The Overnight Report: Weary Wall Street

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By Greg Peel

The Dow closed up 4 points while the S&P rose 1 point to 1193 and the Nasdaq fell 0.5%.

The Nasdaq was lower last night largely due to a weak lead from PC manufacturer Dell, which provided disappointing third quarter guidance after the bell on Tuesday night. This was taken as another indicator of a slowing US economy because Dell is considered somewhat of an economic bellwether. The question must be asked, however: Do slowing PC sales reflect a weak economy or a hint of impending PC obsolescence?

The flat close for the less tech-weighted indices belied another session of volatility, which saw the Dow up 120 points at 11am and down 80 points at 2pm. Volumes were back to pre-turmoil levels, albeit still not bad for the summer holidays.

Summer holidays? That's right – we were going to take some of those, we can hear Wall Street traders think. Perhaps now we can, and we're exhausted.

The lower volume and flat close last night was largely due to Wall Street not really being able to find direction. The session started with a flurry, but rather than meeting determined sellers it merely ran out of buyers. The Dow then fell 200 points, but next it was the sellers' turn to run out of enthusiasm. Wall Street has bounced back from the S&P downgrade-inspired plunge, but that just takes us back to worrying about a slowing US economy. There is much talk of value available, particularly via dividend yields, but what of earnings forecasts? Surely the E in PE must come down (and hence PEs will look less cheap) as analysts adjust their forecasts for a weaker GDP growth expectation? Best now wait to see what they come up with.

And then of course there's still Europe to worry about. When we left Wall Street at the close on Tuesday night, traders were concerned that eurozone bond markets had not yet had a chance to respond to what was considered by many to be a disappointing outcome from the Merkozy meeting. The fear was that the bond vigilantes would go back to hammering Club Med bonds, and maybe French bonds too. 

But they didn't. Most of the yields on PIIGS government ten-years were actually down and the couple that were up were up small. French bonds were also bought as were German bonds, and while the London and German stock markets were down 0.5% and 0.8%, the French market was up 0.7%. At the end of the day, no one really believes a financial transactions tax limited to European markets is at all rational, and no one with any sense could see how a eurobond was possible. Before there can be a common bond there would have to be centralised fiscal management. Merkozy went one small step towards that by agreeing to coordinate corporate tax rates.

That just leaves concern over the size of the EFSF, which traders were hoping would be significantly increased, but then the ECB is in supporting bond prices anyway which is really just a form of EFSF. We all know that any mandated EFSF increase would have to pass through twenty-seven parliaments.

We also now know that the Swiss franc's days of being the global safe haven currency are over, given the Swissy's float is now considered “dirty” due to central bank manipulation. That leaves only two safe havens – gold and AA+ US bonds. Last night the yield in the US ten-year fell 6bps to 2.16%, putting it back to around turmoil levels and not that far off the GFC low at 2%. It's difficult to see a strong stock market rally emerging until bond yields start to rise again.

Gold was quieter last night, rising only US$2.30 to US$1789.00/oz, but still hanging in around those turmoil levels. Again, its hard to see stock markets rising if gold continues to rise, because that would imply continuing risk aversion, mostly derived from Europe fears given Wall Street has shrugged off the downgrade. Analyst forecast of US$2500/oz are clearly keeping investors in the gold market, but the technicians are looking for gold to breach US$1800 first. This price was hit intraday twice last week, so another trade over US$1800 and a failure to follow through would mean a dreaded triple-top and a wailing technical alarm.

Why is the Aussie not a safe haven? Wayne Swan certainly likes to press the point. The problem is that if the developed world goes down it is assumed China goes down, and if China goes down we might as well stick up the Banana Republic sign once more. The Aussie thus fell 10% in the turmoil, but has rebounded half of that and is about half a cent higher this morning at US$1.0542. 

So it looks like we might take a breather now until we see what happens next. In the US, the last of the quarterly earnings reports are still trickling in and in Australia, the earnings season is now in full swing and has two more weeks to run. Some interesting data have emerged, nevertheless, with regards to just who was panic-selling in last week's downgrade plunge.

It's easy to assume retail investors are always the ones prone to panic, but data collected by BA-Merrill Lynch has found the big global sellers last week were actually big fund managers, who not only have now increased their cash positions to the same proportions as early 2009, they have done so this month at the fastest rate ever recorded. Retail investors might be the jumpy ones, but for fund managers it's all about not being the one who got caught out (going down or up) with the wrong weighting because fickle unitholders will jump ship at every quarter's underperformance.

The implication from this data is that were the stock market to turn more healthily to the upside, the big fund managers will be underweight equities. At some point they will then have to chase, and buying begets buying, meaning there could be accelerated upside. Fund manager cash weightings are thus a contrarian indicator, and you can read all about it in this weeks' Rudi's View. We still have to see the market actually start rallying first, and that doesn't mean just for a day or two.

The fact that global markets didn't all tank last night on perceived Merkozy disappointment meant commodity markets could feel a little less nervous, and here traders suggest it is the short positions looking the more vulnerable. Hence we saw base metals all up around 1% in London and Brent oil up US$1.47 to US$110.60/bbl on the new October front month. West Texas added US72c to US$87.37/bbl.

Also testament to the fact we appear to consolidating and stabilising at these levels for now was the reaction, or lack thereof, to last night's US producer price index result for July. The headline was up 0.2% compared to a 0.1% expectation, but more importantly the core PPI was up 0.4% compared to 0.2%. Food and energy prices eased in July, but other prices didn't. If we were to get QE3 at all in a more meaningful way than just a two-year fixed zero cash rate, then the Fed would need to be concerned about deflation. We still need to see the CPI tonight but a stronger than expected PPI is pointing to no more quantitative easing, and Wall Street didn't seem to mind too much.

After a strong day yesterday on the local bourse, the SPI Overnight is down 12 points or 0.3%.

Local earnings highlights today include reports from AMP ((AMP)), ASX ((ASX)), and Wesfarmers ((WES)).

Rudi will be appearing on Sky Business at noon. 

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