Daily Market Reports | May 08 2009
By Greg Peel
The Dow fell 102 points or 1.2% while the S&P lost 1.3% and the Nasdaq 2.4%.
The stress test results came out at 7am Sydney time. First glance suggests this week’s rumours have been accurate. The US government requires a total of US$74bn of common equity to be raised by the 19 banks deemed too big to fail. Under the worst case scenario as determined by the test criteria, it was calculated that a further US$600bn would be lost by the banks in the event of further significant economic weakness, mostly from credit card defaults.
While the US$74bn requirement represents balance sheet-bolstering common equity, or ordinary shares as we would call them in Australia, the government determined that the banks have sufficient tier one capital in total. Fed chairman Ben Bernanke’s comment was that the test results should provide “considerable comfort” to Americans.
Even before the results were released, Morgan Stanley announced it would issue US$2 billion in common equity and Wells Fargo announced it would issue US$6bn. The banks have six months in which to improve their balance sheets, but clearly the time won’t be wasted.
As far as the big four commercial banks were concerned, rumours proved to be sufficiently on the money. Bank of America will need to raise US$33.9bn, Wells Fargo US$13.7bn, Citigroup US$5.5bn and JP Morgan zero. Citi has already announced it will convert US$5.5bn of preferred stock into common equity, thus avoiding any fresh capital issue. For the former investment banks, Morgan Stanley is required to raise US$1.8bn and Goldman Sachs zero.
Goldman Sachs and Bank of New York Mellon (another with no new capital requirement) have announced they intend to pay back their TARP funds as soon as permitted.
As I write, the Dow futures are trading higher from their closing level at 4pm NY (6am Sydney). And as I write, commentators in the US are attempting to wade their may through what is an extensive Treasury document. I will thus leave the stress tests for now, other than to say the results are good but they match the leaks that have been flowing all week – leaks which have seen the US stock market in strong buying mode on heavy volume. Is there, thus, more impetus to buy on the fact or will profit-taking be the order from here? Before the opening bell on Friday in New York, the monthly unemployment data will be released.
Wall Street opened higher last night and the Dow was up 65 points early, but the sellers then moved in. Retailers began to announce their same store sales results and all in all they were surprisingly healthy. Nevertheless, there was an unsurprising move by American consumers towards lower-end value chains and away from the high-end luxury stores. The consumer discretionary sector has been a strong outperformer in the recent rally having been, along with the likes of banks and materials, one of the most beaten down sectors in the bear market. After a very solid run, Wall Street began to take profits on the sales news.
The Dow thus fell below the line by lunchtime and then stabilised, but another fall followed when news came through that a government auction of 30-year Treasury bonds had been indifferently supported.
As stocks have fallen over the past several months there has been a rush to the safe haven of US Treasuries, despite the Fed funds rate having been lowered to zero. Those who bought bonds early in the credit crisis have done extremely well, while those entering late in the bear market have done so at very low yields. To date Treasury auctions have been relatively well supported but the cracks are now beginning to appear. The two-month rally in stocks has been accompanied by a move back out of the safe haven, sending bond prices lower and yields higher. Overriding any safe haven issues is a deeper fear that the US government has simply been printing too much money.
When the US government prints trillions of dollars to fund its various rescue packages, it must issue bonds on the other side, or effectively “borrow” money from the world. If the printing is not funded by borrowings, the value of the US dollar is debased and monetary inflation becomes an issue. The higher inflation, the less real value there is in holding stocks. So when the 30-year auction failed to excite last night, Wall Street began to sell stocks again. The 30-year bond yield jumped from 3.19% to 3.30%.
The Dow fell to its lows of the day of down 154 before recovering somewhat to the close. Stocks and bonds have a yin-yang relationship, so there’s a certain irony in the fact that if the stock market loses its bottle because bond yields start to rise significantly, money will flow out of stocks and back into the safety of short-end bills and bonds. The result is a steepened yield curve which is not good for stocks but is actually good for banks. Banks can borrow short term at low yields and lend longer term at higher yields. But that also means mortgage rates will rise, and that is not good in the current environment.
Tonight’s session on Wall Street should be an interesting one.
In the meantime, the rest of the markets were relatively quiet last night ahead of the stress test results. The US dollar was mixed and gold barely changed at US$910.00/oz. The Aussie is up 0.6 of a cent to US$0.7545 but that move is largely a response to yesterday’s unemployment data.
Just on that unemployment data, these seemingly contradictory fluctuations are not unusual, and do not overlook the fact the trend in unemployment remains up. It was, however, interesting to watch Joe Hockey squirm when interviewed yesterday given a jump in jobs was not a result the Opposition wanted. I don’t think I’ve ever seen Joe lost for words before.
Oil gained another US37c to US$56.71/bbl last night while base metals mostly took a breather. London trading closes around 2pm New York at which point Wall Street was at its lows, and after a big run yesterday copper fell back 2.5% last night.
The SPI Overnight fell 21 points or 0.5%.
It’s Friday in Australia. Does that mean profit-taking? Local traders will be keeping a wary eye on any further details emerging from the US stress test results and a close eye on movements in the Dow futures.
