FYI | Sep 21 2007
By Greg Peel
Well somebody had to be on the other side.
Anticipation gripped the pre-market on Wall Street last night as traders awaited earnings reports from the world’s largest investment bank – Goldman Sachs – and the investment bank that started the rot – Bear Stearns.
Consensus was for Goldmans to post a 33% increase in earnings, but the reason for expectation of the only earnings rise among the four big investment banks reporting this week was all to do with a big one-off sale of a power company asset. Remove that, and the market was nervous as to just what the trading losses might really be. Last quarter Goldman posted an EPS of US$3.26. This quarter analysts expected US$4.35.
There was nothing short of shock when the figure came out at US$6.13 – 88% higher than the second quarter and 41% better than expectation. Quarterly revenue rose 21% year on year. But within the numbers, Goldmans booked a US$1.5bn loss in credit markets. This was primarily as a result of write-downs in leveraged buyout paper, and was just the sort of thing the market expected. So how on earth then did it make so much money?
Simple. Goldmans was short the mortgage market. America’s largest and most diversified investment bank showed just why it is Number One.
The story was not quite the same for mortgage market buyer Bear Stearns. Consensus was for a 41% fall in quarterly EPS, from US$3.02 to US$1.78. The number came in at US$1.16 – a 62% loss, 35% worse than consensus. Nobody needed to ask where the losses came from.
Elsewhere significant earnings reports were also to the bearish side. Fedex – a transportation company considered a bellwether for economic activity – posted a slightly worse than expected third quarter loss but the impact came from its accompanying guidance which suggested the fourth quarter was going to be a lot tougher as high oil prices and reduced consumer activity would threaten a recession.
Another surprisingly poor earnings result was posted by electronic goods retailer Circuit City, which saw its shares tumble 18%.
But just when the R-word was raising its ugly head once more, out came the week’s jobless claims. To the surprise of everyone, they fell by 9,000. While the weekly numbers can be somewhat volatile they are nevertheless timely. It is important to note that the past two recessions in the US were preceded by a significant rise in jobless claims, which makes perfect sense. The trend over 2007 has been steady so far. Does this mean there won’t be a recession? Or does this mean we haven’t started feeling the real impact just yet?
To add to the confusion, the Conference Board index of leading economic indicators declined in August, while the Philadelphia Fed’s activity report was positive. Just what signals are the data sending?
Wall Street mulled over this question, and decided that after two days of solid gains it might be time to take stock. The Dow closed down 49 points or 0.3%. The S&P lost 0.7% and the Nasdaq 0.5%. We’ve had the snap adjustment to the rate cut. What happens next?
Weighing on the market last night was not so much the R-word, because the Fed has indicated it will do what it has to to prevent an R, but the I-word, because the Fed has indicated it would do what it has to to prevent an R.
The US dollar had begun to tip over as soon as Bernanke slashed the rate. On Wednesday the greenback took a breather while the world digested the new regime, and then last night they sold it like there was no tomorrow. While the realisation that a lack of rate cut from Saudi Arabia indicated America’s great Arab ally was now decoupling from the dollar was no doubt catalyst, consensus has formed that the Fed rate cut, and possible further rate cuts, are just too inflationary.
The euro surged against the dollar to break 1.40 for the first time since its inception. The Canadian dollar rose to parity with the US. The US dollar fell against the pound and the yen, and again against the Aussie which pushed ever higher to US$0.8618.
The US yield curve saw a sharp sell-off in ten-year bonds, confirming the tenuous reversal that had begun to occur following the flight to safety during the worst of the credit crunch. The ten-year yield climbed 15 basis points to 4.67%. The two-year bond was also sold off, pushing the yield above 4% once more and maintaining the slope of the curve. Bonds are usually sold when inflation fears bite.
And gold is usually bought. Gold accelerated its move into new quarter century record territory, surging by US$11.70 to US$733.00/oz. The oil price just knows no barriers at present (it is in unchartered waters), and it leapt yet another US$1.39 to US$83.32. Base metals took a breather after Wednesday’s solid gains in London, with the exception of runaway nickel, up another 3%.
The SPI Overnight fell 22 points. The September SPI contract rolled off yesterday and we are now following December.
Goldman Sachs shares finished down on the day.
