The Overnight Report: Profit Taking

This story features BHP GROUP LIMITED, and other companies. For more info SHARE ANALYSIS: BHP

By Greg Peel

The Dow fell 32 points or 0.3% while the S&P fell 0.3% to 1007 and the Nasdaq fell 0.4%.

I have just seen coming across my screen that two major earthquakes have hit in Asia – one 7.6 in the Indian Ocean and one 6.3 off Honshu, Japan. India, Bangladesh, Burma, Thailand and Indonesia are on tsunami watch. Japan’s quake is the second in two days. And there we were worried about “financial” Armageddon.

After a strong week last week, culminating in a big rally on the back of Friday’s employment data, Wall Street went back to a more cautious mode last night at these lofty levels. But again it was a battle of the bears and the bulls, given the Dow was down 80 points at 2.30pm but recovered toward the close.

There were no economic data releases in the US last night and the US reporting season is now winding down, with only the last stragglers remaining. Last night Dow component McDonalds reported better than expected same-store sales for July, bucking the trend of recent retail figures, but given Maccas is a staple in the US and not discretionary it is no great surprise.

Sponsored mortgage provider Freddie Mac posted a profit for the quarter and suggested it would not need further government assistance for now, sending its shares up a nice 128% (to US$1.69). Sister Fannie Mae chimed in with a 51% rise.

The story is different in Australia, given this week sees a real step-up in company reporting for the financial year. Investors took the opportunity of the early rally in the ASX 200 yesterday to take profits and square up ahead of reports from some big names this week such as BHP Billiton ((BHP)) and CommBank ((CBA)). There is also more talk of Chinese monetary policy tightening, which is causing Chinese markets to be jittery, however Wen Jiabao ensured his people on the weekend that policy would remain relaxed for the time being. There are still fears nevertheless, despite observers pointing out Beijing is not going to let the share market collapse ahead of the October 60th anniversary celebrations.

For more on Chinese monetary policy and its impact, see last month’s When Will China Pull In The Reins?
Wall Street is also keeping a weather eye ahead of yet another record Treasury auction for the month, following successive records in June and July. This week sees a total of US$75bn of notes and bonds up for grabs, beginning tonight with US$35bn of three-years. Wednesday sees US$23bn of ten-years and Thursday US$15bn of thirty-years. The ten-year bond yield had been rising steadily again last week although it did pull back last night to settle at 3.78%.

Adding to the mix will be the Fed’s monetary policy meeting on Wednesday, in which traders are looking for hints of an end to quantitative easing given signs of economic recovery. Expectations are that the Fed will wind down its program of buying bonds over the next few weeks to stick to the original plan. If the Fed stops buying bonds it is a double-edged sword, for while the end of quantitative easing means less money is being printed, thus taking some pressure off monetary inflation, it also means the Fed is no longer supporting bond prices. Yields could rise as a result. It will all come down to just how keen foreigners are to keep supporting US debt. A rise in bond yields is not healthy for the stock market.

We have also now experienced another interesting development. Since the release of the unemployment number on Friday, the US dollar has changed tack. All through the March-August rally the dollar has fallen as risk confidence has returned. Having pulled their money back to the safe haven of home post-Lehman, US investors have been once again seeking risk opportunities offshore in emerging or other markets, or by selling dollars to buy commodities. This has meant the US dollar has fallen every time the stock market has rallied.

But on Friday, the relationship reversed and the US dollar rose with the stock market. The thinking now is that the US economy might come out of recession faster than Europe or Japan, meaning the dollar should strengthen against those currencies. The unemployment number was the trigger. Investors are looking ahead for the Fed to raise interest rates, even though the Fed keeps sticking to its stated policy of rates being on hold for a long time. Importantly, every man and his dog has been suggesting the US dollar must fall given the weight of US debt. Thus everyone is short the dollar, and any adverse move should spark some rapid short-covering.

If the US dollar bounces, the commodities rally, which many believe is overdone, is over, at least for the time being. Last night the US dollar index rose 0.4% to 79.23. Gold thus fell another US$8.60 to US$945.80/oz. The Aussie, which is also being supported by the possibility of an interest rate rise ahead, remained steady at US$0.8375.

Base metals now have to decide between a stronger greenback and the demand-side push from China although, as noted, commodity prices have already run hard on the latter. Last night aluminium, lead and zinc fell 2-3% while copper fell 1%, tin was steady and nickel was 2% higher.

The SPI Overnight fell only one point, no doubt accommodating the fact the ASX 200 did not share in the US unemployment rally yesterday.

Click to view our Glossary of Financial Terms