Daily Market Reports | Sep 18 2008
By Greg Peel
The Dow fell 449 points or 4.1% to 10,609 to close on its low, which is also a new low for the year. Similar lows were marked in the S&P – down 4.7% to 1156 – and the Nasdaq – down 4.9% to 2098.
The Dow fell steadily through to 2pm before bargain hunters began an hour long rally, taking the index from down 360 to down 170, but late panic selling saw a collapse to the close.
The focus of last night’s trade on Wall Street was not on the stock market itself, but on credit markets. The stock market followed. The fall of Lehman and the nationalisation of AIG have turned attention fairly on the credit default swap market – which FNArena flagged late last year as a latent source of potential turmoil – and on corporate bond spreads. Corporate bond spreads on financial institutions blew out to unheard of levels as investors ran in panic from names they thought might be next and interbank lending froze up once more.
The Lehman collapse brought focus on the CDS market given the Fed allowed the investment bank to fail, thus triggering default. As fear reached its greatest heights, investors turned on the last remaining investment banks – Goldman Sachs and Morgan Stanley – and crippled their credit. The result in the equity market was a 14% fall in Goldman stock and 24% fall in Morgan. Both companies on Tuesday “beat the Street” with third quarter earnings results. The financial sector index was down 10%.
The problem with credit derivative markets is they are thin, opaque, largely unregulated and subject to manipulation. The bulls on the NYSE are furious that their own fully transparent market is being hammered as a result of a market that operates behind closed doors. The transparent manifestation of CDS panic is the blow-out in the credit spreads of financial institutions such as Goldman and Morgan, resulting in a nobbling of those institutions’ capacity to stay liquid. It is a slippery slope that brings the ratings agencies into the spotlight as they look for a reason to downgrade credit based on the equity moves which are based on the credit market moves from panicked investors and counterparties.
It was the ratings agencies that were complicit in creating fallacious AAA asset-backed derivatives in the first place, and now the ratings agencies who are exacerbating the demise of financial institutions by downgrading their credit for the very reason they hold those same securities the ratings agencies once told them were of high quality. It is an exercise bordering on criminal.
As investors piled out of stocks and corporate bonds they ran screaming towards the two traditional safe havens – Treasuries and gold. Ironically, to run to both simultaneously is almost a contradiction.
The three-month US Treasury bill last night fell to almost a 0% yield as investors looked to park their money somewhere that will not make them a return but will save them from losing more. This is the lowest rate since World War II. With inflation running at 5% in the US investors are effectively investing for a minus 5% real return. The only alternative to this trade is cash – actual banknotes under the mattress. The two-year Treasury bond yield fell to 1.6%. Bear in mind that the overnight cash rate is 2%.
But the other safe haven once upon a time was gold, and last night gold acted like a true safe haven arguably for the first time since the fallout from the LTCM collapse in 1999. Gold jumped 11% or US$83.20 to US$862.10/oz. Silver jumped US$1.53 or 15% to US$11.98 – its biggest move since 1979. Gold had steadily risen over past years all the way to US$1000 on first the gradual weakening of the US dollar and finally the rapid weakening in the US dollar in the face of Fed rate cuts. It has fallen more recently as the dollar staged a brief rally, but also because market-wide deleveraging has seen a rush out of commodity funds.
Last night gold was not a commodity.
The impetus for the gold rally can be traced back to the loan made by the US Treasury to AIG. Having first nationalised Fannie and Freddie but then allowing Lehman to fail, the Treasury and Fed were initially going to let AIG fend for itself and refused the request for a US$20bn bridging loan. Once both parties realised the extent of potential disaster, they had no choice to extend such a loan but in two days it became US$85bn.
This “bail-out” has thus received a very different response from global markets to previous government or Fed interventions. Whereas the backstopping of Bear Stearns and F’n’F sparked the stock market into relief rallies – based on the comfort of knowing the Treasury/Fed was there as ultimate saviour – this time the bridging loan has been seen as a desperate measure by a government that did not want to go to such lengths given the rapid dwindling of the coffers. Last night the world reached its tipping point on such use of dilutive, freshly printed greenbacks.
The US dollar subsequently fell despite the rush into Treasury securities, prompting gold’s rally. But the rally in gold was a record smasher as investors feared the global withdrawal of central bank funds out of the diluted greenback. So while locally investors saw little choice but to park their money with the US government, internationally the response was quite the opposite.
Whereas gold is the traditional “safe haven”, some would argue in this century that it has realistically been replaced by oil. Oil shot up US$4.75 to US$95.90/bbl last night on such a notion and on the sudden appreciation that the Nigerian rebels have declared all-out war, with oil installations being their target. Throw in extremely tight gasoline supplies in the US following two hurricanes and you have the recipe for oil to skyrocket. However, the offsetting force is that of falling global demand for crude given an inevitable sharp slowing in the global economy in the wake of financial market disaster.
Base metals are not a safe haven. Hence it was that same economic fear that prompted more selling in the complex in London, although volumes pushed to record levels as the gold/oil factor pushed the other way. Late liquidations saw all metals fall 1-3%.
The SPI Overnight fell 153 points.
That’s the bad news. There was also a string of what might be construed as good news overnight.
There was a very sharp drop in US housing starts and building permits registered in August. Why is this good news? Because the more building activity slows in the US the less inventory is being added into an well oversupplied market. Applications for mortgages and refinancing soared in the wake of the F’n’F nationalisation, which has affected a fall in the 30-year fixed mortgage rate of around 1%. This provides fuel for owners to avoid foreclosure, and buyers to emerge.
After the bell the SEC issued new rules intended to once again curb “naked” short selling. A similar move was made only recently to prevent financial stock collapses prompted by hedge funds selling stocks they did not own, but it expired after two weeks. Short sellers must now come up with borrowed stock on the trade settlement date (three days later). The move was rushed ahead in the wake of the hammering of shares in Goldman Sachs and Morgan Stanley. The last time the new rules were introduced the financial sector staged a solid rally.
At the same time one major pension fund in the US put out the call to all pension funds to follow its lead and limit the level of borrowings to short sellers. This means that not only would short sellers need to come up with the stock in three days, as opposed to the previous “whenever”, they may not even be able to borrow it. They will likely also have to cover short positions, as they did last time.
There was a concerted move among global financial institutions last night to circle the wagons. It is understood Lloyds of London is looking to merge with the Halifax Bank of Scotland (HBOS), that Morgan Stanley has received a merger offer from fourth largest US commercial bank Wachovia, and that America’s largest thrift Washington Mutual has hired Goldman Sachs to find it a similar suitor.
United we stand, divided we fall.
The final piece of good news stemming from last night is that we truly look like having reached a point of capitulation. The gold price tells an important story. The VIX volatility index last night jumped over 36, making it almost as high as it has been since the credit crunch began.
This is not a time for heroes. We may not have seen the low yet but the stars are aligning into a position where that bottom may be coming into view. Incidently, Wall Street closed on its lows but the SPI Overnight was down 204 before a late rally to down 153.
