Daily Market Reports | Oct 03 2008
By Greg Peel
The Dow fell 348 points or 3.2% while the S&P dropped 4% and the Nasdaq 4.5%.
While all in Washington appear confident that the amended rescue bill will pass successfully through the House of Representatives tonight, it is not yet a fait a compli. Understandably therefore Wall Street remains jittery, unprepared to accept the bill as a given until the final vote is cast. As fear continues to grip the Street, the sidelines are clearly the safest place for many an investor.
But it was not just this anxiety that pushed the Dow down 350 last night. The euphoric rallies that have transpired each time it appears the bill will be passed, among the crashes when it seems it may not, fly in the face of economic reality. To believe that Paulson’s rescue Plan is a panacea that will suddenly turn the US economy around, and end the bear market, is to live a fantasy. The bill is only a safety net that should prevent a catastrophic collapse of credit markets, thus of stock market markets and the global economy. It will not change the fundamental economic realities that brought the world to this point overnight. The developed world has run up too much debt, and now either that debt must be repaid, written off, or worked out of the system. There must be failures. There will be failures.
Following from Wednesday’s ominous plunge in the US manufacturing sector index, two more pieces of economic data spooked Wall Street again last night.
Economists were expecting August factory orders to fall by 2.5% but, just as they were with the manufacturing index, they were shocked to see a fall of 4%. This is the August number – the real credit market turmoil did not begin until September. Falling factory orders are as good an indicator of recession as one might find, and anyone who still believes the US is not necessarily in recession is acting on blind faith. If factories are not getting orders for goods, revenues fall, margins evaporate, and the next step is to lay off workers – workers who may be struggling to pay a mortgage in a collapsing housing market.
Which brings us to jobless claims. Last week new jobless claims rose by 1,000 to bring the seasonally adjusted total to 479,000 new claims per week. Economists had pencilled in 475,000. Tonight we await the passage of the bill, but as fate would have it the morning session will see the release of the official August employment figures – a number that will often move markets substantially by itself. And it is unlikely to be pretty.
Last night the European Central Bank made its monthly rate decision and there had been high anticipation that the ECB would cut the rate from 4.25%. The European economy has been steadily weakening ever since the credit crunch began, but the ECB – a convoluted central bank to a disparate trading bloc – is not charged with the responsibility of managing European economic growth. That falls upon the individual member states within their fiscal policies, despite being contracted to the one currency and the one cash rate. As we have watched various institutions fall, spare a thought that one of the last victims of the credit crisis might be the European Union as a structure.
The ECB is charged only with controlling inflation, and to that end its only monetary policy change throughout the chaos has been to raise the cash rate from 4.00% to 4.25%. This as the Fed has cut from 5.25% to 2.00%. With inflation still a major concern to president Jean-Claude Trichet, last night the ECB left the cash rate unchanged. However, it was unchanged with qualification.
Trichet noted that weaker demand has meant inflationary pressures “have diminished somewhat but they have not disappeared”. But he revealed that the committee had indeed debated cutting the cash rate as the only other option to holding fast. While the ECB is not charged with controlling economic growth, if economic growth is slowing inflation should follow. And Trichet suggested “the most recent economic data clearly confirm that economic activity in the Euro area is weakening, with contracting domestic demand and tighter financial conditions”.
That was enough to be considered a rate cut by proxy, as the world does not believe anything is going to improve economically in a month. That’s when the cut will come. So the market sold the euro, and sold it down hard, to under US$1.38.
The irony is that the euro hit its peak of US$1.60 – twice – with the ECB rate at 4.00% and the Fed rate at 2.00%. The ECB rate is now 4.25% and there is a growing belief the Fed will finally start cutting again. Yet now the euro is at US$1.38. Something is wrong with this picture.
And if it is not clear that something’s wrong, consider that the plummeting euro equates to a soaring US dollar, and that’s exactly what the greenback did last night. The US Congress is about to release US$700bn of fresh greenbacks into the system. That is the equivalent of the total cost of the Iraq war to date. With amendments including increased deposit insurance and tax breaks, that amount is now more like US$850bn. That’s 850 billion fresh dollar bills that did not exist before, yet on a relative basis, the world wants to buy them.
The soaring dollar thus sent gold down another US$34.40 last night to US$834.50/oz. This is no more or less than a currency trade. The Aussie fell nearly two more cents to US$0.7701. The yen was strong as carry trades continue to be unwound.
But the real impact was in real commodities. A bizarre combination of collapsing demand in a US economy that represents 25% of the world economy and a soaring US dollar broke the back of metals prices.
Copper fell 6% in London. Copper has now fallen below the significant US$6000/t mark at which an enormous volume of long positions in put options (short copper) sits. This has triggered scrambling hedge selling from options market-makers. As the price falls further, market makers need to sell more copper contracts to hedge, thus only exacerbating the fall. For those who understand such things, copper options were last night bid 52% volatility.
The rest of the spectrum fell in sympathy, marking losses of 5% each. Only lead held up with a 2.5% fall. Silver – that odd combination of industrial and precious metal – fell 14%.
Oil fell US$4.56 to US$93.97/bbl.
It is a very unusual day when all of gold, oil and the stock market fall in unison. It is called simple asset deflation, and is the mark of recession.
The SPI Overnight fell 95 points.
To help put things into perspective, consider the recent deals transacted by Warren Buffet.
Buffet continues to suggest that he would dearly love to get his hands on one percent of the US$700bn of distressed securities the US government is hopefully about to acquire. He is convinced the US taxpayer will profit from The Plan. His US$10bn investment in Goldman Sachs backs up this confidence, although as far as deals go this one was as sweet as they come. A US commercial bank (which Goldman now is) is paying 10% to borrow when the US treasury rate is 4%.
That vote of confidence was seen as a positive, other than for the reality of what Goldman has had to pay away. But now Buffet has gone and done the same deal with General Electric. Goldman Sachs operates in the ephemeral world of money-lending. General Electric is representative of the real economy. So large and diverse is GE’s operation that it rates as one of the biggest economies in the world by itself.
That GE would be forced to stoop to GS rates to continue to fund its operation is not a positive for the stock market. It only underscores just how dire the situation has become. To top things off, Buffet has alluded to the fact he feels he owes it to his country to help. The deals may be sweet, but this qualification does not engender confidence. Buffet is meant to be coldly pragmatic.
Incidentally, a subscriber has pointed out that Buffet bought into Goldman with faith that Paulson’s rescue bill will be passed. US Treasury secretary and ex-Goldman CEO Hank Paulson owns US$700m worth of Goldman stock options. An unfortunate conflict.
Please note that the coming weekend is a long one in NSW, meaning there will be no FNArena news stories on Monday. There will be an Overnight Report published tomorrow, and again on Tuesday morning. On the weekend NSW switches to summer time meaning the local closing time of the NYSE moves from 6am to 7am. As of next week the publication of the Overnight Report will thus be up to one hour later. When the US reverts to its standard time at the end of this month, the NYSE will close at 8am.
