The Overnight Report: Correction Resumes

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By Greg Peel

The Dow closed down 139 points or 0.8% while the S&P fell 1.0% to 1920 and the Nasdaq lost 0.9%.

Happy Birthday 2.5%. It is one year since the last RBA rate cut. And judging by yesterday’s RBA statement, there is no change on the horizon.

The statement was virtually word-for-word a repeat of the July statement, and indeed it’s been difficult to spot any variation over the past few months. However there was one line inserted that wasn’t there last month:

“Recent data showed an increase in inflation, with both headline and underlying measures affected by the decline in the exchange rate last year.”

Then came the “But”, which took us back to the previous statement’s observation that:

“…growth in wages has declined noticeably and is expected to remain relatively modest over the period ahead, which should keep inflation consistent with the target even with lower levels of the exchange rate.”

So the RBA is staying put while the two camps of economists – next move down, led by Goldman Sachs, and next move up, led by several banks – argue the toss. We can only now wait for June quarter data due next month, after the corporate result season.

It was another soggy day on Bridge Street yesterday despite a late rebound on Wall Street, and despite Cochlear ((COH)) showing what can happen when you’re the most shorted stock on the ASX, by a margin, and you post a positive earnings result. Cochlear shares jumped 10%.

Not helping the cause was HSBC’s read on China’s July service sector PMI which came in at a neutral 50.0, down from 53.1 in June. This is the lowest reading since HSBC started this index in 2005, and representative of the flow-through to related services of the Chinese property market slowdown. Meanwhile, the Australian equivalent measured 49.3, up from 47.6, which is an improvement but represents yet another month of contraction.

It may have been sensible for the local market not to become excited by an apparent turnaround on Wall Street, given the US indices gave up those late Tuesday night gains from the opening bell last night. The early dip belied a solid US service sector PMI, which hit its highest level since 2008 at 58.7, up from 56.0, and a stand-out June factory orders number, which showed a 1.1% increase when consensus was for 0.6%.

The problem here is the old good news is bad news theme, vis a vis the timing of the first Fed rate hike. The good news meant stocks sagged and the US ten-year bond yield jumped about five basis points to be up over 2.52%. Wall Street rolled through the morning uncertain as to whether more rate-related selling was going to hit. But then all of a sudden it didn’t matter.

At 1.30pm news hit the wires that the Polish foreign minister had declared Russia was about to invade Ukraine. Putin has further increased the number of troops amassed on the border, which now number 45,000. The troop movements are in direct defiance of the US/EU sanctions designed to force Russia to do just the opposite.

Further news suggested Putin was about to ban Western airlines from flying in Russian airspace, and just to rub America’s nose in it, a particular brand of Kentucky bourbon whiskey was deemed not to meet Russian “quality controls”. This follows on from a similar “quality” ban on McDonalds. Presumably apple pie is next.

The Dow plunged to be down 200 on the news. It proved the low point of the session, with those buyers ever vigilant on the sidelines moving in to pick up some bargains, but the closing level of down 139 does little to convince there’s not more selling to come in this traditionally weak, summer holiday-thin month of August.

While I have suggested more than once that corrections don’t occur because they are expected, and that the trigger for a correction is never one that can be specifically identified ahead of time, what we’re currently seeing is a confluence of factors. Fed rate rise fear has clearly heightened, but the ten-year bond yield ultimately fell back last night to 2.48%. The 2014 low is 2.44%. This implies a “flight to safety”.

Ukraine is providing the flight to safety impetus – not directly, but indirectly via the impact of the sanctions and tit-for-tats on the European economies. And the Portuguese bank failure is another Euro-factor that was not on the radar a month ago. We thought Europe was sufficiently covered by the ECB.

But were a true “flight to safety” in play, we would normally see gold rallying. It was steady at US$1288.60/oz last night as the US dollar index rose 0.2% to 81.51.

So that’s confusing as well. And never mind that the eurozone service sector PMI came in at a three-year high 54.2, up from 52.8. And for the record, the UK is surging on 59.1, up from 75.7.

So what exactly is causing the weakness? Well, I think that’s the point. The catch phrase now is “no one’s looking for reasons, just excuses”. If you’re not entirely sure why a pullback is in train, it’s best not to argue. Just get on. But once again I suggest that it won’t be too long before the dam of pent up buying demand breaks at lower levels.

Oil is another asset class that has observers confused. Geopolitical tensions suggest oil should be bought, but still it keeps giving back any premium built in a while back. Last night Brent fell US62c to US$104.81/bbl and West Texas fell US77c to US$97.64/bbl. Dow heavyweights Exxon and Chevron have been weak for a while now, and last night their falls of around 2% each accounted for 45 Dow points alone.

Having shot up in a thin market on Tuesday night, base metals shot down in a thin market last night. Aluminium, copper, lead and zinc all fell around 1%.

Iron ore rose US10c to US$95.50/t.

The Aussie is down 0.3% to US$0.9306 in the wake of the RBA statement and a stronger greenback.

The SPI Overnight closed down 31 points or 0.6%.

Rudi will appear on Sky Business at 5.30pm.
 

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