FYI | Nov 21 2007
By Greg Peel
It takes me less than ten minutes to walk to my corner store and back, something I did this morning when I realised we’d run out of milk. When I left, at around 3.30pm New York Time, the Dow was down 70 points. When I returned, it was up 70 points.
That was the way it was on Wall Street last night as the headless chooks took over the floor in low-volume, pre-holiday trading. The Dow burst hard out of the blocks to rally 149 points in early trade, spurred on by a couple of positive earnings results announced in the previous after-market. Dow component Hewlett Packard and large retailer Nordstrom bucked the recent trend by posting solid gains.
But then Freddie Mac announced its third quarter earnings.
The Federal Home Loan and Mortgage Corporation (Freddie Mac) is an enigmatic organisation – a publicly listed company but also a “government sponsored enterprise”. Like its partner, the Federal National Mortgage Association (Fannie Mae), Freddie writes loans to Americans under government controls but is not actually guaranteed by the government. The important point about Freddie however is that under said controls it is not allowed to write subprime mortgages. Freddie deals only in prime.
Last night Freddie Mac announced a third quarter loss of US$2bn which included a provision of US$1.2bn for expected bad home loans. This was much worse than the market had expected. It also suggested it may have to halve its dividend – which would represent its first ever public dividend reduction – and may have to stop writing loans to seek new capital. Stunned traders sold the stock down nearly 30%. The shares had already fallen 45% since August. Fannie Mae lost 25% in sympathy.
Freddie’s competitor Countrywide (which otherwise specialises in subprime) also came under fire last night – again – as rumours went around the company was facing bankruptcy. Management sternly denied the rumours, but for a stock whose share price has just about gone out the back door such denials probably had a hollow ring.
Suffice to say the wind went out of Wall Street’s sails on that announcement, and the Dow turned abruptly around. Then the Fed released the minutes of its October meeting.
The highlight of this particular minute release was that for the first time ever the Fed had pledged to divulge its own forecasting in a new spirit of disclosure. So as well as the look-back (the minutes themselves) the world was also let in on the look-forward. The highlight from the minutes was that October’s 25bps rate cut was “a close call”, meaning that the committee was split on its views. One feature of the statement that accompanied the rate cut at the time was a return to inflation concerns.
On the strength of the minutes alone, one would draw the conclusion that a December rate cut was unlikely. This is bearish. However, the Fed’s 2008 forecast told a different story.
The Fed cut its 2008 GDP growth forecast by about 0.5%, suggesting a range of 1.8-2.5%. At present, the bulk of economists are working off 1-2%, while others are calling a recession. So the Fed has decided the US economy will slow more than it had believed last month, but still its forecast is more optimistic than most. How does one read that?
Well it doesn’t really matter because while the Fed decided unemployment would only rise slightly as a result of the slower economy, it also decided that headline inflation (including food and energy) would fall from 3% to 2% in 2008, mostly reflecting lower oil prices. It is logical to assume a slower economy would mean lower oil prices, but Wall Street traders could simply not believe what they were hearing. Inflation fall by 1%? On which planet?
The Dow had already wiped off its gains by this stage, and headed further into the red. At its low it was down 119 points which, at 12,839, was a breach of the August low. But then I went out to buy some milk.
The conclusion was that the Fed’s forecasts may not mean a rate cut in December, but the way is very much clear for one or more rate cuts in early 2008. Despite the fact the 0.75% in cuts to date have done nothing to stimulate either the housing market or credit markets, this is still bullish news. Sort of. But it was actually the big oil companies in the Dow – Exxon and Chevron – that led the index back up, and dragged the rest of Wall Street with them. The Dow closed up 52 points, or 0.2%, while the S&P gained 0.45% and the Nasdaq 0.1%. At the depth, the Nasdaq had been down 1.2%.
The oil companies took off because the price of crude oil took off, again. Oil for January delivery rose US$3.39 or 3.6% to US$98.03/bbl, spurred on by expectations that tomorrow night’s inventory numbers will be low, and also by a fire at one of Canada’s oil sands operations. Just as well the economy will slow and inflation will fall.
The US dollar weakened to a new low on interpretation of more rate cuts to come, and that set gold off once again. Having shaken out the nervous longs, gold shot back up US$23.00 to US$804.40/oz, assisted by the oil price rise. The Aussie rallied to US$0.8905.
Base metals began the London session weak again after Monday night’s big falls, thus posting losses at the official settlement. However, a late market reversal saw metals largely unchanged from Monday, a move which is better reflected in New York session prices.
The SPI Overnight ended a night of confusion up 32 points.
The Dow is now back over 13,000 (13,009), having breached the previous low on intraday trading. For the moment that has kept the technicians at bay, for they are waiting for a close below 12,845 to call Armageddon (particularly the Elliot Wave surfers). While this is a relief, the sheer speed of last night’s late rally (even measured in terms of the usual last half-hour mayhem) was not something you’d call convincing. Tomorrow is as good as a half-day on Wall Street as everyone jumps at plane back to Home Town USA for Thanksgiving. Could be interesting.
