Daily Market Reports | Dec 21 2015
By Greg Peel
Too Soon, Again?
After a day of rallying ahead of the Fed rate decision, and a subsequent day of rallying after the Fed rate decision, a 250 point fall in the Dow on Thursday night spooked investors on Bridge Street who were likely convinced the Santa Rally had finally begun. False alarm! they cried. And they proceeded to offer the ASX200 down 76 points on the opening rotation.
Both Wall Street and Bridge Street had experienced a somewhat euphoric couple of sessions centred around the end of uncertainty resulting from the Fed’s long-awaited rate hike. Many had assumed the end of uncertainty would translate into a resumption of the longer term stock market rally. But when the champagne ran out and the band started packing up, reality set in that at least in the short term, the market would have to return to a consideration of those things called…um…oh yeah, fundamentals.
One of the more prominent fundamentals is the oil price. But the Fed has not gone away, as Wall Street now has to weigh up the likely pace of the Fed’s ongoing tightening cycle. Consensus had four subsequent rate hikes in 2016. The Fed’s “dots” suggested three. Suddenly US bank stocks, noting that banks are beneficiaries of higher interest rates, looked a little bit overvalued in anticipation.
And more generally, implicit strength in the US dollar is set to weigh further on the earnings of US multinationals.
None of which (other than the oil price) is likely to have a specifically negative impact on the Australian stock market. If anything, a stronger greenback means a weaker Aussie, and that’s positive, and a slower pace of Fed tightening means a slower pace of US investors bailing out of the longstanding carry trade (buying Aussie stocks for yield).
So when the ASX200 opened 76 points lower on Friday, in came the buyers. Outside of tiny info tech, the only sectors the ultimately end the session in the red were, predictably, energy and materials.
The question for today is: Can the ASX200 again defy another huge fall on Wall Street, as was the case on Friday night?
Toil and Trouble?
It is unclear just how much of Wall Street’s plunge on Friday night, which on the back of Thursday night’s fall represented the biggest two-day drop since August, is directly attributable to a “quadruple witching” expiry of equity futures and options that came so soon after the historic Fed rate rise.
The Dow fell 367 points or 2.1% while the S&P lost 1.8% to 2005 and the Nasdaq fell 1.6%.
It is not untypical to see a degree of volatility on “quad witch” days given the S&P500 tends to gravitate towards the most commonly held option strike price as market-makers race to cover their exposures. We may surmise that on Friday the target was S&P 2000. But behind that smoke screen there were clearly other issues at play.
The worst performing sector on the S&P was the banks, which harks back to the “slower pace of tightening” argument above. The best, or rather least-worst, performing sector was utilities. Again we see a slower pace of tightening at play. The oil price was down again, albeit by less than a percent this time, but bottom pickers in oil stocks appear to have retreated, bruised, to the sidelines.
Of more concern with regard to oil is the ever widening spread between investment grade corporate bonds and non-investment grade (junk) bonds which can be directly linked to fear of oil companies defaulting on their debt. The US ten-year Treasury yield fell another 4 basis points on Friday night to 2.20%.
There was also some concern surrounding a surprise announcement on Friday from the Bank of Japan.
Setting Sun?
Given Japan officially fell into recession in the September quarter, markets had been expecting the BoJ to announce increased QE. But no, all is on track, the central bank insisted. Then the ECB extended its own QE program early this month, so on a tit for tat basis the market again began to expect a response from the BoJ when it met on Friday.
The expectation was that the BoJ would increase the level of bond purchases within its QE program. But it didn’t. Instead, it extended the maturity of the bonds it would target. And it would increase the amount of equity EFTs it has been buying to “invest in physical and human capital”, which is code for “support the stock market”.
Again, the BoJ announced these adjustments with a familiar air of optimism for the Japanese economy. But the brave face is starting to become a little bit worn. If there’s no problem, why tweak QE? And if there is a problem, why not increase the level of bond purchases? Has the BoJ reached its limit of QE fire power?
On that fear, the Nikkei fell 1.9% on Friday, when typically extended QE would spark a rally. The surprise and concern was not lost on Wall Street, again making it difficult to decipher exactly what it was, other than a range of issues, that sent Wall Street into a tail spin on Friday night.
The US dollar subsequently fell against the yen, leading the dollar index down 0.6% to 98.68.
Commodities
The dollar’s decline could not stop West Texas crude falling another US26c to US$34.66/bbl and Brent falling US30c to US$36.69/bbl.
The dollar did help out base metals, although volumes have now become thin on the LME as the market winds down ahead of Christmas. News broke on Friday that nine major Chinese copper smelters would meet on Saturday to discuss stockpiling a level of production rather than dumping it onto an oversupplied market, and as a result copper jumped 2.7%. There were sympathetic moves in aluminium and zinc, up 2%, and lead rebounded 3.6% having been heavily sold down earlier in the week on excess inventory numbers. Nickel and tin sat put.
Iron ore rose US80c to US$39.30/t.
It was a rollercoaster ride for gold last week, as markets struggled to figure out whether a combination of Fed rate rise and gradual subsequent rises was bullish or bearish for the US dollar. On the dollar’s fall on Friday night, gold rallied back US$14.00 to US$1065.50/oz.
The Aussie dollar is also up on the greenback’s fall, by 0.8% to US$0.7178.
The SPI Overnight closed down 40 points or 0.8%.
The Week Ahead
Historically, two of the best two weeks of the year for Wall Street are the last two weeks of December. Yes, it’s called a Santa Rally. But the reality is the vast bulk US corporations, including fund managers and stockbrokers, account on a calendar year basis. Thus December 31 represents not only the end of the quarter but the end of the fiscal year and with that comes the potential for an elevated level of “window dressing”.
This is important for the purposes of lifting apparent fund manager performance as marked at the end of the year, but also important for employee bonuses, which are paid based on calendar year success, or lack thereof.
In other words, don’t yet write off Santa, as long as those dreaded fundamentals don’t get in the way. And consider that most of Australia’s major investment banks are foreign, and also operate on a calendar year basis, and otherwise it’s still an end of quarter approaching. Being the December quarter, for most of the market the year actually ends this week – before Christmas and the summer break.
All Western markets are closed on Christmas Day, Friday.
The US will cram a lot of data releases into the first three days of this week. Tonight sees Chicago Fed national activity index, tomorrow the Richmond Fed manufacturing index, existing home sales, FHFA house prices and a final revision of the September quarter GDP. The market is forecasting a pullback to 1.9% from the last estimate of 2.1%.
On Wednesday it’s durable goods, new home sales, personal income and spending and the fortnightly Michigan Uni consumer sentiment measure.
The NYSE will close at 1pm on Thursday.
Japan will be closed on Wednesday.
There are no Australian data releases of note this week. The ASX will close at 2.10pm on Thursday.
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