The Monday Report

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By Greg Peel

A bombshell was dropped on Wall Street on Friday night in the form of fraud charges brought against leading US bank Goldman Sachs. The surprise sent the Dow down over 170 points to under 11,000 at lunch time before recovering to close down 125 points or 1.1% at 11,018. The S&P lost 1.6% to 1192, thus falling back through the 1200 level, and the Nasdaq lost 1.4%.

The Securities Exchange Commission has alleged that as the subprime crisis was unfolding in the US, a Goldmans hedge fund had tailored a suite of subprime collaterlised debt obligations (CDO) as a preferred short against the market, and then that portfolio was marketed to clients of the bank to take the other side. Goldmans famously announced as the crisis deepened that, unlike rivals such as Bear Stearns and Lehman Bros, the investment bank was “short” subprime. Its losses were thus much less than those of its rivals.

Goldmans has of course denied the charges, suggesting the portfolio was chosen by a large client looking to invest in CDOs and that the hedge fund took the other side, as is its wont. The bank says it actually lost US$90m on the deal. What is known is that despite its “short” CDO positions, the knock-on effect from the fall of Lehman still meant Goldmans had to be bailed out by US government TARP funds when the GFC hit in earnest.

Goldman shares fell 13% on Friday night while shares of rivals such as JP Morgan and Bank of America fell 5%. Notably, the VIX volatility index on the S&P 500 jumped 15% to 18, as well it might. Commentators suggest the SEC's case is a bit sketchy and evidence not robust, but the simple fact of the matter is that this will not prove a one-day event. It will likely be a long and protracted court case which will likely spark a whole round of similar allegations and possible charges across the financial sector. It could take years.

One thing is for certain and that is the US taxpayer will not be amused. Goldman Sachs is already the bullseye in most taxpayer's dart boards and this charge will no doubt only raise hackles further at a time when regulatory reform legislation is being debated in Congress.

One thing we must hope doesn't take years is the eruption of the Iceland volcano. While this baby apparently rumbles and spews a bit every now and again, it was late in the nineteenth century when it last erupted to this extent – when Orville and Wilbur were still at school. That eruption apparently lasted two years.

And more ominously, locals note that any rumblings from this particular, relatively small Icelandic volcano in the past usually proves only the support act for the much bigger volcano just down the road. If that one goes up, heaven forbid. In the meantime, European air controllers are now considering allowing some short haul flights which do not require rising to the altitude of the volcanic plume. However, long haul flights are still off the agenda at this time, and it is simply unknown as to when they might be back on again.

Some long haul flights have apparently been able to sneak up behind the plume, crossing the pole to land in Scandinavia. Wind direction is an important factor. But the simple fact remains the disruption has been devastating for global airline companies at a time when recovery has been tenuous, and on slim margins. It is the knock-on effect into international trade which is of significant concern. Already reeling from sovereign debt issues, Europe can little afford a disruption to import and export deliveries which could last who knows how long. Maybe it will all be over tomorrow, or maybe not.

I recall writing an article over a month back on the VIX volatility index and noting that whenever it falls to below 20, “something” usually happens. The index has since spent a solid period under 20 as Wall Street has quietly pushed to post-GFC highs, trading as low as 15. Analysts and economists will spend their days arguing about what known and predictable conditions are likely to impact on the market, but those “somethings” often come right out of left field. The Greek debt situation is an example. Now we have the Goldmans bombshell and an unprecedented natural phenomenon.

The reaction on Wall Street on Friday night was a typical flight to quality, mostly into US Treasury debt and out of stocks and commodities. The US ten-year yield fell 7 basis points to 3.76% and the US dollar index rose half a percent to 80.82.

Oil fell 3% or US$2.68 to US$83.24/bbl. Aluminium fell 1.5%, copper and nickel fell over 2% and zinc and lead fell over 3%. Silver fell 4% and gold dropped US$22.00 to US$1136.80/bbl.

It is the nature of gold that any sudden fear sparks selling to raise cash, which always sends gold lower immediately when one might expect uncertainty to be a reason to buy gold. Gold investors are long used to this reaction, and usually step aside and wait for the opportunity to buy more gold at a better price. It's often a case of one step back, two steps forward for gold.

The Aussie took a bath, falling a cent to US$0.9247, while the SPI Overnight fell 48 points or 1%.

Lost in the wash of Goldmans charges on Friday were two important earnings results, from Bank of America and General Electric.

BofA posted earnings of US28c per share on revenue of US$32bn when the Street had expected US9cps on US$28bn. It was actually a weaker result than the same quarter last year, but that impacted by the absorption of investment bank Merrill Lynch. BofA shares were nevertheless down 5% in sympathy with Goldmans.

Economic bellwether General Electric posted a profit one third lower than the same quarter last year, impacted mostly by its financial and media arms. Earnings per share of US17c matched the Street, but revenue of US$36.6bn fell short of US$37.3bn expectations. GE shares were down 3% in a day when everything was down and volume was comparatively heavy.

US housing starts rose 1.6% in March to 626,000 when economists had been expecting 610,000. This is a sixteen month high, but unfortunately the seemingly good result was due to an 18.8% jump in the very volatile apartment block figure. Single-family home starts fell 0.9% which is not encouraging. In February, apartment block starts fell 21.6%.

Surprisingly bad news was also forthcoming from the fortnightly Michigan Uni consumer confidence index. In late March the index read 73.6 and economists had been expecting a jump to 75 in this first April read, but instead it fell to 69.5.

We now move into this week with a level of uncertainty. It may be that the knee-jerk Goldmans reaction actually provides a good buying opportunity in the near term given resolution could take months, weeks, years. But we also have to see who might be next. The volcano is simply an unknown. It is, however, known that officials from the EU and IMF were supposed to be meeting with the Greek government in Athens tonight, in a move that suggests Greece is ready to trigger its bail-out package. That's if said officials can find a way to get there.

The list of post-GFC monetary policy tighteners now includes Australia, Israel, Norway, India and Singapore with China possibly not far off. The US is holding fast, but next week sees a rate decision from the Bank of Canada. Given Canada's by-far biggest trading partner is its southern neighbour, where goes the US economy so goes Canada's to a great extent. But the BoC was apparently very close to raising rates last month so interim commodity price rises may push it over the line. The Canadian dollar is a component of the US dollar index.

This week's economic data in the US include the Conference Board leading economic indicators tonight, and existing home sales, the FHFA house price index and the monthly PPI on Thursday in what is a relatively quiet week. Friday sees new home sales along with durable goods so it's nevertheless an important week for the housing sector.

There will, of course, be a flood of quarterly earnings reports to rival economic news.

There's not much on the Australian economic front this week. The minutes of the last RBA meeting are released on Tuesday, Westpac provides its leading economic indicators on Wednesday, we learn monthly vehicle sales on Thursday and the first quarter import/export price index (important for inflation) on Friday. The RBA governor will also speak on Friday.

Elsewhere in the world, the UK will release unemployment data on Wednesday and its first estimate of first quarter GDP on Friday – both important considerations for voters heading into the May 6 election. Once again the polls are slipping back towards predicting a hung parliament, which would not be positive for the pound.

On the local stock front AGM season is in full swing and more resource sector production reports will be forthcoming from a few of the big players, including BHP Billiton ((BHP)) on Wednesday. The ACCC is scheduled to rule on National Bank's ((NAB)) bid for AXA-AP ((AXA)) on Thursday.

For further global economic release dates and local company events please refer to the FNArena Calendar.

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