The Overnight Report: Losing Faith

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This story features BHP GROUP LIMITED, and other companies.
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The company is included in ASX20, ASX50, ASX100, ASX200, ASX300 and ALL-ORDS

By Greg Peel

The Dow closed up 44 points or 0.5% while the S&P added 0.3% to 898 and the Nasdaq lost 0.5%.

The mixed results within the indices told the story of last night’s session. Given most of Wall Street was already off on the long weekend when Thursday’s surprisingly poor jobs data were released, the market opened lower from the opening bell. It then recovered, with the S&P all but square 15 minutes from the closing bell, but to take the Dow move alone as a positive session would be a blinkered view.

The feature of last night was a switch out of the risk sectors such as materials, consumer discretionary and tech and into the defensive sectors of consumer staples and utilities. While such switching provided a net square result for the stock markets, it indicates a growing loss of faith in the integrity of the rally. Stock markets peaked at the beginning of May and have drifted sideways – albeit not without some volatility – ever since, as investors await more positive data to confirm just why the markets are up 40% in the first place.

Wall Street has placed great faith in the tech sector and it has outperformed the broad market, up 12% for the year. But tech is a risk trade, relying on a recovering global economy, growth in emerging markets, and a weaker US dollar which boosts export revenues. At the first sign of nervousness Wall Street races back into the dollar and switches out of the risk trade. That’s why the Nasdaq bucked last night’s trend. The Dow, on the other hand, is weighted towards consumer staples with such names as Kraft, Johnson & Johnson, Proctor & Gamble and McDonalds. Hence its outperformance last night.

One might say that the best indicator of risk appetite at the moment, and a proxy for the global economy, is the oil price. Last night oil fell US$2.68 to US$64.05/bbl to continue its recent pullback from over the US$70 mark. The herd of investors is finally coming around to believing oil and other commodities have run too far and run ahead of themselves.

From New York’s point of view, base metals were also weak, although the bulk of that weakness was delivered in London on Friday night when the US was on holiday. Last night in London base metals were mixed on small moves, but the net to New York was falls of 1-3%.

The US dollar strengthened early in the session as investors moved back into the safe haven, reaching as high as 81 on the index before the close of commodity markets. Speculation was also rife that the G8 meeting, which commences in Italy on Wednesday, would feature a commitment to supporting the greenback. However as late buying hit Wall Street, albeit into defensive stocks, the US dollar index drifted back to be slightly lower on the session at 80.33.

The Aussie barely moved as a result on the measure from Thursday night, marking US$0.7978. Gold was weak in the face of a stronger dollar, with safe haven investors also having been frustrated in recent weeks by gold’s failure to go anywhere much. It fell US$7.10 to US$924.70/oz.

Early weakness on Wall Street belied what was otherwise a positive result for the monthly ISM services (non-manufacturing) index. Services covers everything from IT to accountants, restaurants, hairdressers and telephone sanitisers (What ho, pass the gin and tonic)*. While economic focus tends to be on the “real” world of manufacturing, the services industries actually account for about 75% of the US economy these days. The June figure was expected to rise to 45.5 following a 44 in May, but instead posted 47.

This is a typical “less bad”, “green shoots” result, but Wall Street has become a bit frustrated with green shoots. It wants leaves and flowers and fruit, but is clearly impatient. Remember that a reading under 50 still implies contraction in such an index, so one might now suggest that until some of these indices actually pass the 50 mark, Wall Street will not be excited anymore.

Another indicator of growing nervousness, or frustration, is the VIX volatility index. Having reached as low as 25 recently, the VIX has been rebounding again, rising another 4% last night to 29. If it reaches back over 30 it would indicate Wall Street again has an appetite for put option protection, and thus fears a pullback. But so far any decent pullback has been met by reasonable buying, although we must also remember it’s summer holidays in the northern hemisphere and volumes are very light. Will the late buyers continue to be keen?

The SPI Overnight fell 1 point having already fallen 1.2% on the physical yesterday. For Australia, the move out of the commodities trade has a greater weighting. BHP Billiton ((BHP)) was down 4% and Rio Tinto ((RIO)) 7% last night in London after New York provided the weak lead but there’s a little bit of catch-up involved here.

*For Douglas Adams fans.

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