The Overnight Report: Chinese Take-Away

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By Greg Peel

The Dow closed down 47 points or 0.5% while the S&P fell 0.8% to 1020 and the Nasdaq lost 1.0%.

The feature of trade on Wall Street last week was one of attempting to grind higher without solid conviction. After a 50% rally Wall Street is now taking positive economic data as positive affirmation of economic recovery rather than positive inspiration for more exuberant buying. The wobbles set in somewhat on Friday and last night a weak lead from Shanghai was not going to provide any good reason to buy.

Australia’s ASX 200 hit a new 2009 intraday high of 4537 yesterday in defiance of Wall Street, spurred on by a positive trading update from ANZ Bank ((ANZ)) and confirmation from the government that stimulus measures will be maintained. But a 6.7% drop on the Shanghai index helped to wipe out those gains as profit-taking at month-end became a sensible option into a rising market.

After looking like it might be trying to recover from August’s 20% correction, the Shanghai index rolled over yesterday as investors backed away from the increasing number of public share offerings hitting the market at these levels (Shanghai was up over 100% from November trough to July peak), providing a supply-side excess, while fears were also raised on the issue of funding liquidity (demand-side drought). Part of Beijing’s stimulus package policy has been to encourage banks to lend backed by a low cash rate, but while this lending was intended for construction projects and domestic consumption incentives, much has found its way into stock and property market speculation. Excessive bank lending began to slow down in August with the stock market correction, and regulators had warned the banks not to rush into last minute end-of-month loans just to get the numbers back up.

In the US, talk is now of September and that month’s history of being the weakest for US stocks, followed by October which traditionally has provided stark volatility. In China, talk is of the approaching 60th anniversary of communist rule in October and how Beijing will not likely want to see a falling stock market when it again attempts to showcase Chinese superiority to the world. Thus were the Shanghai index to really go into a tumble, expectations are that Beijing would step in.

Trading was not exactly panicked on Wall Street either. The Dow was down 108 points at its depths but a late buying spurt halved the losses, despite month-end perhaps suggesting some more concerted locking in of profits.

While the fall in Shanghai probably lent little to fears Chinese economic growth might be stalling, oil was nevertheless flighty on the news and plunged 4%, or US$2.78, to US$69.96/bbl. The fall came despite the US dollar index being slightly weaker and sparked a sell-off in the cap-heavy energy sector. The financial sector also came under pressure on Wall Street following last week’s astonishing (ridiculous?) 200 plus percent moves in the likes of AIG and Fannie and Freddie. AIG had previously been given a boost in July when it “reverse split” (consolidated five to one) its shares to rise above the US$5.00 minimum for margin lending on stocks. Rumour had it that Fannie and Freddie would do the same, but the rumour was denied and talk from Washington is that the Administration did not want to be seen attempting to artificially improve its investment in the mortgage lenders without substance. Analysts agree that both Fannie and Freddie are insolvent but for government support.

And on the subject of mortgages, Wall Street is now fearing a possible wave of bank foreclosure sales in the next couple of months.

When the credit crisis first hit, the first wave of foreclosure casualties was the subprime walk-aways. Then as the CDO market defaulted innocent mortgage holders were caught in a need to refinance at a time when lending standards were tightened. Banks responded by attempting to modify loans in order to prevent foreclosure – offering extended maturities and interest holidays for example – given there’s no benefit for banks to have to sell assets into a plummeting market. The result is that for quite a while now banks have been warehousing delinquent loans which at any other time might have been foreclosed and sold, and are also hanging on to foreclosed properties rather than sell them which would only exacerbate the house price collapse.

But the lagging factor is rising unemployment. There is no point in trying to hold a mortgagors hand through the tough times if the mortgagor simply has no income. And the average cycle from mortgage issue to default is four years. The bulk of the more spurious loans were issued two and a half years or more ago, meaning the US is still building up to its peak of foreclosures based on historical averages, and has another 18 months of pain ahead. The peak of the reset dates for reset mortgages is also not due until 2010. Now that the house price index has shown signs of turning, and sales figures are on the rise, Wall Street fears banks will now take the opportunity to open the warehouse doors and expunge their growing inventory of foreclosed and seriously delinquent loans, lest they simply continue to build.

The fear is that the apparent housing market recovery could be quickly derailed.

The good news last night was that the Chicago purchasing managers’ index rose for a third straight month, from 43.4% in July to smack on 50.0% in August. This implies the index is now at the neutral point, on the cusp of moving out of contraction and into expansion.

There was also M&A activity to the tune of over US$10bn announced last night, as Dow component Disney moved in on Marvel Comics (Spider Mouse?) and an energy services company took a swing at a rival.

All in all it was simply a subdued day, as the shadows grow longer over the US summer. The unofficial end of the summer holiday period is the Labor Day long weekend of September 5-7, after which a wave of suntanned traders is expected back on the Street to return trading volumes to more normal levels. Will they be buyers or sellers?

Speaking of public holidays, it was August Bank Holiday in the UK last night meaning no London metals trading. There was thus no response from New York spot metals prices although Comex futures were active, and as was the case with oil the market, Comex was spooked by Shanghai, sending copper down 4%. Gold fell US$5.10 to US$951.10/oz.

The Aussie is relatively steady from Friday at US$0.8443, while the SPI Overnight lost 10 points or 0.2%.

No more earnings results!

We’re firmly back in economic data mode, however, and today will see the RBA leave its cash rate on hold at 3.0%. What will be important nevertheless will be Glenn Stevens’ commentary. Economists have already begun to talk of an interest rate rise as early as October, but yesterday’s private sector credit and inventory numbers had them all scurrying back into their caves to reassess Wednesday’s second quarter GDP number which, incidentally, I have been warning for some time would not be surprising if actually negative.

Today will also see the release of two manufacturing surveys in China.

Happy Spring.

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