The Monday Report

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This story features BENDIGO & ADELAIDE BANK LIMITED, and other companies.
For more info SHARE ANALYSIS: BEN
The company is included in ASX100, ASX200, ASX300 and ALL-ORDS

By Greg Peel

At 8pm on Friday night New York time, it was announced ratings agency Standard & Poor's had downgraded US sovereign debt to AA+ from AAA — the first such downgrade in ratings history. Last week both Moody's and Fitch elected to maintain their equivalent AAA ratings in the wake of the debt ceiling resolution but S&P has decided the bill did not go far enough.

The Wall Street Journal reports that when presented with S&P's assessment at 1.30pm NY, the US Treasury disputed the calculations by a small matter of US$2 trillion. The release was thus delayed, but the WSJ suggests that at 8pm S&P went ahead anyway.

As to what happens now is unclear. Many suggest Wall Street has already downgraded US debt by implication, such that S&P has merely provided late confirmation. Others suggest the number of institutions which will be forced to offload US debt as a result are few, given most are mandated to hold "US Treasuries" and not "AAA US Treasuries". Chinese ratings agencies downgraded US debt long ago. But there remains a distinct possibility that the downgrade could cascade through to US financial institutions and corporations, leading to need to bolster capital positions which would in turn mean selling other assets. The Fed has nevertheless since suggested it will not be requiring capital injections from banks.

One thing that is clear is that S&P has been threatening a downgrade for over a week, and yet all that time the benchmark US Treasury bond has not breached 3% in yield. Late last week it fell to as low as 2.4% in the stock market rout. By implication, a downgrade should mean a reflex surge in US bond yields. Unless the market was so utterly convinced a downgrade could never happen, the bond market has already indicated it is unperturbed. At AAA or AA+, US Treasuries are still considered a safe haven and the safe haven trade may well counterbalance the downgrade implications. There remains one overriding consideration — where else would I put my money?

Media reports have suggested over the weekend and this morning the damage to the Australian market should be minimal today because the SPI Overnight was only down 5 points on Friday. Please note that the SPI Overnight closed at 7am Sydney time, or 5pm New York time on Friday, three hours before the S&P announcement. The SPI does not reflect the downgrade. The Dow futures have opened this morning in electronic trade down 287 points, suggesting at this early stage that Wall Street's opening response will not be pretty.

In the meantime, the G7 finance ministers are believed to have called an emergency hook-up Sunday night in the US time zone, which means this morning in Australia. Some measure to avoid global panic may be announced after the meeting, although that cannot be clear. The G7 may wait to see what damage is done in the Asian time zone before acting. And of course there is always the possibility the G7 will not be able to reach an agreement.

The real risk to the stock markets in New York is that Wall Street and global markets are in a very fragile state right now. This is what transpired on Friday night up to the close of the NYSE at 4pm:

In recent months the US monthly jobs report has become such a chocolate wheel that anything could happen, only to be revised to something completely different one or two months later. There was almost an inevitability on Friday night that the market would underestimate the July result given the downgrade in economic expectations over the past month.

And so it was that the US added 117,000 jobs in the month, or at least that's what the spin of the chocolate wheel decided. The result provided blessed relief given Wall Street had expected 85,000. A fall in the official unemployment rate to 9.1% from 9.2% was also a positive, and the numbers were worth a 140 point Dow rebound from the opening bell.

The problem is that in isolation, 117k is simply not a good result. It's certainly not enough to outpace population growth, and is weak compared to the 200k plus numbers being achieved earlier in the year. The unemployment rate may have dropped but that number is as much about participation as it is about actual work. While 9.1% of work-age Americans might be collecting the dole, the actual level of unemployment is measured at around 16%.

A simple reality on Friday night, nevertheless, is that there would have been plenty of investors who only found out about Thursday's 500 point drop at the end of day, others who sat stunned willing a bounce that never came, and still others who decided after Thursday they didn't want to play any more. Hence the 140 point opening rally was a red rag to a bull, or in this case bear, and thus by midday the Dow was down 240 points for a 380 point turnaround and it was looking like Thursday's 500 point drop might prove just a stroll in the park.

In the wake of the eleventh hour US debt ceiling resolution, the famous line from Winston Churchill has been oft quoted in the media: “America will always do the right thing, but only after exhausting all other options”. In a similar vein I might proffer a contemporary adage: “The ECB will always do the wrong thing first before realising just what extraordinary fools the market assesses them to be and only then will they, sheepishly, do the right thing”.

Thursday's global stock market rout did not come out of the blue but the actual trigger was judged by the markets to be the ECB's sheer arrogance, belligerence, and incompetence. If Jean-Claude Trichet had said nothing at his post-meeting press conference, then the Dow would probably had never fallen 500 points. Had he said that the ECB was reimplementing its eurozone sovereign bond program and that would now include purchases of Spanish and Italian bonds, the Dow would likely have staged a significant rally. And that's exactly what the market initially assumed he meant when all he said was that the bond-buying program would resume.

The market was a little unnerved by the fact he added that it was not a unanimous decision of the ECB board, because while the bulk of European debt crisis is obviously a result of too much debt, the resultant market turmoil has been just as much about the failure of the various European representatives to reach an agreement on what to do about it – a failure steeped in centuries of cross-border hatred. But if the ECB was going to buy bonds, then obviously it would be buying Spanish and Italian bonds. I mean really – how could one assume anything different?

Wall Street plunged from the open on Thursday because European markets had plunged late in their sessions, and had done so when bond traders came to the sudden, shocking realisation that the ECB was not buying Spanish and Italian bonds at all. It was only buying Portuguese and Irish bonds. You can't be serious. Not only is this like trying to douse your burning letterbox when there's smoke coming out of your house, Portugal, Ireland and Greece are all under protection from their previously established bail-out funds.

The sad thing is that this has always been the way European officials have operated. Their tactics are based on a anachronistic belief that if the powers that be demonstrate a lack of concern, then the market will assume there's no need to panic. This approach was most recently blindingly on display last month when suddenly Italian bonds started to crash at a time when officials were still trying to sort out Greece. Eurozone leaders called a meeting, which all the world assumed was in response to the new and far more onerous Italian threat, and at the post meeting press conference the comment was “Italy was never even discussed”. Clearly the tactic was one of shrugging off the issue to provide confidence to the world that it really wasn't an issue at all. But you know what? The world isn't nearly as stupid as European officials are. They sold Italian debt with their ears pinned back.

They did it again on Thursday as soon as it was realised the ECB was not buying the debt that mattered, only the debt that no one could really care less about anymore. But then a not-so-funny thing happened on Friday, around midday New York time. Yep – the ECB came out and announced it would buy Spanish and Italian bonds.

If the ECB has only showed some intelligence one day earlier, we would not have seen a global stock market rout that now has the world in an extremely nervous state. At midday NY on Friday the Dow was down 240 points and looking like it might end down a thousand. The US VIX volatility index, which had jumped 35% to 31 on Thursday, hit 40 at this point, indicating extreme panic.

Then the world turned.

By 1pm NY the Dow was up 100 points again. For all those who had decided to just get the hell out in the morning, there have been plenty waiting for the right buying opportunity. This was no short-covering snap-back. The volume at the end of the day on US stock markets was double the recent average, and greater than the volume on Thursday. This was real buying.

Blue chips were the clear target. At the closing bell the Dow was up 60 points or 0.5% but even after recovering, the Nasdaq was still down 0.9%. The S&P was off less than one point at, to be precise, 1199.38. Technicians had warned that a close below 1200 would mean we must go lower.

The ECB announcement inevitably sent the euro surging as well, resulting in the US dollar index falling 1% to 74.53 by day's end. On the implication of more global quantitative easing (not the Fed yet – ECB bond buying equates to ECB QE), gold jumped US$14.60 to US$1663.40/oz. The collapsing Aussie stopped collapsing and was only down 0.25% to US$1.0441.

Oil rebounded, sending Brent up US$2.33 to US$109.38/bbl and West Texas up US63c to US$87.27/bbl.

It was a different story for base metals. As I often point out, final settlement for base metal prices in London occurs at 2.30pm New York time. On Thursday all metals were down 1-3% but the LME missed the final plunge on Wall Street. There was thus, in theory, some catching up to do on Friday. On Friday, however, Wall Street had rebounded before 2.30pm. Yet base metals all closed down 3-5%.

The ECB's purchases of Spanish and Italian debt come with a caveat. It's a bit vague at this point but Spain and Italy must show signs of expediting austerity measures in exchange for the “rescue”. Pretty much all of Europe is now in austerity mode, and last week's budget cut bill in the US implies similar restraint. The world is responding to slowing economic growth, itself the result of the global debt crisis, by deliberately slowing economic growth. Who wants to buy metals?

Just out of interest, it was no great surprise on Thursday that the popular media decided to roll out the inevitable talk of “GFC2”. This is not GFC2 people, and I don't mean because there's no reason to be concerned. In 2008, all the world's toxic private debt was taken on board by the public. It was not extinguished. This is still GFC1 playing out. We are reminded that Wall Street crashed in 1929 but the Great Depression didn't end until 1936 when Hitler invaded Poland. We haven't yet marked the third anniversary of the fall of Lehman.

The SPI Overnight was down 5 points, as noted.

Next week the US Treasury is scheduled to auction US$72bn of three and ten-year notes and thirty-year bonds. On Thursday the benchmark ten-year yield fell 23 basis points to 2.4% as the world switched from stocks to bonds but on Friday it rebounded 15 bps to 2.55%. The markets had closed by the time S&P dropped its bombshell.

The Fed will hold a scheduled meeting on Tuesday to discuss what monetary policy response might now be appropriate. It is unlikely the Fed has remained blissfully unaware of the ratings agencies' intentions. Were all hell to break loose tonight, it would not be beyond the realms for the Fed to hold an emergency meeting and act accordingly were it deemed necessary.

There is little more we can do now but hold our breath. It may seem trivial, but here follows a rundown of the week's economic data releases.

The US Treasury will release its monthly budget on Wednesday, along with the release of wholesale trade data, and the monthly trade balance will be revealed on Thursday. Friday sees business inventories, retail sales, and the fortnightly consumer sentiment index.

Ahead of Tuesday night's Fed meeting, China will deliver its monthly “data dump” of inflation, industrial production, and retail sales numbers. On Wednesday China will release its monthly trade balance. Trade balances are popular this week, given we'll also see Germany's and the UK's on Tuesday.

The banks will do their monthly thing in Australia this week, starting with ANZ jobs ads today, followed by the NAB business confidence survey on Tuesday and the Westpac consumer confidence survey on Wednesday. Tomorrow also sees housing and investment finance, Tuesday general lending finance and a June quarter summation of retail sales. Thursday is unemployment day.

Plenty of fodder there for the RBA, which by now must really be wondering whether Westpac is right and their next rate move will have to be down. 

Results season in Australia also steps up a gear this week. Today we'll see Bendigo & Adelaide Bank ((BEN)) and JB Hi-Fi ((JBH)), Tuesday it's Coca-Cola Amatil ((CCL)) and Cochlear ((COH)), Wednesday Commonwealth Bank ((CBA)) and Stockland ((SGP)), and Thursday Telstra ((TLS)) and Amcor ((AMC)). They're just the highlights.

Also this week we have quarterly earnings from News Corp ((NWS)) on Thursday, a quarterly update from National Bank ((NAB)) on Tuesday, and quarterly sales results from Harvey Norman ((HVN)) on Tuesday and David Jones ((DJS)) on Thursday. 

Rudi will appear on Sky Business on Thursday at noon and by popular demand, FNArena's new televisual sensation Market Insight will return on Thursday at 4.00pm on BRR (brr.com.au). 

For further global economic release dates and local company events please refer to the FNArena Calendar.

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