Daily Market Reports | Feb 13 2009
By Greg Peel
The Dow closed down 6 points. The S&P closed up 0.2% and the Nasdaq up 0.7%.
Wall Street kicked off the day with not only a better than expected result from Coca-Cola, but a shock rise in January retail sales. Sales rose 1% in January to end a seven month run of declines. It was the biggest rise since November 2007. Economists had pencilled in another decline of 0.4%. It should have been great news.
But it wasn’t. Economists familiar with the vagaries of statistics were quick to point out the very weak numbers recorded in November and December were due for an offset somewhere when seasonal adjustment was applied. They obviously adjusted back in January. The January figure was a bit of a mirage.
Either way, Wall Street had not responded with any enthusiasm, even erroneously. The Dow fell a couple of hundred points early and despite some claw-back could not gather any momentum. By 3pm the Dow was down 240 points and getting rapidly weaker. The weakness was across the board, driven by lingering concern over a weakening economy and the disappointment of a TARP package that is still seen as vague.
The wagons had been circled as the Native American persons came ever closer, but the expectation was that the cavalry was due over the hill at any moment. Joy soon turned to heartbreak, however, when the wagoners saw it was F-Troop.
It is understood that immediately after the Geithner speech on Tuesday, and ever since, leading bankers and other industry leaders and experts have been called into the Treasury Secretary’s office to provide counsel. The TARP announcement had clearly been poorly received, and a greenhorn secretary was looking for help. The plan needs detail – perhaps we can fill in some blanks. As to whether these meetings were a direct impetus or not is unclear, but just after 3pm a story from Reuters hit the wires and Wall Street turned on a dime.
One issue of the TARP lacking detail is that of the solution for the purchase of toxic assets – the so-called Bad Bank plan. For the most part, those “toxic” assets are mortgage CDOs – instruments that package up prime, mid-prime and subprime mortgages together and then (originally) offer a high yield and a AAA-rating. Not all CDOs contain a subprime element. Indeed, some are purely prime. But they have all been tarred with the same brush and thus valued at next to nothing by the market for the last 18 months or more. This has impacted on bank balance sheets, as massive write-downs in valuations of CDOs have put bank capital ratios under pressure. Uncertainty on those valuations has frozen credit markets.
The Paulson and Bernanke team wanted to buy up all the toxic assets and warehouse them back in September. That was the original TARP plan (the acronym means “troubled asset relief”). They were overruled by Congress. Instead, the TARP injected capital into banks. But this solution has not worked because those CDOs are still on bank balance sheets and no one knows where. Moreover, US house prices have continued to fall and more and more jobs are being lost. Foreclosures continue to rise. Every time another house is foreclosed, somewhere a CDO loses even more value. The toxic assets have continued to become even more poisonous as each month has passed and no government solution has succeeded.
There are now a vast number of Americans who owe more on their house than those houses are worth. If one cannot make mortgage payments – and a loss of job is an obvious reason why not – then one will surely walk away. This leaves the banks with, say, a US$250k bad loan on a US$150k house which could possibly be sold for US$100k in a hurry. This is not what the banks want.
President Bush had appealed to banks across the country to sit down with mortgagees and offer some relief on loans for their mutual benefit. Were banks to write down the face value of the loan to a level closer to the value of the house, thus reducing mortgage payments, then many houses would be saved. And, perhaps, the US economy. But it was no more than an appeal, and there was no coordination.
In the face of a Wall Street backlash, last night the Obama administration announced a new mortgage plan. Supported by Fannie and Freddie, the government would move to subsidize mortgage payments for means-tested home-owners. In short, the plan is an attempt to stop the downward spiral. Arrest the rate of foreclosures and you crimp the write-downs on CDOs. Sort out the CDOs first and then you can start talking about a value for which the Bad Bank can buy them. Did this plan comes out of Geithner’s meetings? We don’t know.
What we do know is that the Dow closed down 6 points having been down 246 points 45 minutes earlier.
Commodity markets had closed before the news hit the wires and the US dollar had again risen, against all currencies. The Aussie dollar fell 0.8 US cents to US$0.6480 over 24 hours. Gold once again did its own thing, however, adding another US$9.30 to US$949.60/oz. There is now talk of US$1000 next week, but then we have heard this before.
Oil crashed again in New York, falling US$1.96 to US$33.98/bbl. However, there are two points that should be taken into consideration here.
I have made note recently that there is a very big commodity fund holding in March oil futures – the current “front month”. These contracts must either be allowed to expire later in this month or rolled over into the next or more distant months. If one assumes the fund or funds do not want to crystallise a loss at what might be the bottom of the market, then one assumes they would roll the position. And that’s exactly what appears to be happening. Normally there is not much more than a dollar’s difference between the front and next months. Last night the April delivery contract closed at US$42.17/bbl – down only US30c and a clear US$8 above the front month. What this implies, all things being equal, is that the day after the February 20 expiry the oil price will suddenly jump US$8 for no apparent reason.
Not only is the benchmark oil “price” being affected by this one position, the global price of oil is being affected by a specific build up of crude inventories in the US. West Texas Intermediate is used as the benchmark for world oil trade, but there are actually many different “oils” from different sources. The next popular benchmark is the price of Brent crude form the North Sea, as traded in London. Last night Brent closed at US$46.12/bbl. And that was actually up US80c on the day. Brent and WTI prices rarely move beyond a spread of a dollar or two. The current spread is over US$12.
What these two factors suggest is to bring into question – at least for the moment – as to whether the world should be focusing on the price of WTI futures at all as a reliable gauge of world oil demand.
Base metals in London, which were well closed before the mortgage announcement in the US, closed mildly weaker.
The SPI Overnight gained 20 points.
Another point to note from last night’s trade is that the Baltic Dry Index dropped 3.2% to 1,989, having more than doubled over the past 17 trading sessions. The BDI is a benchmark for the freight cost of shipping dry commodities (iron ore, coal, metals etc) across oceans. It is thus used by economists as a good proxy for the state of global commodity demand. Having collapsed last year along with the collapse in commodity demand, the BDI had recently been exciting commodity price followers who were hoping the index’s “lead indicator” status was signalling that a bottom for commodity prices had been put in place.
