The Overnight Report: Buy Those Bonds

This story features SUNCORP GROUP LIMITED. For more info SHARE ANALYSIS: SUN

By Greg Peel

The Dow closed down 42 points or 0.3% while the S&P fell 0.1% to 1909 and the Nasdaq lost 0.3%.

Yesterday’s release of March quarter construction work done in Australia pleased economists. Consensus was for a 0.5% fall but instead a 0.3% gain was delivered, to suggest 2.6% growth year on year. The swing factor was residential construction, which rose by 6.8% and finally confirmed a flow-through from growing building approvals numbers over the past months.

This is what policy makers want to see. Engineering construction fell 1.6%, but from record highs, confirming the reduction in mining investment. This figure will continue to fall but will be dampened by ongoing LNG-related construction. Non-residential construction remains muted, falling 1.5%.

The private/public split saw a 2.0% increase to a 6.8% fall, but the latest budget, for what its worth at this stage, has public infrastructure spending on the up.

All up, the construction result will make a small positive contribution to next week’s GDP number, the CBA economists suggest. The good news is that a rebalancing of the Australian economy away from mining investment-dependent is evident, with housing construction leading the charge.

The ASX 200 pushed up 30 points by mid-afternoon yesterday but faded to the close to halve that gain. Last night Wall Street suffered a similar fate after a choppy session, leaving the S&P below its all-time high and the Dow once again failing to get there. A four-day winning streak was broken.

The Dow fell from the open to be down 55 points early before bungling its way back to be almost square before the last half hour. Then the sellers arrived. A pullback from a new high after four days of rally is nothing unusual, but all eyes were fixed on the US bond market.

Having hovered around the 2.5% mark now for some time, suddenly the ten-year yield chose last night to plunge 8 basis points to 2.44%. There were no US economic data releases to spark the sudden rush into bonds, but there was an unexpected jump in unemployment registered in Europe’s economic draught horse, Germany. Once again commentators debated over why investors continue to search for safety when the stock market is at new highs, and why those new highs are being almost reluctantly achieved without the support of funds otherwise attracted to fixed income.

Nothing is crystal clear, but a couple of factors are likely combining. Some argue the bond market is simply indicating disagreement with the Fed, and the stock market, on the pace of the US recovery. In the shorter term, unjustifiably low bond rates in the eurozone – the Spanish yield is at 2.8% to the US at 2.4%, hardly representative of the risk spread – encouraging traders to sell peripheral Europe and buy German, UK, and US bonds on the hedge. If there were any doubt the ECB is ready to cut its cash rate next week, and perhaps instigate some form of QE in due course, the German jobs numbers swept that away. That’s what’s been bringing down European bond yields, artificially.

The other longer term argument is the global search for yield for an ageing developed world population increasingly concerned over retirement funds and too scared to risk it, again, in the stock market. This, too, makes perfect sense.

The other issue of concern for all and sundry at present, and a possible cause of why US stocks are now wavering at the highs despite guaranteed Fed support, is ever lower volatility. The VIX volatility index on the S&P sits as low as it was pre-GFC, while bond yields have also seen low volatility and the US dollar index has barely moved for months. When everything goes quiet, that often signals an approaching storm.

The euro fell on the German jobs numbers, pushing the US dollar index up 0.2% to 80.56. After its big fall on Tuesday night, gold dropped another US$5.20 to US$1258.50/oz. The Aussie is down 0.3% to US$0.9233.

Movements on the LME were mixed, with copper stalled but a 1% gain for aluminium offsett a 2% fall in nickel. Iron ore fell US$1.30 to US$96.80/t.

Having built in a geopolitical risk premium, the West Texas crude price suddenly fell US$1.17 to US$102.99/bbl last night with Brent down only US14c to US$109.97/bbl as Nymex traders took positions ahead of an expected jump in weekly crude inventories, data for which will be released tonight.

The SPI Overnight fell 13 points or 0.2%.

Arguably the most important of the quarterly GDP components is due today, being private sector capex and capex intentions, which impacts not only on the forecast March GDP result but also GDP forecasts for 2014-15. Monthly new home sales data are also due.

In the US, Wall Street will hold its breath to see just how negative the first revision of the US March quarter GDP will be.

In the wake of its big Life division write-down, Suncorp ((SUN)) will hold an investor day today while AGMs will be held by both Westfield Group ((WDC)) and Westfield Retail ((WRT)) at which the latest version of the Scentre demerger/merger proposal will be the hot topic.

Rudi will appear on Sky Business at noon and later, between 7-8pm on Switzer TV, as well as tomorrow on Bonds versus Equities.
 

All overnight and intraday prices, average prices, currency conversions and charts for stock indices, currencies, commodities, bonds, VIX and more available in the FNArena Cockpit.  Click here. (Subscribers can access prices in the Cockpit.)

(Readers should note that all commentary, observations, names and calculations are provided for informative and educational purposes only. Investors should always consult with their licensed investment advisor first, before making any decisions. All views expressed are the author's and not by association FNArena's – see disclaimer on the website)

All paying members at FNArena are being reminded they can set an email alert specifically for The Overnight Report. Go to Portfolio and Alerts in the Cockpit and tick the box in front of The Overnight Report. You will receive an email alert every time a new Overnight Report has been published on the website.

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.

Click to view our Glossary of Financial Terms