The Overnight Report: Shrugging Off Freddie

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 By Greg Peel

The Dow gained 40 points or 0.3% while the S&P added 0.3% and the Nasdaq 1.2%.

The additional gain in the more volatile Nasdaq was due to a good result from database specialist Cisco, announced in Tuesday’s aftermarket. Technology stocks seem to be either screaming buys one week, or screaming sells the next, but never anything in between.

But the big news of the day was the second quarter result from one of the sponsored mortgage lender twins, Freddie Mac. Freddie’s shares have fallen from high of US$70 in late 2006 to US$3.89 on July 15, where the US Treasury announced a potential rescue, and back to US$10 before slipping again. They closed at US$6.49 last night after falling 19% in the session.

Wall Street had been expecting a loss of US53c per share, but the result was a loss of US$1.63 per share. It was blamed squarely on the 10% of Alt-A mortgages in Freddie’s portfolio (no doc resets), written in 2006-07, and concentrated in the basket-case states of California, Florida, Nevada and Arizona. These mortgages are not strictly subprime, because credit records were checked, but beyond that Freddie did not care to know whether the lender even had an income. That 10% made up 50% of the overall loss in the quarter.

Freddie’s CEO, who believes the US housing market is only halfway through its price slump, has been under considerable pressure since a 2004 memo was leaked recently – one in which the company’s CFO warns the CEO about deteriorating mortgage quality. The CEO is said to have dismissed the memo.

Freddie’s result sent twin sister Fannie Mae’s shares down 15% in sympathy (Fannie reports tonight) and the Dow down a hundred points in early trade. But that’s where it ended. Buying steadily returned to provide a positive close. Despite the twins, broader financial sector activity was mixed, with the index finishing down only 1% on the day.

Assisting the ongoing positive mood was the continuing fall in oil, which dropped another US59c to US$118.58/bbl on news of higher than expected weekly crude inventories. But there was nevertheless a return to buying in some of the knocked-down commodity names after a couple of days of steep falls. Base metals on the LME once again held steady, encouraging a bit of hunting around in the materials sector.

Gold also clawed back some losses, having dropped like a stone this week. A US$4.90 rise to US$879.20/oz came despite a yet again stronger US dollar.

Last month it would have seemed incredible to think that the dollar could rally on a three-times worse than expected loss from Freddie Mac, but recent dollar strength is not reflecting any belief the US economy is no longer slowing. It would be more correct to suggest that major currencies are now falling against the dollar, as the realities of a global slowdown begin to hit home.

A case in point is the Aussie dollar, and as local economists scrambled yesterday to flip their views from on hold to several rate cuts ahead, the Aussie slipped another US0.7c to US$0.9086.

Europe has also been in focus as facing economic weakness, and tonight the central banks of Europe and the UK need to make rate decisions. With oil down close to 20%, the hawkish ECB may just be able to let things go for now. But last night the focus was on the forgotten economy – Japan. With China in the foreground it’s easy to forget that Japan is still the world’s second biggest economy by a long chalk. Last night the government released its economic indicators for June, and a weak result saw an official downgrade on the state of the economy to “worsening”.

It appears that Japan’s six-year run of gradual economic expansion – a run which has seen Japan attempt to claw its way out of the pit of a decade of deflation – has ended, and the economy is headed for recession.

As a major buyer of Australian resources (don’t forget Japan and Korea buy all the coal, and China buys none), one might expect this news to weigh on the likes of BHP ((BHP)), but last night the offshore markets followed yesterday’s local market and drove a 2% rise in the Big Australian.

The SPI Overnight added 15 points.

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