The Overnight Report: Wall Street Follows The Fallout

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By Greg Peel

The Dow fell 117 points or 1.0% while the S&P fell 0.8% to 1314 and the Nasdaq lost 1.0%.

Australia woke yesterday to an IMF report suggesting firstly that the string of natural disasters earlier in the year will impact on local economic growth and, more broadly, that there was a risk of a commodity and property bubble-and-bust in Asia (ex Japan). In the first case, thanks Scoop, and in the second case, well that's why China is tightening monetary policy. The IMF suggests China is moving too slowly, which is probably fair. But one must take into account that the people who remember the last time the IMF got anything right are no longer with us.

It was enough to set a weak tone for the opening of the local session nevertheless, and coincidentally oil had also fallen sharply on a combination of Libyan developments, a US dollar bounce, and a Goldman Sachs report informing its commodity fund was exiting oil. But as the Asian markets opened the “new news” was the upgrade to the Fukushima nuclear disaster to the highest level of seven, putting it on par with Chernobyl.

Media companies know full well that the public soon tires of the same old story, which is why the Fukushima story had slipped into the background lately. Out of sight, out of mind. The natural audience response is to assume everything's now fine, rather than there's actually nothing new to report. So while this risk upgrade may not be that much of a shock, it still managed to jolt the markets back to reality. With global stock indices having pushed towards or through their pre-GFC highs, it was a clear opportunity to take some risk off the table.

And that's what has happened over the past 24 hours. We saw the fall in Australia snowball as Asian markets tumbled; Europe then followed and when it came to the US it was a simple case of the Dow falling around 120 points from the bell and pretty much staying there all day.

The clearest signal the markets can provide of an indiscriminate “flight to cash” is the gold price movement. Gold fell US$11.00 to US$1452.30/oz last night when one might immediately assume nuclear threats provide a good time to buy gold. The market is not disagreeing, it's just that a sharp unwinding of the “risk trade” includes cashing in on gold positions as well. Gold bulls know such periods ultimately provide good buying opportunities.

To make matters worse for stocks, Goldman Sachs was in the spotlight for the second day running. This time it was the Goldmans oil analysts who downgraded their three month West Texas forecast to just under US$100/bbl. All other analysts have been quietly upgrading their 2011 and beyond forecasts – some substantially given they had watched oil run away from them – over the past few weeks and now suddenly Goldmans goes the other way. And Man, how lucky was that? Imagine if the the Goldman analysts had decided to downgrade the day before the Goldman strategists had decided to exit oil, rather than the day after!

Phew.

Realistically the downgrade suggests that in June the West Texas price will be about US$100 rather than about US$110 where it has been. That means Brent will be somewhere in the US$110-115 range rather than US$125, which largely reflects some removal of the MENA risk premium now that Gaddafi is possibly ready to capitulate. It's not the sort of bust the IMF is talking about. Last night West Texas crude fell another US$3.66 to US$106.26/bbl and Brent fell US$3.06 to US$120.92/bbl.

Energy is a good chunk of the Aussie market, and the biggest sector in the S&P 500. So the sell-off in oil and gas stocks over 24 hours forms the bulk of index weakness. Base metals have followed the flow as speculators depart, with aluminium down 1% last night, copper 2%, and everything else 2-4%. It's not good medicine for the big miners, but today's quarterly production release from Rio Tinto ((RIO)) will be closely watched as well.

US Treasuries have suffered quite a sell-off this past month as equities have risen and QE2 nears its end, so last night's sharp reversal as part of that “flight to quality” was no great surprise. It was a good night for the Treasury to auction US$32bn of three-year notes given demand suddenly returned and the three-year yield was down 10 basis points on the day. The benchmark ten-year yield fell 9bps to 3.50%.

The flight to quality was also evident in last night's shift back into the safe haven Swiss franc which, combined with renewed yen carry trade unwinding, saw the US dollar index down 0.2% to 74.87 and the Aussie down 0.6% to US$1.0434.

The US dollar was not helped by news the US budget deficit jumped 15.7% to a record US$829m for the six months to March, which rather puts the current battle with Congress into perspective. The monthly trade deficit did decline, but not as much as was expected.

The SPI Overnight fell 26 points or 0.5%. There is a risk here of doubling up on yesterday's move given Wall Street was only catching up last night, but then yesterday's accelerating fall suggests there might yet be some more short-term weakness in this market as investors step aside to reassess. 

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