Daily Market Reports | May 22 2009
By Greg Peel
The Dow fell 129 points or 1.5% while the S&P fell 1.7% to 888 and the Nasdaq fell 1.9%.
Before US markets opened last night, news came through from the UK that ratings agency Standard & Poor’s has downgraded the UK’s credit outlook from “stable” to “negative”. The UK has never, in its history, lost its AAA rating and as of last night still had not. S&P has simply put the UK on a negative credit watch for the time being as it ponders the effects of growing British debt, which is set to hit 100% of GDP. S&P has previously downgraded the actual ratings of GFC victims Ireland, Spain, Greece and Portugal.
Britain is the new basket case of Western Europe, having concentrated so much of its GDP in banking and financial service-based industries. The Bank of England cash rate is at 0.5% and the central bank began buying gilts (quantitative easing) long before the Fed began to do the equivalent. Prime Minister Gordon Brown has set a budget steeped in deficit, the unwinding for which he is placing his confidence in signs of global economic recovery. S&P is not so confident.
The effect of a lower rating would be a higher cost of borrowing for the UK. This would extend the time for which it would take to unwind the deficit. UK gilts (bonds) are immediately devalued. On the release of the news last night, the pound initially plunged. The FTSE (UK stock market) finished the day down 2.75%.
Could the same thing happen for the US? According to highly respected US bond fund manager – Bill Gross of Pimco – it could. Speaking on CNBC, Gross suggested the level of debt issuance in the US and the extent of current account and fiscal deficits may well be enough for S&P to put America – which has held an AAA rating since being first granted one in 1917 – into negative watch.
The US is already struggling to find willing buyers of its bonds, which it needs to offset the effects of its printing press. China has pulled back from recycling its massive surplus directly into US Treasuries and has now turned to hard commodities – gold, copper, iron ore and oil – as a means of by-passing the reserve currency. Commodities do not pay a yield, as do bonds, but China’s fears of an overblown supply of US dollars has encouraged a move to stockpile reserves of commodities in order to circumvent price rises based on a weaker greenback. The irony is that the less US Treasuries China buys, the more likely the dollar is to tip over.
US Treasury prices have held up as traders have played ahead of the Fed buying bonds as it has so indicated. To date the Fed has bought US$100bn of its US$300bn intended purchases, but in the recent FOMC minutes it was revealed the Fed is considering increasing that target. But traders who bought bonds ahead of Fed purchases are now having second thoughts. Last night the Fed backed off on the amount of bonds it intended to buy on the night given the sheer volume of willing offers tendered. And next week the US Treasury will issue a huge volume of new bonds across various maturities.
Who will buy?
This credit watch wake-up call had an unusual effect on US markets last night. Everything was down. Bond prices fell (yields up) and the US dollar index dropped to 80.50 – its lowest level for 2009. The drop was even severe enough for the pound to end higher on the session. Traders are looking for a confirmed break below 80 as a very bearish sign. But despite the US dollar being down, commodity prices also fell.
Bond prices have been falling lately as money has flowed out of the safe haven and back to work in the stock and commodities markets. But last night as bond prices fell so too did the stock market. The Dow fell as low as down 201 just before 3pm. With the stock market tipping over there was a flight out of commodities. While reduced credit ratings affect lower exchange rates, their implication is also of a weak economy. With the Fed having downgraded its GDP forecasts (as revealed in the release of the FMOC minutes) on Wednesday, and the US credit rating under pressure, a weaker US dollar is not necessarily the perfect excuse to buy commodities for which there is no true demand anyway.
Oil fell US95c to US$61.09/bbl. Copper, aluminium, lead, nickel and zinc all fell 3-4% while tin fell 2%. Natural gas, which has been enjoying a strong recovery of late, fell 9%.
The effect on the stock market was a bad day for both bank stocks and material stocks. Markets did manage to recover somewhat in the last hour, but volume was very light. Remember – the buyers are all operating in the off-market of secondary capital raisings.
Weakness in the stock market belied what otherwise might have once been considered bullish “green shoot” economic data released last night. The index of leading economic indicators as measured from April showed a 1% increase – up from negative 0.2% and the first positive reading in seven months. This should have been fabulous news. It portends of an improving US economy as early as the second half of the year. But interestingly, the biggest contributor to the positive net lead indication was the stock market, itself a lead indicator. If you bought the stock market because the lead indicator was positive, and the lead indicator was positive because you had bought the stock market, you must be then double-counting.
The weakest lead indicator was – wouldn’t you know – the increased US money supply.
The Philadelphia index of economic activity was also of the “green shoot” variety. It rose to negative 22.6 from negative 24.4 in April to give yet another indication of a slowing of the economic decline. But Wall Street is beginning to become just a little wary of this field of green shoots. This result is eight straight months of negative results, meaning economic decline, and the index is still a long way from the zero point which indicates flat growth.
The weekly new jobless claim number fell 12,000 to 631,000 which, perhaps only a couple of weeks ago, would again have been seen as an encouraging result. But one cannot deny the underlying figure of 6.66m continuing claims, which was up 75,000 from the week before and yet again a new record.
The one bright spot of the night – if it can be seen as such – was a US$15.30 rally in gold to US$952.70/oz. Everyone was on the same page for gold last night – the inflation traders and the safe haven traders. A weaker stock market, a weaker bond market, a weaker US dollar, and questions over economic recovery were all good reasons to push gold back over the US$950 mark. The Aussie – confused by a weaker US dollar and lower commodity prices – ticked up slightly to US$0.7778.
Also confusing the issue last night was news that the Union of Auto Workers had reached a deal with the US government that would see labour costs cut, factories closed and health care funds restructures in an attempt to stave off the certain bankruptcy of General Motors. GM shares ran late to close up 32% for the session, thus assisting the Dow to stabilise toward the close.
However the VIX volatility index jumped 8% to be back over 30. This week it has traded as low (intraday) as 26.
The SPI Overnight fell 57 points or 1.5%.
Take note that both the US and UK have public holidays on Monday. Also note that the Australian government’s ban on short selling of bank stocks expires on Sunday (unless extended, which is not so likely this time).
