The Monday Report

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

By Greg Peel

It seemed for all the world that the eleven hour grilling of Goldman Sachs by US senators last week was largely a point-score to Goldmans, given the executives were well prepared and the senators mostly naïve. Knuckleheads like Fabulous Fab don't help your cause, but despite a stack of spurious emails it appeared the Security and Exchange Commission's civil fraud case against Goldmans was going to be a difficult one to win. What was really needed was an obvious smoking gun.

Goldman shares had been quietly regaining some ground over the week but that all changed on Friday night when the SEC referred to the Justice Department and a criminal fraud charge was added to the civil charge. Looks like there might be a smoking gun after all. Goldman shares were trashed 9% by Wall Street on Friday and shares of major banking rivals were dragged down 3-4% in the wake.

I have noted on previous occasions that when the S&P 500 volatility index (VIX) falls below 20 it indicates complacency in the market and then “something” usually happens. While Wall Street was complacent for long periods during the boom up to 2007, the VIX has only made very brief forays under 20 since that time – when Bear Stearns was rescued, just before Lehman went under, and just before the Greek situation came to light. With Wall Street having decided the Greek situation was nothing to fear, the VIX fell once more below 20 in mid February and has remained there right up to Greece's downgrade to junk – the longest stretch of complacency since the subprime crisis began.

To break the relaxed mood something must come out of left field, and that was the case with Greece. Now we have Goldmans as well, and as of Friday night what had seemed like a tragic but ultimately innocuous sinking of an oil rig in the Gulf of Mexico has now become a disaster to likely well exceed that of the Exxon-Valdez in 1989.

I don't know what it is about Louisiana, but it seems to be the state that US presidents ignore. President Bush was extremely slow to provide aid to New Orleans and other areas ravaged by Hurricane Katrina in 2005, and now President Obama is being widely condemned for only swinging into action now that the massive oil slick has reached the coastline – too little, too late. Wall Street is only now tallying up the potential cost of the spill, particularly for the local fishing industry, the nation's restaurant industry which revels in Gulf shrimp, and the more widespread implications for sea-going goods transport to and from Gulf ports, including that of oil.

The oil industry did, however, breathe one sigh of relief on Friday when the Obama Administration qualified an earlier threat to ban all offshore drilling until the cause of the rig's sinking was understood and suggested only that no new rigs would be allowed to start up in the interim. That's at least some small comfort for BHP Billiton ((BHP)).

Wall Street thus had little not to be concerned about on Friday. Europe is still on tenterhooks, the Goldmans case has shifted to a new level and the oil spill looks like incurring a substantial cost.

Friday night's session began well with a pre-opening earnings report from Dow component Chevron which handsomely “beat the Street”. The Chicago purchasing managers' index (PMI), which measures manufacturing activity in the bustling Chicago Fed region, rose to 63.8 in April from 58.8 in March and ahead of consensus expectation of 60.0. But it was all downhill from there.

The fortnightly Michigan Uni measure of consumer confidence rose to 72.2 in the last April survey, up from 69.5 in the first April survey. However Wall Street was disappointed that the index did not recover its late March peak of 73.6.

Then came the first estimate of first quarter GDP. At 3.2% the result was considered a tad under consensus expectation of 3.4% but well below some outlier forecasts (I saw 4.5%). The result takes year-on-year growth to 2.5% and the good news was a 3.6% jump in consumer spending's contribution – the best result in three years.

The result can nevertheless be taken one of two ways. The December quarter result was 5.6%, so 3.2% indicates slowing growth at a time when the economy's leading indicator – the stock market – is pricing in a V recovery. But December was all about inventory restocking which typically, after a recession, does tend to provide some honeymoon numbers. Within the December number, however, there was little contribution from consumer spending suggesting a risk that restocked inventories would simply gather dust on the shelves, leading to discounting and entrenched deflation.

So 3.2% has to be seen in the context that inventory restocking has now waned but consumers are indeed buying those goods. It's thus good news, except that in a session dominated by bad news Wall Street would have liked a nice upside surprise.

All up the Dow lost 158 points on Friday or 1.4%, while the S&P dropped 1.7% to 1168. The 1200 level seems difficult to conquer right now.

The flight to quality was on again, with gold jumping US$12.10 to US$1179.30/oz and the US ten-year bond yield falling 7 basis points to 3.65%. The euro nevertheless had a good session for once on easing debt fears which meant the US dollar index fell slightly to 81.90.

Greece agreed on Friday to the stricter austerity measures demanded by Germany in exchange for its rescue contribution. Another 23bn euros is to be cut from the Greek budget through measures including a three-year freeze of public sector wages and an increase in the retirement age from 53 (can you believe it!) all the way to 67. The streets of Athens were already filled with protesters prior to this announcement, so civil unrest will now become the government's preeminent problem. Papandreou is having his “ask not what your county can do for you” moment.

Base metals were little impacted in London on Friday bar nickel, which jumped 4%. Oil rose another US98c to US$86.15/bbl.

The Aussie dropped a bit despite the lower US dollar to US$0.9241. In flights to quality, the “risk” or “commodity” currencies take a hit. The SPI Overnight lost 62 points or 1.3%.

The VIX volatility index jumped 20% to 22.

It was a volatile Friday night but there was still action a-plenty to come on Sunday.

Further confirmation was given by the EU on Sunday of the 110bn euro rescue plan going ahead after members accepted Greece's latest more stringent austerity plan. This was the good news, albeit parliamentary approval in member states is still required.

Given a holiday today, China released its PMI manufacturing index yesterday showing an increase to 55.7 in April from 55.1 in March to mark the fourteenth straight rise. At the same time the government further tightened monetary policy by increasing its bank reserve requirement by 0.5 of a percentage point. Following similar increases in January and February the reserve requirement now stands at 17% for most banks.

The market has been expecting further tightening measures from China so this should not come as a complete surprise.

But Sunday also potentially marked a dark day for Australia's miners and international miners with Australian-based profits. The government announced its intention to include in next week's budget a new 40% resources rent tax on miners' super-normal profits as recommended by the Henry tax review, similar to the existing petroleum rent tax and on top of, rather than instead of, the existing state-based mining royalty system (though there is compensation available).

The government is justifying the move based on figures which show royalties and corporate tax payments by the miners are not a sufficient reflection of profits now being made by the miners and that all Australians own these resources – not just the states in which those resources are concentrated. It is thus an attempt to draw more revenue for the public coffers which can be more equally distributed across the country.

The government also intends to raise the compulsory superannuation contribution gradually from 9% to 12%, offset by a gradual reduction in the corporate tax rate from 30% to 28% or maybe even less. The government is thus preparing for the aging population problem by increasing forced savings but at the same time it is cutting the net earnings of those very mining companies which form a core holding in virtually every super portfolio.

While mining stocks will no doubt respond in today's trade, notwithstanding the drop on Wall Street on Friday, the budget still has to pass through the Senate and stand by for some very heavy lobbying from the mining industry. The Opposition is clearly opposed and the Greens clearly in favour. Xenophon will likely be in favour while Fielding's opinion is anyone's guess, although likely in favour as well.

This will be a politically popular tax from the general point of view of super-normal mining profits benefiting “all Australian people” and not just “greedy” local and international miners. While the states get to keep their royalty systems, implicit in the tax is a redistribution of wealth away from WA and Queensland and into NSW and Victoria and those states will no doubt put up a fight based on potential loss of mining investment to overseas locations with a less onerous tax system.

The resources tax obviously goes some way to addressing Australia's “two-speed” economy, and today sees the release of the local AiG manufacturing index. Today we also have a quarterly house price index, the RBA's commodity price index and a timely release of the TD Securities monthly inflation gauge. It is timely because tomorrow the RBA will make a rate decision. My tip is “unchanged” but it's a close-run thing this month. The RBA will also now have to consider the fiscal impact of proposed budget measures.

Wednesday sees the local AiG services sector index along with building approvals, while Thursday brings retails sales and the trade balance. Friday wraps up with the AiG construction sector index and the RBA's quarterly report on monetary policy.

Tonight in the US sees the ISM manufacturing index along with construction spending, personal income and spending and vehicle sales. Tuesday is factory orders and pending home sales and Wednesday sees the ISM services index along with the monthly ADP measure of private sector unemployment.

Thursday is productivity and same-store sales while Friday brings consumer credit and the all important official unemployment numbers for April.

Elsewhere in the world, China has a holiday today as noted while Japan is off from today through Wednesday. The UK has a holiday tonight and will release its PMI manufacturing index on Tuesday. All major regions release all three sector indices this week (manufacturing, services, construction). Both the ECB and BoE will make rate decisions on Thursday and leave rates unchanged in the face of the European debt crisis.

On the local stock front, Orica ((ORI)) will report today and Westfield ((WDC)) tomorrow. News Corp ((NWS)) and Westpac ((WBC)) report on Wednesday and National Bank ((NAB)), AMP ((AMP)) and Sims Group ((SGM)) on Thursday. David Jones ((DJS)) reports sales numbers on Thursday and across the week there are a handful of AGMs.

For further global economic release dates and local company events please refer to the FNArena Calendar.

Click to view our Glossary of Financial Terms