The Overnight Report: Short Squeeze

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By Greg Peel

The Dow closed up 187 points or 1.1% while the S&P gained 1.0% to 2082 and the Nasdaq rose 1.1%.

Material Gains

Strong rallies overnight in oil, iron ore and base metals set the scene for yesterday’s market-leading 3.4% gain for Australia’s materials sector. Underscoring renewed interest in this beaten-down bunch were China’s surprisingly positive March trade numbers, released late morning.

The headlines in this morning’s papers are suggesting that after throwing loads of liquidity and stimulus into the system, Beijing has finally succeeded in reviving China’s “old economy”. “Old” being the economy of manufacturing and export – the economy Beijing is attempting to wind back from overcapacity — with “new” being an economy based on services and domestic consumption.

In US dollar terms, Chinese exports rose 18.7% year on year in March after falling 25.4% in February. Economists had forecast a 2.5% rise, Imports fell 7.6% after falling 13.8% in February. Economists had forecast a 10.2% fall.

The sighs of relief across Australia’s mining industry were notably audible yesterday. We won’t mention, nevertheless, that every year Chinese data are volatile and distorted in the months around the New Year break and as such, usually misleading.

Such a consideration did not faze Fortescue Metals ((FMG)) yesterday, which having picked a good day to chime in with a production report showing even further astonishing cost cuts, saw its shares jump 8%. BHP Billiton ((BHP)), which drew upon the rallies in both iron ore and oil, rose 6%. Rio Tinto ((RIO)) gained 4.5%. On the base metal front, one of the most shorted stocks in the market – Western Areas ((WSA)) – enjoyed a 4% rally, as did Independence Group ((IGO)), which has also been popular among the shorters.

The energy sector was the next best performer yesterday, posting a 2.6% gain. But the real clout in market cap terms, helping the ASX200 up 1.6%, was a 1.8% rally in the banks. How are those resource sector loan exposures looking now? Not as bad as they were a week ago, when bank investors were heading for the hills.

We might suggest that every time the index heads north through 5000, it is a “risk on” trade. Telcos and utilities comparatively sat on the sidelines yesterday and healthcare managed only a modest gain. Consumer staples did post a 1.0% gain, but only after having been hammered this week thanks to the Target scandal.

Today’s session will be interesting. Iron ore and base metal prices are again up strongly overnight. Oil is off, but only by a tad. And on Wall Street, the banks were the big winners on the day.

Chase JP Morgan

Well you could knock me down with a feather, but apparently when asked whether an agreement on an oil production freeze was likely to be reached in Doha on Sunday, the Saudi oil minister last night responded with “Forget about this topic”.

One wonders, thus, just what the meeting is for.

I suggested yesterday that after a couple of days of sharp rallies, you wouldn’t want to be standing under an oil price on Monday if nothing was to come out of Doha. And to top things off, last night’s weekly US crude inventory numbers showed a build of 6.2 million barrels when analysts had forecast 1 million. By rights, oil prices should be down about 10% this morning.

But they’re not. They’re only off a smidge. There are two reasons we can consider.

WTI is not back over 40 due to any false sense of hope an agreement can be reached in Doha. Nobody ever actually believed one would be. Which leads into the second point, WTI is back over 40 because the trend of US production is heading in the right direction, ie down, notwithstanding weekly inventory fluctuations. The weekly US crude data also showed that production has now fallen below the 9 million barrels per day mark. And gasoline inventories fell more than expected in the week, as is the current trend, suggesting growing demand.

The fact that oil prices held up when they had every right to tumble was supportive of the rally on Wall Street last night, but not the driver. The driver was JP Morgan’s (Dow) March quarter earnings report. The talk leading into the US earnings season has been of forecasts being marked so far down as to skew the odds heavily in favour of upside surprise. All that was needed was some confirmation.

JP Morgan’s result was not a good one, but it wasn’t as bad as had been forecast. JPM shares jumped 4%, and subsequently floated all US bank share boats. Tonight sees results from Bank of America and Wells Fargo.

US bank stocks have been very much out of favour in 2016 for a number of reasons: sluggish US economic growth; ultra-low interest rates, crimping earnings potential; volatile markets, hitting trading profits; and credit exposure to the stricken energy sector. It is said that a bull market on Wall Street is not possible unless led by the banks. The fact Wall Street has been stuck in a range for many months now can to a great extent be explained by bank underperformance.

Maybe this earnings season will prompt a bank comeback. But as many a trader has pointed out, the short interest on US stock markets is currently as high as it was in 2009, and market scepticism surveys have been hitting peak levels. Wall Street is rife for a break-out rally, but does it have substance? Volumes have been on the tepid side, including last night, suggesting a lack of buying conviction. Retail investors remain absent. The conclusion as to why Wall Street rallied last night was simply one of “short squeeze”.

And short-covering rallies tend to be ephemeral.

Commodities

West Texas crude is down US8c at US$41.56/bbl and Brent is down US36c to US$43.90/bbl.

Harking back to the strong Chinese data released yesterday, all base metals are up 1-1.5%.

Iron ore is up another US$1.40 to US$59.90/t.

While the strong Chinese data are good news for the Australian resource sector, they are not good news for the Aussie dollar. It jumped sharply on yesterday’s release. So the RBA will be very relieved to see that last night’s bank-led rally on Wall Street was accompanied by a 0.8% bounce-back in the US dollar index, to 94.82.

The Aussie is subsequently down 0.3% over 24 hours to US$0.7652. Gold is off US$13.30 to US$1242.30/oz.

Today

The SPI Overnight closed up 38 points or 0.8%.

The Aussie will be very much in focus today when the local March job numbers are released.

The Bank of England will hold a policy meeting tonight, but no one much cares ahead of the Brexit referendum.

US CPI numbers are out tonight, following disappointing retail sales and PPI releases last night.

Whitehaven Coal ((WHC)) will release a quarterly production report today, Transurban ((TCL)) was to provide a quarterly update but postponed it until Monday, Bendigo & Adelaide Bank ((BEN)) will hold a strategy day and tonight, Rio Tinto will hold its UK AGM.

Rudi will make his weekly appearance on Sky Business from 12.30-2.30pm.
 

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