The Overnight Report: The Gap Between Optimism And Economic Reality

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By Rudi Filapek-Vandyck

Ground control to Major Tom.

Major Tom, we think it’s time to come back to earth.

This is exactly what happened overnight. Concerns about corporate earnings, continuously rising unemployment, bad economic data and another blow dealt by the harsh reality of sagging demand for oil and commodities, in general, all combined yesterday to wipe away a big chunk of the  investor optimism that had been building in the early days of the new calendar year.

As reality hit home, and hit home hard, investor sentiment took a major blow and so did the prices of assets that had been rising since the last week of December.

Shares in the US lost around 3%. Crude oil fell by 12% to US$42.74 per barrel. The VIX index (also known as the Fear Index) jumped the highest since December 1 last year.

An old adage on Wall Street tells investors: As January goes, so goes the rest of the year. The scenario for 2009 may have already been written within the space of one week.

One of the questions that was repeatedly being asked on Wall Street over the past week was: how bad do negative data and news have to get to still spook the markets? Surely, now that we all know things are not looking good, we can safely assume that investors will simply shrug off more bad news and focus on cheap asset prices with a longer term view instead?

The answer came yesterday when jaws dropped across trading floors and the general murmur was: that bad hey?

First off the rank was alumina-aluminium giant Alcoa. The company announced a day earlier, after the market close, it would shed more than 13,500 workers and significantly cut production and capital expenditure plans. The news went around the world like a spreading fire but was mostly ignored in Australia where investors continued their buying spree, pushing up share prices of BHP Billiton ((BHP)) and Rio Tinto ((RIO)) and many other commodity plays to new multiple-week highs. In the US, however, investors did not take the news in equal fashion.

The sector is in trouble, companies like Alcoa are forced into survival and cash-conservation mode. The shares dived 11% overnight.

Intel followed suit last night, informing the market its sales had not been able to keep up with expectations. The news was super-bad because management had lowered its own Q4 guidance only two months ago. Intel’s Q4 sales dropped by 23%.

Within the Wall Street framework, Alco is an important bellwether for commodities. Intel is a similar barometer for everything that starts with “tech”.

What got the market really spooked yesterday were some really, really, really bad economic data.

A private gauge of job losses in the US,  the so-called ADP Employer Services report, which is oft read as a precursor to the official numbers that will be released on Friday, surprised even the gloomiest of the gloomiest forecasts. The report showed US payrolls shrunk by 693,000 jobs last month. This was the worst result since records began in 2001.

To top it off, official estimates of US oil inventories showed a rise no less than eight times what the market had been anticipating.

The first release revealed that employers in the US are accelerating job cuts programs. The second one revealed there’s still too much oil around in a world that is contracting.

WTI Crude oil futures dived in one fell swoop from near US$50 to a little above US$42 per barrel. The rest of the commodities followed suit with big losses for copper, gold, silver, nickel and others.

Many investors (and investment advisers) had become excited as commodity prices had been rising fast since late December. However, yesterday brought a reminder that there is still a huge gap between the all-encompassing but elusive investor optimism and the harsh cold reality of a global economic recession.

This discrepancy was perfectly summarised by TD Waterhouse Global Strategist Stephen Koukoulas whose title above his latest email reads: “Markets say the worst is over: The facts suggest otherwise”.

The Dow managed a minor comeback in the final hour of trade and kept losses for the day limited to 2.72%, closing at 8769.70, down 245.40. The broader S&P500 index lost 3%, 28 points, and closed at 906.65. The Nasdaq lost 3.23% and closed at 1599.06.

European equities were also lower; the DJ Euro Stoxx 50 closed lower 1.5% to 2439 and the FTSE100 closed down 2.8% to 4508.

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