FYI | Jul 22 2007
By Greg Peel
It’s Goldilocks one day and cold porridge the next on Wall Street. The bell might have rung at 14,000 in the Dow but with the subprime crisis continuing to weigh the bulls have been hanging on expectantly in the hope that strong earnings would once again prove that the US economy is firing along nicely thank you. But quarterly earnings results to date, while positive, have not really stood up to close scrutiny.
For starters, the financials can’t take a trick. Heavyweights Citigroup and Wachovia both posted record quarterly earnings and both closed lower on the day on Friday. It doesn’t matter how much the top tier investment banks entreat that their subprime troubles are minimal, the market is not yet convinced. Further down the scale, smaller financials, those with higher proportionate exposure to risky debt, have been hammered.
And the US is beginning to focus on how this problem is manifesting itself elsewhere in the world. Standard & Poors cut ratings on a number of European CDOs on Friday night, and news spread that an Australian – yes, an Australian – hedge fund was going under. Basis Capital has hit the international headlines.
Whatever the mood in the financial sector, it was never likely the market would open strongly on Friday. Late Thursday profit reports from both Microsoft and particularly Google (shares down 5%) disappointed the market despite appearing relatively positive on the surface. The scene was then set for Dow stalwart Caterpillar to make its announcement.
And it was bad. Caterpillar has been one of the strongest among the thirty Dow stocks during the long rally. As a supplier of heavy equipment, the global mining and construction boom was always going to be a boon for the world’s most recognisable bulldozers. But Caterpillar thrives on the US housing market too, and its weakness, along with rising costs, were enough for the company to post a 21% fall in profit from the previous corresponding period. Profit per share came in at US$1.24 against market expectations of US$1.49. The stock fell over 4%.
And the news from the housing market only got worse as builder KB Homes declared that the housing slump will continue through 2008 and price rises should not be expected until 2009.
The Dow closed down 149 points or 1% although it had been down as much as 200 points earlier in the session. Both the S&P and Nasdaq fell 1.2%.
As the credit jitters intensified the flight to quality appeared to begin in earnest on Friday night. US 10-year bonds, which had traded on a yield as high as 5.30% earlier in the month as global inflation fears began to mount, were heavily sought after which sent yields crashing through to 4.96%. Most of the demand must have been local, as the US dollar once again weakened against the euro and the pound.
This was all good news, however, for the Phoenix that is the gold price. Gold posted yet another strong rally, rising US$6.00 to US$683.50/oz. The big cry on the Comex floor was: They’re baaaaaack!
Yes the word is that a major return of investors into gold ETFs has provided the impetus to push gold fairly rapidly from its recent sub-US$650/oz lows to be back setting US$700/oz in the sights once more. ETF investors ran for the exits one month ago when the 10-year bond yield leapt up through 5%. On a higher long term discount rate, gold costs more to hold and gold provides no offsetting income. The irony is of course that bonds were pushing up on inflation fears, and gold is a hedge against inflation.
This has provided a warning from the more sober heads amongst the gold watchers. While bulls are readying for another assault on US$700/oz, some note that a gold rally based purely on weakness in the US dollar is not really a gold rally at all, given the gold benchmark is denominated in US dollars. The bulls point to the surging oil price as another impetus but that, too, is denominated in US dollars. (Although the oil price was down slightly on Friday to US$75.57/bbl).
Only if gold continues its rally despite the US dollar (which really means rallying in euro terms) will the sceptics concede that gold is indeed strong.
A lower US dollar also assists dollar-denominated base metal prices, but in this case there is little doubt the metals are back firing again on their own terms. Although lead remains the most remarkable story – up another 4% in New York on Friday – nickel also bounced 2.5%, zinc rose 2.5% and copper added another 1%.
Recent metal strength undoubtedly has much to do with the Chinese economy, which we learnt last week grew 11.9% in the quarter. The Chinese stock market obviously likes this news, as the Shanghai Composite rose close to 4% in Friday’s trade. This was despite the fact that the PBoC would surely have to raise rates soon.
And it did.
The one year renminbi borrowing rate was hiked the customary 27 basis points on Saturday to 6.84% in the face of a surging economy, a surging stock market, and 4.4% inflation. In another of China’s ancillary attempts to cool the stock market, the tax on domestic bank deposit interest was lowered from 20% to 5%. China wants its citizens to save their hard-earned, and not blow it on a stock market bubble.
The fall in US markets will likely put the dampeners on the local bourse on Monday morning after a couple of days of solid gains, although strong commodity prices cannot be ignored. The SPI Overnight closed down 41 points.
