Daily Market Reports | Aug 24 2011
By Greg Peel
The Dow rose 322 points or 3.0% while the S&P gained 3.4% to 1162 and the Nasdaq jumped 4.3%.
Around 2pm local time last night a magnitude 5.9 earthquake struck in Virginia, some 80 miles west of Washington DC. Minor damage was reported and precautionary evacuations in New York's financial district were brief. There were no fatalities. There was some concern with regards to a string of nuclear reactors in the region, the nearest only 15 miles from the epicentre, but they switched automatically to emergency power and no damage was reported.
One wonders what the market response might have been had last night been a day Wall Street had decided to tank rather than decided to surge. Stocks had been running hard up to 2pm and the dip on the earthquake news (and a shaky floor on the NYSE) was also only brief, with insurance companies and nuclear power companies falling into holes before recovering. The quake nevertheless dominated last night's US financial news.
So why the rally? One might cite three reasons: the rally yesterday in Asia; no new news out of Europe; and building expectations ahead of Jackson Hole. One might also add, however, a short-covering rush in a session of relatively light volume.
Yesterday's 2% rally in Australia began with some strong corporate earnings reports, kicked on with a "positive" PMI estimate from China, and accelerated on the first real sign the RBA will not be raising rates anytime soon.
There have been some duds among the results in the local season so far but on average the scorecard to date has been a solid one. Given the market has been sold so far down to this point there has already been plenty of “bad news” built into prices, and expectations of reduced earnings forecasts, so downside from here on weak results is limited and upside more available, particularly for the bargain hunters.
HSBC's “flash” estimate of China's August manufacturing PMI came in at 49.8, which is a shade into contraction but implies an increased rate of growth from July's reading of 49.3. The meter is not exactly flailing about, but a potential bottom in Chinese contraction is good news for a global market in a very nervous state over what's going on in the developed world. The last thing we need is a weak China as well, so the HSBC result was well received in Australia and in Chinese and other Asian markets.
The last time we heard officially from the RBA was before the US downgrade and so before the extreme volatility in markets experienced this month. Prior to the turmoil RBA rhetoric remained very much to the hawkish side, with the one caveat of holding off to see what transpired in Europe. But yesterday in a scheduled speech deputy governor Ric Battelino spoke to the recent turmoil and drew comparisons to similar European scares this time last year.
Yes, even the RBA is having a Groundhog Year.
“An important issue ahead of us,” suggested Battelino, “will be to assess what impact this is likely to have on global and domestic economic activity, commodity prices and inflation. As yet, there is little information on which to base such judgements."
Battelino also spoke to the domestic situation, acknowledging the ever widening gap between the resource sector and the rest of the economy:
"The effects of the mining boom have turned out to be stronger than expected a year ago. The terms of trade are noticeably higher and forecasts for national income and mining investment have been revised up over the year. Despite this strength in the mining sector, overall economic growth is turning out to be weaker."
That, my friends, is what economists call “stagflation”, in which GDP growth falls while inflation rises. Stagflation dominated the 1970s across the developed world before central banks realised they should also look to control inflation as well as growth. Stagflation puts a central bank in a very difficult position – on the horns, one might suggest – given monetary policy can't solve both problems at once. This means that at such times, monetary policy is best left alone.
Naturally the mass media jumped on Battelino's speech yesterday as an indication that a rate cut is just around the corner, and accelerating strength in a beaten-down stock market suggests investors were backing policy relief for hard hit sectors as well. Adding to mass media hysteria was a well covered report from BA-Merrill Lynch economists forecasting 100,000 Australian job losses ahead. (See this week's Weekly Insights). I would suggest the RBA will definitely not now raise rates, but there was nothing in the speech to suggest it was about to cut them either. Having compared 2011 to 2010, Battelino pointed out that last year the RBA remained on hold, and on careful watch, until November.
Until further data releases suggest otherwise (including local unemployment), it would appear the RBA is simply on hold.
Wall Street was spending too much time talking about the earthquake at the close last night to consider the factors which drove US stocks higher in the session, other than to suggest the market was gearing up for good news from Ben Bernanke on Friday. It's interesting, because no one actually expects QE3 to be announced. They do expect some sort of soothing address, but it is also noted that President Obama is due to outline his new jobs policy in two weeks time. The Fed is unlikely to upstage fiscal policy with monetary policy at this point, it has been suggested.
However, as Jackson Hole approaches we seem on last night's trade to be back into a “bad is good” mode, given last night it was revealed the Richmond Fed manufacturing index fell to minus 10 from minus 1 when minus 5 was expected, as new home sales dropped to their lowest level since February. But the Dow was up 300 points. The worse the US economy, the more likely it is the Fed must act.
It is nevertheless clear that Wall Street's strength last night was encouraged by the good news out of China, and nowhere was that more clear than in yesterday's activity in Australia. Despite talk of a potential rate cut, the Aussie is up a cent in 24 hours to US$1.0526. Investors have been looking for a rate cut to provide relief on the Aussie, and thus those sectors impacted by a strong Aussie (eg steel). Yet over 24 hours the Aussie has shot ahead again, which simply means the US was buying Australian stocks with gay abandon yesterday. The “risk trade”, at least for a day, is back on.
And “risk on” factor was most evident in last night's movement in the gold price. At 1700 we were looking for the inevitable blow-off top, and then at 1800. Turns out we should have waited for 1900, which was breached in Asian trade yesterday. Gold has since fallen US$68.00 to US$1830.10/oz overnight.
Seems like an awful lot, but we must remember gold is trading at rather large absolute numbers theses days. The fall is thus only 3.5% which is not quite so material. Silver moves by that amount every other day and last night fell 4%.
By contrast, lead and tin were up 4% in London last night, zinc up 2%, and copper and aluminium up 1%, which has China and the “risk trade” written all over it.
Oil was also up, by US95c in Brent to US$109.31/bbl and by US$1.02 in West Texas to US$85.44/bbl. Aside from the risk trade push, it would appear rumours of Gaddafi's demise are exaggerated at this point.
US bond prices did not reflect the strength in stocks or commodities or the fall in the safe haven gold price. The ten-year yield was up 5bps to 2.14% but the Treasury's auction of two-year notes was settled at 0.22% – the lowest yield in history. It's hardly surprising given the US cash rate is fixed at zero for two years, and foreign central banks bought 32% compared to a running average 30%.
The SPI Overnight was up 60 points, or 1.4%, to add to yesterday's 2.4% in the physical.
Is this another false rally? Well, clearly we have to get past Jackson Hole on Friday, but remember that real problem lies with Europe. I'd like to say it's all over, but I won't.
Today's earnings highlights include Asciano ((AIO)), BHP Billiton ((BHP)), Qantas ((QAN)) and WorleyParsons ((WOR)) among many, many more.
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