The Monday Report

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By Greg Peel

Swing Low

Now what?

That is the question on everybody’s lips, and even among those who believe they have an idea, there is no agreement.

The situation remains fluid, thus uncertainty prevails. When uncertainty prevails, volatility thrives. A common call from global commentators on Friday night, with regard stock markets, was “buying opportunity”. But not right now. Right now there remains further downside risk and as such longer term investors are being told to stand aside for the time being until the fallout from this unprecedented event is more clear.

It is typical for markets to sell first and ask questions later. But we can perhaps take some heart in the fact that when the dust settled after 24 hours of trading on Friday, the reaction was not quite as bad as had been predicted by, for example, futures markets heading into the open of the UK and US stock exchanges.

In Australia the index fell 167 points or 3.6% on Friday but closed 33 points off its lows. We’re sitting just above 5100 – a level last seen in April on the way back from the February commodity crunch. We recall how hard the index had to work to finally move away from the 5000 resistance level. We’re still a hundred points above what will now be solid support.

In London the stock index futures were indicating a fall of 8% heading into the open. Ultimately the FTSE only closed down 3.2%. The Dow futures were showing close to an 800 point fall before the bell. Ultimately the Dow fell 617 points or 3.4%. The S&P fell 3.6% to 2037, and the riskier Nasdaq fell 4.1%.

The real damage was done in Europe, where the German market fell 6.8% and the French market 8.0%. Bank stocks were the main target, falling up to 20% across the UK and Europe. The Australian financials index fell 3.8%.

What happened to the pound over the course of Friday is already the stuff of legend. But the wild gyrations and ultimate collapse of the pound remind us that on Thursday, and as late as Friday morning, markets had rallied back hard on the assumption “stay” was winning. So we first had to give that rally back as we fell on Friday.

As both the pound and the euro tanked, the US dollar index was up a whopping 2.6% on Saturday morning at 95.54, despite carry trade-reversal also sending the “safe haven” yen surging. Caught in the cross-rates, the Aussie fell 2% to US$0.7476.

The US dollar was a headwind for gold, which still managed to shoot up US$59.30 to US$1315.60/oz in its safe haven capacity.

The strong greenback should have been a major headwind for commodity prices, notwithstanding the impact on prices of global uncertainty, so when we look at the 5% drop in West Texas crude, taking it back to US$47.64/bbl, and the one to two percent falls in base metal prices in London, we might conclude it’s not that bad.

Iron ore fell US30c to US$51.40/t.

An adjustment was made across the globe on Friday. In Australia, the SPI Overnight closed up 3 points on Saturday morning, suggesting we will probably now hit a wait and see period, given a bout of vu-deja – the eerie feeling nothing like this has ever happened before.

Politics

It is also important to remember this is not 2008. This is not Lehman. While uncertainty may prevail, there is no credit freeze going on due to financial organisations fearing their counter parties may go under. Global banks are no less capitalised this morning than they were on Friday morning. It’s simply the value of their shares that has suffered. The Bank of England, for one, has pledged to pump hundreds of billions of pounds of liquidity into the system to maintain stability.

Other central banks are preparing to do whatever they may have to do. One has to feel for the Bank of Japan, which just can’t catch a break in trying to rein in the yen, and the ECB, which has fought hard to promote even the slightest of economic growth in the eurozone.

Presumably the Fed will now not raise in July, if ever there were an actual possibility. But with a US dollar now rocketing once more, the Fed is in an even more difficult position. The Aussie dollar appears somewhat caught between its US dollar denomination and the fact Australia has been seen as a form of safe haven at times in these post-GFC years, offering high yields in a well-regulated environment. The RBA will be watching closely, but obviously has plenty of fire power left in the form of rate cuts.

Interestingly, it was the May rate cut which allowed the ASX200 to finally break away from 5000 and find new resistance at 5400.

David Cameron has resigned. It looks like the Labour Party leader will either go or be pushed. There is already a call for a second referendum in Britain. There is already a call for a second vote on Scottish independence, given Scotland voted overwhelmingly to remain in the EU.  To that end, there is talk Scotland will attempt to veto Brexit legislation.

And when does the actual “Brexit” begin? Cameron says he’ll hang around for three months and then the new prime minister can pull the lever which begins a supposed two-year process. Boris Johnson, arguably prime minister in waiting, has urged even less urgency.

Angela Merkel has said take your time. EU bureaucrats have, on the other hand, spitefully insisted the process is overdone with swiftly. They fear the dominoes. Which brings us to the question…

Is this the beginning of the end of the EU?

Europe is littered with euro-sceptics. Nationalist and far right parties have been on the upswing. The talk is a Nexit, Dexit and even Frexit might be on the cards. Over the weekend Spain held a general election.

There was a surge in support for the ruling conservatives, opting for the status quo, ie “stay”.

The Week Ahead

The week ahead will no doubt be an interesting one. As noted, the local market is poised with the futures up 3 points. At least we won’t be flying around on every little shift in bookie odds.

Thursday is nevertheless end of financial year, which can in itself provoke last minute volatility. Obviously portfolio returns are looking a little less flash than they were a week ago.

The final revision of the US March quarter GDP result is due tomorrow night. Tomorrow also sees Case-Shiller house prices, Conference Board consumer confidence and the Richmond Fed index. Wednesday it’s pending home sales, personal income & spending and the PCE inflation measure. Janet Yellen will be speaking yet again on Wednesday night.

Thursday it’s the Chicago PMI and Friday the manufacturing PMI, construction spending and vehicle sales.

Friday is the first of the month, hence manufacturing PMIs from around the globe and both manufacturing and service sector PMIs from Beijing.

In Australia we’ll see new home sales on Wednesday, private sector credit on Thursday, and house prices and the manufacturing PMI on Friday. And just to add more spice to the curry, we have the election on Saturday.

On the local stock front, Collins Foods ((CKF)) will post its earnings result tomorrow.

One fact that caught my attention over the weekend was this one…

In order for Britain to leave the EU, a “qualified” 72% majority of the remaining 27 member states must approve, representing a simple majority of at least 65% of the EU population. I’m not sure what the “qualifications” are, but presumably this means the EU has the power to say “No, you’re staying”.

We live in interesting times.

Rudi will appear on Sky Business on Tuesday, via Skype-link to discuss broker calls around 11.15am, then again on Thursday at noon and again between 7-8pm for the Switzer Report and lastly on Friday, via another Skype-link up to discuss broker calls at around 11.05am.

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