Rio Explodes As Wall Street Fights Back

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By Greg Peel

As far as the Australian market is concerned, the big news for today is the announcement late yesterday that BHP Billiton ((BHP)) had approached Rio Tinto ((RIO)) with a 3 for 1 share offer that would create the world’s biggest mining company and represent the biggest M&A deal in history. Rio has rejected the deal on the basis it undervalues the potential of the company, sending Rio shares skyrocketing by as much as 30% in London. Similar gains were made in its New York listing. BHP on the other hand suffered around a 5% fall.

This move will likely set the local market on fire today.

But back to Wall Street. Suffice to say it was a wild ride. Ultimately the Dow closed down 35 points or 0.3% while the S&P closed virtually unchanged. The Dow had been down 220 points at its lows but once again the last hour made the difference. The story here was a financial sector recovery, but the highlight of last night’s trading came from the Nasdaq, which closed down 1.9%. It was down over 3% at the lows.

The tech sector was very much the centre of attention last night as suddenly the bubble burst. Large cap techs such as Apple, Google, Research in Motion and Microsoft have had an extraordinary 12 months, some up by 100-200%. As the subprime crisis has unfolded, the tech sector has been the place to hide. With large proportions of overseas earnings, tech has been deemed not only to be immune from US domestic woes, but a booming growth story in itself. This is still likely the case, but Cisco spooked the market last night.

Networking equipment and internet management specialist Cisco Systems last night reported earnings growth of 37% in the third quarter, but fourth quarter guidance that missed the mark. This in itself was not the problem – the problem was Cisco revealing that its US corporate business has begun to appreciably suffer as corporations pull back from their IT spending plans in the face of a slowing economy and – uh oh – credit market losses. The subprime crisis has hit tech.

All the big names were trashed last night on the Nasdaq as the index was looking at a rare triple digit fall. It was only the Dow bounce that prevented such. With so much money having been recorded on tech investments it was time to secure some of that in case the ride had come to an end. Maybe tech isn’t quite so immune after all.

The low point in the Dow featured yet another low point in financial sector stocks. All the major banks and brokerages were down a few percent again, with Citi staring at its eighth straight down day in what has been an extraordinary slashing of value. The catalyst for this further fall was all about Ben Bernanke. Indeed, Morgan Stanley had bucked the trend by announcing further write-downs of only US$3.7bn when some expected US$6bn.

Bernanke made his presentation to Congress and basically made two assertions that the financial markets did not want to hear: (1) the economy is continuing to slow; (2) inflation is becoming more of a concern. This implied a December rate cut was probably not on offer.

While the inflation call would tend to put paid to any ideas of a December rate cut, just as the Fed had hinted in October anyway, in fact the opposite is apparent. The Fed funds futures market moved to a 100%+ chance of a December cut last night based on the slowing economy/credit problem duo and the assumption the Fed would be forced to cut anyway. What this would normally do is shift the yield curve down in parallel and provide an impetus for stocks, just as it has done in the past. However, inflation is the monster in the cupboard.

Lat night the US yield curve steepened dramatically as the 2-year bond fell as much as 25 basis points while the 30-year bond budged not one iota. This is a stagflationary curve (receding economy with rising inflation). This is not good for stocks because in an inflationary scenario longer term bond yields are more attractive than longer term equity yields. The financial stocks led the market down.

It was not an even spread however. Whereas on Wednesday the Dow 30 was a sea of red last night there was just as much green as red at the bottom of the market. The fall was very much concentrated in financials. Then, for no apparent reason other than perhaps an “overdone” scenario, the financials started to pull back from their nadirs about an hour out from the close. Was it because traders began to assume a rate cut anyway? In the last half hour that pullback accelerated so swiftly that most stocks actually finished in the green or close to it. Was it buyers coming in? Was it the bottom pickers back for another round? The speed of the reversal smacked very much of rapid short covering, which most traders would perceive as an unconvincing rally.

However, the financial sector has been hit so hard there must eventually be some sort of plateau, one assumes.

But the news was not all rosy in the rest of the index. Hot on the heels of General Motors recession warning came the retailers same store sales figures for October. 70% of those reporting announced lower numbers. If a recession starts anywhere it starts here – when consumers start to curb their spending.

And in a more obscure but worrying development, art auction house Sotheby’s held an auction of mega-dollar impressionists on Wednesday night and the sales were dreadful. 20 out of 86 paintings on offer failed to even receive a bid, including a Van Gogh with a reserve of US$25m. This was not good news for Sotheby’s which is obliged to underwrite the reserves. Sotheby’s shares fell 33%. The top-end buying spree may well be over. No more multi-million Wall Street bonuses.

The other, more relevant, market that lost all its bids last night was the credit market. Corporate paper has been trying to recover, but not any more. We’re back to August.

Elsewhere was a less volatile day in the markets. The US dollar held largely steady overnight as neither the European Central Bank or Bank of England raised their respective interest rates. Both are on the horns of a dilemma as they wrestle with rising inflation offset by rapidly rising currencies and credit crunch fallout. The ECB was the hotter tip to raise, if at all. This would have sent the US dollar spiralling once again. The dollar managed to remain steady to slightly down instead. The Aussie was similarly steady, while gold added US$1.10 to US$832.20/oz.

Oil bounced around in the red last night, ultimately closing down US91c to US$95.46/bbl. It looks like oil might be attempting to acclimatise around this US$96 level before deciding whether or not to make the final assault on the summit of US$100/oz.

It was similarly a red day for base metals as copper broke a significant resistance level. The bellwether metal was down 3% in London while lead lost 5% and the others around 0.5%.

After a bad day yesterday, the SPI Overnight was up 79 points, with Rio Tinto a large cap in the index (although so is BHP).

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