FYI | Dec 05 2007
By Greg Peel
The Dow fell 66 points or 0.5% last night, while the S&P and Nasdaq each fell 0.65%.
Weighing on the market was the financial sector, yet again. Throughout the course of this second pullback in the index, investors have been trying to find a bottom in financials – not such a silly trade given many big names have fallen 30-40% since May. However, at each turn the bottom-pickers have come away disappointed. Last week’s Abu Dhabi injection into Citigroup offered the most recent silver lining, but even the weight of Arab money – and the potential for so much more – is currently failing to overcome the general gloom surrounding US banks and brokers.
Broad market fourth quarter earnings expectations have now fallen from +10% a month ago to +2% now. The bulk of those downgrade has come from a near 30% reduction in financial sector expectations over that time. A lot of this has had to do with new accounting standards which came into force in November and force institutions to be more realistic about valuations on distressed CDO positions.
Last night analysts at JP Morgan downgraded Goldman Sachs, Merrill Lynch, Lehman Bros and Morgan Stanley. It is not everyday an analyst will downgrade a stock which has already fallen substantially – it’s hard to admit you were wrong. But JPM has decided the ongoing problem lies not in the immediate credit security write-downs that are yet to be fully determined, but in the longer term market perception that such institutions can no longer be considered good risk managers. This is particularly interesting in the case of Goldmans, which was the only major US institution to actually short dodgy mortgage derivatives.
While JPM may have targeted these particular stocks, the market read the opinion as being more universal. Hence every financial stock copped last night, including other banks such as JP Morgan Chase itself, mortgage lenders and mortgage insurers.
Back in the real world, pharmaceutical giant and Dow component Merck issued downbeat 2008 guidance sparking selling in its shares as well. Merck has been neck and neck with McDonalds in 2007 as to who will post the best return. Both are currently over +30%. Merck is considered a consumer staple as recessions don’t stop people buying drugs, while the sad reality is that McDonalds is also a consumer staple for Americans. Both, however, boast significant offshore earnings so when one reduces guidance it’s a bit of a downer all round.
So it’s a gloomy mood as far as credit concerns and recession concerns dictate, but the unusual aspect of this is that there is increasing talk the Fed must now cut by 50 basis points next week. When last there was rampant expectation of a big Fed cut the market kept soaring towards new highs.
Perhaps traders are now coming to terms with the fact that (a) if the Fed has to cut by 50, it means things are pretty bad; (b) it has already cut by 75 and achieved nothing; and (c) Libor continues to rise.
The three-month London Interbank Offered Rate (Libor) spiked in August, eased back a tad, but has spent the last month pushing ever higher once more. It has now pushed over 5% from about 4.5%. While the Fed can lower the cash rate all it likes, the fact remains Libor is the rate at which global banks exchange funds. Despite talk of another big US rate cut, Libor has continued to rise.
The point about the Fed cash rate is that you can lead a horse to water but you can’t make it drink. Banks do not borrow at the Fed’s cash target, the Fed simply ensures there is enough liquidity in the system to allow this to be the case. The liquidity might be there, but no one is lending. The Fed discount rate is more important in this credit crunch scenario, as that is the rate at which the Fed itself will actually lend to banks. But this facility has also been sparsely used given the stigma attached to running to the Fed.
The most important point about Libor is that this rate forms the basis from which most adjustable rate mortgage rates are set. Everyone is worried about the wave of substantial rate resets that are about to occur, and yet a lowering of the Fed cash rate may not actually have any direct effect.
In a move that may seem surprising, Canada last night lowered its cash rate by 25 points to 4.25%, reversing the July hike. As the Canadian dollar has soared against the greenback this year Canada’s export industry is in disarray, while Canadian inflation has slipped under 2% as another strong currency effect. This has interesting implications for Australia (more on that later today).
The US dollar thus had a mixed day of reasonable moves but in all different directions. It was down against the yen and euro but up against the pound. It was obviously up against the Canadian loonie, and also against the Aussie (which is really the fault of a rising yen). However, the move in the Aussie was not really an overnight one, for the Battler had already slipped to its level of US$0.8737 in yesterday’s local market.
Gold took off to be back over US$800. Spot rose US$11.00 to US$801.90/oz in what was described as a move on the falling dollar, but lends more to a technical factor of the nervous +$800 longs having bailed on recent weakness. With the impetus of another rate cut, gold was able to return to bullishness now that its overbought futures contract levels have been reduced. As much as the world has been short the greenback, it has been long gold.
Oil fell again last night ahead of the OPEC production meeting tonight. Last night’s impetus, apart from general economic gloominess, was an announcement from US officials that Iran actually did stop its nuclear weapons program – back in 2003. So what the hell was all the fuss about? Did someone say WMD? Oil fell US99c to US$88.32/bbl, but at one stage was a good dollar lower. Given a lot of oil’s premium has been to do with geopolitical tension (particularly Cheney’s threats of military attacks against Iran’s nuclear facilities) one might have expected a somewhat stronger fall. It just goes to show that demand/supply considerations are alive and well.
The official base metal closing prices in London look very, very ugly. (aluminium -2%, copper, nickel, tin -4%, lead -5%, zinc -7%). The global economic outlook continues to weigh. However, “official” prices are marked before the end of open outcry trade and last night the late bargain hunters moved in to pare back a lot of the losses. Closing prices are thus better reflected in the New York session (aluminium unch, copper -1.5%, lead -3%, nickel, zinc -4%).
The SPI Overnight fell 27 points.
