Daily Market Reports | May 15 2008
By Greg Peel
Futures traders on the floor of the Chicago Board of Trade were obviously expecting a questionable outcome. When the April CPI figure came out at only a 0.2% increase, below market expectations of 0.3-0.4%, many traders donned chefs’ hats. Their protest was made more credible when the breakdown of the figure included an increase in food of 0.9% (and specifically “food consumed in the home” of 1.5%) – the biggest gain in 18 years – which was offset by a 2.0% fall in gasoline prices (seasonally adjusted, of course). The Labor Department, the traders implied, was cooking the books.
And it wasn’t just floor traders who were bemused. Many across the market greeted the April CPI with a roll of the eyes. The core CPI – which excludes food and energy – only rose by only 0.1%. The annualised CPI now stands at 3.9%. During the Clinton era, changes were made to the way the US CPI is measured – changes which never met with support from real world economists. Shadowstats.com continues to measure US inflation on a pre-Clinton basis. Its annualised reading is currently in excess of 7%.
Many also found the CPI figure somewhat questionable when compared to data released on Tuesday. On the back of the weaker US dollar, prices of imports into the US have surged to an annual increase of 15.4% – the highest figure registered since the data began being collected in 1982.
Despite the eye-rolling, a sufficient proportion of Wall Street was prepared to accept the number on face value. Following on from what was a relatively good retail sales figure on Tuesday, the benign CPI gave investors enough reason to believe the US economy is not in dire straits. But a benign CPI gives the Fed an excuse not to raise the cash rate – a move which would put more pressure on mortgages and credit markets. Somewhat convenient?
The Dow closed up 66 points or 0.5%. The S&P rose 0.4% and the Nasdaq finished barely in the green. But the Dow was up 161 points at its peak, driven by euphoric buying, and by a stronger US dollar that helped to tip oil over slightly again. Oil fell despite a build in inventories being less than expected. But then crude has been ignoring both inventories and the dollar in recent times. What was more significant was an increase in refinery production. Oil fell US$1.58 to US$124.22/bbl.
The US dollar rallied on the weak CPI. This seems counterintuitive, as low inflation means less chance of an interest rate rise. But a low CPI also means less risk to the US economy, and that is positive for the dollar. The US dollar rallied to follow the stock market.
Glossed over in the surge to the highs were the latest foreclosure data. RealtyTrac, which began tracking foreclosure data in 2005, measured the highest monthly jump in foreclosures it has ever seen in April. Three years is not a long time, but from April 07 US foreclosures have risen by 65% (and accelerating). May and June represent the 2008 peak volumes of the dreaded reset mortgage resets.
The financial sector was boosted by a less than expected loss from government sponsored lender Freddie Mac. It was still a loss of US$151m, but it was enough to send the shares up 9%.
But just as the Dow was hitting 12,993 and looking like it could break back through 13,000 once more, a funny thing happened. At 3pm, the sellers arrived. And they sold very quickly – all the big names that have run up hard, particularly in the tech and material sectors. The Dow crashed 100 points in the hour. Where did this selling come from?
The trigger was the VIX volatility index. This index relates to options volatility and can loosely be described as the price of protection against adverse moves in the S&P 500. When Bear Stearns went under, before the Fed stepped in, the VIX index hit lofty heights. This reflected the inflated prices investors were prepared to pay to secure put option protection against financial Armageddon. But since the Fed pulled the rabbit out of the hat, and the market has returned to optimism, the VIX index has understandably been drifting back down.
This is all well and good, until it starts to get a bit too low. Any bounce-back rally, such as the one we’ve been experiencing since March, will be influenced by two factors – fresh buying coming in from the sidelines, and short-covering. But there is a third factor. When investors buy puts in a panic they do so from market-makers, and those market makers have to sell stock to cover their hedge positions. In a panic, this selling only exacerbates the fall. But when those put options are sold back gain, once the dust has settled, market-makers have to buy back those stock hedges.
This only adds to the upward pressure on the stock market in a bounce. And the stock market has run up pretty quickly. But last night a milestone was reached in the VIX. The index fell back to the level it started at, pre-credit crunch. This can only mean all the puts that were bought have now been sold back. If we assume the short-coverers are already done, then we can now assume there’ll be no more option hedge buying either.
That’s why the sellers moved in. To put it another way, the sellers believe the VIX index is showing that the market has become complacent. And complacent is a dangerous place to be.
On the rise in the US dollar, gold fell US$2.20 to US$863.70/oz. The Aussie dollar was slammed down in local trading yesterday when a very surprising wage index number was released – a number much lower than expected which thus suggests the RBA may not have to raise again. (And no, I don’t have any doubts about that one). On a 24-hour basis, the Aussie is down nearly US0.7c to US$0.9344.
Base metal price fell moderately lower on the stronger US dollar, although they pulled back from bigger falls earlier in the session. It was mostly sideways as base metal prices continue to juggle conflicting influences.
The SPI Overnight rose 15 points. What shall we do today? I know! Let’s buy some BHP and start a rumour.
