Daily Market Reports | May 26 2010
By Greg Peel
The Dow closed down 22 points or 0.2% while the S&P closed up 0.04% at 1074 and the Nasdaq lost 0.1%.
Talk about being kicked while you're down. With European debt, Chinese slowing, the Goldman Sachs case, US financial reform, the RSPT, the volcano and the oil spill all sent to test us at this time, we now face a brand new series of MASH?
The Australian market had begun to play out as I suspected yesterday morning – opening lower based on what was only a very late sell-off on Wall Street before quietly beginning to claw its way back. Wall Street had all of Monday's session to respond to the Spanish bank seizure, but fell only in the last twenty minutes. While the seizure only served to heighten fear, it was not enough to devastate Wall Street.
Then I received a phone call from an associate asking me if I'd seen the news on Korea. I had been reading all about Korea on the weekend, I noted, but no, I was busy writing copy. Has Kim Jong-il fired off some nukes? That was not the case, but North Korea had apparently moved into full war readiness. And then, the market tanked.
All the financial news reports in the popular media last night cited the “ongoing European debt crisis” as the reason for yesterday's 3% rout, but realistically it was the Korean news that simply added insult to injury and really spooked a market already up to its eyeballs in bad news. What on earth could happen next?
Australian traders watched as the South Korean and Japanese stock markets tanked and the Dow futures headed lower, and sold in concert. Trading then moved to Europe, where the London and German markets also tanked. Then the opening bell rang on Wall Street, and the Dow was down 292 points to below the 10,000 mark.
But that was the end of it.
The Dow very quickly regained 100 points, hovered at lunchtime, and then raced back towards the flat-line by the closing bell. This was no twenty-minute short-covering run, it was a good two hours of legitimate buying.
After the initial panic on the news North Koreans were being told to dust off the battle fatigues, it became clear to US observers that no actual troop movements were afoot. Tensions eased. Perhaps it is simply posturing in the face of South Korea's ban on trade with North Korea, and closure of its waters to PRK ships. But then, perhaps it is the last dying wish of an insane dictator to go out with the most spectacular fireworks display of all. The once devoted North Koreans have lost faith in their “Dear Leader” ever since he recently revalued their currency overnight.
It is just another ingredient to add to the current uncertainty pot. What is perhaps more worrying in the global framework is the quiet but inevitable rise in the Libor rate, and subsequently the TED spread.
The London Interbank Overnight Rate is that rate from which all global bank funding is based. Aside from tradition, it must be remembered that London is still the biggest financial centre in the world. Movements in the Libor rate then impact on the US TED spread. The TED spread is the spread between US Treasuries and the eurodollar rate. The eurodollar rate has nothing to do with the euro currency, and the expression was coined decades before the euro came into being to represent the rate on US dollar-denominated debt issued offshore from the US. This connects Libor to US bank funding. The upshot of all of this is that global bank funding costs have begun to rise, just as they did in the GFC, and all the way across the Atlantic.
The bears say this is a precursor to the next wave of financial crisis in which banks again cease lending to each other. The bulls note the actual increases in Libor and TED are understandable and so far minimal under the circumstances (equivalent to July 2009), and nothing like that which even late 2007 brought about. In short, the world is looking for European resolution, and soon please.
In the meantime, Wall Street is seeing an oversold market. Whether it is only short-term oversold or more emphatically longer-term oversold is yet to be determined. But the buyers came in last night.
I noted yesterday that despite the late sell-off on Wall Street, the VIX volatility index actually fell from 40 to 38, contrary to every other day stock markets have ended lower. Last night brought significant volatility on Wall Street – 300 down then almost 300 up – but the VIX fell again, to 34. That's a 10% drop in the session.
The VIX rises when the market buys options on the S&P 500 index. Panic periods see investors rushing for put option protection, and a jump in the VIX indicates the cost of that insurance has jumped. The VIX falls when the market sells options.
If you were looking to buy into an oversold market using options instead of stocks or futures, you could buy call options. Your downside would be limited and your upside open-ended. But the current cost of options is very expensive, so the other way to go long is to sell put options. That way not only do you set your position to the upside, you receive all that overblown premium. It can prove a win-win, but the only problem is it is now your upside that is limited and your downside that is open-ended. In other words, selling put options is the riskiest option trade of all.
But it looks like there are enough traders on Wall Street currently prepared to take that risk.
Once again lost in the wash last night of all the global volatility was a round of US economic data.
Any rebound in the US housing market again showed to be stuttering last night as the Case-Shiller 20-city house price index showed a drop of 0.5% in March. This was disappointing in absolute terms, but also disappointing considering the rise in home sale figures over the period. It means houses are being bought, but at lower prices, and that corroborates the still rising foreclosure rate.
The FHFA house price index, which measures only prices of those homes with prime agency (Fannie and Freddie) mortgages, fell 3.1% in March.
The Richmond Fed manufacturing index fell to 26 in May from 30 in April. While a drop, a reading of 26 on this zero-neutral index is still strongly positive and the index has been positive, indicating expansion, for 10 of the last 12 months.
But the best news was the Conference Board consumer confidence index for May, which jumped to 63.3 from April's 57.9 and against expectations of 58.5. This is still quite a low reading given true confidence means results around 90, but the big jump, and the trend up from a reading of 46.4 in February, is a comforting sign.
In the afternoon, NY time, the US Treasury auctioned US$42bn of two-year notes and sold them at the lowest yield in history – 0.77%. To put that into context, a US two-year was yielding 16% in 1981. But despite the high price, demand was not actually as strong as traders had expected. Foreign central banks bought only 36% compared to the recent average of 40%.
The benchmark ten-year yield slipped 4 basis points to 3.16%, and it's amazing to think we were talking a break-up through 4% only a couple of months ago. But what does the weak demand indicate? That the world still fears US debt and deficits? Or that the “flight to quality” into US debt – the last bastion of financial sanctuary outside of gold – has eased? The latter would be an echo of last night's trading on the stock market.
But when nuclear war threatens, gold is the place to be. It was up US$8.90 last night to recover the US$1200 mark at US$1201.20/oz.
Not surprisingly, last night's trade in the euro matched that on Wall Street, or vice versa. The euro plunged initially to around US$1.22 in Europe before rebounding back to US$1.243 by the close of New York to be little changed. The US dollar index was off a tad to 86.40 and the Aussie, which had another one of its dumpings yesterday, rebounded to be up 0.6 of a cent to US$0.8293 over 24 hours.
Commodity markets close at 2pm New York, and thus miss those vital last two hours of Wall Street trade. Thus oil was down 2% or US$1.46 to US$68.75/bbl last night, while London base metals shook off the last two sessions of technical rally and sold off again, with moves down 2-4%.
So was yesterday's collapse in Australia another panic dumping that could be overdone? Wall Street was square so the SPI Overnight is up 65 points or 1.5%.
And as I sign off (08:44) the Dow futures are up 67 points in the after-market.
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