The Overnight Report: If You Blinked…

This story features CUSCAL LIMITED, and other companies. For more info SHARE ANALYSIS: CCL

By Greg Peel

The Dow rose 120 points or 1.3% while the S&P rose 1.2% to 1005 and the Nasdaq added 1.5%.

Well, there went the pull-back. Did you miss it? Wall Street retraced all of its losses and some from Tuesday last night on what wire services are largely attributing to a positive response to the latest Fed monetary policy update. This is not true.

Wall Street opened strongly from the bell and by lunchtime the Dow was up 146 points. On the release of the Fed statement at 2.15pm the Dow “popped” again to be up 183 points, but by the last hour the sellers had returned to send the markets back down somewhat, resulting in a net Dow gain for the day of less than the pre-Fed level. I will get to the Fed statement in a moment.

The reason for the early turnaround was a group of  influential late-season earnings results.

Toll Holdings is only an S&P 500 mid-cap but it is one of the largest US “luxury” (I think that means McMansion) homebuilders and has become a bellwether for the US housing market. Last night Toll announced a 47% drop in year-on-year revenue for the June quarter but that was not as much as Wall Street had feared. Beating the Street on the revenue line has not been a feature of this earnings season. But most importantly, Toll announced a 3% increase in new contracts – the first rise in four years.

Toll also suggested the cancellation rate of such contracts was, at 8.5%, the lowest in three years, and that the backlog of unsold houses is now stabilising. For a market looking for clear signs of an end to the US housing crisis, the Toll result was gold. Never mind that Toll’s revenue figure is actually only 25% of what it was four years ago. Toll shares were up 15% on the day.

If Toll is a bellwether for housing, famed department store chain Macy’s is a bellwether for discretionary spending. Macy’s announced earnings per share of US20c in the June quarter compared to a US15c Wall Street estimate. Most importantly, Macy’s raised its September quarter earnings guidance to US70-80cps. Macy’s shares rallied 6%.

Never mind that the upside surprise was all to do with cost-cutting – a feature of so many of this season’s results. Indeed, Macy’s missed on the revenue line, and the CEO suggested he does not see much improvement in consumer spending ahead for the critical next few months (which means heading into Christmas).

The next kicker was not a result per se, but one might suggest it was certainly “a result”. Standard & Poor’s raised its credit rating outlook on commercial and personal insurance giant (and new Dow component) Travelers from “stable” to “positive”, suggesting the company is continuing to post “above average” results. Travelers stock gained over 3%.

On Tuesday night Wall Street sold down the financial sector as profit-taking was sparked by a respected analyst’s sector downgrade (specifically he noted some banks were “running on fumes”). But last night the sector spun around and led the rally, taking in the flow-on from supposedly great news in housing, discretionary spending and insurance, all of which bodes well for banks.

We then began to approach the 2.15pm Fed announcement, but not before US$23bn of ten-year Treasury notes were auctioned. Ten-years are considered the inflation bellwether, and clearly monetary policy is key. Despite the pending danger of buying US Treasuries ahead of a Fed policy announcement, the auction was relatively well received, if not fabulously.

When the Fed statement was released the market shot up once more, quickly reaching its peak for the day. Realistically, nothing much had changed in the statement. The zero to 0.25% funds rate did not change, the Fed still saw the inflation outlook as “subdued” given excess capacity and unemployment and thus the funds rate would remain at its current level for “an extended period”. All of this has become a broken record. However, whereas recent monthly statements have suggested the US economy was showing “signs of stabilising”, this time the Fed noted the economy was “flattening out”.

That was enough.

Most importantly, the Fed confirmed it would indeed bring its US$300bn Treasury purchase plan, which has been running since early in the year, to an end. That end will now come at the end of October however, and not mid-September as recently suggested. The purchases will be strung out a bit more but not increased in volume.

The end of quantitative easing is a positive for the market because it implies that the Fed no longer sees a need to provide life-sustaining oxygen to Wall Street. The zero interest rate will remain for the indefinite future as an IV feed, but the Fed now sees Wall Street as soon being able to breathe on its own. The question is: will it do so and continue to quietly regain its health, or will it cough, splutter, gag and threaten asphyxiation once more?

The earnings results above point to such quiet recovery. The emphasis is nevertheless on the word “quiet”, or more realistically “slow”. The stock market, on the other hand, is factoring in a relatively rapid recovery based on its current level, in the eyes of analysts. That’s why so many are predicting a pull-back from these lofty levels before a real recovery rally can be sustained. Tuesday night gave the first signs this might happen, but last night suddenly quashed that idea for the moment. But what was rather notable in last night’s trade was that volume was thin. This implies more short-covering than genuine buying – hardly a surprise when it would appear the market had been getting itself short lately in anticipation of a pull-back. The last hour did, nevertheless, feature selling, effectively negating any positive impact from the Fed.

The US dollar was all over the shop last night as traders tried to take in all that was going on. It settled down 0.3% on the index to 78.91. The Aussie regained some ground to US$0.8329 and gold was up US$2.00 to US$946.80/oz.

For commodities, it was all about a positive stock market response to the day’s events and a slightly weaker US dollar. Oil rose US71c to US$70.16/bbl to end a four-day losing streak despite the weekly US inventory numbers showing a 2.5m barrel increase in crude against expectations of only a 1.2m barrel rise.

London base metals trading closes before 2.15pm, and at that point the US dollar was at its lowest for the session. Throw in the good market news and metals also bounced back to the upside, with copper, lead and zinc all up around 3% and aluminium, nickel and tin 1-2%.

Somewhere lost in all the wash around housing, spending, insurance and Fed incentives were, however, a couple of rather important numbers.

The US trade deficit widened in June to US$27bn from US$26bn in May. While this was actually not as big a move as economists had expected, it is nevertheless indicative that the trade balance has stopped contracting from its huge pre-GFC deficit as oil import costs once again rise. As Americans reel in the spending, the US deficit should fall, particularly if US exports can show some growth from low levels as the economy recovers. Right now, it is not falling.

The trade balance and subsequent current account deficit is part of the “twin deficit” problem facing the US and half the reason why the Treasury needs to raise trillions in debt. The other half is Obama’s fiscal deficit. In July the federal budget marked another record at a deficit of US$181bn, taking the year’s total to US$1.26 trillion. The monthly figure was up 26% on last year and featured a drop in receipts of 6% from last year.

As the Fed moves to wind up its US$300bn support program for US government debt, the deficits continue to grow. Obama is expecting to need a total of around US$2 trillion this year for the fiscal budget alone, and US$300bn was quite a strong crutch.

The SPI Overnight was up 50 points or 1.2%.

Earnings watch today includes Coca-Cola Amatil ((CCL)) and Telstra ((TLS)).

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

Click to view our Glossary of Financial Terms