Daily Market Reports | Sep 24 2008
By Greg Peel
The Dow fell 161 points or 1.5% while the S&P fell 1.5% and the Nasdaq 1.2%. In so doing the Dow broke back through 11,000 – a psychological level if for no other reason that it contains three zeros.
At 5am Sydney time (3pm New York) the Dow was unchanged, and I sat pleading with the television to let that be so for another hour. Is just one day of respite from multi-hundred point moves too much to ask? Apparently so.
The reason Wall Street was square at 3pm was basically because there was no new news yet emanating from Capitol Hill, where Messers Paulson and Bernanke were under stark spotlights being mercilessly grilled by the House Committee, particularly by the liberal Left among the majority Democrats. Will this new plan work? was the straightforward question, and if so why? – nothing else you’ve spent taxpayer money on has worked so far. Obviously the answer from the sleepless duo was yes, with a qualification that to do nothing at all would not be something worth even contemplating.
The Left will likely accept the plan in principle, but its members are questioning the sheer size of the bail-out (US$700bn minimum) and whether a smaller amount could be used to begin with (which largely defeats the purpose). It is also a case that if ever there were a time the socialists had the capitalists firmly by the you know whats, this is it. So it will likely transpire that the capitalists will have to provide two concessions – concurrent aid for homeowners on Main Street and caps on salaries on Wall Street. Once again, the most engaged political economist viewing from afar would have been one Karl Marx.
With no result forthcoming by late in the session, and indeed a stalemate apparent so far, Wall Street got the wobbles again. The longer this takes the more the impact of The Plan will be compromised. But there is also a deeper concern. Paulson argues that by buying up (or investing in) the toxic assets held by Wall Street, Main Street homeowners will ultimately enjoy the mortgage rate reprieves they need, indirectly. Thus further direct concessions are actually redundant. There is little doubt that if credit markets were allowed to collapse, as they were about to do last week, no one would be any more affected than the struggling mortgage holder. However, the “but” – and it’s a big “but” – is that the sheer size of the bail-out will require an unprecedented creation and issue of US Treasury securities (the funding) which, by any other name, means printing Monopoly money. Already the world outside the US domestic market has become sceptical about buying more US government debt, so not only will there be a sudden surge in supply of such debt there will also likely be reluctant demand.
The end result of too much for sale and not enough buyers, as we all know, is lower prices. In US Treasury terms this means higher yields, and higher yields translate down the lending chain to a higher cost of bank funding, higher cost of corporate funding, and, ultimately, higher mortgage rates. In other words, The Plan may not provide credit relief at all. On that basis, can it really provide the stability intended?
One element of the late fall in the Dow which was much noted by traders was the lack of volume. We have gone from super-volumes of the previous week back to very little volume once more. Why? Because there ain’t no short sellers, that’s why. The thinner the market, the greater the volatility. But wait, I hear you think. Wasn’t it short selling that compounded volatility in the first place?
Yes it was – naked short selling. But less experienced investors need to get over this hang-up that all short selling is bad. A common style of investment fund, for example, and this is just one example, is the “long-short” fund. Such a fund attempts not to play the direction of the index, but attempts to profit by correctly picking relative trades. Let’s use an Australian example, such as buy BHP, sell ANZ (covered). You can argue all you like that no one should be allowed to short sell ANZ, but in this case neither will BHP be bought. Result – less liquidity, more volatility, and the potential for a bull market to run so hard that the eventual correction will be even more severe than we have experienced this year.
If you need any proof of what can happen in a thin market just look at oil on Monday night – up US$25 at one point. (The authorities have now said they will now investigate those trades. Lord give me strength.)
Last night oil closed at US$106.61/bbl, which was down US$13.39 from Monday’s official close. However last night’s close was in the November contract, for October expired, and as I warned yesterday Monday’s closing price was thus erroneous. The reality? Oil was down US$2.76 last night.
Oil was down mostly because it had been up, but also because the market is still trying to reconcile the potential collapse of the US dollar (upward pressure on commodity prices) with an inevitable US recession (downward pressure on commodity prices). After crashing on Monday the US dollar was slightly higher last night (aided by some weaker than expected European economic data), allowing oil to fall, gold to fall by US$8.30 to US$892.20/oz, and copper to fall by 4.5%. All the other metals were down 2-4% in London as well.
And so they should have been. The US will go into official recession shortly, which will inevitably put pressure on commodity prices. However, the US dollar will weaken. But at the end of the day, the US dollar is merely an exchange mechanism. In anyone’s currency, if supply outweighs demand then real commodity prices will fall. I do not include gold in this equation, for it is a currency and not a commodity. The extent of the fall will be determined by supply capacity. For oil, that is apparently low, so oil’s fall cannot be too extreme. For base metals, that is high, which will mean lower prices. But as base metal prices have fallen below the cost of production, the result will be mine closures and new project abandonments. Therein lies a price floor.
If you had any need to further question the inevitability of a US recession (and global net slowdown) then last night there was proof positive. Caterpillar – the US giant and Dow component which makes Tonka toys in full scale – had a need to issue corporate paper in the normal course of its business. It’s last issue only weeks ago cost the company less than 200 basis points of credit spread (buyers are happy with an interest rate of less than 2% over government paper). Last night Caterpillar’s issue cost the company 320 points. This is a company feeding the mining boom. This company cannot keep up with demand. Yet this company is now paying more than 1.2% more in interest to keep its operation going. Bear in mind the Fed has already cut the cash rate down to 2%. There’s little room to move to cut further and prop up the economy.
But what about The Plan? Well, as discussed earlier, The Plan may not yet manage to reduce borrowing costs, only stabilise them at higher levels.
The Aussie fell back over a cent to US$0.8329 last night.
The SPI Overnight fell 71 points.
Breaking news: Warren Buffett has just injected US$5bn of his fund’s capital into Goldman Sachs Bank. Goldman will raise another US$2.5bn in the market. The US financial sector index has spiked up in the after-market.
