The Monday Report

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Greg Peel

If you'd been away for a week's holiday and asked the question, “What did the Dow do last week?” then the answer would be “Fell 1.5%,” to which you might respond, “Not much then”.

On Friday night the Dow closed up 125 points or 1.1% while the S&P gained 0.5% to 1178 and the Nasdaq added 0.6%.

The European short-selling ban came into force on Friday night sending the major European stock indices up 3% as traders rushed to cover. Markets were also encouraged ahead of the planned meeting between the German and French leaders tomorrow night to discuss ideas to stop the rot.

The critical economic release for the US on Friday was July retail sales. Given the data reflected sales ahead of August's extraordinary market turmoil, largely attributable to S&P's downgrade of US debt, it represents a clearer picture of the prevailing trend. Economists had expected an increase of 0.5%, and thankfully that's what they got. Given Wall Street is now primed to expect the worst, this was a positive result.

The mood was somewhat tempered, nevertheless, when Michigan Uni delivered the results of its fortnightly consumer sentiment survey. This data is more real time, so it was hardly a surprise that a poor result was forthcoming. But a plunge to 54.9 from 63.7, when economists had expected 61.0, was a bit of a shock. It is the lowest reading since 1980. Note that 1980 was a time when the world was suffering a stagflated recession, the second Arab oil shock had occurred, and gold hit its all time high of US$2400/oz in today's dollars (800 at the time).

Many are currently assuming that gold price is the target before year-end.

Gold eased off on Friday however, down US$21.30 to US$1746.30/oz, as the nervousness across markets subsided slightly. Stock volumes were still comparatively heavy but not as heavy as they had been earlier in the week. The VIX volatility index traded up to 48 last Wednesday but settled on Friday at 36. One analyst, appearing on CNBC, noted that the VIX has traded up to the 45 mark on six occasions in the last two decades. On all occasions bar one – the GFC jump to 90 – the stock market reached a new interim high four months later. On that basis the analyst in question expects Wall Street to exceed last April's high by year end.

Bold prediction.

For everyone else, volatility is expected to continue. The market remains polarised between those seeing rarely available value, and those fearing the worst. As can be deduced from the stronger effort on the Dow on Friday compared to the broader S&P, quality is being sought. The Dow has a high weighting in defensive stocks such as consumer staples and telcos. As can be deduced by a rally in US bond prices on Friday, despite the rally in stocks, safe havens are still being sought. The ten-year yield fell 10 basis points to 2.24%.

Currencies were quieter on Friday, with the US dollar index barely changed at 74.57. The Aussie is also steady at US$1.0351. Silver managed another 1% gain but base metals took a breather in London, slipping less than 1% across the spectrum.

The SPI Overnight gained 41 points or 1.0%.

An emergency cabinet meeting was held in Rome on Friday night after market-close, at which an E45.5bn package of deficit cuts was agreed with the intention of balancing the budget by 2013. While the package was applauded by EU officials, it immediately drew staunch criticism from within Italy. The suggestion is that such measures will simply strangle Italy's already stagnant economy. Spending cuts and tax increases will most impact on lower income earners while the rich will feel little pain. Strikes are already being planned, and one presumes Rome will become the new Athens.

The Italian government's response further highlights the “damned if you do, damned if you don't” scenario facing not only Europe but also now the US at present. It is agreed that the world simply cannot go on accumulating more and more debt, but it is also noted that budget cuts will also mean a further crimp on GDP growth, threatening to plunge the world into its second post-GFC recession. Thereafter, it depends whether or not you subscribe to the Paul Keating school of recessions. In this case a recession might help to clear the decks, but it is the workers who will suffer and not the wealthy who most see as responsible in the first place. 

Were the wealthy the only greedy ones?

In Australia, politicians (who we can dismiss) and economists (who we can endorse) have been at pains to point out Australia is in a much better position than the bulk of its Western counterparts. We can look to China more than others, our levels of government debt are comparatively low and our levels of household debt have fallen substantially since 2008. However, as true as this might be, comforting words do little to stem Australian market volatility, as was evident last week. It would be foolish to discount the possibility of further volatility ahead in the short term. What we do have upon us, coincidentally, this week and next, is the bulk of full-year or interim earnings reports from Australian companies.

To date, results have not been all that bad on average, and pretty good in some cases. It helps that a nervous market has marked down expectations significantly even if stock analysts haven't. These results are, of course, no older than June, so profit guidance and anecdotal outlooks from managements are of vital importance. Again these have been okay so far – no worse than might be expected – but we have an awful lot of reports about to hit us.

Data-wise, a quiet week in Australia sees vehicle sales today and the June quarter wage cost index and the Westpac leading economic index on Wednesday. Tomorrow the RBA will release the minutes of its August monetary policy meeting but given that meeting was held prior to the US downgrade the minutes may not prove much of a guide. We know that the central bank held off on a rate rise given a return of uncertainty offshore, but as to whether that uncertainty has sufficiently escalated now to suggest an RBA rate cut ahead is not something the minutes will be able to tell us.

Last week saw a rare occurrence – that of the RBA governor making a public statement in view of the volatility being experienced in the stock market. He noted that the RBA was in the money market conducting its open market operations as usual and it was not seeing any dysfunction. One feels that the RBA would only move to cut rates were credit markets to show signs of freezing up again as they did in 2008. If banks and institutions become too fearful of the liquidity of their counterparts to lend into the market, a withdrawal of credit would bring the economy to a halt and then, and only then one presumes, force the RBA to return to “emergency” measures.

The US is in for a pretty busy week of economic data, beginning tonight with the Empire State manufacturing index, the NAHB housing market index and Treasury international capital flows for June. Tuesday its housing starts and industrial production, Wednesday the PPI, and Thursday the CPI, existing home sales, the Conference Board leading index and the Philadelphia Fed manufacturing index.

Japan will release its estimate of June quarter GDP today, and the eurozone will follow suit on Tuesday. Clearly the world will be waiting with baited breath to hear what Sarkozy and Merkel might com up with on Tuesday night.

In an uncertain market, today's local earnings result highlights include Ansell (((ANN)), Leighton ((LEI)), Newcrest ((NCM)) and United Group ((UGL)).

Rudi will be appearing on Sky Business on Thursday at noon and on Friday on BoardRoomRadio's Afternoon Round Table.

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

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