The Overnight Report: Here It Comes

This story features RESMED INC. For more info SHARE ANALYSIS: RMD

By Greg Peel

The Dow fell 317 points or 1.9% while the S&P lost 2.0% to 1930 and the Nasdaq dropped 2.1%.

It was back to business as usual yesterday on Bridge Street as the market quietened down again after Wednesday’s out of the blue rally. But while some selling may have been expected after a nervous session on Wall Street, we held over the 5600 mark and even pushed a bit higher into new post-GFC blue sky. In retrospect, perhaps not a great idea.

The fall on Wall Street last night was the biggest since February. Commentators were throwing up a plethora of reasons as to why the indices suddenly turned tail but arguably there was only one reason that actually mattered.

Increased sanctions against Russia are creating nervousness, particularly in Europe, but the Ukraine-Russia story has been running for months now, increased sanctions have long been a threat, and Wall Street has had plenty of time to worry about it. It may sound callous, but Gaza does not matter to financial markets. Argentina defaulted on its bonds yesterday but realistically this only affects a handful of US hedge funds who were silly enough to buy them in the first place. So insignificant is the Argentinian economy that it is not included in any “emerging market” index funds.

Last night’s US corporate earnings results were weak. Yet the earnings growth run-rate for the season has hit 10% and while revenue growth of only 4% remains an issue, it’s been an issue for three weeks now.

The real reason Wall Street sold off last night is exactly the reason everyone has proffered as the likely trigger for a sell-off – anticipation of the first Fed rate rise. I have noted time and time again that the “smart money” on Wall Street never trades in the final hours after a Fed policy statement release. Fund managers go home, have a think about it, have a meeting, and then respond the following day. What they decided is that the Fed has fallen behind the curve and has begun to admit it.

In recent months there has been much talk of US inflation creeping up, and that if the Fed wasn’t careful, inflation would suddenly run away. In each case the Fed has dismissed the notion, describing monthly CPI data as “noise” and forecasting ongoing softness. Until Wednesday night’s statement, that is, which tacitly acknowledged inflation pressure had indeed risen.

But the offset, said the Fed, was lingering “slack” in the labour market. The unemployment rate might be at 6% but participation is low and the true rate is 12%. This implies a lot more jobs have to be created to fill that void before there is any pressure on wages, and thus dangerous pressure on inflation. Few commentators disagree with this observation, but one day after this statement was made, everyone got a bit of a shock.

Last night the US June quarter labour cost index was released along with the weekly new jobless claims number. Aside from the monthly trend of new jobless claims having fallen to their lowest level since 2006, the June quarter marked the biggest jump in labour cost in five and a half years. No one saw this coming, least of all, it would seem, Janet Yellen. When the labour cost data hit the wires, the Fed’s labour market “slack” argument went out the window.

So let’s recap. While the Fed under Yellen has dismissed the earlier notion that specific unemployment and inflation targets will be automatic rate rise triggers, previously stated unemployment and inflation targets have now been breached. The US economy grew 4% (annualised) in the June quarter. New jobless claims are at pre-GFC levels and labour cost growth is almost back to pre-GFC levels. The US stock market is above pre-GFC levels. June quarter corporate earnings growth was in the order of 10%.

And the Fed cash rate is zero. What’s wrong with this picture?

That’s what the US bond market asked itself when the opening bell rang last night. The ten-year yield immediately jumped 6 basis points to 2.61%, having risen 9bps the night before. Stock market traders look to bond market traders as representing the true “smart money”. The bond market has decided a rate rise is imminent, they concluded. For God sake, sell!

And so they did. And they kept on selling. So much so that the ten-year yield actually started to retreat again in somewhat of a Catch-22 scenario. If the stock market is about to correct, many an investor decided, then I want to shift into bonds. As it was, the ten-year closed within a basis point of Wednesday’s night’s 2.55%.

But we can certainly argue that were all those other factors suggested above the real trigger – geopolitical issues, sovereign defaults etc – then stocks would have fallen, bond yields would have fallen and gold would have risen. Stocks indeed fell, but bond yields held fast and gold fell US$13.30/oz to US$1281.90/oz as the US dollar index ticked up once more, to 81.46. Together, they all say “rate rise”.

So how low can we go?

Well let’s consider that a correction would be really good for the stock market (Australia included). It would snuff out talk of “overvaluation” and allow all that cash sitting patiently, or is that anxiously, on the sidelines to enter the market at realistic levels from which one can enjoy the longer term bull market trend. Problem is, that’s what everyone is expecting, wanting, and ready for.

We could see 5%, we might see 10%, but we won’t see 20%. In fact, I doubt we could get much past 5% (unknown external shocks notwithstanding). This could yet be another false alarm before the real one, or the real one may never come. Everyone got over tapering pretty quickly, after a lot of angst in the lead-up. I believe everyone will get over a rate rise pretty quickly too. They might even embrace it.

Tonight will see the US July non-farm payrolls release. If it’s much more than current 230,000 consensus, the selling will probably continue. If it’s much less, Wall Street might steady.

The LME was looking towards tonight’s jobs number as traders squared up last night, and no doubt a sliding Wall Street was also noted. Aluminium, lead, nickel and zinc all fell 1-2%, with copper down 0.4%. Spot iron ore fell US30c to US$95.60/t.

It also happened to be the night weekly US oil inventory data were released, and of course they showed larger than expected crude supplies. West Texas thus fell US$1.93 to US$97.61/bbl, while Brent fell US46c to US$1.05.58/bbl.

The bad news, if we want to look at it that way, is that the SPI Overnight closed down 53 points or 1%. Just when we thought we may have, it appears we haven’t yet escaped the gravitational pull of 5500.

The good news is the Aussie is off another 0.4% to US$0.9396. The even better news is that the US dollar seems to have now established an upward trend, and if the Fed does finally raise rates, the Aussie can finally kiss the nineties goodbye.

US jobs number tonight, along with the manufacturing PMI, construction spending, personal income and spending (watch that income growth number), consumer sentiment and vehicle sales.

July manufacturing PMIs are due across the world today.

Otherwise, Australia sees the June quarter PPI and the monthly RP data-Rismark house price index.

ResMed ((RMD)) is due to report earnings, while Woodside Petroleum ((WPL)) shareholders will meet extraordinarily and if the late mail is accurate, will reject the structure of the Shell divestment.

Happy Birthday Dobbin.

Go the Tahs!
 

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. www.fnarena.com

Click to view our Glossary of Financial Terms