Daily Market Reports | Aug 17 2010
By Greg Peel
The Dow fell one point, the S&P was flat at 1079, and the Nasdaq added 0.4%.
When the NYSE can't even generate turnover of 800m shares you know that there simply isn't any interest. Not only does such indifference result in flat closing prices, it can also provide intraday volatility. The Dow was actually down 94 points on the open and up 30 points at lunch time. When it drops it finds a couple of buyers, and when it rises it finds a couple of sellers. But it ain't goin' nowhere.
So where is the money going? Well perhaps the fact the US ten-year bond yield fell 11 basis points last night to 2.56% provides a clue. Headline inflation is currently running at an annualised 1.9% in the US at present, so investing your money for ten years is providing you with a handsome real return of about 0.7% before tax. The two-year bond, which is more of a safe haven play, is yielding less than 0.5%, or negative 1.4% in real terms. So you can give your money to the US government and watch it erode in value, but at present this is a safer bet, the market has decided, than the stock market.
There has been much talk of a “bond bubble” in the US. With the two-year rate trading at its lowest yield in history, one can see why many commentators are warning that something has to give. But others point to historical data which suggests bond rates have been very good at predicting recessions. So either the bond market is right – and the US will “double dip” – or at some point there is going to be one helluva bail out of US Treasuries.
On last night's US data, the bond market is looking wise.
The NAHB index of housing market sentiment fell to 13 this month from 14 in July. That's its lowest level since the stock market bottomed in March last year. Economists had expected a rise to 15. Is it really a surprise? (See our story "US Mortgage Foreclosures Running Riot")
The New York Fed's Empire State manufacturing index rose to 7.1 in August from 5.1 in July – looks okay, except that economists had expected 8.5. The good news within the numbers is the hiring component was largely responsible for the rise. The bad news is that the shipments component fell from 11.5 to 6.3 and the new orders component from 10.1 to minus 2.7. America, or at least New York State, is shutting up shop.
The weak US data added to the negative sentiment on the opening bell which had already been piqued by yesterday's release of Japan's second quarter GDP.
Japan's first estimate of June quarter GDP showed an annualised rise of only 0.4% when economists had expected 2.3%. In the March quarter, Japan's GDP grew by 4.4%. The quarter-on-quarter growth from March to June was a mere 0.1% compared to 1.1% from December to March.
Much has been made of the fact Japan's second quarter GDP in US dollar value was actually less than China's equivalent, thus moving China into the silver medal position on the podium and relegating Japan to bronze. But Japan's calculation is seasonally adjusted and China's isn't, so it's misleading. Nevertheless, it is expected China's economy will surpass Japan's in size before the end of 2010.
Japan's economic growth appears to be running out of steam, given the move down from 4.4% growth to 0.4%. The numbers echo a similar pattern in the US, which has seen consecutive quarters running 5.7%, 3.2% and then 2.4% on first estimate. That 2.4% is expected to be revised down closer to 1.0% this month. If the numbers aren't indicating a move back into recession, then what would? No wonder US bond yields are falling.
But there are those who are unfazed, for a couple of reasons.
Firstly, It is not unusual for a recession to be followed by a honeymoon period of rapid return to growth and then a slowing of the initial exuberance. The net trend is simply a slow and sluggish return to growth which takes years, not months. A lot can be attributed to the inventory cycle. Companies desperately destock in a recession until the shelves are all but bare but at the first sign of recovery they rapidly restock lest they miss out. This restocking shows up in the GDP numbers as strong growth.
But in the case of the US in particular, ultimate GDP will depend on “final demand” and the consumer is 70% of US economic activity. If fresh inventories only get as far as the shelf but not out the door, then restocking will slow and so will GDP. The above Empire State index showed falling shipments and orders. The latest business inventory and wholesale inventory data in the US showed modest inventory gains but falling sales. The greatest perpetrators of deflation are the words “discount”, “sale”, “everything half price” etc. That's what happens when companies find themselves stuck with unsold goods bought on credit.
We know that stock markets always overshoot on the upside and on the downside, and the stock market is only an analogue for all markets, or even “life”. It simply looks like the V-bounce proponents were wrong and were always going to be wrong and that inventory building is reflecting that. Hence there is an argument that while a six-month fall in US GDP from 5.7% to only 1.0% plus (as anticipated) looks disastrous, it really means the 5.7% was always an overstatement.
The second reason many commentators are unfazed is the safe knowledge that if the US does dip into recession again, the Fed will simply turn back on the quantitative easing taps.
The US dollar has been rising again this last week or so seemingly in contradiction to weakening economic data, but that's because risk trades are being brought home (and put into bonds). But the dollar index has been rising even as the yen has been rising, given the yen was previously the carry trade currency of choice and those positions are still being unwound. The yen thus jumped yesterday on the GDP news, and the euro also rose despite growing fears of an Irish debt default, so this time the dollar index fell 0.5% to 82.46.
A weaker dollar was a green light for gold, and weak data fuels expectations of greater Fed QE ahead. Gold thus jumped US$10.10 to US$1225.50/oz. The Aussie also added half a cent to US$0.8982 despite supposed risk aversion.
Activity in commodities was nevertheless just as lacklustre as it was in stocks. Oil fell US15c to US$75.25/bbl and base metals in London went nowhere much.
The SPI Overnight fell 5 points.
Today sees the release of the minutes of the RBA's August board meeting, which probably won't hold too many surprises. There is a wealth of stocks reporting today.
Tonight in the US sees housing starts, industrial production and the producer price index. More grist for the mill.
A last word on US bonds. While the two-year yield is at an all-time low, two-years are the shorter -term safe haven play. The ten-year is seen as the benchmark measure for the US economy. At the height of GFC fear, the ten-year yield fell, to 2.0%. Earlier this year, after a strong stock market rally and a strong US GDP result, punters were expecting a Fed rate rise and the ten-year yield rose to 4%. It's now back at 2.5%.
Is the US economy going to double-dip or collapse again? Those bond prices look very high. But if the Fed pumps up QE once more, they'll be buying even more ten-year Treasuries. So at this stage, there's little reason to sell bonds, and that means little reason to invest in stocks.
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