Daily Market Reports | Mar 01 2008
By Greg Peel
Up by the stairs and down by the elevator – after a week of tentative gains Wall Street gave it all back on Friday as a wave of bad news hit the markets. If you want to make it sound really disastrous, it was the worst leap day on Wall Street since the nineteenth century, but in nominal terms that ‘s a bit sensationalist.
Friday saw a meltdown in the municipal bond market. The subprime mortgage crisis which the bulls called a storm in a tea cup last July has spread from CDOs into all asset-backed securities, private equity debt, all non-prime mortgages, corporate debt, credit default securities, bond insurance, and now municipal bonds. There are trillions of dollars of municipal bonds on issue in the US, and the asset class is considered in many cases to be second only to US Treasuries in terms of capital security.
Municipal bonds are issued at state and local level in the US to finance capital projects such as infrastructure or utilities. You might, for example, buy a New York State water & sewerage muni bond. Muni bonds came into the credit crisis frame in February as it became clear the big US monoline insurers, which insure everything from munis to CDOs, were under threat of losing their AAA ratings which would, in turn, cause the bonds insured to lose their AAA ratings and spark a massive sell-off. Government agencies and banks are currently in a race against time to come up with rescue packages for these insurers in order to avoid this disaster. It is the CDOs in insurers’ portfolios that would trigger the downgrades. Munis would be collateral damage, if you pardon the pun.
But information is instantaneously discounted in financial markets and risk adjustments made accordingly. Under real threat of a potential sell-off, muni bond credit spreads have blown out meaning prices have already tumbled, if not yet crashed. But Friday saw the end of the month and that means margin calls. Many hedge funds have long been playing the long munis/short Treasuries spread as means of picking up a few basis points on the spread. That trade has now gone awry, and hedge funds were forced on Friday to unwind positions to try to make good on margins. The muni market took a big dive.
US Treasury yields had been ticking back up last week as inflation concerns blew out the long end and the possibility of the Fed suspending its rate cuts drove up the short end. But while we began the week with the two-years over 2% and the ten-years over 4%, a rush of buying in the last couple of sessions has seen the two-year yield fall to 1.65% – the lowest since the 2002 recession – and the ten-years to 3.5%. Money has flowed back into Treasuries as the Fed has made it clear another rate cut is coming and everything else has imploded in the meantime, including munis. And including stocks.
The Dow closed down 315 points or 2.5%. The S&P lost 2.6% and the Nasdaq 2.7%. After four consecutive down-months Wall Street was hoping earlier in the week February would break the run, but now it hasn’t. Many traders have suggested Wall Street would need to retest the January lows before it could meaningfully begin a rally. The close last night was 12,266 – 296 points shy of that low in the Dow.
It wasn’t a case of what was the bad news on Wall Street on Friday, it was a case of what wasn’t. The session began with the news the Chicago purchasing managers’ index fell to 44.5 in January, down from 51.5 in December. Economists were expecting a reading of 49.7. The index is based on 50 being the neutral point, and as such a number below 50 is recessive.
The Reuters/Michigan University consumer confidence measure for February fell to 70.8, down from 78.4 in January. This is the lowest measure in sixteen years, and represents a 30% fall in confidence from January 2007. Survey directors said falls off such magnitude have always preceded recessions, and noted the number of households reporting financial distress in February was greater than in any time in the depths of the 1991 recession.
Conversely, consumer spending rose by 0.4% in January against an expectation of only a 0.2% gain. A silver lining? No way. Inflation also rose 0.4% in January, meaning the increase in consumer spending was not a volume increase, but simply a price increase. Spending was thus actually flat.
A bagel seller interviewed on CNBC on Friday (bagels are the staple diet of cosmopolitan Americans) noted that last year he was paying US$12 for a bag of wheat. On his latest price enquiry he was offered US$68.
And the corporate news didn’t get any better. Financial insurance giant and Dow component AIG announced a loss of US$5.3bn in the fourth quarter – much worse than analysts were expecting – blamed on mortgage security and credit default swap write-downs. AIG shares lost 7%.
News emerged the rescue package for monoline insurer Ambac, which was expected to be sealed during the week, was rejected by the ratings agencies as insufficient to prevent a downgrade from AAA. It’s back to the drawing board for the banks involved.
UBS analysts issued a report suggesting total credit market write-downs would reach US$600bn. Only US$160bn has been written down to date.
The tech sector has attempted to be an oasis of stable offshore earnings and defensive quality to date, but Dell reported last night profits from computer sales had fallen 5% year-on-year in the fourth quarter. The market reacted by sending Dell’s shares down 6%, and the Nasdaq was dragged down in sympathy. Or is that empathy?
Do we need to hear anymore?
The US dollar rose slightly against the European currencies last night, possibly reflecting Treasury buying, but fell heavily once more against the yen. At 103.7 yen this is the lowest level for the dollar in three years, and the dollar index again ticked down to a new low. This conspired to spark a rapid turnaround in the Aussie dollar’s surge (yen buying implies carry trade unwinding), following on from preliminary GDP data which showed the Australian economy had slowed from 4.3% to 3.9% annual growth in the December quarter. The Aussie fell US1.76c in 24 hours to US$0.9312.
Gold rose slightly on Friday – up US$3.50 to US$973.60/oz.
Oil finally took a breather on Friday, but not before registering a new intraday high over US$103/bbl as news came in of a pipeline shut-down in Ecuador. Any little thing is going to send oil flying at the moment, but weak economic news finally gave some cause for profit-taking and oil fell US75c to US$101.84/bbl. The fall in the oil price also sparked selling in Exxon and Chevron, as if the Dow needed any more help in falling.
Base metals decided also to take a breather, as the buying frenzy gave way to profit-taking on the weak economic news in the US. Metals fell 1-2% with the exception of recent star nickel, which added another 1.5%.
The fall on Wall Street was accompanied by high volume – much higher than the average volume on the previous up-days. Despite the fact the muni crunch was put down to end of month margin calls, one trader commented that the end of month, and the fact it was a Friday, probably saved the Dow from falling over 500 points as speculators would have been less eager to increase short positions over the weekend and into March.
The SPI Overnight fell 144 points to 5420. This closing level implies that Monday will see the ASX 200 open below the significant support level at 5500. Friday’s trade saw yet another attempt by the short side to push the index through this barrier, but like so many times in the past two weeks the strategy failed, and buyers turned the market around. Technicians suggest that a break of 5500 will see a sharp move to 5300, which on Friday’s physical close is 272 points away. The January low is 5186.
