FYI | Nov 29 2007
By Greg Peel
Perhaps the most defining difference in last night’s 331 point rally in the Dow was the fact there was no last-half-hour mayhem. There was no reversal, no ridiculous falls or gains on thin air. Wall Street opened strongly on the bell, went up all day, and held it at the close. The final print was only slightly off the +367 peak.
That was a 2.6% rally for the Dow to 13,289, while the S&P added 2.9% to 1469 and the Nasdaq shot up 3.2% to 2663. It was the biggest single-day percentage gain in the Dow in four years.
The stage had been set for a more positive move following Tuesday’s Abu Dhabi rescue package announcement for Citigroup. While the capital injection itself was not momentous, the implication of lurking foreign buyers was enough to make the shorts in the market sit down and have a rethink. And this market has been very short. There were likely a few investment committee decisions made on Tuesday night reaching a conclusion that covering might be prudent, particularly in the financial sector. But when the opening bell tolled, the short coverers were already queued out the door.
After the close of the market on Tuesday, semi-government mortgage lender Freddie Mac announced it would be cutting its dividend. While this is usually ritual suicide for a financial institution, the market had already sold Freddie down precipitously on expectation of such an announcement. It wasn’t good news, and the fall in the Australian market yesterday was attributed to some extent what it may represent. But accompanying the dividend announcement was a further announcement that Freddie would issue US$6bn in capital in order to shore up its reserves. That’s US$6bn at its absolute share price nadir.
Suffice to say, the issue is already oversubscribed. If the Arabs can buy in at the bottom, everyone can. Freddie rallied 13% on the day, and sister Fannie Mae put in a similar performance. Suddenly the floodgates opened on the oversold financial sector. Fresh buyers, who have been sitting in cash for weeks, were elbowing aside the shorts in the rush to snap up financials at what might be the end of the correction. And if financials have been sold down, so has everything else – home builders, retailers, airlines – everything was up for grabs in the pre-Christmas run-out sale.
Then at around 2pm, it got even better.
When Wall Street rallied off its August lows to return to its highs once more, it did so because of expectation of a Fed rate cut. Good news was good news and bad news was good news. Even after the Fed cut by 50bps, more was expected. But when it cut by another 25bps, the Fed’s rhetoric suggested it was all over, and there would be no more cutting. It was time to let the market sort itself out.
Well sort itself out it did – all the way back down to the 10% correction mark. Bad news was now bad news, and all the news was bad. While the futures market was still building in a 100% expectation of a December rate cut, the stock market just wasn’t confident. The credit crunch was only getting worse, and a recession was looking more and more possible. And supposedly, there was no cavalry.
Last night the October durable goods orders number came out down 0.4%. It was just the latest in a long line of ominous data. But when the Fed opened up its Beige Book – a largely anecdotal survey of economic conditions across the country – it revealed findings that were very discouraging. The economy did actually grow in October to mid-November, but at a much reduced pace. Conversations with retailers were very downbeat about consumer spending. The Fed could no longer remain on the sidelines.
The clincher came when Fed number two honcho Donald Kohn spoke at a function in New York. Kohn pointed to the recent acceleration of weakness in sentiment on Wall Street and suggested such turbulence was a real threat to economic activity. The actions taken by the Fed in August and September had clearly now been undermined by ongoing turbulence. The Fed committee, said Kohn, must remain “nimble”.
Read: We will cut in December.
Hooray! There is a Santa Claus! A rate cut means the Fed is at the wheel, ready to steer the US economy and financial markets out of the mess. The fact that a cut is only a response to conditions being so bad is not a consideration for the stock market. Cheap money is the investor’s fuel, and cheap money is what investors are going to get. Buy!
And buy they did. The rally in stocks was offset by an equivalent rush back out of the safe haven of US Treasuries. The 2-year bond yield soared 20bps and the 10-year 10bps. And risk was back on the agenda, as carry traders returned to dump the yen and buy whatever they could. The US dollar indexed thus bounced up hard, despite making little headway against the pound and euro. The Aussie dollar – recipient of carry trade funds – jumped almost US1.5c to US$.8903.
But wait, there was more good news. The oil price fell solidly again – down 4% for the second consecutive day as news came out that inventories had not declined by as much as was expected. The January contract fell US$3.80 to US$90.62/bbl, going a long way to erasing fears that US$100 oil was inevitable. If the oil price is retreating, that’s very good news for the US consumer.
Gold traders had a bit to think about. The US dollar bounced, but only really against the yen. Expectations of a Fed rate cut should send the dollar lower but the market had already built one in. Gold can be a target of carry trading, and any rate cut should be inflationary from a money supply sense. But then oil fell heavily again. What to do? Sell gold down another US$7.70 to US$803.70/oz.
The situation was similar over in London. While a rate cut is a positive, it would only happen because the economy is already so bad. There is still a fear of a fall in demand for base metals. Last night metals did bounce somewhat in the exuberance late in the day, but not convincingly. Metals are currently volatile and largely directionless.
After anticipating the worst and defying the trend yesterday, the Australian market is set for at least some sort of a bounce today. But oil is down again and gold is weaker. Metals are not giving much indication. The SPI Overnight rallied 128 points.
Is it the bottom this time? It didn’t seem to work last time. Remember – the real economic uncertainty is still out there. But we may be in for a bit of a rally ahead, if only in the short term.
A note to subscribers: Just to remind you that you can now use the Cockpit to examine the equivalent Aussie dollar-denominated movements in US dollar-denominated commodity prices overnight. Just click the appropriate tab, and the model will apply the overnight change in the Aussie to the overnight moves in prices on a fix-to-fix basis.
