The Overnight Report: Fighting Hard

This story features NEWS CORPORATION. For more info SHARE ANALYSIS: NWS

By Greg Peel

The Dow closed down 39 points or 0.4% while the S&P closed down 0.3% at 1002 and the Nasdaq fell a more substantial 0.9%.

Early economic data releases saw the Dow drop sharply in the first half hour to be down 114 points. This took the S&P 500 down below 1000 to 994 while the Nasdaq was weak all day, finishing below 2000 at 1993. Both the Dow and the broad index were supported by a lot of shenanigans going on the financial sector.

I noted on Tuesday that the level of 1000 in the S&P 500 was conquered following a raft of manufacturing index readings across the globe which showed actual growth (China, UK) or at least a reduction in contraction (Australia, EU, US). The US index only just fell short of 50 in July and is expected to exceed that number in August to finally indicate growth. However, I also noted the US manufacturing sector only represents 20% of US industry. Non-manufacturing, or “services” (banking, information technology, health etc), represents the other 80% of industry in terms of contribution to GDP.

(Just in case there’s any confusion, readers will note I constantly point out the consumer represents 70% of GDP. That’s the demand side. The supply side is split 20/80 between manufacturing and services.)

In June the US ISM services index marked 47.0. Economists were expecting the July reading to match the manufacturing index in terms of a reduction in contraction to 48.0, but instead it slipped to 46.4 to mark the tenth straight month of decline. It was on this news that Wall Street hit the Sell button. The subsets of business activity, new orders and employment were all lower within the index.

Next came the ADP jobs number, which is a private organisation’s measurement of private sector employment and is seen as a precursor to the official jobs number which always follows on the Friday. Early on in the GFC the ADP numbers and official numbers rarely correlated, but recently the ADP has been surprisingly accurate (following a change in methodology). Its measure for July was a loss of 371,000 jobs.

This was both bad news and good. It was bad because economists had forecast only a 350,000 drop, but it was good because June saw a 430,000 drop in a declining trend of job losses, so July maintains that trend in that each month is showing a slowing of unemployment growth.

But there was also more good news. New factory orders were expected by economists to fall 1.0% in June, consistent with a fall in durable goods orders, and despite both April and May showing rises. Factory orders are orders for all manufactured products, durable and consumable. But in June, factory orders rose 0.4%. The light at the end of the tunnel grows, but again bear in mind this reflects the 20% manufacturing sector.

The earnings reports highlights from last night came after the bell.

News Corp ((NWS)) posted a quarterly loss of US$203m, which translates to earnings of US8c per share compared to US43cps in the same quarter last year. Aside from a plunge in advertising revenue, the loss represented a big write-down in value of Rupert’s MySpace acquisition. Adjusting for such one-offs, the apples-to-apples EPS was US19c which was a penny better than Wall Street expectation. Revenue also just beat estimates. News Corp shares were unchanged in the after-market.

But commentators suggest News is increasingly looking like an Old Media company staring down extinction. Rupert is on record as calling the advertising slump now past its trough, but industry experts do not expect the recovery in advertising (if there really is one yet) to ever return meaningfully into twentieth century concepts such as newspapers, magazines and free-to-air television. This leaves News Corp’s only real jewel in the crown as cable television, given the big write-down in its New Media diversification move – MySpace. While MySpace initially looked like a brilliant move on paper, it has now become so-last-week. Everything newer from Facebook to Twitter has left MySpace looking like a relic, and no doubt everything newer will also look like a relic in the next decade, such is life in the New Media game.

Database specialist and recently-added Dow component Cisco also reported after the bell. Cisco posted a 46% drop in profit from the same quarter last year but on apples-to-apples EPS, US31c beat the consensus forecast of US29c. Revenue was right on the money. Cisco’s CEO also heartened the market by suggesting new orders are implying the trough in IT sales has also now been seen. But Cisco shares fell 3% in the after-market. Tech has had a pretty good run lately.

I noted yesterday that the key to any economic recovery – anywhere in the world but certainly in the US – is consumer spending. As we begin to see the end of the US earnings season approaching, we note that 74% of reporting companies have beaten Wall Street EPS estimates. That’s a record. But at the same time, 54% have fallen short on revenue estimates. That’s also a record. Revenue means sales.

It was all happening in the US financial sector last night. Firstly, we recall that it was the banks that kicked of the rally in March. They then largely stalled in June as investors moved to buy other sectors, including materials. But in the last couple of weeks banks have been back again leading the charge as investors decide improving economic conditions will filter straight into bank bottom lines, and banks were so, so beaten down in 2007-08. Indeed, the bank sector index was up last night despite more general weakness, which is why the Dow and S&P did not fall as much as the non-bank Nasdaq. JP Morgan shares last night traded above their pre-Lehman bankruptcy level for the first time.

But the highlight was AIG, the former global insurance leader now 80% owned by the US taxpayer. Unconfirmed rumours that the government was looking to now swap all or perhaps some of its loans to AIG into ordinary shares saw those shares jump over 60% in the session. The extent of the move was attributed to short covering. The rumour also had a guilt-by-association affect on our old friends Fannie and Freddie, which jumped over 30% each.

Adding to overall bank sector strength was the previous move by Citigroup to swap some of its preferred stock into ordinary shares (which is ostensibly also a debt for equity transfer). The move impacted last night because the increase in Citi’s ordinary share count was officially included in S&P 500 index weighting calculations, providing Citi with a higher weight. This then means every index tracking fund – those that simply buy and hold the S&P 500 in its correct weights – has to buy more Citi shares to readjust their portfolios. Citi shares were thus up 10% on the session.

In theory, this should be a zero dollar sum game for the index trackers. In other words, they will have to now sell some parcel of the 499 other stocks in the index due to their subsequent weighting reductions.

In other news last night, Goldman Sachs analysts raised their second half 2009 US GDP growth forecast from 1% to 3%. Given the second quarter GDP reading was an annualised negative 1%, Goldmans is forecasting a return to actual annualised growth (albeit below trend) in 2010. This may have also helped the intraday recovery in the stock market, but it had a greater impact in the bond market – Goldmans is a significant primary bond dealer. The ten-year yield shot up 14 basis points as a result to 3.64%. The connection is that a return to economic growth implies an increase from the Fed funds rate above its current zero-based range.

The US dollar index ticked down slightly again with bond sales no doubt helping, to 77.56.

Weekly crude inventories last night came in slightly above expectation, but oil rallied nevertheless, adding US55c to US$71.97/bbl. But it’s all happening in base metals at the moment.

While the commodities boom that lasted through to 2008 featured the endogenous factor of increased emerging market demand and slow-to-respond global supply, price spikes were also felt due to the exogenous factor of mine-worker strikes. Mining companies were quick to book extraordinary profits but slow to allow workers to also enjoy the spoils. While most strikes end eventually with some sort of settlement, history shows mine strikes can drag on for months and send metal prices flying to the moon on resultant supply-side squeezes.

Aside from a tentative return to demand growth in the stainless steel market, the nickel price has recently been affected by ongoing strikes at Vale’s two big nickel mines in Canada. As Vale moved to declare force majeure on deliveries last night, nickel consolidated above the US$20,000/t mark for the first time since the 2008 commodity down-leg commenced in July. Over in South Africa, workers in general have become restless about economic conditions and are letting new prime minister Zuma know. Power workers have downed tools, threatening the country’s aluminium industry. Power problems in South Africa were also a feature of early 2008 commodity price jumps.

Last night aluminium and zinc jumped 3% while nickel jumped 4.5%. Copper lead and tin were all up around 1.5%. Basemetals.com reports the recent big moves up in metal prices can mostly be attributed to buying from commodity funds.

Just like a reweighting of Citigroup shares in the S&P 500 can force index trackers into buying more shares, increasing metals prices force commodity funds to buy more metal which in turn pushes up prices, which in turn…

Gold fell US$2.40, after a big rise on Tuesday, to US$964.50/oz. The Aussie, which has been rocketing recently, decided to remain unchanged last night at US$0.8407.

The SPI Overnight added 3 points.

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