FYI | Nov 02 2007
By Greg Peel
Welcome to the new world. It is a world in which, strangely, good news is good news and bad news is actually bad news. Yes – bizarre, I know.
Elvis has left the building. When the Fed cut the cash rate by 25 points on Wednesday it implied in its statement that that was all for now. There would be no December rate cut. The “Bernanke put” has been exercised, and now the markets are on their own. If there is trouble afoot Wall Street can no longer fall back on the comforting knowledge the Fed will step in and save the day. At least for the time being.
The Dow started the day off about 200 points, held that level for most of the session, and then collapsed at the end to be down 362 points, or 2.6%. The S&P was down 2.6% and the Nasdaq 2.2%. Only one of the thirty Dow stocks ended in the green last night, that being Microsoft. Decliners on the NYSE led advancers 4 to 1. Volume was up on Wednesday.
So what happened?
Well there were a number of influences. Firstly, after the close on Wednesday analysts were still trying to get their heads around why the Dow had rallied so strenuously off its lows to close up 137 points on the day. When the Fed announcement came out, and the cuts were declared over, the initial response was a sharp sell-off. That reaction, said the analysts, made sense. But that was not the end result. Consensus has it that the rally was merely a result of mutual fund buying. The fiscal year for US mutual funds ends in October. October 31 is often an up-day, as funds push prices higher in order to show the best possible returns for the 12 month period. Funds live and die on those published numbers.
So if you take that into consideration, you can say that last night’s fall was simply an adjustment back to what should have happened after the Fed suspended rate cuts. But there was a lot more to it than that. The financial sector was absolutely trashed last night when the analysts at CIBC downgraded Citigroup.
CIBC put out a report questioning Citi’s capital adequacy. As indicative values for distressed asset-backed securities continued to slide, CIBC made the suggestion Citi may have to cut its dividend, or take another very big write-down, or both. Financial sector investment is all about those healthy dividends. Citi shares immediately sold off 7% – its biggest down move in five years – and stayed there. The rest of the financial sector followed in sympathy – even Goldman Sachs. Amongst the biggest losers were bond insurers such as Dow component AIG.
And the news didn’t get any better over in Europe. Swiss banking stalwart Credit Suisse announced it had written down CHF2.2 billion in valuations and there would no longer be a share buyback. It’s third quater performance was a 31% loss.
Despite rumours to the contrary, the credit crunch is alive and well. The burgeoning question remains: what is a mortgage CDO actually worth?
Then there was more bad news. The largest market cap company on the planet – oil producer Exxon Mobil – announced a 10% fall in profits for the third quarter. Hang on – oil is trading above US$90/bbl. How could Exxon possibly have a weak quarter?
The answer lies in rising costs. The crude price may be at all times highs, but Exxon’s refining margins have been so squeezed by costs that its profits have suffered as a result. It also noted falling production. Just don’t mention the word “peak”. Exxon shares were down 4%.
Economic data were also weak last night. September consumer spending rose by 0.3% when 0.4% was expected. The October ISM manufacturing index fell to 50.9 from 52.0 in September, against expectations of 51.8. Weekly jobless claims rose by a greater than expected 6,000. These are the sorts of numbers which, up until yesterday, would have driven the market up on increasing expectation of a Fed rate cut. But there was no cavalry this time.
What the cavalry was busy doing was pumping US$41 billion into the US financial system – the largest injection since 2001. On the surface this was another credit crunch-related piece of alarming news. However, some analysts have pointed to a big rollover being due for Fed funds, and the fact that an interest rate cut requires a liquidity injection anyway. But boy – it was a big one.
Similarly, financial analysts outside of CIBC scoffed at that firm’s suggestion Citigroup might need to cut its dividend. Even if Citi brings back US$70 billion worth of SIV distressed positions onto its balance sheet, that amount is dwarfed by the trillions Citi holds in capital. This disagreement is somewhat of a deja vu for Australian investors. Banking analysts in Australia were yesterday having exactly the same argument over St George Bank ((SGB)).
The US dollar also responded last night the way one would have expected it to respond on Wednesday when the Fed put rate cuts on hold – it rallied back some. The reverse was true against the yen, however – the measure of risk aversion. Credit crunch fears saw the reversal of carry trading as the yen rose. This left the Aussie high and dry, and it fell back over a full US2c to be US$0.9125.
The response was similar for gold, which gave back a modest US$7.40 to be US$788.90/oz on a close-to-close basis. Oil also saw profit taking, and despite having traded as high as US$96/bbl in Wednesday’s after-market it fell US$1.04 to be US$93.49 on a close-to-close basis.
Base metals in London were mixed, with copper, lead, tin and zinc all down by 1-2%, while nickel was up 2%.
The SPI Overnight fell 109 points.
Is it for real this time? The last down move of this magnitude occurred on October 19, the anniversary of the ’87 crash. It didn’t take long for Wall Street to recover in the ensuing week, but at every turn markets were spurred on by their belief in an impending rate cut. That is now gone. Tonight in the US, before the bell, we learn the October employment numbers, which are a vital indicator of the health or otherwise of the US economy. Consensus is that 80,000 jobs will be added – a figure lower than the 100-odd thousand usually expected.
If the number is more, then that’s good news. If the number is less, then that’s bad news. And now bad news really is bad news.
