Daily Market Reports | Jul 16 2009
By Greg Peel
The Dow jumped 256 points or 3.1% while the S&P jumped 3.0% to 932 and the Nasdaq leapt 3.5%.
Wall Street surged from the opening bell last night, sparked by Tuesday’s after-the-bell strong earnings report from Intel. Intel shares jumped 7% in the after-market on the release and held that rally in last night’s floor session. From the open it was a one-way street as the indices climbed steadily higher on rolling enthusiasm.
Last night’s session was actually devoid of earnings reports. But American Express stepped in to fill the gap, announcing a surprising fall in credit card defaults and a prediction that second half 2009 defaults may be less than previously expected. Amex’s charge-off rate (debts deemed irrecoverable) fell from 10.0% in May to 9.9% in June. This seems rather trifling, but the point is Amex had set itself for steadily growing charge-offs as a recession-lagging inevitability. Was it too pessimistic?
Wall Street clearly thought so. Amex shares jumped 11% and provided impetus for enthusiasm across the consumer space.
On the economic data front, US June industrial production fell 0.4% compared to economist expectations of a 0.6% fall. The smaller fall was a positive, as was the fact May IP fell 1.2%, suggesting a slowing in contraction. In the first quarter 2009, US IP fell 19.1%. The second quarter is now marked with an 11.6% fall – still a big contraction, but less bad, with the month of June least bad.
The capacity utilisation rate (call it factories in operation) fell again to 68% nevertheless – the lowest reading since 1967. Such slack in capacity is one reason the Fed does not fear inflation, given a return to economic strength requires a third of productive capacity to fire back up before there could be any concept of a product price squeeze. (The RBA holds the same opinion regarding Australian capacity). The argument also has its bearish implications nevertheless, as the same effect provides for struggling corporate margins for a while yet.
Weak capacity utilisation implies deflation, but last night the June CPI was released and showed a 0.7% gain – the biggest since July 2008 – against expectations of 0.6%. It was all about oil of course, such that the core rate (ex food & energy) only rose 0.2%. In May the headline CPI rose only 0.1%, but fears of an inflationary push are put into perspective on the annualised number, which is a fall of 1.4% – the biggest decline in over sixty years.
The New York (Empire) State manufacturing index was negative 9.4 in May, and economists had pencilled in a rise to negative 4.6. The result was positive 0.6. Within the number, the new orders index turned positive for the first time since last September, while inventories fell to a record low. That dichotomy makes sense, and is why the bulls believe inventory rebuilding will be the saviour of the US economy.
Then came the minutes of the last Fed monetary policy meeting, which contained two specific elements of good news.
While the board believed the US economy remained “vulnerable”, and was concerned as to whether consumer spending could kick on now that stimulus hand-outs had run their course, it also upgraded its GDP forecast for 2009. In May, the board forecast a drop in 2009 GDP of 1.3 to 2.0%. In June this was lifted to a drop of 1.0 to 1.5%. The Fed nevertheless maintained its view that the second half would see a return to growth but that growth would be sluggish at best.
The bad news was the Fed also revised its unemployment expectations, suggesting the peak could be 10.1% instead of a previous forecast of 9.6%. This ties back in to the central bank’s concerns over consumer spending. Yet the Fed also upgraded its consumer spending expectations, from 0.6-0.9% to 1.0-1.4%.
Those on Wall Street concerned about the potential for an inflation blow-out given the excessive amount of US national debt have been waiting with baited breath for the Fed to announce an “exit strategy” from its policy of monetary stimulus in general and quantitative easing in particular. While no specific strategy was outlined, the Fed did hint that a time may be nearing. It elected not to increase its planned total US$1.75 trillion asset purchase plan, and suggested:
“Although an expansion of such purchases might provide additional support to the economy, the effects of further asset purchases, especially of Treasury securities, on the economy and on inflation expectations were uncertain.”
In other words, the Fed has now reached a point where it doesn’t think further quantitative easing is going to help and would fuel inflation expectations. It follows that expected inflation usually leads to actual inflation. If you buy oil fearing inflation, you push the price of oil up, thus causing inflation. This is not an exit strategy announcement, just a hint that quantitative easing is drawing to a close.
The response was a near 4% surge in the ten-year Treasury rate, up 13bps to 3.60%. Bond yields have been on the move again this week, but one can cite three different, interlocking reasons. Firstly, when the stock market is strong it implies money is moving out of the safety trade of bonds and back into the risk trade of equities. Secondly, if the Fed is not going to buy any more bonds than originally planned then there is no further downward pressure on yields. And thirdly, rising inflation (PPI, CPI) implies lower real bond yields, giving reason to sell bond holdings (in which case nominal yields rise).
What commentators need to figure out is whether the first reason is the most influential, because that implies the stock market surge this week has some grounding. Otherwise, it is no more than a short-covering squeeze precipitated by strong initial earnings reports in a market that had resigned itself that green shoots were withering. If it is short-covering only, and not actual buying from money coming off the sidelines, then it is a false rally.
The chatter suggests it is a bit of both. Until 3.30pm last night, volume on the NYSE was anaemic, implying short-covering only. The last half hour, however, saw a big jump in volume to take the day’s total to respectable level for a holiday period. Word was the mutual funds were getting in, and this is positive (except that mutual fund buying was the feature of the previous market top).
The S&P 500 closed at 932, meaning only another 1.5% rally is needed to reach the previous high of 946. Yesterday the ASX 200 closed at 3924, and it needs another 3.1% to get to its high of 4047 posted on June 11.
The ASX 200 will probably give it a good go today, given commodity prices were once again strong. And this time, oil joined the party. Oil was up 3.4% or US$2.02 to US$61.54/bbl to suddenly halt its losing trend. Base metals were all up 2-4% in London, with copper the star at 4%.
Commodities were higher on the same combination of good news that drove stocks, and on the weaker US dollar which results from a move back into the risk trade. The dollar index fell nearly 1% to 79.40. Gold jumped US$13.90 to US$939.30/oz as the dollar fell and inflation again was in the frame.
The Little Aussie Battler surged yet another cent to US$0.8033.
There was interesting movement in the VIX volatility index last night. Regular readers will know that the VIX trends lower in rising markets because investors don’t feel the need for put option protection, and jumps in panicked downward markets as investors pile into protection. Anything below 20 on the index nevertheless tends to suggest the market has become a bit complacent.
This week the VIX has reached as low as 24, which is not surprising given the stock market’s strength. However, last night it jumped 3.5% to near 26 on very heavy options volumes. How can this be so? Isn’t it going the wrong way?
No. The VIX volatility index is usually driven higher on put option buying, because downside panic will always outweigh upside panic. But it can just as easily be pushed up on call option buying as well. It is a volatility index, not a directional index. Normally, call options are quietly popular in bull markets. But last night’s sudden burst of call option buying suggested only one thing – the rare case of upside panic.
What this means (with a nod to the experience of CNBC’s option trading specialist here) is that last night was more about panicked short-covering from those investors who’d set themselves for further falls, rather than honest buying from those waiting for such an opportunity. Those caught short can jump quickly into index options as a blanket hedge to the upside, whereas real buyers buy actual stocks.
The bulls would disagree, of course.
The SPI Overnight was up 72 points or 1.9%.
Stand by today for the release of China’s second quarter GDP. That could be a real market mover. Earnings reports in the US tonight include JP Morgan and Google.
