The Overnight Report: Baked In?

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By Greg Peel

The Dow closed up 4 points while the S&P was unchanged at 1028 and the Nasdaq was also unchanged.

It has been reiterated often enough in this report that the stock market is a leading indicator of economic activity. It has also been noted that turning points tend to occur when they appear least likely. In late February it seemed all was lost, all was plain despair. That’s when the smart money – the early buyers – began to mobilise. In order for the March bounce from an oversold position to have legs, there had to be economic signs of support. They came in the form of “green shoots”, or signs that things were becoming “les worse”.

The rally gained momentum. If things were now appearing “less worse” then the next step would be for things to start looking “better”. In June there was a brief period of fear that the rally had run too far on what was still only “less worse”, but by July there were signs of “stabilising”. This was enough to cause panic among those who had not moved early, those who had been left behind. The second leg of the rally assumed that from “stability” the next step must be “growth”.

And so it was that the data again become supportive. Unemployment looks like it may have found a peak in the US. House prices look like they may have found a bottom. The stock market is now 50% higher, as the leading indicator of positive economic developments. But if the market is already assuming a return to growth, the next requirement is for the data to begin catching up and confirming that assumption. The smart money got in early, ahead of the data. The late money can’t just keep pushing the market higher on new data. If it does, the smart money will take profits on the assumption the late money has now pushed the lead indicator beyond that which it was trying to indicate.

After having appeared to have rolled over somewhat in Tuesday’s session, Wall Street started last night’s session on a weak note, with the Dow falling 54 points. Twenty minutes later, it was up 43 points. An hour later, it was back to the flat line, and but for a few gyrations, that’s where it stayed.

The reason for the abrupt early turnaround was two pieces of very strong economic data.

Sales of new homes jumped by 9.6% in July to 433,000. It was the fourth consecutive month of gains, the best result since last September, and a much better number than the 390,000 expected by economists. July sales are still 13.4% below those of July 2008, but they are now 31.6% above the sales trough recorded in January.

New orders for durable goods (goods with a three-year or more shelf life) jumped 4.9% in July. That’s the biggest gain in over two years. Economists were expecting a jump of only 3.0%.

A month or two ago, results like these would have sent Wall Street skyrocketing. This is not “less worse” anymore, this is “better”. This is not just “stability”, this looks a lot like “growth”. And so it was the Dow immediately bounced about 100 points. But then it couldn’t go on with it. Why?

There are two things to consider. The first is government stimulus. Sceptics of the new home sales number point once again to the US$8000 tax credit for first homebuyers – a scheme which is scheduled to end in November. The building industry is lobbying hard to have the program extended, but the Administration and Congress have to consider that economic disaster now appears to have been averted, and that attention is constantly being drawn to the extraordinary level of the fiscal deficit projections. The government cannot prop up the economy forever, and nor is its role to drive positive economic growth with debt that taxpayers must cover. At some point the economy has to go it alone.

Sceptics also pointed out that if you remove transport from the durable goods number, new orders only rose by 0.8% in July. That’s actually less than economists had expected. The transport segment was blown out by the “cash for clunkers” stimulus program, in which Americans received US$4500 if they traded in an old car for a brand new one. That program has now ended. Of all Obama’s stimulus programs, “cash for clunkers” has attracted the greatest level of criticism from the other side of the Congressional aisle.

The second point to consider is, to put it one way, is the new news “new”? Taking the big jump in new home sales as the example, is it really a surprise? We have previously seen a big jump in existing home sales, the first turnaround in the Case-Shiller home price index, and for the last couple of months big jumps in housing industry sentiment have caused Wall Street to surge. Should new positive data ensure the leading indicator must push ever higher, or are new positive data simply confirming what the leading indicator has already assumed?

One gets the impression that if last night’s data weren’t extremely positive, the stock market might well have sold off big time.

We have also now about wrapped up the US second quarter result season, and a very long-winded process these results seasons are. It was a positive season, and that is now accounted for in the market. We now wait about six weeks before it all starts again with the third quarter result season. And this time, stock analysts may not be quite as pessimistic as they appear to have been prior to the second quarter season.

Everything screams pull-back, but Wall Street’s been saying that for a month. If there is universal agreement, it won’t happen. Only when Wall Street has given up on a pull-back will we have likelihood.

In three days the Australian six-monthly result season will be over. It has also been a very positive one. Can we make 5000 before the impetus dries up?

Last night the US dollar rallied 0.5% on its index, to 78.62. One might say that positive US data should lead to a stronger dollar, but the truth is the dollar has been falling for months as the stock market has risen, implying a shift out of the safe haven reserve currency and back into the “risk trade”. Last night the US dollar went up on good news which is the opposite of what it has done since March. Everyone is short the US dollar because of the US deficit. Is that trade now turning?

The “risk trade” includes commodity markets, which have surged on Chinese stimulus and driven the stock market higher. A reliable lead indicator of commodity prices is the Baltic Dry Index. It has now been falling for five straight weeks.

Oil fell US62c last night to US$71.43/bbl. Aluminium fell 2% while the other metals were mixed on moves of 1% or less. Is this how commodities should respond to a big jump in durable goods orders?

Gold actually rose US90c to US$945.50/oz despite the stronger greenback. The Aussie lost 0.7 of a cent to US$0.8281.

After another big rally on the local bourse yesterday, the SPI Overnight fell 10 points or 0.2%.

Earnings watch today includes OZ Minerals ((OZL)), Toll Holdings ((TOL)) and Woolworths ((WOW)).

For the full list of reporting dates and major economic data releases please refer to the FNArena calendar.

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