The Overnight Report: Day Two

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By Greg Peel

The Dow closed down 260 points or 1.5% while the S&P fell 1.8% to 2000 as the Nasdaq dropped 2.4%.

Pause for Thought

It may have been panic selling from those who were caught in the headlights on Friday or maybe the computers were just up to their usual tricks yesterday morning when the ASX200 plunged 62 points on the open. Whatever the case, it didn’t last. In the second half hour we were back to square.

There began a stumbling attempt at a rally through to lunchtime before the market largely decided it had now set itself for the day, ready for what might transpire overnight on Day Two for the post-Brexit world.

The biggest movers up on the session were materials, telcos and utilities, which all put in 2% gains. The defensives of telcos and utilities were among the least sold off on Friday and with time to reflect over the weekend, investors likely decided these sectors offer safer harbours for the time being. For materials, which are the opposite of defensive, there may have been expectation on Friday metals prices would tank on Friday night but they didn’t.

Oil dropped 5%, but in the scheme of things that was nothing too dramatic. Energy was flat on the local bourse yesterday. Outside of insignificant info technology (in terms of market cap), a further 0.2% fall for the banks kept a lid on the bounce-back rally.

It wasn’t much of a bounce-back, more a squaring up on the possibility Friday and Friday night saw typical overreaction. Investors also had the weekend to consider what the real implications for Australian stocks were. Outside of some select direct exposures, there is not a great deal of crossover into the UK and Europe compared to exposure to Asia and the US. An FTA with the UK could no doubt be conjured up in a weekend. The only issue is whether possible recession in the UK could flow through for some companies.

Whatever the case, if local traders were hoping for a snap-back or at least some stability offshore after Friday night’s carnage, they got that wrong. The SPI Overnight is down 67 points.

Trading elders on Wall Street have pointed out that such financial storms typically result in selling on the Friday, because no one wants to risk carrying positions over a weekend, followed by selling on the Monday, because there are always those who were slow to move in the first place, then selling on Tuesday from the open, because things are starting to snowball, before the start of the bounce mid Tuesday morning, when the traders move in on oversold opportunity.

Pounded

As to whether that scenario plays out remains to be seen. Meanwhile, last night S&P cut its credit rating for the UK to AA from AAA. The pound duly plunged once more, trading below 1.32 against the greenback at a thirty-year low. That’s a 12% devaluation from the 1.50 peak on Thursday.

Perversely, the UK ten-year bond yield fell to below 1%, for the first time in history. The credit rating was cut and investors piled into the bonds. If it was Spain, it would be the other way around. But when risk assets are crashing around your head, government bonds still offer security, particularly gilts. It is also now assumed the BoE will have to cut its cash rate.

The 3%-odd fall in the FTSE on Friday night appeared quite tame under the circumstances, and nothing when one considers the futures were suggesting an 8% plunge. European stock markets crashed but then they do have a habit of doing so. The measured fall in London may be one reason the Australian market paused cautiously yesterday.

But last night the FTSE fell another 2.6%. Germany and France both fell another 3%. The bulk of the selling was again in the banks, which for the second session running saw falls of 10-20% for UK and European banks, which translated across the pond to further 5-7% falls for US banks.

Oil fell another 2%, thus the banks and energy led down Wall Street along with high-risk technology sectors, as reflected in a 2.4% fall for the Nasdaq. Utilities, telcos and consumer staples all finished in the green, but do not have the market cap clout to overcome selling in the bigger sectors. The Dow did nevertheless recover from a 350 drop to close with a 260 point drop.

Interestingly, the VIX volatility index on the S&P500 fell by 7%. It had jumped up 50% to 25 on Friday night as those caught out by the Brexit shock piled into put option protection. Last night it appears some who had sought protection – possibly as a hedge prior to the shock – decided to cash in their positions. This suggests a feeling a bottom may be nigh, once the panic subsides.

And that harks back to the aforementioned Tuesday turnaround tradition.

The S&P500 initially plunged through, but ultimately recovered back to, the psychological 2000 level. On Thursday it was above 2100, which had been proving resistance. It would be rather neat, one presumes, if 2000 proves the level that supports the rebound.

All speculation of course, for who knows what’s going to happen next? The UK Labour party leader is struggling on with several knives sticking out of his back, the Tories have yet to begin a leadership battle that Boris will probably win, the Scots have all painted their faces blue and are lining up along Hadrian’s Wall, seeking assistance from the Jacobites in Paris, while the leaders of France, Germany and Italy are refusing to negotiate anything with London until the actual exit lever is officially pulled.

Donald Trump clearly made no bonny friends when he hailed the Brexit as a great thing while teeing off at St Andrews. We now have that election ahead of us.

Which is one reason many on Wall Street are assuming no Fed rate hikes in 2016, despite what Janet Yellen might say. There is nevertheless some grudging respect that in offering up Brexit risk as a reason not to hike this month, Yellen has actually got it very right.

The US ten-year yield fell another 12 basis points last night to 1.46%. Last week it hit 1.75%.

Commodities

Gold’s inevitable rally continued last night, but gold still has to plough into the fierce headwind of a surging US dollar. The dollar index is up another 0.8% at 96.24 and gold is up US$8.50 at US$1324.10/oz.

West Texas crude is down US$1.03 at US$46.61/bbl.

London base metal traders are likely still trying to figure out where this Brexit business leaves the demand-supply equation. Given that mostly swings on China, probably little changed. There is still the matter of the stronger greenback, but while aluminium, lead, nickel and zinc all fell 0.5-1% last night, copper rose 0.9%.

Which brings us neatly to iron ore. It has jumped US$1.80 to US$53.20/t.

Once again the Aussie has been caught in the cross-rates, reflecting US dollar strength rather than sort of commodity price risk we normally associate with Aussie weakness. It’s down another 1.7% at US$0.7347, which of course is not a bad thing.

Today

The SPI Overnight closed down 67 points or 1.3%. If accurate, that will take the index into the middle of the 5050-5100 range that chartists are suggesting is support that must hold, lest we head back down through 5000 once more.

The final revision of US March quarter GDP is out tonight.

Collins Foods ((CKF)) will post its earnings result today.

Rudi will Skype-link with Sky Business at around 11.15am today to discuss broker calls and later tonight, from 8-9.30pm, he will host Your Money, Your Call on the channel.

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