Daily Market Reports | Feb 28 2008
By Greg Peel
On February 27, 2007, China’s Shanghai stock market fell 9% – not a hugely unusual fall for a very volatile market but a definite break in what had appeared up to that point to be an endless run. That night the Dow fell around 400 points – a very big daily correction in what had also been a comfortable bull market. Australia was surprised by the extent of the US response, and fell 160 points the next day (ie, today).
It was not the specific fall in China that spooked Wall Street, it was a more fundamental underlying recognition that risk had been stretched to the limit. Emerging market investment represented risk, but suddenly a new word appeared in the traders lexicon. It was “subprime”. The fall in the risky Chinese market exposed the high levels of risk built into the subprime mortgage and related CDO market. While many a trader may have jotted down these concepts for future reference, it was all quickly forgotten and the bull market returned pretty swiftly.
Until July, when Bear Stearns brought the reality home. Two of its hedge funds invested in subprime securities were facing bankruptcy. The rest is history.
The Dow closed last night up a mere 9 points, which is as good as unchanged. The S&P lost 0.13% while the Nasdaq gained 0.4% led mostly by a recovery in the Google share price after some big falls. Year-on-year the Dow is up 6.1%. Given all the turmoil, that figure’s almost hard to believe. The ASX 200 to yesterday is down 1.1%. We were supposed to be the immune ones. Shanghai, which set the whole global credit crunch in train, is up 56%.
Arthur and Martha returned to Wall Street last night, ensuring a topsy-turvy session which saw both up 72 and down 75 at different points. There was no closing momentum in either direction. The volatility was in response to a combination of bad news, good news, and bad news that is good.
The bad news was January durable goods orders declined by a greater than expected 5.3%, and January new home sales fell 2.8%. While bad, the news is hardly a shock, but it was still enough to take the wind out of the recent rallies.
The good news was that regulations had been lifted on the government sponsored mortgage buyers Fannie Mae and Freddie Mac, allowing the two to expand their portfolios of mortgage purchases from prime into other variations. In other words, Fannie and Freddie can start buying some of the more distressed mortgages, which in theory should ease some of the current default risk. Fannie and Freddie then securitise these mortgages. I wonder who will buy them.
The bad news that was good came from Ben Bernanke, as he began his regular bi-annual testimony to the House. It was a very downbeat presentation. “The economic situation has become distinctly less favourable,” he noted.
This was the first time we’d heard from Bernanke since the recent release of the February FOMC minutes, which are now a month old. The mood has clearly become one of greater concern. Bernanke sees the housing slump continuing throughout 2008, and suggests the US should prepare for “sluggish economic activity in the near term”.
But the Fed chairman also noted “Should high rates of overall inflation persist, the possibility also exists that inflation expectations could become less well-anchored”. So far the Fed has increased its 2008 inflation expectation slightly, but expects pressure to later ease due to the slowing economy. But Bernanke has now conceded that inflation can be self-fulfilling, and that it would be “hard to maintain low inflation” if oil prices continue to rise.
But the critical pronouncement was that the Fed “will continue to act in a timely manner as needed to support growth and provide adequate insurance against downside risks”. In other words, we’ll cut rates again if we have to.
This is what Wall Street wanted to hear, and the market responded by pushing higher. The rally ran out of puff however, as traders watched the US dollar collapse. The euro pushed to a new all-time high of US$1.5136. The dollar index sunk to a new all-time low. The Aussie gained yet another US1c to US$0.9428 to push it back to the highs of November.
This is the stagflation conundrum – cut interest rates and the US dollar falls, and then by default all commodity prices rise, increasing inflation.
Gold responded accordingly, rising US$9.00 to an all-time high of US$958.00/0z. Oil initially did the same, pushing to above US$102/bbl but the weekly inventory numbers came in with a bigger “build” than expected and profit-taking saw oil fall by US$1.24 to $US$99.64. Inventories have been building now for weeks, which is exactly what one might expect in a slowdown. It has been outside factors, mostly geopolitical, keeping the price pressure to the upside.
On the London Metals Exchange, it was a fund buying frenzy. Real commodities are regaining their appeal as a “safe haven” from the troubled financial markets, and another inflation play outside of gold. Gold is at new highs, but most metals are still below their peaks. Zinc rose 8%, aluminium and nickel 4%, and copper and lead 2%.
The SPI Overnight fell 37 points.
Happy Anniversary.
