The Monday Report (on Tuesday)

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By Greg Peel

It was a volatile session on Bridge Street on Friday. Having tanked on Thursday on the weak Chinese PMI, the ASX 200 opened lower but resisted the urge to double count and follow Wall Street down after US markets responded to the same Chinese data on Thursday night. Indeed, the index managed a rally to be up 15 points by midday, but then China reared its ugly head once more to affect a close down 22.

Information leaked from Beijing during the session that the Chinese banking regulator has ordered regional offices to scrutinise credit risks in China’s coal industry.  It is well known China is the biggest consumer of coal used for electricity generation and for steel production but few realise China is actually the world’s biggest producer of coal as well. In recent years production has fallen short of consumption, forcing China to import some coal from the likes of Australia (the world’s biggest exporter of coal, mostly to Japan, Korea, Taiwan) but suffice to say China’s domestic coal industry is fundamental to GDP growth.

Regional offices have been told to specifically investigate the extent of loans to coal companies by trust and wealth management funds. These products offer Chinese investors higher yields than traditional bank options but form part of the country’s unregulated shadow banking system. The alarm was raised when one coal company collapsed owing US$496m to investors. Such a default threatens to shake the faith in China’s US$1.7 trillion trust industry and raises questions over the risks of extensive loans to the coal industry from China’s official banks.

Sudden concern over China is flowing through to Australia’s markets. The stock market is obviously being affected but another 0.7% fall in the Aussie to US$0.8706 over the 24 hours to Saturday morning is the definitive indicator. The Chinese renminbi is pegged in a range to the US dollar, offering no efficient opportunity for trading/hedging of China exposures, but the Aussie satisfies as a proxy in an open but safely regulated market.

Before China started to raise concerns, money had already been flowing out of emerging market investments and currencies. This began as soon as the Fed raised the possibility of tapering and has accelerated now tapering has begun. Tapering implies a rise in US interest rates which closes the gap on emerging market yields on the one hand and implies US economic strength on the other. No longer are emerging markets, with their inherent risks, the place to be to offset minimal returns in the US. Among those currencies being thumped recently are the Indian rupee, Brazilian real, Turkish lira and the South African rand, while on Friday night Argentina gave up on intervention efforts and the peso took a dive. The currency exodus reflects an exodus from offshore investment in emerging market stocks and bonds.

Meanwhile, the US corporate earnings season has continued to deliver results which have been little more than “okay”, and still weak on revenue growth. Microsoft (Dow) and Starbucks reported after the bell on Thursday and the shares of each rose 3% on Friday. It was a very good effort against the powerful tide.

While China in particular and emerging markets in general are being seen as more than an excuse than a reason, heavy selling continued on Wall Street on Friday night. It has not been sufficient that earnings results to date are “okay”. They had to be pretty damned good to justify the faith placed in stocks by investors as indicated by elevated PE ratios, which rose all through 2013 on expectation of, rather than definitive evidence of, earnings growth. They also have to be good to prove US corporations and thus the stock market can survive without QE liquidity. So far, not so good.

The Dow fell 318 points or 2.0% on Friday night and closed on its lows, breaking back down through the 16,000 mark. The S&P broke 1800 to close at 1790, down 2.1%, while the Nasdaq fell 2.1%. The uniformity of index falls, unseen in earlier sessions last week, indicates the indiscriminate nature of the sell-off. The Dow and S&P both broke down through their 50-day moving averages, bringing technical sellers into the game as well.

Falls were also globally indiscriminate. London fell 1.6%, Germany 2.5%, France 2.8% and Japan 1.9%. What went up? China, by 0.6%. Go figure.

Not unsurprisingly thus, the US dollar index was steady on Friday night at 80.44. The index basket consists only of major developed economy currencies and not of any emerging market currencies, many of which saw 1-2% falls against the greenback in the session. Nor is the Aussie included. Interestingly, gold was also steady on Friday night at US$1264.00/oz. The US ten-year bond yield fell 4bps to 2.74%.

Base metals were all up to a percent weaker except lead, which went the other way. Spot iron ore rose US40c to US$123.30/t. Brent crude managed a US52c gain to US$107.92/bbl while West Texas fell US43c to US$93.89/bbl. But the big news in energy on Friday was natural gas.

At the beginning of November, the benchmark US natural gas price was trading at US$3.50/mmbtu. On Friday night it traded over US$5 after a whopping 10% jump in the session. Clearly traders are being caught short as US gas consumption surges in America’s Big Freeze.

Those looking to make a positive connection to the share prices of Australian gas producer stocks should note the correlation is minimal at this stage. The US does not export gas and will not begin to do so for a few years yet. Australian gas contract prices are benchmarked to the oil price, not the US gas price. It nevertheless doesn’t hurt, but then the US spot price is clearly volatile and weather-dependent.

On Friday night the SPI Overnight fell 75 points or 1.4%.

The global sell-off continued on Monday as Australia rested after its celebrations. Japan fell 2.5%, London 1.7% and Germany 0.5%. At lunchtime in New York, the Dow was down another 100 points.

Economic data weren’t helpful. US new home sales fell 7% in December, although once again snow was blamed. Sales for 2013 grew by 4.5% to an annualised rate of 428,000 which is the highest level since 2008. Those fearing the return of the housing bubble in the US will note the peak of annual sales occurred in 2005, at 1.4m homes.

The earnings highlight last night was Caterpillar (Dow). Seen as a global economic bellwether, Cat shares jumped 5.6% on an earnings beat, a guidance beat, and an announced buyback. But Caterpillar alone was not going to determine sentiment on the day. Aside from everything else going on at the macro level at present, the Fed is expected to announce further tapering on Wednesday. The nervous money is taking profits ahead of the meeting.

Wall Street did nevertheless stage a comeback in the afternoon, confirming there are plenty of investors looking to buy on any pullback opportunity and are not going to wait for an official “correction” whether one is overdue or not. Around 3.30pm the Dow was up over 60 points, for a 160 point rebound on the session, but the profit-takers remain intent and in the last half hour the average fell back into the red to mark a fifth consecutive fall.

The Dow closed down 41 points or 0.3% while the S&P lost 0.5% to 1781 and the Nasdaq dropped 1.0%.

The US dollar index remained relatively steady at 80.50 but while Australian markets were closed, the Aussie rebounded 0.5% to US$0.8750. The gold recovery is also faltering, with gold falling US$11.50 to US$1252.50/oz last night.

Base metals continued to drift slightly lower, albeit nickel fell 2.5%. Spot iron ore was unchanged in the session at US$124.30/t ahead of Wednesday’s New Year shutdown. The oils were weaker, with Brent down US84c to US107.08/bbl and West Texas down US76c to US$95.88/bbl.

The SPI Overnight is showing down 39 points. However the SPIO closed at 5122 on Saturday morning and at 5118 this morning, or down 4. A 39 point fall on top of a 75 point fall with no physical session in between looks a bit steep given Wall Street only lost 0.5% last night.

Wednesday night’s Fed statement will be the primary focus this week and on Thursday, markets are expecting the first estimate of US December quarter GDP to come in at 3.2% annualised. During the week we’ll also see durable goods, the Richmond Fed manufacturing index, the Case-Shiller house price index and the Conference Board consumer confidence measure, tonight, pending home sales on Thursday, and personal income and spending, the Chicago PMI and the Michigan Uni fortnightly consumer sentiment measure on Friday.

Elsewhere, the UK will provide its first estimate of GDP tonight, with 0.7% growth expected for 2.8% annualised, while Japan will provide a data dump of inflation, industrial production, manufacturing and unemployment numbers on Friday. Yesterday Japan reported a December trade balance showing a greater deficit than expected.

It’s a quiet week economically in Australia, with new home sales on Thursday and private sector credit on Friday the highlights.

It will be busier on the corporate front, with the last of the resource sector production reports merging with early earnings report. There are several production reports due across the week, including those from Oil Search ((OSH)) and Fortescue Metals ((FMG)), while Energy Resources of Australia ((ERA)) and Navitas ((NVT)) will release earnings results on Thursday.
 

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