The Overnight Report: Can’t Kill It With A Gun

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By Greg Peel

The Dow closed down 26 points or 0.3% while the S&P fell 0.5% to 975 and the Nasdaq fell 0.4%.

The Shanghai stock market fell 5% yesterday to mark its biggest one-day fall since last November. Like most global stock markets, the Shanghai index has rallied 45% since March, but unlike most global stock markets, the index is up over 80% since its November low. There is little doubt China has played a big part in the global recovery-rally to date.

The drop was sparked by a realisation that corporate profits were not keeping pace with stock prices, and a fear that the Chinese authorities would step in and take measures to crimp “hot money” inflows, perhaps through increased lending rates. (For more on hot money, see China: Global Saviour Or New Bubble?)  But in the scheme of things, a 5% correction in China is probably healthy and anything the Chinese authorities ever do they do gradually and subtly.

The news was not good for commodity markets however. A combination of demand fear and a flow of US dollars out of emerging market investments last night, which sent the US dollar index shooting up 0.8% to 79.51, impacted heavily on the commodity space.

Nor did the weekly inventory numbers help the oil price. These numbers are always volatile, but analyst were expecting a 1.1m barrel increase in US crude supplies and instead got a 5.1m barrel increase. Oil fell 6%, or US$3.88, to US$63.35/bbl.

Aluminium, copper, lead, nickel and zinc all fell 2-3% in London, with only tin holding up. Silver fell 3%.

Wall Street was not provided with a positive opening, and things didn’t get any better.

The last two months have seen an increase in US durable goods orders – orders of big-ticket non-consumables – but this month economists were expecting a 0.6% drop to reflect a lack of new orders in the troubled auto market. The June figure came out at a 2.5% fall with said autos being worse than expected, along with weak demand for commercial aircraft. This was an alarmingly large fall in a supposed “green shoot” environment, but if you remove transport from the calculation remaining durable goods orders actually rose 1.1%, which is a bit more heartening.

I noted last month that an enthusiastic Wall Street had responded very positively to the Fed’s Beige Book. The Beige Book is a form of survey to determine how economic activity is faring in the twelve Fed districts. Last month Wall Street was all excited that four districts had shown signs of stabilisation. I rather thought the fact that eight districts thus weren’t was a bit more of a concern, but what do I know?

This month the score card still has only four districts “showing signs” of stabilisation. Two more are seeing a “moderation of decline”. Five said their economies remained “subdued” and one said things were simply worse. So it’s still a case of eight districts going backwards, albeit the “signs” of turnaround are creeping in, ever so slowly. Nevertheless, Wall Street apparently took comfort from this report after the durable goods shock.

So what we had was a very choppy market, and nothing changed when the next bond auction took place.

After a lacklustre response to Tuesday’s auction of two-year Treasury notes, it was the same story last night as the Treasury tried to entice buyers into a record US$39bn of five-years. Interest from foreign central banks and sovereign funds again dropped substantially to be only about a third of the buying interest, compared with the two-third ratios being achieved in previous months. This week it appears the world is starting to tire of funding the US deficit.

The risk is that the Fed will soon have to raise interest rates to attract more interest. This is particularly bad news for retailers, REITs, and other yield funds as a rise in Treasury yields makes yield funds less attractive, and a rise in interest rates hits the consumer’s pocket in an already tough environment. The saving grace at present is that these are shorter-end issues (twos, fives) which lend more to immediate risk aversion buying rather than longer term inflation implications (tens, thirties). This week the ten-year yield has actually slipped lower, and did so again last night on a durable goods number that implies deflation remains more of a concern so far. But tonight sees a record amount of seven-years being auctioned. This is the not-short-not-long maturity, and another lacklustre performance may have more meaningful implications for longer term monetary inflation.

So Wall Street took all of this on board, and realistically you’d be forgiven for thinking if ever the rally was going to tip over, last night provided all the incentive. But no – the Dow bottomed out at lunch time down only 82 points and then began yet another afternoon rally of dip-buying.

Gold was down another US$8.00 last night to US$929.20/oz, still being impacted by the US dollar. If monetary inflation does rear its head, that could change. Either way, gold seems stuck in a range for the time being.

The Aussie did not like the news from China, nor the subsequent commodity price falls. It dropped over a cent to US$0.8168.

And the SPI Overnight? Well it was up 3 points.

Earnings watch today includes Alumina Ltd ((AWC)) and Austar ((AUN)).

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