Daily Market Reports | Sep 29 2009
By Greg Peel
The Dow rose 124 points or 1.3% while the S&P gained 1.8% to 1062 and the Nasdaq added 1.9%.
For the previous three sessions, Wall Street has drifted lower largely on concern of having run too far against a backdrop of fresh economic data which have not been quite as encouraging as previous months. Over these three days, the Dow lost around 150 points. But Wall Street managed to snatch back a good bulk of those losses in the session last night. Volume was very light on the NYSE as Jews celebrated Yom Kippur.
Yet another case of shorts having been built at what looked like it could be the top of the market, only to be caught out yet again? Or a simple case of very thin volume suggesting no one to keep a lid on a burst of enthusiasm?
The impetus for last night’s rally came not from any economic data release, of which there was nothing significant last night, but from two new announced takeover bids each representing around US$6bn. Xerox put in a bid for Affiliated Computer Services and pharma company Abbot Laboratories put in a bid for the pharma operations of Belgian chemical maker Solvay. The deals followed last week’s announcement of a takeover bid by Dell for Perot Systems and the earlier bid by Kraft for Cadbury. Last night Johnson & Johnson also announced it had taken a stake in flu vaccine maker Crucell. It was a big night for M&A.
Merger and acquisition activity had been all but non-existent since the collapse of Lehman Bros following a much lower level of activity earlier in 2008 compared to record levels in 2007. In 2007 it was all about private equity and leveraged buyouts, but LBOs are now a pre-GFC relic and private equity has been quiet in a credit-squeezed world. As conditions improve, however, M&A activity is quietly beginning to pick up.
M&A is usually most active at the top of a bull market when listed companies making plenty of cash are egged on by impatient shareholders looking for acquisitions to provide further earnings growth. Most such acquisitions end in disaster, given they are often rash, megalomaniacal and made under duress from stock analysts. Think Rio and Alcan, Foster’s and Southcorp. But M&A is also a feature of market bottoms, in which the surviving stronger companies look to snap up bargains among the weaker, struggling companies to consolidate market share and integrate businesses ahead of a more prosperous future. It is the classic case of Schumpeter’s “money passing from weak hands to strong”.
With credit conditions easing, the global economy stabilising and stock markets surging off the lows, the time is again rife for M&A to proceed before prices become too overblown once more. This is what was in evidence on Wall Street last night.
But a funny thing happened.
Since the fall of Lehman Bros, the US dollar has moved in almost perfect negative correlation with the stock market. As stocks collapsed this time last year investors withdrew in panic to the safety of the reserve currency, irrespective of zero interest rates. When stocks turned around in March, and China led the way for emerging markets, funds flowed back out of the safe haven and the zero interest rate dollar became the funding mechanism for emerging market investment. The US dollar carry trade took over from the longstanding yen carry trade, sending the dollar lower against the yen as well as the euro and pound.
But the world has set itself short against the US dollar in constant expectation that excessive public debt in the US must devalue the currency. The Fed has indicated it has no intention of raising its cash rate for some time, while across the globe, including in Australia, central banks are looking towards their first post-GFC interest rate rises. The US dollar has weakened considerably over 2009, but as stock markets have hit their recent highs the reserve currency has refused to capitulate. The world is simply too short.
Last night saw what one might describe as a return to “normal” conditions. The stock market rallied strongly, but the US dollar refused to fall. Indeed, with growing expectation that the Fed will simply have to raise rates some time soon, carry trading took a breather as the dollar rose against the euro and pound and held steady against the yen carry trade rival. Thus we also had a case of the dollar index being up 0.4% to 76.97 but the Aussie also rising solidly to US$0.8716. Aussie strength was also underpinned by RBA governor Glenn Stevens yesterday informing despondent Opposition senators that he can happily live with ongoing fiscal stimulus in conjunction with higher interest rates.
The stock up/dollar up combination confused the hell out of the London Metals Exchange last night. LME trading has lately been dominated by commodity fund activity and little else, with a weaker greenback driving more and more metal buying from index funds. Last night’s stock surge should have seen a weaker dollar and thus higher commodity prices, but this was not the case. Copper initially pushed back over US$6000/t, but couldn’t hold it as the greenback rallied. At the end of the day metal price movements were small and mixed.
Similarly gold remained steady, falling only US70c to US$990.20/oz.
There was no confusion in the oil pit however. If everything old is new again, such as M&A activity and a strong dollar, it was a case of deja vu in the oil market last night as traders responded to more missile testing from a hostile Iran. It was oft noted back in early 2008 that Iran could hold the world to ransom by simply blocking the Straits of Hormuz – through which the bulk of the world’s oil exports pass – and that oil would see US$200/bbl as a result. Last night oil ignored the dollar and rose US82c to US$66.84/bbl. It was not a significant move, but oil had suffered an 8% fall last week which had looked like gaining momentum.
Strength in the US dollar was also aided by comments from the Bank of England last night. Reports emerged that last week BoE governor Mervyn King had suggested a weaker pound – weaker since the fall of Lehman – was a helpful step towards rebalancing Britain’s economy towards an export leaning. Unfortunately for red-faced BoE officials, this was a departure from the adage that central bankers should be seen and not heard on currency policy, and sparked selling from those assuming King was advocating an even weaker pound.
King’s comments are nevertheless representative of discussion held at last week’s G20 meeting, in which leaders, including Barack Obama, agreed that a more balanced global economy is needed in order to avoid another GFC. Thus while the Obama Administration should always be heard to be supporting a “strong dollar policy” from a political angle, from an economic angle it is clear to the G20 that a weaker US dollar would encourage less US consumer spending and more saving, with the flipside being more spending and less saving in emerging economies. The same can be said of Britain and its recent excessive consumption.
Last night World Bank president Robert Zoellick threw his hat into the ring, post-G20, by suggesting the US should not take the reserve currency status of the dollar for granted given other options are emerging. While no one expects the US dollar to lose its status overnight, there is general agreement that a global balance requires less investment in US debt and more diversification into the euro (the EU economy collectively was larger than the US economy in 2008) and the renminbi (the Chinese economy is still much smaller than the US economy but growing rapidly).
Zoellick’s comments, however, clearly did not spark weakness in the dollar. It’s now a bit of a broken record, and the dollar, while weaker, has not broken down. If anything it has the capacity to experience a sudden and sharp short-covering rally, which would be a case of goodnight to commodity prices in the short term. If the world was truly worried that the US dollar was about to collapse due to monetary inflation, then US bonds would be quickly sold. But last night the ten-year yield fell to 3.28% having been as high as 4.0% some months previously.
Underscoring all activity this week is the fact the September quarter ends on Wednesday. Bond portfolios are typically topped up towards the end of a quarter and window-dressing in stocks is also rife. Underweight fund managers also need to show sufficient equity weighting in their portfolios in their quarterly reports or risk redemptions from investors frustrated by having missed out on the rally to date.
It’s a case of anything can happen, and probably will.
The SPI Overnight was up 56 points or 1.2%.
