The Overnight Report: Mixed Messages

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By Greg Peel

The Dow rose 70 points or 0.8% while the S&P added 1.1% to 1007 and the Nasdaq rose 1.0%.

The S&P 500 pushed back through the 1000 mark last night and was once again eyeing the previous closing high of 1012. Wall Street opened higher from the bell on relief from a 4.5% rally in China yesterday while financials led the charge throughout a steadily rising session.

Shares in AIG rose 25% last night following a strategy speech from its new CEO. Robert Benmosche told investors (of which there are fairly few outside the US government) that unlike his since-executed predecessor he would not be rushed into selling off the farm to quickly repay the government, but would instead look to rebuild a once great company. The entire floating market capitalisation (non-government) changed hands last night in an extraordinary trading session. Commentators noted that with so few floating shares on offer, short-sellers are always ripe for a good squeeze.

Shares in Fannie Mae – another stock with a majority government shareholding – rose 20% in sympathy.

Shares in once beleaguered Citigroup traded above their 200-day moving average early in the session last night for the first time in two years, thus sparking a rush of buying from excitable tea leaf-readers. Citi closed the day up 8% and dragged along its peer banks into rises of a couple of percent as well. The financial sector accounted for 25% of the day’s volume.

As the financials are the most heavily traded sector at present, it is important to note that August stock options expire tonight, leading commentators to suggest an expiry-shove was mostly the reason for last night’s strength in the sector.

From a broader market context, good economic news came last night in the form of the Philadelphia Fed manufacturing index – the regional index considered to be the best benchmark for the broad economy among the various Fed divisions. The Philly index works on the basis of a zero reading as the neutral point, and following a negative 7.5 reading in June economists were expecting another negative read last night. However, it came in at positive 4.2.

This was the best reading in ten months, and the “new factory orders” segment of the calculation also flipped into the positive for its best read since November 2007. One must keep in mind, however, that manufacturing now only represents about a quarter of US GDP, with service industries the other three-quarters.

More good news arrived in the form of the Conference Board index of leading economic indicators, which posted a positive 0.6% to mark its fourth consecutive positive read. Leading indicators provide a sentiment-based guide to activity six to nine months ahead (a guide – not a crystal ball), and after four straight gains economists are now happy to agree the US recession “ended” in June. No one’s really quite sure what that means, however.

But every silver lining has a cloud, and the less euphoric noted that the past three positive readings have been 1.2% in May, 0.8% in June, and now 0.6% in July (when economists had hoped for 0.7%). Sentiment might be positive, but waning.

But Wall Street embraced the good bits, and then appeared to ignore any other data on the night. The bad news started with the weekly employment data.

In the last few weeks the rate of growth of new jobless claims had appeared to have rolled over into the negative, suggesting a peak in unemployment was now visible on the horizon and which is also another reliable indicator of the “end” of a recession. However that changed last week, and again this week. Economists had expected new claims to fall from 558,000 to 550,000 this week but instead they rose to 586,000. The monthly average rose 4,250 to 570,000 to indicate the growth trend may not actually be over, although economists took heart the figure is still below 600,000. Continuing claims also rose, by 2,000 to 6.24m.

The Mortgage Bankers Association reported last night that the proportion of US mortgages in arrears rose to a record 9.24% in the June quarter having posted a record 9.12% in the March quarter. Mortgages in foreclosure rose to 4.3% – the highest reading in 30 years of data. As these figures continue to climb, one is reminded that we are yet to hit the peak of Alt-A mortgage resets. That occurs in 2010.

[Back in 2007-08 when the world was despairing over “subprime” mortgages, which were basically mortgages given to people who simply could not afford them, attention was also drawn to another class of mortgages known variously as Alt-A’s or resets. These were considered to be sort of “medium prime”, and worked on the basis of providing an interest rate honeymoon for three or so years. You’d start on a really low mortgage rate, and then a few years later (at which time, one presumes, your income has risen) that rate resets to a higher level. Seems reasonable, except a “higher” level in most cases was a much, much higher level. The bulk of this little derivative nightmare was issued toward the end of the housing boom, pre-GFC. And the bulk resets next year.]

The retail sector was the focus of attention earlier in the week but last night it quietly slipped past the fact that department store giant Sears Holdings posted a surprise loss for the second quarter, sending its shares down 11%.

Strength in the sock market sent the US dollar index slightly lower last night to 78.38, and the Aussie managed to tick up to US$0.8319. Gold slipped nevertheless, by US$1.70 to US$940.80/oz.

After a big surge on Wednesday oil managed to add another US12c to US$72.54/bbl, but a weaker greenback was not enough to stem a growing tide of weakness in base metals.

Wall Street might have been able to cherry-pick from the various data last night but over in London the various good/bad releases caused some choppy LME action. In the end, base metals could not muster the sort of upward momentum they have been exhibiting up until recently and fell instead. Copper was down 1%, aluminium, nickel, lead and zinc were all down 2-3% while only tin held its ground.

Basemetals.com noted stocks of all metals and plastics (yes, the LME also trades plastics) held on the LME have reached a new record high of 5.93Mt, and commented “stocks continue to build over the slow summer season and physical demand remains shallow at best”.

The SPI Overnight was up 23 points when I sat down to write this column this morning but at the close is up only 13 points, or 0.3%, despite a strong finish on Wall Street.

Earnings watch today includes Billabong ((BBG)), Insurance Australia Group ((IAG)), and a handful of Macquarie satellite funds.

For the full list of reporting dates and major economic data releases please refer to the FNArena calendar.

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