FYI | Nov 17 2007
By Greg Peel
When they tossed the coin at 3.30pm on the floor of the NYSE on Friday, finally it came up heads. Six of the last eight sessions it had come up tails. This meant that traders could evoke a rapid half-hour rally instead of the recent half-hour crashes. The Dow subsequently closed up 66 points, or 0.5%, having been in the red at about twenty-to-four.
It was a fun ride to get there however, as Arthur and Martha spent all day banging into each other. It was up double digits, down double digits, up triple digits, down double digits, and finally up. Friday’s session was representative of a similarly wild week, where the Dow passed through a close-to-close range of about 400 points and an intraday hi-lo range of about 800. When the traders finally got to hit the bars on Friday evening, that first beer must have tasted really good. All up, the Dow rallied 1% for the week.
The S&P finished up 0.5% and the Nasdaq up 0.7% for the session.
The week could be summed up into two questions – is the US economy heading into recession?; and is there more to come on the credit crunch? But you can probably add a third question – if the answer to both is yes, has the market already adjusted accordingly?
Which goes along way to explaining why the week was so volatile. Both the first questions are linked to one source, and that is the US housing market. Mortgage defaults = less consumer spending + more credit write-downs. Over the course of the week, analysts continued to downgrade fourth quarter earnings assumptions. For the S&P 500 this meant a fall in growth forecast from 11.5% to 3%. The major contributor to this adjustment was the financial sector, which fell from flat growth to down 20%. That’s in a week!
Friday saw the usual good news/bad news mix. On the good news front, Morgan Stanley upgraded Hewlett Packard to Overweight and it shot up. Troubled Cisco Systems announced a $10bn buyback and it shot up. But despite the positive close, the bad news was probably more daunting.
October industrial production plunged 0.5% – the largest drop in nine months and a much worse figure than expected. This is the stuff coming out of America’s factories, mines and utilities. Within the number, third straight monthly reductions were registered in auto, timber and anything else related to housing. Roll out the R-word.
In more fuel for the R-word, leading US freight company Fedex came out and slashed its earnings expectations for the December (its second) quarter and for its full financial year. Apart from a drop-off in freight demand (as correlated by the IP number), Fedex has struggled to raise fuel surcharges fast enough to offset losses on av-gas and diesel costs. If the oil price does not come down from here, said Fedex, its forecasts will have to be cut further.
Moving from Main Street back to Wall Street, mortgage lender Fannie Mae came under fire once more and saw its shares plummet for a second day in a row. The accusation is that Fannie’s accounting methodology understates mortgage losses. Fannie has only just settled its new accounting methodology following the scandals of 2004. The company has a track record of cooking the books. Probably not the best time to cook them now.
General Motors has a finance division – GMAC – and GMAC has a mortgage division – Residential Capital, which has since been sold off to private equity. Press reports suggested late on Thursday that Residential was close to breaching loan covenants, and that its private equity backers may not be prepared to bail it out. (Cue Queen)
Perhaps most unnerving for global credit markets is that the London Interbank Offered Rate (LIBOR) is once again widening over cash. This is that rate upon which all global banks base their funding costs. The greater the spread on Libor to cash, the more banks must raise their lending rates. This is the sort of stuff John Howard has been on about. “There is no reason for banks to raise their mortgage rates beyond any RBA move,” says John. “Oh yes there is,” say the banks.
The Libor spread had settled back from its heights at the depth of credit crunch phase I, but its movement now, countered by a fall in US Treasury yields, confirms credit crunch phase II. Over the last week, news has emerged that some US$5bn of intended high-yield corporate bond offerings have been pulled.
Put all of this together and we have our Arthur and Martha story. There are still more US retailers to report their quarterly earnings and guidance, and these will be closely watched. Analysts are busy going into downgrade mode, but analysts are usually behind the market. Financials and retail have already been hit very hard, and traders are finding it difficult to sell them down further. But they’re not really a great buying story while uncertainty remains, so it’s a case of what to hide in. Tech has obviously been one sector, and another is consumer staples. Stocks like Proctor & Gamble and Coca-Cola are hitting new highs as recessions do not affect the buying of washing powder or fizzy drink.
We’re really now in wait-and-see mode, with the previous Dow low looking perilously close as we hold our breath for Christmas trading. If the mortgage Grinch steals Christmas (accompanied by his cohort, the oil Grinch) then early 2008 does not look promising for the US stock market. At least until all the bad news is out in the open, and stocks suddenly look very cheap.
The US dollar continued its fall again on Friday, while carry trade unwinding took another breather. The Aussie finished up at US$0.8921. Gold is still nervous, falling another US$2.90 to US$785.40/oz despite a falling dollar and another up-night for oil. Oil closed out the December delivery contract up US$1.67 to US$95.10/bbl. On Monday we roll into the January contract which closed at US$93.84/bbl.
All base metals were weak on the official London close despite the weaker US dollar, with copper managing to stage a fight-back in late trading.
The SPI Overnight was up 43 points.
