FYI | Nov 28 2007
By Greg Peel
This time it’s for real. The 215 point rally in the Dow last night was not about thin market holiday shadows, it was about a significant change of mood on The Street. If it’s always darkest just before the dawn, then Monday may have been Wall Street’s dark day. As to whether the dawn will bring sunshine or more storms is still, however, uncertain.
The news that dominated Monday was speculation America’s largest bank – Citigroup – would need to jettison some 45,000 staff in order to slash costs and avoid capital adequacy issues. It is probably no coincidence that this (unconfirmed) commitment occurred just before yesterday’s announcement that the Abu Dhabi Investment Authority had agreed to inject US$7.5bn of capital into Citigroup.
Abu Dhabi is the largest of the seven United Arab Emirates, and the city of Abu Dhabi is arguably the richest in the world. The Investment Authority is the emirate’s sovereign wealth fund and is the largest such fund on the planet. The fund is overflowing with petrodollars garnered from selling oil to Americans at today’s extraordinary prices. There is a certain symmetry in petrodollars being fed back to invest in a US bank.
It is not so much the size of the investment that matters – US$7.5bn equates to a good Friday lunch in Abu Dhabi. And Citigroup had to pay dearly for the rescue package. The deal represents converting preference shares at a massive 11% coupon. It represents 4.9% of Citi’s current balance sheet and is a “silent” stake, with no exclusive voting rights or board participation. What matters here is that it may prove a drop in the bucket of an Arab (And Chinese? And Russian?) invasion. The US dollar is making everything cheap.
The effect of the deal was, however, to swing sentiment back to the positive. The Arabs are reputedly not just looking at Citi, but also at JP Morgan, other financials, as well as troubled home builders and retailers. The word is that other US companies have put up for sale signs and are madly soliciting Arab funds for similar packages. Who’d have thunk it?
The Citi news broke yesterday Australian time and was responsible for turning around a very weak ASX 200. The US followed suit and pushed the Dow up 215 points, or 1.6%, at the close. The S&P was up 1.5% and the Nasdaq 1.6%. Having broken down into 10%+ correction territory on Monday, the Dow passed back through the mark to close 113 points above the August low. The S&P was within an insect’s appendage of its low on Monday, but has similarly rallied away.
It wasn’t all smooth sailing for Wall Street, however. The Dow needed two gos to get over the 200 point mark, and fell back to under +100 mid-afternoon. One reason for the wobbles is that not all consider Citi’s deal to be a good one, and indeed for a stock that has regularly been moving down 5% a day, its rally of 1.6% last night seemed fairly muted.
But Wall Street will clearly take what it can get at the moment, and the market is definitely feeling oversold in the short term. The reversal of sentiment was widespread across financial markets as US bond yields bounced back the 20-odd basis points they’d lost on Monday and the US dollar rallied away from its lows, including quite a sharp move against the yen. The Aussie dollar was the beneficiary of yen selling, and it put on over 60bps to be US$0.8769.
Oil was another story unto itself last night. OPEC is still carrying on about increasing production, peace talks have once again been initiated in the Middle East, and there are still recession concerns. Oil fell a solid US$3.48 to US$94.42/bbl – another positive for the US stock market in general.
A rising dollar, peace talks and a big down-move in oil is not the stuff of gold bullishness, and the precious metal lost US$12.20 to US$811.40/oz.
Arab-mania may have swept The Street and ensured the big closing rally, but a couple of other points were washed over in the stampede (except in the oil pit). Another reason, perhaps, the market wobbled mid-session.
The official November consumer confidence measure was released last night, and for a pre-Christmas portent it was bad. The index fell to 87.3 against expectations of 91.5. The revised October number was 95.2. It was the worse confidence reading since immediately after Katrina.
The minutes of the Fed’s discount rate meeting were released. Now this meeting occurred before the last cash rate meeting, the minutes for which we’ve already seen. Don’t ask me why the delay. But the point is the Fed representatives were split over whether to cut the discount rate, and this is just another element to the potential of no Fed interest rate cuts early next month. The governor of the Philadelphia Fed also reiterated inflation warnings last night – another pointer to no further monetary action. Nevertheless, the futures market is still factoring in 100% for a 25bps cut in December.
Over in Britain there was good news on the financial front. Barclays announced that due to the solid performance of non-credit related areas of its operation it was still on track to meet consensus expectation for its FY07 (ends March) profit result. Barclays shares rallied close to 6%, although the FTSE fell 0.6% because it closed when the Dow ran out of steam mid-session.
The story at the LME was not so hot. Metals traders had suggested that Monday’s rallies were timid and unconvincing, and sure enough most metals slid quietly last night. While Abu Dhabi was good news metals traders still fear the credit crunch and a US recession, evident in the fact copper fell 2% despite its first fall in inventories for a while. The bounce in the US dollar was also a headwind.
In terms of today on the local bourse, it must be remembered the Abu Dhabi news broke mid-session yesterday, turning the ASX 200 around from down 120 to down only 40. Last night further saw heavy falls in oil and gold and ongoing weakness in base metals. All of the above is reflected in the fact that despite the Dow being up 200 points, the SPI Overnight only gained 27 points.
What does the Abu Dhabi news ultimately mean? What it doesn’t mean is an immediate resolution of the credit crunch or an end to recession fears. It should not be forgotten that Bank of America made a big capital injection into Countrywide in August, and that company is now flirting with bankruptcy. However, it does reinforce the fact that the rest of the world still has plenty of liquid funds and that the weak US dollar makes the US stock market very attractive. There is hence unlikely to be a black hole underneath current index levels, but perhaps a series of safety nets in the form of bargain-hunting sovereign wealth funds.
