The Overnight Report: Momentum Problems

This story features HARVEY NORMAN HOLDINGS LIMITED. For more info SHARE ANALYSIS: HVN

By Greg Peel

The Dow closed up 48 points or 0.4% while the S&P rose 0.1% to 1241 and the Nasdaq added 0.1%.

At its close of 11,476, the Dow has now regained the level from which it fell the day Lehman died, being the last of the three major indices to do so. But while this achievement should be some cause for celebration, Wall Street is clearly suffering from momentum issues at present.

A late kick was all that saved both the S&P and Nasdaq from posting a down-day, and the Dow's close of up 48 looked tepid compared to the level of up 86 it had achieved after lunch. Volume was not inspiring. For the second day in a row, Wall Street tried to push up solidly in the morning only to be met by selling in the afternoon. Technical selling at these pre-Lehman levels perhaps? Well that doesn't work for the Nasdaq, which is already well above now.

The unconvincing drift up continues in the face of some pretty good economic data.

Before Wall Street arose the closely watched German ZEW economic sentiment index was released, showing an increase to 4.3 from 1.8 in November. The result had the euro looking stronger as the bell rang on the NYSE.

The US producer price index rose 0.8% on the headline in November, up from October's 0.4% rise. Gasoline (4.7%) and fruit (13.6%) were big contributors, leaving the core PPI to rise only 0.3%, as expected, following a fall of 0.6% in October. Annual producer inflation is running at 1.2%.

The Fed continues to monitor only the core rates of inflation and tonight brings the more important consumer price index. While QE2 is a fight against low core inflation, many commentators warn that a weak US dollar is playing havoc with inflation of staple goods and energy prices – a direct hit to the consumer's pocket.

Yet consumers were enthusiastic in November, sending retail sales up 0.8% against an expectation of 0.6%. Take out volatile and lumpy auto sales, and the rise was 1.2% versus expectations of 0.7%. Previous months' gains were also revised higher. The surprisingly good retail sales results have seen economists gradually lifting fourth quarter GDP growth forecasts, now averaging 2.9% up from 2.5% only a month ago.

Further good news came in the form of business inventories and sales data. There has been concern in recent months over solid rises in inventories, which support GDP growth, not being matched by rising sales. The risk is goods are soon discounted for clearance and deflation results. But in October inventories rose only 0.7%, short of 1.0% expectations, while sales rose 1.4% to mark the biggest jump since September 2008.

But not all retailers are created equal, and there were echoes of Harvey Norman's ((HVN)) current consumer electronic woes last night in a profit warning from US equivalent Best Buy. An unexpected drop in third quarter earnings sent Best Buy's shares down 16%.

When Wall Street was reaching its lunch time highs, the US dollar had weakened after an earlier rise and the risk trade was back on. Base metals had already closed flat in London but gold had regained US$1400/oz and the Aussie had returned to parity. The afternoon reversal saw the dollar index rally to close up slightly at 79.46, gold to close flat at US$1395.90/oz, and the Aussie to be only slightly higher at US$0.9980.

The timing of the reversal coincided with the release of the Fed's latest statement on monetary policy. While little change was expected from the current QE2 program, there was some anger that the statement was almost word-for-word a carbon copy of the previous statement six months ago – the one which introduced QE2. The only difference was a further nod to unemployment problems. Between the last statement and this one, the US ten-year Treasury yield has exploded up 90 basis points. Last night it rose another astonishing 20 basis points to 3.48%.

Is there a problem? We know that US Treasuries had been “bubbling” and we know that Wall Street has been hoping for the day that bonds are sold off and stocks are bought once more. We also know that rising yields reflect a stronger economy given the implications of an eventual cash rate rise. But the point is QE2 is all about the Fed buying Treasuries in the two-ten range in order to keep money “cheap”, in order to stimulate corporate earnings and thus stock prices, and ultimately to spark some fresh hiring. Memo to Ben: it ain't workin' sunshine!

Stocks are stronger but not very convincingly, and money is getting more expensive, not cheaper. This includes mortgage rates. Thus the anger stems from the Fed's seemingly “rubber stamped” policy statement which did not address such issues.

There is, of course, the underlying risk that QE2 will spark too much inflation rather than just correcting deflation, particularly when the central bank ignores the effects of rising commodity (eg oil and food) prices. Bond yields appear to be reflecting this fear more than reflecting a stronger economy.

Tonight's CPI release will be interesting, along with industrial production and housing market sentiment.

The SPI Overnight was up 3 points.

Today in Australia Westpac will release its monthly consumer confidence survey. Retailers will be holding their breath for signs of an upbeat Christmas which, based on trading turnover since mid-November, has not yet materialised.

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