cap internet companies. Share prices of Chinese property developers, banks and mega-cap  internet companies may potentially fact a new wave of selling. 

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