The Overnight Report: Not So Super Tuesday

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By Greg Peel

Obama or Clinton? McCain or Romney? Right now nobody cares that much on Wall Street. It will still be a few hours before the results of all the US primaries are known, and there is more immediate news. The Dow closed down 370 points last night, or 3%. The S&P was down 3.2% and the Nasdaq 3%.

Sparking the big fall was the release of the January ISM non-manufacturing index. The Institute of Supply Managers collate information each month and provide an index measure for both the manufacturing sector and the non-manufacturing, or services, sector. Services include everything from hairdressing to banking. A measure of above 50 implies economic growth, and a measure below implies contraction.

There was weakness in December when the manufacturing index fell below 50 for the first time in a long while. Out came the R-word. But the January figure (released on Friday but lost in the jobs number surprise) actually bounced back from 48.4 to 50.7 when economists were expecting 47. This only added to the confusion. Are we or are we not in a recession?

The December services number was a more positive 54.4 however, and for January economists were expecting only a fall to 53. Hence you can understand the shock when the number came in at a very low 41.9. The last time there was monthly contraction in services was in 2003. This is made even more significant by the fact that if you divide the wholesale economy into these two divisions only, services account for close to 70% to manufacturing’s 30%.

The Dow opened lower and just kept going. The situation was made worse by the release of similarly poor services data in Europe. And the JP Morgan’s Global Total Output index, which surveys data from the US, Japan, Germany, France, the UK, China and Russia among others, came in at 47.7 for January – down from 53.8 in December and the first sub-50 number since 2001. While the US result clearly was influential in this particular number, the bad news for Europe was that contractions were also felt in Germany, Italy and Spain.

Europe was hammered, given the bad news on all fronts. London fell 2.6%, Germany 3.4% and France 4%.

In other Wall Street news, credit ratings agency Fitch announced it was planning to downgrade another US$100bn of CDOs. This will test just how realistic banks, brokers and funds have been on their CDO write-downs to date. Have they taken the big hit? Or are there more write-downs to come?

And one Fed Governor became the first to say on the record that it looked like a recession was nigh.

Suffice to say it was the financials which led Wall Street down today, along with the other “early-cycle” sectors such as retail and builders which have been popular with bottom-pickers this last week or so. Materials also came in for a beating, given recession fears mean lower commodity prices, and despite global anticipation that BHP Billiton ((BHP)) will increase its bid for Rio Tinto ((RIO)) at today’s deadline by 20-30%.

There was another shift back into US Treasuries, with the two-year yield falling below 2%. The ten-years slipped back to around 3.6%, but the yield curve continues to steepen. The short-end is anticipating another rate cut, and the Fed funds futures have now moved to 100% chance of another full 50 points. Merrill Lynch has suggested this will come in the form of another emergency cut, given it’s two months to the next official meeting. A steep yield curve is good for the financial sector (borrow cheap-lend dear) provided the longer end is not growing in yield on inflation fears. A recession should curb those fears (at least that’s what the Fed is hoping), given the prices of commodities should fall – oil in particular.

One might expect that recession talk and more rate cut anticipation might send the US dollar southward in a hurry once more, but last night the opposite was true. Not only is every cab driver already short the dollar, but the various data released last night showed that while the US is looking weak, now Europe is really starting to look weak as well. The Fed has cut rates from 5.25% to 3%, but the ECB has not budged from 4%. The ECB makes a rate decision on Thursday. Will it finally cut? The problem is Trichet is an inflation fighter, and inflation data have remained strong. It’s a tough one.

Anticipation was enough to continue the short-squeeze on the dollar, and so it ran up strongly against all currencies. The Aussie thus fell back over US1c to US$0.8959. And gold, which has been wobbling lately as longs lose their nerve, tumbled US$15 to US$887.90/oz.

Oil read the script, and indeed was double-whammied on recession indications AND a rising dollar, which is unusual. Crude fell US$1.61 to US$88.41/bbl. There is talk tomorrow’s inventory numbers will show a build as well, but then those numbers are just a lucky dip.

There was only one way for base metals to go, particularly after some strength last week. Copper fell 2%, zinc 4% and nickel 6%. However, prices did not quite fall off a cliff, given continuing supply disruptions, particularly in China, and this week has also been quieter given the Chinese are all off partying.

The SPI Overnight fell 156 points.

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