The Daily Prophet: Trump Does His Best to Make Defense Shares Great

Connecting the dots in global markets.

Whether President Donald Trump’s first foreign visit is deemed a success, failure or something in between, winners in markets are already starting to emerge.

The S&P 500 Aerospace & Defense Sector Index rose to an all-time high, led by Lockheed Martin, L3 Technologies, Boeing and Rockwell Collins, after Saudi Arabia reached deals valued at more than $100 billion with U.S. defense companies during Trump’s visit. The gains pushed returns on defense shares further above the S&P 500 Index to most since the U.S. election in early November, according to Bloomberg News’s Eshe Day. The arms deals with Saudi Arabia show a growing need to update and modernize defense equipment amid rising regional tensions and escalating geopolitical threats, Buckingham Research Group analyst Richard Safran wrote in a research note.

The rally helped propel major stock indexes higher, with the S&P 500 now close to erasing all of last week’s losses that were related to turmoil in Washington, including reports Trump asked former FBI Director James Comey to drop the bureau’s probe into ties between the administration and Russia. “With Trump on a tour, the hope is we see less news over the next couple of days -- a chance for the waters to settle,” said Andrew Sullivan, a managing director for sales trading at Haitong International Securities in Hong Kong. 

It’s a big week for the oil market, as OPEC members meet in Vienna. Iraq backed a proposal from Saudi Arabia and Russia to extend output cuts for nine months, removing one of the last remaining obstacles to an agreement. Although the price of crude has jumped back above $50 a barrel, there’s one group that seems unimpressed: hedge funds. Money managers trimmed wagers on higher West Texas Intermediate crude for a fourth week, bringing them to the lowest since early November, U.S. Commodity Futures Trading Commission data show. Hedge funds’ WTI net-long position, or the difference between bets on a price rise and wagers on a drop, slipped 4.5 percent to 161,294 contracts in the week ended May 16, according to Bloomberg News’s Mark Shenk. “There’s been investor commentary mentioning doubts about OPEC’s commitment to curtail production,” said John Kilduff, a partner at Again Capital, a New York-based hedge fund that focuses on energy. “There are also questions about the effectiveness of any deal.”

A buildup in risk across the globe is getting too big for U.S. bond investors to ignore, according to Bloomberg News’s Brian Chappatta. After staking their biggest bet ever against the $14 trillion Treasuries market at the start of 2017, hedge funds and other large speculators have had a rapid change of heart. Their net-long position in 10-year Treasury futures is now the most since December 2007, reaching 240,010 contracts as of May 16, U.S. Commodity Futures Trading Commission data released Friday show. “That’s quite some turn around and captures the market’s mood shift,” Kit Juckes, a London-based strategist at Societe Generale, wrote in a note to clients. “Hope of a significant fiscal boost have melted away and been replaced by fear of both domestic and international turmoil.” The median year-end estimate for 10-year Treasury note yields stands at 2.80 percent, down from 4.90 percent in a March survey of strategists.

Given the political turmoil in Europe, it wasn’t all that long ago that traders were talking about the euro falling to parity with the dollar. That’s now looking very unlikely anytime soon after German Chancellor Angela Merkel talked up the shared currency. “The euro is too weak -- that’s because of ECB policy -- and so German products are cheap in relative terms,” Merkel told a group of students in Berlin during a school visit on Monday. “So they’re sold more.” While the comments were not new, the euro soared nevertheless, rising as high as $1.1264, its strongest level since Nov. 9. That puts it well above the $1.10 year-end median forecast of strategist surveyed by Bloomberg News, and Brown Brothers Harriman analyst Marc Chandler said there’s potential for it to rise to $1.13 in short order. Euro strength may have staying power, the options market is signaling. The one-year risk reversal, a barometer of investor positioning and long-term sentiment, reached its highest since 2009, according to Bloomberg News’s Robert Fullem.

Emerging-market traders are continuing to keep an eye on Brazil, where financial assets resumed their selloff as President Michel Temer’s support deteriorates after an audio recording emerged last week in which he appeared to endorse illegal bribes to a disgraced lawmaker. The losses have been magnified because so many global investors had piled into Brazilian assets on bets that Temer would push through measures to shore up the country’s finances, according to Bloomberg News’s Paula Sambo and Aline Oyamada. Unlike last week, the weakness didn’t spread to emerging-markets outside the region today. “Selloffs are just buying opportunities and what is happening in Brazil is positive for long-term institutions,” said Bryan Carter, the head of emerging-market fixed income at BNP Paribas Investment Partners in London, who bought Brazil debt as prices fell last week “This investigation has proven the independence of the judiciary, the inspector general, the police and the Supreme Court, free from presidential pressure.”

The Trump administration will release on Tuesday its formal budget request for the 2018 fiscal year. The details should come just a few hours before the Treasury Department begins auctioning $101 billion of bonds over a period of three days. Demand for the safety has been has been trending higher of late because of concern the turmoil in Washington may curb Trump’s pro-growth initiatives at the same time the economic data comes in on the softer side. First up will be the sale of $26 billion in two-year notes. At the Treasury’s auction of that maturity a month ago, investors bid for 2.85 times the amount offered, resulting in the highest bid-to-cover ratio since May 2016. Yield are little since then at 1.28 percent.

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