Daily Market Reports | Oct 26 2011
By Greg Peel
The Dow fell 205 points or 1.7% while the S&P dropped 2.0% to 1229 and the Nasdaq lost 2.3%.
The ill-conceived nature of the eurozone came to the fore last night as talks broke down amongst EU members. Tonight was to see a meeting of EU leaders and a separate meeting of eurozone finance ministers. The former will still go ahead but the latter has been cancelled pending rescheduling.
There are twenty-seven members in the European Union but only seventeen members form part of the common currency bloc, the eurozone. The other ten maintain their own currencies (for example the UK still uses the pound) and hence are sheltered from issues impacting on the euro but are still beholden to measures agreed on by the EU. The original schedule laid out for this week effectively asked non-eurozone EU members to pre-approve whatever it was the eurozone members would then agree upon later with respect to the proposed final solution for Europe. Understandably, those members said no.
The eurozone finance ministers have thus been forced to cancel their meeting tonight while the wider meeting of all EU leaders will still go ahead. The bottom line thus is that while we may still learn tonight what the EU plan is for the EFSF, bank recapitalisation and Greek haircuts, it will remain only a proposal that must yet be agreed upon in final detail. As to rescheduling, that is yet to be decided. We may yet be back to the original deadline, that being the November 3 meeting of G20 leaders.
Another issue complicating matters is a definition of the word “voluntary”. Earlier in the proceedings European banks holding Greek sovereign debt had voluntarily agreed to take a 21% haircut on their investments, but it appears the latest proposal takes that haircut to 60%. If the haircut is voluntary then it is not seen as a forced default, meaning insurance policies against default (credit default swaps) are not triggered. But if the banks are not supportive of a full 60% haircut it is seen as involuntary and CDS positions can then be cashed. If they are cashed, the whole benefit of the haircut is lost and financial turmoil once again threatens. At this stage it is believed the banks may stretch to 40%, but beyond that they suggest the haircut would no longer be voluntary.
Oh what a tangled web we weave.
None of the above can be particularly good news, but then one has to say last night's global market reaction was somewhat muted. The French stock market fell 1.5% but Germany's was only down 0.14%. The Dow dropped 170 points on the open but soon rallied to be down only 100 points in a climate which, pre-European resolution, was already looking short-term overbought.
Last night's economic data and earnings reports in the US were, however, mostly disappointing, which no doubt assisted the ensuing slide to the close.
The Case-Shiller 20-city house price index for August showed a 0.2% rise, however year-on-year prices are down 3.8% when economists had forecast 3.5%. The 3.8% is still better than July's 4.1%, but clearly US house prices are far from any sort of realistic recovery. The FHFA house price index, which relates to homes with Fannie/Freddie mortgages, fell 0.1%.
Consumer confidence has taken another sudden dive this month, according to the Conference Board measure, which read 39.8 after last month's measure of 46.4. Economists had forecast 46.0. Again we are back to levels seen at the nadir in March 2009. The Richmond Fed manufacturing index was steady this month, at minus 6.
An earnings miss from 3M (Dow) saw its shares down 6% and while fellow Dow component DuPont reported in line, both companies noted destocking amongst customers. There were also seriously big share price drops for Netflix and MF Global.
Things haven't improved after the bell, given a big miss from Amazon. Blaming capex on developing its new tablet, Amazon posted earnings per share of US14c compared to US24c expectation and its shares are down 14% in the after-market.
All of the above added up to a weak session for Wall Street, although currency movements were surprisingly minimal given the potential implications of the European delay. The euro, which has been the “leading index” for all financial markets these past few months, barely moved, and hence the US dollar index is up only slightly at 76.23. Traders channelled their fears into the non-paper currency instead, sending gold up US$47.80 to US$1702.10/oz.
After a soaring run-up on Monday, base metals were weaker in London but only by 1-2%. The Aussie has lost half a cent to US$1.0423. The Brent-WTI spread continued to close last night, with Brent falling US53c to US$110.92/bbl and West Texas rising US$1.31 to US$92.58/bbl. That spread of US$18 is a long way in from the highs of around US$27 experienced at various times this year.
US bonds were suddenly back in vogue as well, with the ten-year yield falling 10 basis points to 2.13%, while the VIX's brief flirtation under 30 proved again to be just that, and it closed above 32.
The SPI Overnight was down 37 points or 0.9%.
So what should we expect out of Europe tonight? Well, it's a bit hard to know. One presumes something will be forthcoming from the EU summit but as to whether we can call that conclusive is now unlikely given the postponement of the subsequent finance ministers meeting to a time unknown. We will probably have to endure the agony of waiting for a bit longer.
In the meantime, today sees the release of Australia's September quarter CPI data. Economists are expecting both the headline number and the RBA's trimmed mean to come in at 0.6%, down from 0.9% for the headline and 0.7% for the mean last quarter. A month ago, RBA deputy governor Ric Battelino had economists calling off their rate cut predictions given the hawkishness of comments he made in a speech. Yesterday that changed.
"The downward revisions to recent estimates of underlying inflation and the softer global economic outlook have made the outlook for inflation less concerning, providing scope for monetary policy to be supportive of economic activity, if needed,” Battelino declared in his latest speech.
The dial has now swung back toward a Cup Day rate cut and today's inflation data will be crucial. However, we must acknowledge that “if needed” is a reference to Europe, and possible global fallout, rather than to the Australian domestic economy in isolation. So the question still remains as to whether the RBA would make a policy change right in the middle of ongoing discussions regarding the proposed Final Solution for Europe.
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