The Overnight Report: Stress? What Stress?

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By Greg Peel

The Dow rose 101 points or 1.2% to now say goodbye to the 8500 mark, while the S&P jumped 1.7% to 919 as it continues to close in on the January high of 934. The Nasdaq rose only 0.3% as traders fretted over the Cisco result due after the bell. It was well received and Cisco is up 2% in the after-market.

Well I thought it was reasonable to assume this week would be a quiet one on Wall Street ahead of the release of the stress test results, due early Friday morning Sydney time. Nothing could be further from the truth. We had a 200 point rally on Monday, consolidation on Tuesday, and now another 100 points up on Wednesday. The rally has been spurred by solidly “less bad” economic data, and by stress test speculation. It seems the stress test office has more leaks than a Welsh kitchen.

Last night’s bit of positive economic news came from the unofficial ADP private sector employment number. Economists had predicted 644,000 Americans would have lost their jobs in April, which is well under the March figure of 708,000 so still “less bad” in itself. But the ADP number showed a loss of only 491,000 jobs. This had economists scrambling to rethink their expectations for Friday’s official non-farm payroll number, pulling forecasts well back into the fives. And it also ignited another bomb under Wall Street.

The euphoria didn’t last long, given trickles of information were still coming out about the stress test results, all from “reliable sources” of course. Long before the opening bell it had been declared that Bank of America, previously rumoured to be preparing for a US$10bn capital raising, was actually in need of US$35bn as far as the stress test would determine. Traders in Europe sold BA heavily in the electronic market to the point the shares were down 15% before the opening bell on the NYSE. At 11.30am the Dow was about square after its initial surge, but then a funny thing happened.

More evidence of the US$35bn requirement for BA began to flow as more reports surfaced. Now – if this had been the news, say, three or so months ago, Wall Street would have absolutely tanked. But now we are in a different mindset. Now we can look through the numbers and say well maybe US$35bn is not that bad after all. Maybe that’s actually a good result. Maybe we should buy this.

And so they did. BA shares finished up, not down, 17% on the day. That’s a 32% turnaround from Europe’s initial interpretation of the news. It seems Europe missed out on the ecstasy pills they’ve been handing out in New York. (Maybe it’s a covert government operation).

But to be fair, there was good news among the dubious news. The list of those banks supposedly not needing any fresh capital has grown to include Morgan Stanley, New York Mellon and American Express along with JP Morgan and Goldman Sachs. Wells Fargo will need US$15bn and not US$50bn as was the rumour earlier in the week. (Maybe Deep Throat had a cold.) Citigroup would not need US$35bn like BA, nor would it need the US$10bn earlier rumoured, it would only need US$5bn.

And in the case of all of these numbers, they are not necessarily requisites for new capital, they are merely requisites for new levels of ordinary shares or “common equity”. This means the banks can choose to convert other forms of existing equity hybrids, such as preferred stock, into common equity to satisfy the requirements, rather than having to go cap in hand to the market for the total. And there won’t be a pressing deadline. The government will give the banks time to get their balance sheets in order, which will also avoid banks scrambling over each other with offerings. The government also plans to lay down a schedule and set of rules for returning TARP funds.

So all of this – if indeed any of it is the slightest bit true – was taken by Wall Street as fabulous news. Wall Street will be hoping the rumours are indeed accurate, given the market is setting itself up for a big disappointment if they’re not. And if the stress test results are even better than these rumours suggest, how much upside is there left?

The euphoria on Wall Street is taking its toll on the US dollar. The supposed safe haven currency is no longer needed as investors continue to sell out of US bonds and look to get back into “risk” currencies such as the Aussie, which has now reached US$0.7484, helped by a few Pennies from Kevin. And the weakness in the US dollar is spurring on commodities.

The weekly inventory data came out last night, and traders had been expecting another 2 million barrels of crude would have been added to US stockpiles. But the number was only 600,000 – a lot less bad – and what’s more gasoline inventories fell 200,000 barrels. So they bought oil up US$2.50 or 4.6% to US$56.34/bbl to reach the highest level in six months. Never mind that US oil demand is now down 7.9% year on year, or that crude stockpiles have reached their highest level since 1990. Never mind that it might take a generation just to work through them.

And that was nothing compared to what happened in London.

Copper jumped 5.5%. Having come under pressure lately, the primary base metal is now back close to its six-month highs. Zinc jumped 5.7% to hit a seven-month high. Aluminium rose 2.5% for a four-month high. And while lead managed only 2.8%, tin jumped 7.6% and nickel 8%.

The surge was boosted by May option call-ins, but boy, these guys must have gotten themselves short recently.

Gold continues to push higher, up US$14.00 to US$911.60/oz. Gold should be under pressure from safe haven selling, but a combination of a weak US dollar and the consequent inflation fears implied by these commodity price surges has gold traders on the buy-side for now.

The SPI Overnight was up 67 points or 1.7%, matching the S&P 500. With the local bank results now out of the way and commodity prices heading back to the moon, there seems little standing in the way of further strength on the local bourse. Unless Wayne Swan has any nasties up his sleeve. (Or unless someone wakes up and realises it was all just a dream after all.)

Incidentally, News Corp ((NWS)) reported a 47% drop in quarterly operating income after the bell in New York. The stock was already up 6% on the day and has added another 1.5% or so in the after-market.

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