Daily Market Reports | Oct 05 2011
By Greg Peel
The Dow closed up 153 points or 1.4% while the S&P jumped up 2.2% and the Nasdaq a full 3.0%.
If Paul Stanley still wants to rock and roll all night then all he had to do was follow Wall Street last night. On heavy volume, the Dow initially fell 250 points, clawed that back to be down only 55, and fell again to be down 200. Up to about 3pm, one might have been tempted to declare a “capitulation” session which in its self is a positive sign from a contrarian perspective, if not the ultimate signal for a bottom. But there was more to come.
Wall Street simply gapped lower on the open, driven by what seemed to be more delay tactics and dithering from Europe. Greece had hoped it would have received the next E8bn tranche of its bail-out fund by now, but a failure to project sufficient budget reductions has held that up. Initially the troika was to hold up its decision until mid-October, cognisant of the fact Greece would run out of money by end-October. Before the bell on the NYSE last night, it was announced that decision will now be held up until mid-November, at which point, one presumes, Greece would be stone motherless.
Oh God – another delay. Surely the risk of a disorderly Greek default just jumped up to almost inevitable status? At least that's the way Wall Street saw it from the bell. But if we look to the reason why the troika called yet another delay, we might see that there is method in the madness.
I opened my Report yesterday with the question: might this really be good news in disguise? I was referring to the news Greece had failed to reach its budget projection targets, in theory making it ineligible for the E8bn, the news of which had the Dow closing down 250. My suggestion was that given the disaster that would follow a disorderly Greek default, finally Europe would have to be spurred into definitive action.
Wall Street initially saw the new delay as bad news, but the reason for the delay is to allow time for the troika to renegotiate the haircut deal it had previously agreed upon (although not yet enacted) with holders of Greek sovereign debt. The initial deal was for holders to take a 21% haircut on the face value of their positions in return for EU support of Greece and default prevention. At the time, bond markets were pricing in 50% haircut. One reason markets are that much lower in the interim is the difference between 21% fantasy and 50% reality.
It is now clear Greece cannot meet its bail-out requirements and, let's face it, probably never could. No doubt it is with this in mind the troika has delayed the Greek payment to insist upon a more substantial bondholder haircut and put such a restructure to bed. And why not? When the European banks bought the debt, it was simply a free market trading decision, and a very bad one.
Whether or not Wall Street began to figure out that last night's initial news was maybe more good than bad in the scheme of things, it's hard to say. The market turned at 10am and started heading northward, but not before the benchmark S&P 500 index had breached the 1090 level, meaning it was down 20% from its last peak and thus, semantically, in a “bear market”. Such technical levels can either prompt more intensified selling or, in this case, buying from value-seekers. However at the same time, Fed chairman Ben Bernanke was making a testimony to Congress.
In addressing the risk of a potential run on the US banking system as a flow-on from the same in Europe, Bernanke suggested, “We would make sure we would stand ready to provide as much liquidity against collateral as needed as lender of last resort for our banking system”. In other words, if things get bad we'll stop simply twisting and roll out QE3. Whatever it takes.
The declaration was indeed heartening, but then again not all that new. And besides, given QEs 1 and 2 have failed to get markets anywhere other than where we are now, should we be excited? Maybe we were still looking more realistically at some genuine buying. And so it was the Dow was down only 55 points at midday.
Which is where it met the sellers once more, and the battle began anew. Was it hedge funds going short on the assumption Europe must surely implode, or was it simply more capitulation from investors finally giving up? The problem with the last possibility is that given current levels of cash being held by mutual funds and small investors alike, one might argue they all gave up long ago. And that reality was underscored with what happened next.
First came the news of a plan for Dexia Capital – the Franco-Belgian financial institution close to bankruptcy – which would see it park E180bn of toxic sovereign debt positions into a “bad bank”, leaving an unexposed “good bank”. This is exactly the tactic Paulson and Bernanke wanted to employ initially in 2008 for the US banks and their toxic mortgage assets. It didn't happen however, because no one could agree on what over-the-counter CDOs were really worth. Hence was born the alternative TARP plan. In the case of European sovereign debt on the other hand, exchange listings provide price discovery.
Dexia will remain as two banks until the Greek debt restructuring is clearer, but either way the governments of France and Belgium would acquire the “bad bank”. In other words, the plan is a step in the right direction – a direction that should have been taken one, if not two, years ago.
The Dexia news was enough to halt the slide, and the Dow managed to edge a bit higher. Then came the clanger. A report hit the wires from the London Financial Times that the EU finance ministers were examining possible ways to recapitalise European banks. Hellelujah, there it is – the Eurotarp. With such capital support in place, Greece can be guided calmly into an orderly default.
You want to see short covering in action? Just watch the Dow rally 350 points in under 45 minutes.
The stock markets were not the only markets to rock and roll all night. In another sign of capitulation, gold fell sharply to trade below US$1600 as once again positions were cashed in to pay margin calls. Gold subsequently bounced to be down US$40.10 at US$1617.20/oz at the New York close. The Aussie visited the 94s, helped along by yesterday's dovish RBA statement, before rebounding sharply to be up 0.3% in 24 hours at US$0.9557. The US dollar index finished down 0.6% at 79.12. The US ten-year bond yield closed at 1.82% having hit 1.72%.
Oil fell sharply and bounced back, with Brent finishing down US$1.92 to US$99.79/bbl and West Texas down US$1.94 to US$75.67/bbl. London Base metals close at 2pm New York and hence they missed the bounce. Most were around 1% weaker.
The SPI Overnight closed up 43 points or 1.1%.
Are we there yet? No. But we might just be one helluva lot closer.
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