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The Overnight Report: When The Levee Breaks

Daily Market Reports | Mar 22 2017

This story features BLACKMORES LIMITED, and other companies. For more info SHARE ANALYSIS: BKL

By Greg Peel

The Dow closed down -237 points or -1.1% while the S&P lost -1.2% to 2344 and the Nasdaq fell -1.8%.

Rock and Hard Place

“Domestic wage pressures remained subdued and household income growth had been low, which, if it were to persist, would have implications for consumption growth and the risks posed by the level of household debt. Spare capacity was expected to decline slowly as momentum in the economy built; wage growth and underlying inflation were expected to rise, but only gradually.”

“Recent data continued to suggest that there had been a build-up of risks associated with the housing market…Borrowing for housing by investors had picked up over recent months and growth in household debt had been faster than that in household income.”

These excerpts from yesterday’s RBA minutes underscore the dilemma the central bank is facing. Subdued wage growth and low household income growth suggesting weak consumption growth, slowly declining spare capacity, only gradually rising inflation – all elements that in isolation would be a text book case of an economy that could use a bit of a shot in the arm, ie a rate cut.

But household debt is growing faster than household income, and still investors are piling into property. Cut the rate – feed the bubble.

There is talk from ASIC to APRA to the Treasurer as to what to do about the “housing bubble”. The RBA is clearly concerned. The banks have been coming under a bit of pressure of late but nothing too drastic. That will change today, but not because of domestic issues.

Another largely benign session for the ASX200 yesterday masked some significant moves underneath. The Spotless ((SPO)) takeover bid was clearly a standout, but in this tainted company’s shadow was news that Beijing has indefinitely delayed the new cross-border e-commerce laws which were impacting on Australian exporters of milk products and vitamins, providing uncertainty, and leading to some spectacular falls from grace.

To that end, Bellamy’s ((BAL)) rose 15% yesterday, Blackmores ((BKL)) 13%, and the less beaten-down A2 Milk ((A2M)) 4%.

A solid earnings result from TPG Telecom had that stock up 5%, while having copped a shellacking the day before on Amazon fears and insider selling, Harvey Norman ((HVN)) rebounded 3%, probably because Gerry himself has been in there buying.

In the wash-up the various sectors all traded ups and downs for a net flat session. It won’t be the case today.

Trump Dump

Wall Street has not seen a single day’s fall of -1% since Trump was elected, and indeed since October 11. Last night, the dam finally broke. Traders had been watching the water rising steadily to the top these past few weeks.

If we had to pin down one driver of the Trump rally, it would be tax reform, specifically the promise of a significant cut to the corporate tax rate. Yes, healthcare is important too, but not as fundamental for Wall Street as tax reform. No, we’re not that thrilled about the idea of a Border Adjustment Tax, but we can live with it as long as it is offset by a lower corporate tax rate. Bring it on.

Tax reform is still on the agenda, but Trump told the country a couple of months back he needed to get healthcare sorted and then he would move on to tax. It appears the process of repealing Obamacare and replacing it with a new model has hit a wall. The proposed bill will not get through Congress in its current state. This implies possible months of negotiation and renegotiation.

This implies tax reform may not even be seen to before 2018.

News of the stalling of the healthcare bill was likely the major trigger for Wall Street’s long awaited capitulation last night. However, there were other underlying factors at play.

US banks had led the rally from day one as beneficiaries of higher interest rates and deregulation. The banks started to come off again last week when the Fed appeared to be more dovish than had been assumed, maintaining a forecast of only gradual rate rises. If anything would provide the necessity for rapid monetary policy tightening, it would be a significant cut to the corporate tax rate. That is now some way off.

The trickle of bank selling became a flood last night.

It had looked for all the world that Trump’s much vaunted Border Adjustment Tax – cheered by rust belt workers and jeered by major US multinationals – may never even get off the ground. Or if it did, it would be much watered down or specifically applied only to those trading partners putting up protectionist walls of their own. It’s part of tax reform, and not a lot has been said of late, so the BAT had rather slipped off the radar.

Last night a Republican congressman insisted that a BAT was still very much part of the plan. Down went the retailers.

The oil price has been under pressure of late due to record US inventories, an ever growing US rig count, and the possibility of OPEC production cuts not being extended beyond the six months initially agreed upon. WTI fell another -1.8% last night. Down went the energy sector.

Throw in weakness in healthcare stocks as well, and the momentum was building as the session progressed. Many have been assuming Trump euphoria could not last much longer, given Wall Street had priced in Trump’s policies as if they were already a done deal. Such talk of a pullback being inevitable no doubt ensured that as investors watched their screens yesterday, they were seeing this come to pass. Quick, get out.

So the selling fed on itself. While Wall Street maintains a general belief Trump will ultimately be a positive driver of the US economy, the reality of such fundamental change needing time to occur is finally setting in. It’s not the end of the world, and it is difficult to find anyone that does not believe such a pullback from euphoric all-time highs is anything but “healthy”.

And where did the money go? Bonds, bond proxies and gold – three asset classes that were deemed to be the losers in Trump’s America. The US ten-year yield is down 4 basis points to 2.44%, yield-paying stocks such as utilities were among the only winners in last night’s session, and gold is up another ten bucks.

Commodities

A new copper mine is set to open in Chile and Escondida workers have agreed to return to wage negotiations with BHP Billiton ((BHP)). Copper fell -2% in London.

Zinc fell -1%, while the other base metals posted less significant moves.

Iron ore dropped -US$3.30 to US$87.40/t.

West Texas crude is down -US85c at US$47.34/bbl.

Commodity price weakness has come in the face of a big dip in the US dollar index, by -0.6% to 99.71. The greenback had also been a Trump euphoria target. Similarly, Trump’s ascension led to a sell-off in gold. Gold is up another US$10.90 at US$1244.70/oz.

The drop in the greenback could have had the Aussie under some severe upward pressure, but commodity price falls and the fact 77 is brick wall resistance sees the Aussie also down this morning, by -0.5% to US$0.7694.

Today

The SPI Overnight closed down -48 points or -0.8%. Goodbye 5800, we might come and visit again sometime in the future.

Note that while gold miners will no doubt be among the few winners on the local bourse today, Newcrest ((NCM)) goes ex.

Nufarm ((NUF)) will release its earnings report.
 

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