Daily Market Reports | Nov 17 2010
By Greg Peel
The Dow closed down 178 points or 1.6% while the S&P fell 1.6% to 1178 and the Nasdaq dropped 1.8%.
If we cast our minds back to April this year we'll recall that everything was looking rosy for the long rally out of the GFC depths which had begun a year earlier until suddenly a confluence of events had the world running scared once more. Over the next couple of months those events included everything from Goldman Sachs lawsuits to volcanoes, oil spills, US socialist fiscal policy and an Australian mining tax, but there were two main concerns gripping the world.
One was the sovereign debt situation in Greece and the other was an announcement that Beijing intended to reduce the Chinese rate of GDP growth from 12% to 8%. The combined fear was that China would kill off the only driving global economic force at a time when the world's biggest net economy – the EU – was going down the gurgler.
Beijing began its first tightening measures just as the Greek situation cascaded down to the likes of Portugal, Spain and Italy and with Ireland already a basket case so were born the PIIGS. At the time, any concept of an EU-IMF rescue fund was just talk, and a long way off from creation.
Two things have happened between then and now. One is that a multi-hundred billion dollar EU-IMF emergency fund is sitting in readiness, so far untouched, and the other is that when Europe was facing its darkest hour, Beijing halted its tightening measures, making the judgment call that a weak Europe would slow the Chinese economy anyway.
Most recently, the Europe threat had seemed to have abated, Chinese GDP growth bounced and inflation threatened, leading to Beijing's first rate rise in several years, and QE2 has been introduced. But now we have Ireland taking over form Greece as the “nation most likely” and surging inflation in China all but ensuring another rate hike. Thus the market is once again panicking.
Or is it?
Yesterday the Shanghai index took its second major plunge in three days, falling 4%. Some impetus was provided by a rate hike from the South Korean central bank as part of the latest in the round of inflation-tackling rises from the “emerging” markets and their proxies. When China coughs, the world catches a cold (gee, have I heard that somewhere before?). But take a look at this six-month chart of the Shanghai index:
From the beginning of October, the Chinese stock market ran up 23% (as measured from below) before peaking last week when the 4.4% monthly CPI number was released. It has now fallen 10% (as measured from above) which some people call a “correction”. If we now look at the S&P 500, there is a slight timing difference but the pattern is much the same:
The S&P 500 ran up 17% from the beginning of September and has now corrected by about 4%.
We are not looking at another devastating global financial event. We are simply looking at a correction in the risk trade that ran very hard on the speculation over the Holy Grail of QE2 and ran particularly hard towards the end when the Johnny-come-latelies poured into stocks and commodities. This is merely a healthy correction, and I'll offer two examples why.
When the euro first began to tank on PIIGS concerns, the price of gold surged in US dollars even though the US dollar was rising as the euro fell. Why? Because with no sign of an emergency fund Europeans were bailing into gold. Now there is an emergency fund, and gold in USD is off almost US$100 in a week. There is no flight to quality, but rather a removal of late risk positions.
Similarly, the US dollar ten-year bond was the benchmark of flight to quality flows earlier in the year when traders bailed out of dangerous European sovereign debt or out of any other risk trades (including stocks) into the safety of guaranteed coupons. So crowded did the trade become that the words “bond bubble” were thrown around. But in the last week, the ten-year yield has rallied from around 2.5% almost to 3.0% even as the Fed begins to make its first QE2 purchases.
All this month the Irish government has been trying to reassure the world that it did not need bailing out. So far that ploy has worked to some extent. But eventually the world starts to apply the “methinks thou dost protest too much” indicator and goes the other way. The world has been waiting for the announcement that Ireland will accept bailout money from the emergency fund. Last night the Irish government again said it wouldn't need too. This time it was seen as hollow politics and the Irish bond yield blew out yet again, basically ensuring a bailout will be required.
The longer Dublin fannies about the more the world looks across to Lisbon and maybe even Madrid. But the money is there. If Europe does suffer another major setback then there is every chance Beijing will hold off on further tightening until the dust settles. Here's a newsflash: Beijing does not want to kill the Golden Goose either.
Healthy corrections can nevertheless come with a bit of drama. The Aussie dollar is now the world's risk indicator and fell another 0.8 of a cent last night to US$0.9766 to now be down four cents from its above-parity peak. The US dollar index jumped 0.75% to 79.22 to match the euro's fall down to under US$1.35.
Gold fell US$17.20 to US$1341.40/oz although silver held up pretty well at US$25.49/oz. Commodities, however, were absolutely carted.
Oil fell 3% or US$2.53 to US$82.34/bbl. Tin fell 4%, copper 5%, aluminium and lead 6%, nickel 7% and zinc 8%.
The US ten-year bond yield actually started the session by rising again, but it did turn around eventually and closed the day down 14 points to 2.84%.
The SPI Overnight fell 61 points or 1.3%.
Oh and just out of interest, US industrial production was flat in October against an expectation of a 0.3% rise, the October PPI rose 0.4% on the headline against 0.8% expectations and the core fell 0.6% to mark the first fall this year and provide the Fed with justification, and the US housing market sentiment index rose to 16 from 15 this month against expectations of 17.
Wall Street was not paying a huge amount of interest to these releases last night in the wider scheme of things, but they all add up to a focus on QE2 and its necessity (as far as the US is concerned) and potential to be expanded (ie bullish despite their weakness).
The October CPI will be released tonight in the US.
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