The Overnight Report: Financials Mark New Lows

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By Greg Peel

The Dow closed down 134 points or 1% while the S&P lost 1% and the Nasdaq lost 1.2%.

The Dow was down 211 points at lunch time before stabilising. A typical late-session rally took it back to be down 134 on the day. Last night was nothing to do with oil, which posted a mere US41c rally to US$127.76/bbl. Storm clouds had been gathering in the financial sector once more as oil had drawn away Wall Street’s focus. Last night lightning began to strike.

It started across the pond in Britain while Wall Street traders were still blissfully tucked up. Bradford & Bingley is a northern based bank in the St George Bank ((SGB)) model, having begun life as a building society. Last night shares in the bank fell over 30% during the session, before recovering to be down just over 20% at the close. The drubbing was due to a profit warning which saw guidance of a 150m pound profit in the four months to April reversed to an 8m pound loss.

The bank, ominously known locally as B&B, also scrapped a previously announced rights issue given its share price had fallen below the level of the new capital price. Instead it announced a sale of 23% of its capital to private equity.

B&B is a specialist in buy-to-let housing loans, which have turned many an average Joe into a property investor during Britain’s property boom of the previous several years. It also leads in the issue of 100% value loans, negative equity loans, and self-certification loans (which are known in the trade as “liar loans”). In short, B&B is a specialist in subprime mortgages. Britain’s housing slump has only just begun.

Wall Street awoke to this news and began having deja vue flashbacks. Then as the boards opened for the morning it was learnt that the CEO of leading commercial bank Wachovia had been taken out and shot. At the same time Washington Mutual, America’s biggest thrift, announced it had stripped its CEO of his additional chairman’s role. The mood was sour.

And then later in the morning ratings agency Standard & Poors downgraded investment banks Lehman Bros, Merrill Lynch and Morgan Stanley and put commercial banks JP Morgan and Bank of America on negative outlook. S&P is expecting more security write-downs due to continuing weakness in the mortgage and residential construction markets, although not as severe as previous write-downs.

The result was a financial sector rout, which saw Merrills down 3%, Morgan Stanley down 2.5%, JP Morgan down 2% and BA down 1.3%. The bank voted most likely to follow Bear Stearns three months ago – Lehman – was down 8%. And there was no switching – Citigroup and Goldman Sachs were both down 2% as well. These moves conspired to send the financial sector index to a closing level below the low point reached on March 17 – the day the Fed saved Bear Stearns. With all the distraction of oil, nobody much on Wall Street had realised they had never actually heard an aria from the fat lady in March.

The day’s economic data provided some saving grace. The ISM manufacturing index for May rose to 48.6% from 49.6% in April. While this was indeed a rise, and the result was slightly better than expected, numbers below 50% mean the manufacturing sector is still contracting. US construction spending also fell 0.4% in April following a 0.6% fall in March. But Wall Street’s happy to take a rise in the ISM.

The better than expected ISM number actually provided a boost for oil, but enthusiasm was tempered as the first Atlantic storm of the season was said to have by-passed Gulf installations. We will now have a somewhat disturbing situation where oil speculators will no doubt be cheering on any hurricanes. While oil prices are driving along Australia’s stock market at present, remember that BHP ((BHP)) has a lot of its oil operations in the Gulf.

It was a mixed night for the US dollar as weakness in financials wanted to force the greenback down, but greater weakness in the pound with reverberations for the euro saw the dollar index actually gain for the day. Gold rallied US$5.40 to US$891.50/oz as investors snuck back into the safe haven. The Aussie was little changed at US$0.9553.

Base metals fell early but recovered on the ISM news to close mixed and uneventful.

The SPI Overnight fell 69 points. The current Australian market dichotomy will only widen further today, one suspects. There are only two sectors in play – resources and banks. When oil slipped form its highs last week investors jumped back into banks fearing a major correction. As the gas consolidation game has been played out, and oil has not slipped further, investors have switched back again. Today will see more weakness in banks, while resources have no reason to fall.

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