The Overnight Report: The Rally Finds Its Tipping Point

This story features NATIONAL AUSTRALIA BANK LIMITED. For more info SHARE ANALYSIS: NAB

By Greg Peel

The Dow fell 206 points or 1.6% to 12,814 – now well below the 13,000 bull break-out point. The S&P fell 1.8% to 1392, similarly leaving behind both the previous high break-out of 1405 and the psychological 1400. The Nasdaq also fell 1.8%.

The day started flat despite a positive lead-in from the aftermarket results of Disney and Cisco. Disney managed to hold its 3% gain but Cisco faltered, ultimately falling 2% after Wall Street began to wobble.

The wobble started when oil started running up again. While a higher oil price seems now de rigeur, and Goldman Sachs has everyone spooked with its US$200 by 2009 call, this time the oil rally was a step too far. The reason is because the US dollar also rallied and the weekly crude inventories showed a build. Oil is now defying its traditional adversaries. Crude jumped another US$1.69 to US$123.53/bbl – more blue sky.

While production disruption across the globe and a refusal by OPEC to increase production is underpinning oil at this level, last night it was noted that weekly distillate inventories fell as refinery capacity utilisation in the US fell from 85.4% to 85.0% due to spring maintenance, but also due to what is described as a “lack of pricing power”.

The conundrum here is that US gasoline demand has fallen on the higher price, reflected in a weekly build of inventories. Apart from the maintenance issue, refineries are backing off because of that fall in demand as their margins are squeezed if they overproduce. In the meantime crude inventories build up while refiners are consuming less. Reduced refinery capacity also means less diesel and heating oil, inventories of which have fallen. It is this element that is keeping crude oil on the rise. The other side of the crack spread is dragging up the price. You’d really think something would have to give here, but you can’t rule out the effect of general emerging market demand for energy.

The US dollar rose because of the release of the US productivity figures. First quarter productivity rose 2.2% when 1.8% was expected, while labour cost rose 2.2% when 2.6% was expected. The two marry to a good result which has positive implications for lower inflation down the track. However, hours worked fell 1.8% which was the biggest decline in five years. A fall in hours worked is simply recessionary.

Nevertheless, the forex traders liked it and pushed the greenback up regardless of the ECB rate decision which comes tonight (but which will most likely be unchanged). Gold fell US$7.40 to US$868.30/oz as a result while the Aussie, which had kissed US95c yesterday and was looking for multi-decade highs, fell back to US$0.9416.

It would be fair to say that having breached Dow 13,000 and S&P 1400 rather quickly in an 11% run-up since the Bear Stearns low, there were many believing it might be prudent to take some profits. Markets never go down 20% in a hurry and then turn around and go back 20% in a hurry. There is a lot of work to be done. This week the Dow has been stalling around 13,000, and when oil began defying gravity it seemed like the right time to get out.

But while Wall Street had resigned itself to a steady drift down in the session, the weakness accelerated when the Securities Exchange Commission suggested it was going to step up the rules on disclosure of capital and liquidity positions of financial institutions. The financial sector set off to lose a collective 3%.

Now why should this spook the market? Haven’t we now seen the kitchen sink write-downs? Haven’t CEOs trotted out one after the other to tell us just how wonderfully secure their capital and liquidity positions are? They wouldn’t be giving us porkies now, would they?

Apart from the frighteners being put through the investment banks once more, there was more bad news on the housing front. For some reason there are those who seem to think the housing market is bottoming and that the problem is isolated to only a couple of states, but every single piece of data released this year has shown a market getting progressively worse.

Last night it was revealed pending home sales (sales underway but not yet completed) fell another 1.0%, taking the annual fall to 20.4%. With virtually no relief on mortgages, and tighter conditions on new mortgages, Americans are not rushing in to pick up supposed bargains at prices 10% lower than a year ago and in some cities 20% lower. If cheap prices aren’t going to save US housing, what is? It is a slippery slope to accelerating foreclosures.

To top it off President Bush said he would veto the Democrat bill in front of the Democrat-controlled Congress which provides US$300bn to bail out certain stressed homeowners. He suggested the package only assisted the greedy lenders who started the mess in the first place, and not the gullible citizens. Hooray for George – he’s finally got one right.

While on the subject of pollies, Treasury secretary Hank Paulson also suggested last night that credit market conditions have eased (he’s right – credit spreads have begun to come back, including Libor) but that increased food and energy prices are likely to blunt the effects of the $170 billion in stimulus cheques. This was supposed to be the big solution to stop a recession.

And in more disturbing economic news, credit card debt growth increased again in March to an annualised rate of 7.2%. It seems that as banks are no longer lending money against home equity, Americans are turning to credit cards to cover their increased costs. This is another slippery slope, and saw shares in American Express and general insurer AIG both take a dive. AIG reports tonight – a result that is highly anticipated.

If base metal markets were confused before, they’re even more confused now. The US dollar went up but oil went up too. The copper strike in Chile is over but supply remains tight. In the end base metals mostly drifted slightly lower.

The SPI Overnight was down 72 points. Yesterday’s weakness, led by weakness in financials which itself was largely due to the fanciful St George result the day before, saw the 5700 ceiling breached to the downside. Today should take us back toward 5600 which, if breached, means our old friend 5500 will be back in play. National Bank ((NAB)) reports tomorrow.

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