Daily Market Reports | Apr 30 2009
By Greg Peel
The Dow closed up 168 points or 2.1% while the S&P gained 2.2% and the Nasdaq 2.3%.
Wall Street jumped from the open and continued to trend higher, reaching 200-odd points higher in the Dow prior to the 2.15pm Fed rate decision. If ever one needed evidence of (a) Wall Street’s longing to be bullish, (b) the “less bad” theme providing an excuse to be and (c) the fact there are a lot of shorts that keep getting caught out in this rally, then last night was it.
Economists were expecting the first quarter GDP to show a contraction of 5% following the fourth quarter’s 6.3% contraction. This would imply that Q4 was as bad as it would get and Q1 would herald the beginning of the end of the recession. But the number came out as 6.1%. Surely this was a disaster?
No. You could clutch at straws and say that 6.1% is still “less bad” than 6.3% but that is not the point. The most important take-out from the constituent GDP numbers was a huge drop in inventories. The worse thing that can happen to businesses in general in a recession is that they get stuck with stuff they can’t sell. They will then not buy any further stock from suppliers, and will keep discounting and discounting existing stock (deflation) until they can pay the rent. This was how inventories used to respond in recessions.
But in today’s high-tech internet-based world of efficient inventory management, stock comes in and goes out as quickly as possible, alleviating the risk of stock overhang. US businesses have managed to rapidly reduce stock in the first quarter. They have also been relatively quick to lay off workers (they can be another overhang) and cut costs. What this implies, come subsequent quarters, is that if demand begins to improve, businesses will need to start ordering from suppliers again. At worst, they can just sit tight without burning cash.
Among the GDP data was the quarterly consumer spending number. In Q3 and Q4 last year, consumer spending fell at an annualised rate of 4%. In Q1, it rose 2.2%. There’s your rally on Wall Street right there.
For some a 6% number was actually more comforting than a 5% number would have been. It implies capitulation, they say, which is something you need at the bottom of a cycle. Stock and workers have been dumped in fear. If things improve, the scramble will be on to reverse that strategy. That is what an economic recovery is made of. However, one assumes that if the GDP number had come out at 4% contraction, it would have been a cause to buy because that would have been “better than expected”.
Thus the scary realisation is that Wall Street may have bought this whatever the outcome. That’s dangerous.
Ratification of a 200 point rally was nevertheless going to hinge on what remarks Fed chairman Ben Bernanke was going to make in his April FOMC statement. No rate change was expected – it all came down to what view of the world Uncle Ben would provide. And Wall Street only had to read the opening line for an answer:
“Information received since the Federal Open Market Committee met in March indicates that the economy has continued to contract, though the pace of contraction appears to be somewhat slower.”
Champagne corks popped all over the NYSE. The Fed has officially declared the beginning of the turnaround.
The Dow leapt on the news, surging to be up 241 points at 2.30pm. But this also sent the S&P 500 (the real index) up through the 875 mark and on to 882. Technical analysts mark 875 as a vital number. The S&P has failed to push through this level since it broke back down in January despite a couple of attempts. A close above 875 should signal a sharp move to 900, they suggest. But for exactly the same reason, the sellers moved in as soon as 875 was breached. The market fell off towards the end and the S&P closed at 873. So we’re not there yet.
While the Fed’s opening line was the catalyst, the rest of the statement still paints a bleak picture. “Although economic outlook has improved modestly since the March meeting, partly reflecting some easing of financial market conditions,” Bernanke noted, “economic activity is likely to remain weak for a time”. However, “the Committee continues to anticipate that policy actions to stabilize financial markets and institutions, fiscal and monetary stimulus, and market forces will contribute to a gradual resumption of sustainable economic growth in a context of price stability”.
No one wanted to point out, however, that the Fed spent most of late 2008 apologising for getting it so wrong.
The other element to the statement was an anticipation of just what the Fed physically planned to do from here. There is no scope to either lower or raise rates, and indeed, “The Committee will maintain the target range for the federal funds rate at 0 to 0.25% and anticipates that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period”. But what Wall Street wanted to know was whether the Fed might step up its quantitative easing – the buying of US Treasuries with printed money – in order to keep rates low at the long end where the mortgage rates are set. The bond market assumed this might be the case. But what they got was this:
“The Committee will continue to evaluate the timing and overall amounts of its purchases of securities in light of the evolving economic outlook and conditions in financial markets”.
In other words, if the economy continues to show signs of recovery, as the Fed has outlined, then maybe aggressive quantitative easing will not be needed. Certainly it appeared the Fed would not increase its target amount (US$300bn) of bond purchases over the quarter. On that note, bond prices collapsed, sending the ten-year yield up 10 points. Yields have fallen as low as 2.5% ever since the Fed announced it would start quantitative easing, but with little action to date they had begun to drift back up. Last night the tens hit 3.1% – their highest yield since November.
This is a mixed blessing. Falling bond prices usually translate into rising stock prices but rising bond prices imply higher mortgage rates, just as unemployment continues to climb. The Fed has to be confident the economy is improving (or at least getting less bad) or it could make a fatal error.
The shift out of bonds meant a solid drop in the US dollar last night against all currencies except the yen. The selling of yen implies carry trading is back on, and that implies risk appetite returning. When the dollar is weaker against the euro but stronger against the yen, both are positive for the Aussie, which has shot up two cents over the past 24 hours to US$0.7269.
Gold had to fight between a weaker greenback and another bout of euphoria which kills the safety trade, and it ended up US$4.70 on the session at US$898.10/oz.
It was, however, a big night for commodities. The stock market rally ahead of the Fed was enough to help oil turn around, and a report showing weekly gasoline inventories finally fell (ahead of the summer driving season) was further impetus. The fact crude inventories rose yet again was ignored. Oil closed up US$1.05 to US$50.97/bbl.
Base metal trading closed in London before the Fed release. (FNArena closing prices are based on late trade to 7pm London which is 2pm New York.) The greenback had already shifted lower on the GDP nevertheless, and Wall Street spent all morning surging higher. This was positive for base metals, but the real impetus last night was news of the seventeenth consecutive week of falling copper inventories. The evidence now suggests China has exhausted buying in Asia and Europe but has moved on to the US.
Copper thus led the complex higher last night, rising 5%. Zinc and nickel also rose 5%, while tin and lead added 3% and aluminium 2%.
Incidentally, just after the close on Wall Street the WHO lifted its global pandemic alert rating from 4 to 5.
The SPI Overnight gained 35 points or 0.9%.
The ASX 200 closed at 3695 yesterday, now a long way down from the 3779 January closing high. While Wall Street is happily retesting January levels, Australia has been crimped first by faltering commodity prices but now by poor bank results. Can we push back up from here? Clearly Wall Street is rapidly gaining in confidence. Last night the VIX fell 5% to 36 which is as low as it’s been this year. US Treasuries were sold, the yen was sold, and gold was stifled by the reversing of the safety trade. All of this points to growing confidence and a return of risk appetite. The first quarter earnings season has been playing out as one of more “beats” than “misses”.
Barring anything from left field (and don’t forget those swine, and next week’s “stress test” results), Wall Street appears poised to push the Dow to 10,000. Is Icarus watching with discomfort?
