The Overnight Report: Tit For Tat

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By Greg Peel

The Dow and S&P were both as good as “unch”. The Nasdaq lost 0.85%. Despite the apparent inactivity, decliners led advancers across the NYSE board by 2 to 1.

There was some element of quiet ahead of the Fed’s two-day meeting on monetary policy beginning tonight, and culminating with a rate decision on Wednesday. The market firmly expects the Fed to leave the rate unchanged at 2%, however focus will be squarely on the language adopted in the accompanying statement. Will the Fed place more emphasis on inflation or on the weak economy?

The bias is believed to be to the former, such that the next rate move is expected to be up, not down, whenever that may be. But the US dollar wasn’t waiting to find out last night – it shot up against the euro and all major currencies. The reason was some poor economic data emanating from Europe. A measure of German business sentiment posted a larger than expected drop, and a Eurozone purchasing managers’ index fell from 50.6 in May to 49.5 in June. Consensus was for a fall to only 50.5. This is thus the first fall below the 50 mark, which signals economic contraction.

The implication is that such data – which supports the anecdotal evidence and cries from European industry – may encourage the ECB’s Jean-Claude Trichet to rethink his intended rate hike. The US dollar has been sold down against the euro in the belief the ECB will hike and the Fed won’t, so those positions were being hastily reversed for safety’s sake last night.

What this meant was that gold came under pressure. Nevertheless, a fall of US$18.20 to US$883.20/oz seemed pretty steep. The reason for gold’s weakness was a sudden move by investment funds to bail out of the metal given its failure to materially break the US$900 mark. The jump in the US dollar was the trigger needed. The good news is that the fall could have been even worse as the crowd of fund sellers grew, but when gold moved into the 870s the physical buyers rode over the hill and saved the day. It looks like we may have found our new threshold for at least some physical buying.

The oil price rose of course, despite the greenback, responding to the failure of the meeting in Jeddah to result in any production increases out of Saudi Arabia. Officially oil posted a US$1.38 rise, however last night the July contract rolled into August. Up until the most recent rollovers the oil futures curve had always been in backwardation, meaning a rollover resulted in a step back in price. However the curve has most recently been in contango, meaning a rollover actually results in a step up in price. What this means is that on Friday July closed at US$134.62 while August closed at US$135.36. So the US$1.38 rise in the August contract last night actually equated to a US$2.12 nominal move up in the oil price.

With little end in sight to high oil prices the energy sector yet again surged ahead. But removing energy and related stocks left what was otherwise a rather weak session.

Financials came under yet more pressure, and financial stocks continued to make new post-Bear Stearns lows. Both Citigroup and Goldman Sachs announced they would be shedding thousands of jobs. As this is cost cutting to save the balance sheet, rather than cost cutting for efficiency, both stocks were sold down heavily, and most financials fell 3-4%.

It is little surprise that airlines are also under pressure, but airline stocks have been making double-digit percentage moves down on a regular basis recently, including last night. Retailers also copped it again, as did home builders. With tech also under the hammer, it seems the world is buying just the one sector at present. How long will this last?

But it won’t help that after the bell United Parcel Service came out and took a machete to its second quarter profit forecast, citing an “anaemic” economy. The world’s biggest mover of parcels cut its earnings guidance by around 15% ahead of its July report. Wall Street will open with this news under the belt tomorrow.

It was a choppy session for base metals in London last night, but in the end the stronger US dollar won out. Copper, lead and zinc all fell 1% and nickel 3%.

The Aussie slipped back slightly on the higher greenback as well, to US$0.9522.

The SPI Overnight lost 11 points. It was a somewhat inspiring day on the local bourse yesterday as the ASX 200 decided 5200 was too low. Most of the recovery can be credited to financial stocks, where clearly once again the PE ratios of the big banks just look too low to many investors. Let’s hope those E’s hang in there to keep the PE’s real. But once again, we are trying to find some sort of bottom in a process that may yet take months.

The other local news emanating last night is that Rio Tinto ((RIO)) has finally settled on a contract iron oil price with China for the 2008-09 year. A rise of up to 96.5% equates to an average price rise of 85%, with Rio finally securing some relief on the freight exemption. The market was probably hoping for more, and Rio shares were down 1.6% in London.

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