Daily Market Reports | Oct 23 2008
By Greg Peel
The Dow fell 514 points or 5.7% while the S&P fell 6.1% and the Nasdaq 4.8%.
The previous closing low on the S&P 500 in this bear market was 899 and last night we closed at 896. So the S&P is now lower than it has been on a day-to-day basis, although the intraday low remains 6.4% further down at 839. The Nasdaq also marked a lower close last night.
The Dow closed at 8519 which is a mere 68 points above the previous closing low of 8451. The Dow did, however, trade as low as 8335 last night. The intraday low is another 8.8% lower – or 746 points – at 7773.
With a 500 point move the bad news is that the slow reduction in volatility we have been experiencing this week is shattered once more. Indeed the Dow was down 698 points at its low. The VIX volatility index leapt back up from 50 to 70. The session opened weaker from the bell but the Dow largely stayed in a range of down 200 to down 300 for most of the day. And then three o’clock arrived.
We all know the drill by now. Funds with redemption demands need to raise cash, but they will not sell into a market that might be improving. They nevertheless have no choice but to sell into a market that is lower, and the same goes for margin calls. Margin clerks will wait most of the day to see whether they need to make fresh calls. They would rather not have to. Everyone waits until there is only an hour left.
Up to three o’clock it was noticeable that the market was lower but on compatarively light volume given this month’s typical daily activity. This tends to suggest early weakeness was less about sellers and more about not enough conviction buyers. Markets can’t go up without buyers and at this point it’s hard to blame anyone for being hesitant. The volume arrived, of course, with the three o’clock wave, but by the time the closing bell sounded it was still not a high-volume session.
When will this redemption selling end? Well with hedge funds, it’s hard to say, for hedge funds are not beholden to any specific redemption structure. Mutual funds do, however, follow a structure, and last night the word from around Wall Street was that there was not as much sign of hedge fund selling as there was of mutual fund selling.
Mutual fund redemptions end on October 31st.
That’s the good news. The bad news is that day is still a week away, and that day is also a Friday. We may be in for some more pain before then. The other good news is nevertheless that Wall Street did not close on its lows last night. The bottom occurred at 3.45pm. In fifteen minutes we were 200 points higher. There are at least some people out there buying.
I have spoken much of past post-crash patterns and what we might – and I stress “might” – be able to expect. History points to at least a short term rally ahead. The most recent example of relevance is the ’87 crash and the later ’90 bear market. There have been lot of comparisons drawn between then and now. There has been optimism drawn from the suggestion that the world economy going into the early 90s recession was in worse shape than it was in 2007. However, there are also important differences.
The first is leverage. In 2004 the US authorities bowed to investment bank lobbying and allowed an increase in the permitted level of capital leverage from 12x to 40x. A decade earlier investment banks weren’t even listed entities. The bull market we have witnessed since 2004 has been built on debt. On too much debt. That debt has to be repaid by unwinding positions. In the 90s those positions were the financial staples of stocks, bonds and property. Gold investment was made via purchases of bullion. All other commodities were purchased only by industry.
Thus the second is breadth of investment. Not only can the US invest in the traditional three, but it can also now invest directly in commodities. And in the 90s financial markets tended to be more insular. Sure – the adage of Wall Street sneezing was a valid one, but global reaction was only a precursor to the ultimate effect on global trade. Today is different. In the Internet Age the breath of investment from within the world’s largest economy has expanded not only into different asset classes, but into different markets. One of the most popular of those has been the emerging markets – the so-called BRICs (Brazil, Russia, India, China) and their satellites (other Asia, other Eastern Europe, other South America).
Six to nine months ago, when it was really only the US going down the can, there were two elements keeping investors interested. One was the supposedly resilient, “de-coupled” emerging markets and the other was those US companies with a high proportion of exports to the rest of the world, emerging markets in particular. Fuelling the latter was the falling US dollar, which had tumbled as the Fed slashed the cash rate.
Those investors refusing to believe that the “subprime crisis” might have sinister global reverberations took advantage of not only the ubiquitous yen carry trade but also of the fresh US dollar carry trade. The US cash rate hit 2% while cash rates in commodity countries such as Australia were over 7%. Money flowed out of the US – leveraged – and into all parts of the world that provided a solid investment alternative, and into the commodities that emerging markets were so voraciously consuming.
Fast forward to September and the world fell apart. The global banking crisis became just that – global – and suddenly any talk of “de-coupling” or US isolation flew out the window. The US stock market has been hit by wave after wave of margin calls and redemption selling in October, driven by a frozen credit market. A frozen credit market pointed to a posible deep recession. A global frozen credit market pointed to a possible global recession.
What we now have is a very real fear that the BRICs and co are not going to save the world. The response has been to sell down commodities aggressively and that includes redemptions from commodity funds. But the fall in the commodity prices has only been a precursor to a loss of faith in emerging markets. And so now the leveraged money is rapidly flowing back home to the US.
The irony thus is that the world’s largest economy is built on debt. As the US government spends trillions bailing out the banking system it is doing so by printing more US dollars. All things being equal, the US dollar should be down the toilet. But last night the greenback hit a new two-year high aginst the euro. Offshore investments are being shut down and money is being returned to the safety of US short-term government securities, even though those securtities are paying a negative real rate at present.
As the US dollar goes through the roof, it exacerbates the fall in commodity prices. When commodity prices fall, the stock market runs in panic. When commodities traders see the stock market fall, they panic and sell more commodities. As the US dollar surges, that previous safe haven of US exporters is a safe haven no more, and those stocks get sold down. This is no more apparent than in the tech-laden Nasdaq.
And as commodity prices fall, and the world fears a global recession in which no country is spared, the commodity countries are also victims – Canada, Brazil, Argentina, South Africa and, yes, Australia and New Zealand.
This is yet another snowball in the snowball, and another indication that leverage has to be worked out of the system before markets can stabilise. It is also an indication that everything will move into oversold conditions. But just how far the extent of oversold can reach is what no one can honestly estimate. There is long term value in this market. Short term, the jury is still out.
The above preamble will thus explain: last night oil fell US$5.43 to US$66.75 (with a rollover into December delivery), gold fell US$39.10 to a new post-high low of US$730.50/oz. Copper fell close to 10%. All other base metals fell 4-9%.
The Aussie dollar was strangely stable on a 24-hour snapshot at US$0.6740, but every 24 hours is a wild ride.
The SPI Overnight fell 191 points, or 4.6%. If that is accurate the ASX 200 will hit a new low today at 3929. The previous closing low was 3960, as was the intraday low.
