Daily Market Reports | Aug 10 2011
By Greg Peel
The Dow rose 423 points or 4% to 11,239 while the S&P gained 4.7% to 1172 and the Nasdaq jumped 5.3%.
Wow.
Someone might be able to correct me, but I don't believe there has been as volatile a day in the Australian market as there was yesterday – down 5% and up 7% – since I was a young buck yelling myself hoarse in the SPI pit in October 1987. I don't recall a day of such intra-day extremes in 2008.
Realistically there was not a lot of selling on the open yesterday, only selling orders, given the market pretty much opened down 4% before it found action. That sparked a panicked exit from some until the buyers, who have been waiting for it all to get just too silly – and 5% down seemed silly enough – responded. We started to rally until Beijing announced its inflation numbers (more on that in a moment), fell back again for a while, and then the buyers regrouped for an unprecedented assault.
I am reminded of the scene in the 1980s movie Trading Places when Eddie Murphy says to Dan Aykroyd “Now?” and gets a no, then “Now?” and gets a no, before finally getting a “Now!”.
Media reports suggest the market turned on rumours the Fed was going to announce QE3 last night. I believe that's rubbish. The Fed was to hold a scheduled meeting and there's been talk of QE3 for a month or more, particularly in the last few trading days. If someone had “started a rumour” about QE3 the response would have been “Gee, thanks Scoop”.
I suggest the market simply became too oversold and all that was needed was for the first trickles of all that cash that's been sitting in investment portfolios to suddenly be converted into stock investments. If we need to find a trigger, we could look to various announcements from the big banks that they were materially cutting their fixed rates on mortgages. And also that RBA chairman Glenn Stevens made an unsolicited statement (a very rare occurrence) that the central bank was conducting open market operations as it does every day and had noticed no signs of dysfunction – of any credit crunch.
Funnily enough, the two are almost contradictory. Media reports suggest the big banks were “backing the predictions of the futures market” in assuming the RBA would cut rates. This, again, is rubbish. There may be some truth that Westpac (and thus St George) is backing its own economist's outlier call, but the reality is the banks can use the futures market to hedge their short term money. That's what the futures market is there for – it's not there to “predict” the future. Contrary to the rantings of moronic politicians (pardon the tautology), Australia's banks are locked in vicious competition. Yesterday's monthly home loan demand data showed a steep fall. The banks need to lower rates to attract customers and market share and the futures market is currently offering a capacity to lock in those rates in the short term. Banks do not “predict”.
The fact that the RBA found no tightening of money markets tends to shoot down expectations of a rate cut in September at this stage. We recall that the RBA was very, very close to raising in August and the only thing stopping it were debt issues in Europe and the US. Financial markets have become more volatile since but aside from the S&P downgrade, which had been on the cards for months, the only other thing that's changed is that the ECB is in supporting Spanish and Italian bonds. The RBA is only going to cut if an “emergency” is upon us. This is not 2008. Banks are not illiquid and the world is not leveraged to the hilt. The most likely outcome at this stage is that the RBA will hold fast in September, noting that inflation expectations will have eased on the recent drops in commodity prices.
Another “trigger” was in the Chinese data itself. While CPI inflation ticked up to 6.5% from 6.4% – the highest level since June 2008 – and panicked the market once more, closer scrutiny showed that non-food inflation actually fell. (Note that Beijing does not publish a “core” inflation level such as those Western central banks rely on.) While the price of food, and especially pork, is a lot more significant to the poorer Chinese, there are seasonal and weather issues behind the 14.8% food price inflation reading and economists have been expecting a peak soon. The non-food measure backs up expectations of a general peak in Chinese inflation. Even though the PBoC was never going to tighten in the face of global calamity, these data provide relief from global anxiety.
There was always a possibility, of course, that inflation could return if the Fed announced QE3, thus downgrading the US dollar, and thus forcing commodity prices back up as was the case in early 2008. So let's now move to last night's Wall Street action.
Whether or not the market was expecting a QE3 announcement, Wall Street opened with the Dow up a couple of hundred points. I have noted in recent reports that actual QE3 – meaning quantitative easing in the form of Fed purchases of US Treasuries – has never appeared to be on the cards. The Fed has previously intimated that were the US economic recovery to continue to falter, and inflation give way to disinflation, then it would consider fresh measures. Those measures, however, would not take the form of Treasury purchases. Rather the Fed had suggested it would ratify the “extended period” for “exceptionally low rates” first and perhaps lower the central bank rate on US commercial bank deposits, making the “parking” of money by the banks less attractive and lending into the economy more attractive.
So as it was, when the Fed statement was released at 2.15pm New York time, it simply suggested that:
“The committee currently anticipates that economic conditions—including low rates of resource utilization and a subdued outlook for inflation over the medium run—are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013".
That was it. It wasn't even a ratification of the time frame, given “likely to warrant” is not “they will be kept at”. It's less of a pledge and more of a prediction. But it is pretty much exactly what the Fed had suggested it would do. I noted yesterday that the Fed is not in as potent a position as it was in 2008. In 2007, the Fed funds rate was 5.25%. By December 2008, that rate had been cut to zero (0.00-0.25%). By March 2009, the rate had been effectively cut into the negative (QE1) and it was cut further into the negative in September 2010 (QE2). Since the credit crisis began, the Fed balance sheet has been quadrupled. There is a lot less room to move today.
The Fed has also suggested in recent times that it, alone, cannot be expected to carry the can. It would not act, Bernanke pointed out, if there were not fiscal measures also applied to support stimulus. Since then we've gone the other way – a dysfunctional Congress has applied “anti-stimulus”. It is significant that the Fed set its time frame to mid-2013. It takes the low rate period to beyond the next US election.
The Fed has said to the government, “We're giving you time to get your house in order”. The Fed has said to Wall Street, “It's time you guys pulled your fingers out as well”.
So was that very bad news? The statement noted that in 2011, the US economy had grown at a “considerably slower” pace than previously anticipated. That in itself might be enough to scare away stock investors but the Fed also noted some of the weakness can be attributed to the ramifications of the Japanese earthquake. And let's face, did Wall Street really need the Fed to inform it the US economy was growing more slowly than anticipated?
Anyway, there was clearly a cohort of traders who were simply expecting a proper QE3 announcement. It didn't come, so they sold it. Indeed, all hell broke loose. The Dow plunged about 400 points to be down about 200 points. But the real action was in other markets, particularly in the “safe haven” trades.
The Swiss franc exploded up 5%. For a single day's move in a currency, and one that has recently seen a rate cut intended to cap the buying, that is an extraordinary move. Spot gold traded up US$60 from Monday's New York settlement to almost US$1780/oz. Investors ploughed into US bonds – yes, the one's that are meant to be worth less now, not more – sending the two year yield to a historical record low of 0.17%, the five-year also to a record low, and the ten-year to 2.04% – almost the 2008 record low. That was around another 20bps drop in the tens.
But then, as had been the case in Australia yesterday, a bugle sounded in the distance.
And in rode the buyers, and they had numbers. They were looking at a US stock market so oversold that the average dividend yield offered a significantly higher return than a US bond. They were looking at that scenario continuing through to mid-2013 on the Fed's suggestion. They were looking at a retailer of electronic gadgets (Apple) now the biggest company in America by market cap, having overtaken the mighty Exxon-Mobil. This was no short-covering rally. The volumes on the upside were just as huge as the volumes had been on the downside in previous sessions. This was real.
And so the buyers chased the market up to the close, and hence a 429 point up-day in the Dow. That was about a 600 point rally – the sort of moves not seen since 2008.
The Swissy retreated, but not by much. Gold fell back to be only up US$24.80 from Monday at US$1744.10/oz. And US bond yields also bounced, but only in the long end, with the ten-year back to 2.19%. Why only the long end?
Well the Fed has as good as shut down the US short term money market. Traders in overnight to two-year money are pretty much out of a job because there is no reason for prices to move at all until mid-2013. The market will still operate comfortably, but rates are as good as fixed.
Just out of interest, before the Fed announcement the US Treasury held a scheduled auction of three-year notes. They settled at the lowest yield in history, and foreign central banks bought a whopping 48% compared to a running average of 34%.
Standard & Who??
It was also a wild ride in commodities. At the depth of the post-Fed stock selling, both benchmark crudes “tanked” again before closing. West Texas fell to just above US$75. Trade continues on the electronic Globex exchange thereafter nevertheless, and now Brent is up US$1.35 to US$104.96/bbl and West Texas is up US83c to US$82.14/bbl from Monday's prices.
The LME closes at 2.30pm NY and the Fed statement came out at 2.15pm. Metal price movements to that point were all over the shop but mostly slightly higher, but they are yet to respond to the late turnaround in sentiment.
And the humble Aussie? As noted, currency markets had one of their wildest sessions in history last night. Having fallen below parity in Australia yesterday, the AUD was holding just over parity after the Fed announcement. Then it rallied nearly two cents to US$1.0375. The US dollar index is now down 1% to 73.95.
The SPI Overnight is up 114 points or 2.9%.
What now? Have we turned? As I've been saying for the last couple of days, sharp rallies are a common occurrence after enormous falls. They often manage only to find sellers who were too slow to move the first time around and thus they ultimately fail. Thereafter, we usually drift lower before the “real” turn, to lower levels than before.
However, I will say that these sharp rally incidences in the past have often been driven mostly by short covering and not by actual buying, which is often apparent through volumes being a lot lower on the way up than they were on the way down. This time the volumes last night to the upside (which is measured by “up-tick” trades) matched the huge volume seen on Monday on Wall Street the way down.
This is a good sign. But that's all I would say at the moment. The market is still fragile.
One last comment. At the depths of yesterday's market in Australia you could buy the shares of a big bank at a fully franked yield greater than the interest rate cost of a margin loan to buy them – ie, positive carry. If's that not an oversold market I don't know what is. Sure – share prices can fall further and dividends can be cut, but the Aussie banks are not in the same position they were in 2008. They are today among the most highly capitalised banks in the world, they are carrying provisions against disaster, and their payout ratios are not as high as they were pre-GFC.
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