Daily Market Reports | Jun 28 2008
By Greg Peel
The Dow closed down 106 points or 0.9%, while the S&P lost only 0.4% and the Nasdaq 0.3%.
The 30-stock benchmark Dow Industrial Average – and we must remember this index is only a simple average of those 30 prices, not a market cap-weighted index such as the S&P 500 or Australia’s ASX 200 – fell into new post-credit crunch low territory on Thursday, and kept going for another 106 points on Friday. The close represented a bounce-back from the intraday low of down 156 points.
The much broader S&P 500 fell on Friday less emphatically, although followed a similar pattern. Remembering that the March closing low on the S&P is 1276, that index fell to an intraday low of 1272 on Friday before settling back at 1278.
While companies make it into the Dow based only on capitalisation – they are basically the 30 largest, although changes to the index are only made infrequently – the index does represent a reasonable diversification of industry sectors. However, the inclusion of the two big oil names Exxon and Chevron has not protected the average from being beaten senseless by names like Citigroup, AIG, General Motors and even General Electric. In short, the Dow contains quite a few of today’s dogs. Fund managers tend to ignore the Dow and follow the S&P, and for that index one would have to say we are poised at a precipitous position.
Friday was a day like most we’ve become used to. The Michigan Uni consumer confidence index for June fell again, to some minute reading not seen since the Civil War or whatever. The alternative measure of inflation, the core PCE deflator (ex food & energy) again tried to make Americans believe inflation is not quite as bad as thought (a handy number for a Fed that didn’t raise). Moody’s decided to put Morgan Stanley on credit watch, and a Lehman Bros analysts decided Merrill Lynch will write off another US$5.4bn instead of the US$3bn previously thought.
Then there was May personal spending, which rose a solid 0.8% on the back of the stimulus cheques, and a very healthy number in the form of personal income growth, which was a much higher than anticipated 1.9% for the month. Personal income growth is a figure popular with the “there is no recession” brigade.
Just another day really, and another day where a new high was seen in the oil price. Let’s face it, oil is really all that matters right now.
The US dollar fell again as the failure of the Fed to raise continues to resonate, and numbers like the Michigan index point to more economic weakness. This was all oil needed to trade up to a brand new high of US$142.99/bbl, before settling back to its first close above US$140 – at US$140.21/bbl on a rise of US57c.
The US dollar and oil combination again ignited gold, which having broken out of its trading range added another US$10.00 to US$926.80/oz. A less volatile day in yen trading meant the Aussie was able to drift back up to US$96.04, and after Friday’s performance in the ASX 200 one might be forgiven for thinking some distressed money has made its way across the Pacific.
Base metals responded in their usual fashion as well, with the two favourites aluminium and copper rising by 0.5% and 1.5% while the others were uninspiring.
The SPI Overnight learnt a lesson from Friday, and fell only 4 points.
So Groundhog Day aside, are we now looking at the end of the beginning or the beginning of the end? Consider the following chart:
This is the VIX volatility index, which is a valuable measure of stock market fear. Measuring the implied volatility of S&P 500 options trading, the rule is that the VIX runs up to high levels (fearful) when nervous investors rush in and buy put option protection, and falls to low levels (complacent) when either those puts are sold or there simply is little demand for them.
Note the two peaks in the index in January and March and the trough in May. Those two peaks are as good as equal – just over 30 – and represent the “SocGen bottom” and the “Bear Stearns bottom”. These are the two levels in 2008 from which the US stock market bounced hard. Just prior to the May trough, however, wise VIX-watchers were warning that the market had very quickly become complacent, believing the credit crunch to be history. And sure enough, the market turned around quickly and here we are.
Also note that despite the bleak market activity of last week, we’re still only a bit over half-way back in the VIX. If history is a valuable guide, this means we won’t have seen a bottom until the index breaches 30 once again. In other words, we haven’t seen a bottom yet.
The market is in a decidedly weak mood. If the S&P 500 breaks down through its March lows, one presumes that VIX index will start looking for a new top. What could make the S&P break down? Well that’s easy – oil.
It is often the case in a market that when a certain level is bandied about, and people start to believe in that level, the market won’t be satisfied until that level is reached. Take gold for example. For a long time there was talk that gold would go to US$1000/oz, even when gold was down around US$750/oz or lower. As the US dollar weakened and gold rose, that “magic number” seemed more and more possible. And so surely enough, we got there.
Note that in getting there, gold had one final push, breaking away from the trend line on a race for the summit. The same occurred in 2006 when the magic number was US$700/oz. But having reached the summit, there was nothing more to achieve. Take a look around – enjoy the view – but we have to go back down now.
Now take a look at a similar monthly oil chart (and note that June is not over so we haven’t got the last spike to 140 in there yet) and consider the similarity. And what’s our objective this time? What’s our summit? Well – it would seem that the number US$150/bbl has become a very popular one. Some might say a magic number.
Has it now become the case that we must go to 150 before the oil price can actually fall?
What would be the result? Well the S&P would break down, and a new wave of selling would result. Markets only ever form bottoms on significant volume. There would be panic, and thus a rush to buy put option protection. The VIX would push up to 30, where it seems a bottom is thus nigh.
If the ECB raises its interest rate on Thursday, then the US dollar would tank and oil could well go to 150. And bear in mind that the magic number for the dollar is US$1.60 to the euro. We were there back in Bear Stearns time, but we’ve actually had a stronger greenback since. So perhaps the greenback needs to retest its low as well.
The screenplay has been written.
