The Overnight Report: Rough Take-Off

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By Greg Peel

The Dow closed down 179 points or 1.0% while the S&P fell 1.0% to 2078 and the Nasdaq fell 1.0%.

Tragedy

A dismal day on the local stock exchange was led out by BHP Billiton, which posted a 5.6% drop on news of a fatal disaster at a BHP-Vale-owned iron ore mine in Brazil. Early estimates suggest the mine may be closed for several years and cost US$1bn in clean-up and legal costs.

It was never set to be a good day for the materials sector anyway, as evidenced by falls in iron ore mining stocks across the board. The weekend’s Chinese trade data showed a big fall in imports in general and iron ore imports in particular. To date the sector has seemed not too concerned over the gradual fall in the iron ore price to below US$50/t as this has been largely anticipated and costs have been cut in preparation. But the weak Chinese numbers have crystallised the reality. The materials sector fell 3.7% yesterday.

The energy sector saw a 2.5% fall but elsewhere across the index, the other concern is that of rising US interest rates. Friday’s strong US jobs number has led to expectations the Fed will definitely raise in December, and attention now turns to just how fast the pace of subsequent hikes will be.

For years the Australian stock market has largely been a story of yield, given the fall in commodity prices. The banks, telco and utilities and any stock paying a solid dividend have been supported by those seeking a return in a low interest rate environment. Rates don’t get much lower than zero, hence Australian stocks have been very attractive to US investors. As the interest rate differential between Australia and the US begins to narrow, that attraction is incrementally eroded.

Yesterday saw the banks and telcos each down 1.6% and utilities down 2.2%. Only one sector managed to close flat on the session and that’s healthcare – defensive more so from its undeniable growth story than from its yield.

A US rate rise also alleviates some of the pressure on the RBA to cut its own rate, given the subsequent impact on the Aussie dollar, which will disappoint those sweating on further RBA support.

The ASX200 was technically damaged yesterday. The close below 5140 and the promise of further weakness today suggests, on the charts, that 4700 is the next target.

Adjustment Period

History tells us that a period of “normalisation” – lifting rates back to more normal levels – following a period of easing is typically accompanied by a stock market rally over the first four rate hikes. While normalisation implies the winding down of central bank support, that winding down is an indication the economy is growing again and, in normal circumstances, that is good for a stock market. But that does not mean the initial adjustment is not a difficult one.

It has been over ten years since the Fed commenced a tightening cycle – 2004, following the tech wreck and 9/11. Many commentators have alluded to the fact that not only is there a large cohort of younger market participants who can’t conceive that “social media” used to mean one landline telephone on the hall table, and who can’t read analogue time, they have never experienced a rate rise. Thus if the first move in a tightening cycle requires a bumpy period of portfolio adjustment and a rethinking of strategies, this time around that adjustment may be even more bumpy.

Throw in the fact that the UK is still hesitating on a wind-back of its QE program, Japan may yet increase its QE program, the eurozone is certain to extend its QE program in December, and China is all but certain to enact further stimulus measures, including a potential further devaluation of the renminbi, and there is only one way the US dollar can go.

The stronger US dollar is already impacting on large US multinationals, as this latest round of earnings reports confirms. The US manufacturing sector had been managing to get back on its feet post GFC but it is now faced with less competitive pricing power. In short, a Fed rate rise may imply a stronger US economy but a surging US dollar means the economy is dragging a heavy weight along with it.

Wall Street was somewhat stunned on Friday night by the shock jobs number, and its implications. With the weekend to think about it (and throw in the weak Chinese data), last night saw the Dow fall by as many as 243 points by midday. The combination of the stronger dollar (albeit last night the dollar index came back off a tad to 98.96) and further signs of weak Chinese demand sent all commodity prices lower again.

Stocks have managed to regain some ground to the close, falling an even 1% across the major indices. The S&P500 has broken support at 2100.

Santa? Please phone home.

There had been talk, in the wake of Wall Street’s 8% rebound out of the August depths, back to the level from which it had fallen, that perhaps this year the Santa rally came early. That rally was aided by a return to stability in Chinese markets, boosted by ECB QE, and confirmed by two weak US jobs reports for August and September that left Wall Street certain the Fed would not be raising in 2015.

Now that all has to be rethought. Once the difficult adjustment period is over, perhaps then can Santa hop back on the sleigh.

Commodities

The US dollar index was slightly lower last night but the weak Chinese trade data ensured falls across the board on the LME. Aluminium, lead, nickel and zinc were all down over 1% while copper and tin posted smaller falls.

A sad reality of the tragedy in Brazil is that prolonged closure of the mine reduces global iron ore supply, and hence is supportive for the iron ore price. Iron ore is up US30c to US$47.70/t.

Weakness in oil prices continued, with West Texas down US49c to US$43.94/bbl and Brent down US37c to US$47.23/bbl.

There was some respite for gold thanks to the dip in the greenback. It’s up US$3.40 to US$1090.70/oz.

The Aussie is relatively steady at US$0.7052.

Today

The SPI Overnight is down 52 points or 1.0%. If accurate this implies a fall through 5100 for the ASX200 and a move towards tenuous support at 5000.

Australian housing finance data – a hot topic at present – will be released today. NAB will publish its October business confidence survey.

Beijing will post China’s October inflation numbers later today.

The local market will see earnings reports from Incitec Pivot ((IPL)) and Eclipx ((ECX)).
 

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