The Overnight Report: Real Profit Taking

This story features BHP GROUP LIMITED, and other companies. For more info SHARE ANALYSIS: BHP

By Greg Peel

The Dow closed down 96 points or 1.0% while the S&P closed down 1.3% at 994 and the Nasdaq lost 1.1%

Even the uber-bulls know that a market cannot go up every day. This second leg of the rally beginning in March – the “summer” rally – began exactly one month ago and has peaked at a 15% gain in both Dow and S&P points. While it seems like the market has just about gone up every day, there have actually been 8 down-days to 16-up-days. Clearly those down-days have been small by comparison, but most notably every down-day has begun with a fall of some 50-100 Dow points, only to see late buying close the session at only around 20-30 points down. Buyers have been snatching the opportunity of every “dip”.

Last night represented a subtle change. The Dow was down 121 points at 11.15am. Recently the Dow has hit its session low in the afternoon before the late rally. Last night the rally began late morning, taking the Dow back to down 60 just after 3pm. But this time, late sellers arrived.

It was the biggest fall in the stock market in five weeks, and the S&P 500 has fallen back under 1000.

Is it all over? Probably not. But for once it is the bulls calling the pull-back from an overblown high, and not just the bears. The rally beginning in March saw a 7% correction in June, and 5-10% corrections are not only frequent but are considered healthy. If a market runs too far too fast then the inevitable correction will be more severe. But 5-10% is a good little breather.

The bears, of course, have also been expecting a pull-back. But unlike the bulls, the bears see a more pronounced downside in the next few months, the feature of which will be a disappointing third quarter earnings season in the US. The bears argue the second quarter earnings numbers were boosted by cost-cutting and not by revenue growth, and that now that costs have been cut revenue growth will further disappoint in the September quarter results (released in October), thus leading to poor earnings results, and thus showing the current rally to have been premature – a false dawn.

This view is not necessarily bearish. It is simply a view that suggests it’s too early yet to get bullish. There is now little argument across the market that Armageddon has been averted, and that probably the March low was the bear market low. Some uber-bears do still remain, but they are becoming lonely. Elliot Wave specialist Bob Prechter, for example, still believes (from a technical point of view) that the 2008 bear market was just the warm-up for the big one. He also correctly called the rally to 1000 in the S&P from February. But Prechter has rarely been right ever since he correctly called the Crash of ’87. Such is the nature of Elliot wave analysis.

So it’s all just an argument about timing. Should prospective buyers buy on the dip that may now follow or wait to buy lower in October – the most famous month of all for weak markets? Or then again, will there be little dip at all? One swallow does not a summer make.

And that swallow did have some impetus last night, other than “time to take some profits”.

On the economic data front, wholesale inventories fell 1.7% in June when economists expected only a 0.9% fall. This was disappointing, given many expect (hope) inventory rebuilding from low post-GFC levels will be a key driver of economic recovery. But wholesale sales did rise by 0.4%, providing perhaps a little bit of light at the end of the tunnel.

Good news came in the form of a big 6.4% increase in second quarter productivity. However, this result was very much reflective of the big drop in hours worked in the US – a feature (both in the US and Australia) credited with keeping a lid on apparent unemployment growth.

China had also provided some disappointing news leading into the Wall Street session. July exports fell 23% from a year earlier, which put a bit of a dampener on ideas of an export-led Chinese recovery. The result was nevertheless 10% better than the June result, but analysts were rather hoping for more. China is the global saviour and a big feature of the stock market rally. But with a turnaround in exports still seeming a-ways off, it will be solely all about China’s domestic economy for a while yet.

OPEC also came to spoil the party last night. The world’s major collective oil producer reduced its 2010 global demand forecast to 27.97m barrels per day, which is 480,000bpd below 2009 demand. Previously OPEC had forecast a fall of only 380,000bpd. OPEC blamed a slower pace of global economic recovery than it had first anticipated, coupled with a greater increase in non-OPEC supply.

Oil fell US$1.15 to US$69.45/bbl.

The first tranche of this week’s record US$75bn Treasury auction was sold today, and demand was strong for US$35bn of three-year notes. Strong Treasury demand can be a weak indicator for stocks as an alternative investment, so this didn’t help, although with 69% participation by foreign central banks at least Wall Street can rest more easily about foreigners abandoning US debt. If they did, the stock market would crash. The next two nights see longer-dated Treasuries up for grabs.

The VIX volatility index hit a month-high 26 last night after a 4% gain. This implies investors are once again buying put protection (and the suggestion is that mutual funds are the big buyers) in an attempt to lock in gains ahead of a pull-back.

It seems everyone is expecting this pull-back. But we all know what happens when everyone agrees.

Financials led the market down last night, with a 4.4% fall in the sector index. The specific impetus was a report from a respected bank analyst that suggested it was time to take profits, although with banks up some 130% from the March lows, it ain’t rocket science. The energy sector also clearly put in a weak performance.

The US dollar was a bit of a mixed bag, virtually unchanged on the index at 79.15. The dollar was down against the yen, which indicates risk aversion creeping back in, and which also sent the Aussie 0.8 cents lower to US$0.8294. Gold slipped only US$1.00 to US$944.80/oz.

If the US dollar is stable and the oil price falls, then you know the reason for the fall is fundamental and not currency driven. Similarly, base metals all fell in London. Aluminium, copper, tin and zinc all fell les than 1%, while nickel fell 1.8% and lead 2.7%.

But when it was all said and done, one very good reason for last night’s pull-back from the highs in both stocks and commodities is tonight’s Fed monetary policy announcement. There will be no change to the funds rate range, but Wall Street is looking for an update on the Fed’s views on economic recovery, as well as confirmation it will cease quantitative easing by mid-September as planned (meaning it no longer sees a need to “save” the US economy), and perhaps even talk of an “exit strategy” down the track. The market has rallied strongly on a belief the recession is over, so Wall Street would like confirmation from the central bank. Ahead of such an announcement, it’s a sensible bet to take profits.

Yesterday the ASX 200 wavered between a weak lead from Wall Street, disappointment from China and another solid NAB business confidence report. Last night the SPI Overnight was down 35 points or 0.8%.

Its a big day for earnings today, including BHP Billiton ((BHP)), Commonwealth Bank ((CBA)) and Stockland ((SGP)). Also watch out for both Chinese and Japanese industrial production numbers.

All company reporting dates and major economic data releases are available in the FNArena calendar.

Click to view our Glossary of Financial Terms