Daily Market Reports | Mar 26 2009
By Greg Peel
The Dow closed up 89 points or 1.1% while the S&P closed up 0.9% and the Nasdaq 0.8%.
Day Two after Monday’s 500 point rally in the Dow ended with a rise which goes some way to confirming that Wall Street is currently in a positive mood. But at the end of the day it was a close run thing.
Late profit-taking on Tuesday was forgotten as stocks soared from the opening bell, sending the Dow up 204 points or 2.6% just after 11am. Impetus was provided by a surprising durable goods order result. Economists had expected orders for big ticket items from computers to aircraft to fall by 1.2% in February, extending the downtrend to seven months. But instead they rose 3.4% and broke the downtrend.
Durable goods numbers, while considered an important barometer, are often volatile. One reason is that military equipment is included amongst other lumpy purchases and as it was the US bought a few military aircraft in February. But a buoyant Wall Street was happy to overlook such trivialities, just as it was happy to overlook that these numbers are usually revised the following month, and that January’s number was indeed revised down from a 4.5% decline to a 7.3% decline.
If any doubt had begun to creep in however, it was swamped by another surprise. Sales of new homes rose 4.7% in February. It’s all over Martha, pass me my cheque book.
While again the number looked good in isolation, particularly to a market keen to call an end to falling house prices, the truth is February sales still marked the second lowest level on record after the January number, and that year-on-year the pace of new home sales is down 43.8%. There is also an element of seasonality, as home sales typically drop off in the winter and begin to rebound in the spring, just as they do anywhere.
But hey – if we want a rally we’ll take it. Stop being such a stick-in-the-mud!
The rally held to midday, but just as traders were contemplating which restaurant might be most appropriate for lashing out, a sudden shock ran through Wall Street. The news hit that an auction of UK gilts had failed.
Last night the UK government attempted to auction 1.75 billion pounds worth of 40-year government bonds (considered “gilt-edged” securities and thus known as “gilts”). The auction only attracted bids for 1.63 billion pounds, so the auction failed. This may not seem like anything to get overly upset about, but in the current economic climate it is significant.
What it signifies is that the UK government was asking for money and not enough people were willing to lend. Like the US, the UK has been furiously printing billions of pounds to stimulate its ailing economy. To fund those pounds it must issue bonds. If no one wants to buy the bonds, then all the UK government has done is printed unfunded banknotes, therefore debasing the currency and causing inflation.
Just as Wall Street was trying to absorb this information, it was revealed that there was also trouble at home. A US$34 billion issue of five-year US Treasury bonds had not gone as well as planned either. The auction settled on a yield that was higher than expected.
A higher yield signifies that potential buyers of bonds – lenders of money to the US government – were not prepared to pay as high a price as previously for those bonds, or in other words demanded a higher yield as compensation for the risk attached. What is the risk on a US government bond? That the US government is printing so much money to fund its rescue packages that the number of people still willing to lend money to the US – and in this case we include important lenders such as China and Japan – is dwindling. That buyers are concerned as to just how many more bonds the government will issue ahead and as to whether the government can continue to pay interest on all those bonds.
Think of it in stock market terms as being equivalent to potential buyers of a stock being wary that the company may continue to issue more and more new capital, thus diluting existing shareholders.
The news from both sides of the Atlantic caused a panic in the stock market. Ironically, when bond prices fall (yields rise) share prices should rise (and vice versa), given a move out of bonds usually signifies a confidence to take the risk and look for better returns in stocks. Indeed, as the stock market has fallen over the past 18 months US bond prices have rallied to historical highs (yields have fallen to historical lows) as the safe haven trade. But last night when bond prices fell, stocks did not rally. The Dow plunged 300 points to be down 100 points at 3pm. Failed bond auctions were sending a warning sign that global monetary stimulus may be in jeopardy.
Nor did it help when, around the same time, Dow component IBM announced it was laying off jobs in its services sector – the sector previously assumed to be the company’s most robust in the economic crisis.
But at 3pm, the buyers fought back. Closer scrutiny of the UK gilt auction failure – the first conventional gilt failure since 1995 – suggested that 40-year bonds are a lot further along the curve than the market should be too concerned about just yet. The UK has already been implementing quantitative easing, but the Bank of England has been buying gilts in the 5-10 year range. It is at that point on the curve where the most concern lies.
Similarly, while the US auction was in five-years, Wall Street was heartened to know that the Fed is soon to begin its own quantitative easing – buying bonds in the same range – and doing so not by bidding at auctions but by buying in the secondary market. So the Fed’s influence has supposedly yet to be felt.
Whether the fear specifically abated, or enthusiastic buyers just decided the fear was unfounded, the Dow managed to rally back from 100 down to 89 up in the last hour of trade.
The US dollar returned to weakness on the news last night nevertheless, although not significantly so. The Aussie was only slightly higher at US$0.6977. The pound was, however, weaker against the US dollar as one might expect. Gold, on the other hand, responded as well gold might when fears of inflation return to the fore to overcome a reduction in financial risk buying. Gold jumped US$9.30 to US$934.30/oz.
While a weaker US dollar might have been good for commodity prices, it wasn’t. Once again the Nymex pit was fooled by expectations of weekly inventories (they usually are). The expectation was that this week’s gasoline and heating oil inventories would be lower which is exactly what was expected last week, but just like last week they actually proved to be higher. Oil fell US$1.21 to US$52.27/bbl.
Base metals had no idea what to do. The inflation trade is still on, but with short-covering now exhausted there was little buying pressure. Prices closed mixed and inconclusive.
The SPI Overnight rose 15 points.
