The Overnight Report: Let Me Count The Ways

This story features INSURANCE AUSTRALIA GROUP LIMITED, and other companies. For more info SHARE ANALYSIS: IAG

By Greg Peel

The Dow closed down -235 points or -1.1% while the S&P lost -0.8% to 2457 and the Nasdaq fell -0.9%.

Resilience Test

After the Australian market, world markets, and US Dow futures fell only around -0.3% on Monday in response to North Korea’s H-bomb, local futures traders called the market slightly stronger from yesterday’s open, off the 5700 support level.

The computers decided otherwise and sold the ASX200 down -36 points in the first half hour. It took the humans all day to drag the index back to just over 5700 once more.

Unfortunately, this time it looks like the computers may have been right.

It remains strange that in the mixed bag of sector moves yesterday, the most defensive sector was again the worst performer on the day. Utilities fell another -1.4% when no other sector moved more than 0.5% either way. It is the complete opposite of the market response to the missile flying over Japan.

We can only assume investors are ignoring any safety trade and focusing solely on domestic issues, being upwardly revised economic growth assumptions which imply, at least eventually, a higher interest rate. Never mind that last night the US ten-year yield broke down and fell to a new low for the year.

On the other side of the coin, a 0.5% rise for the materials sector yesterday was the major balancing act, thanks to stronger base metal, iron ore and gold prices. The banks closed square.

I noted yesterday that falls in bulk commodity prices in the June quarter from the March quarter would weigh on the terms of trade, but it would come down to volumes. Sure enough, the value of exports fell -2.8% in the quarter and the value of imports rose 1.8%. The value of iron ore exports dropped -13.9% and coal -14.7%.

However the volume of exports increased 2.7% and imports increased 1.4%. Aside from iron ore and coal, Australia is starting to see the impact of decades of investment in LNG export capacity. The value of LNG exports rose 16.3%. A bumper harvest also meant grain exports were a strong contributor.

The net result was the posting of another trade surplus, although the current account deficit widened more than expected. But we note that the 2016-17 deficit was the lowest since 1973-74.

The current account is the last piece of the puzzle, following on from corporate profit and inventory and capex numbers released over the past few days. Economists have revised up their forecast for today’s June quarter GDP result after netting these inputs, with 0.9% growth expected for a 2.0% annual rate.

The result should please the RBA, which has been quietly bullish the Australian economy for a while. But every silver lining has a cloud:

“The Australian dollar has appreciated over recent months, partly reflecting a lower US dollar. The higher exchange rate is expected to contribute to the subdued price pressures in the economy. It is also weighing on the outlook for output and employment. An appreciating exchange rate would be expected to result in a slower pick-up in economic activity and inflation than currently forecast.”

This comment in yesterday’s RBA policy statement provides justification for leaving the cash rate on hold.

The local market faces a more serious test today following Wall Street’s fall overnight. The futures are suggesting down -30 this morning, which would put the index around 5670. Last week’s North Korean scare took us down to 5650 before support was found, so this region is really the testing ground.

It will come down to whether Wall Street now goes on with it.

Much to Contemplate

It was only on Friday when Wall Street decided a weaker than expected jobs number was actually a good thing, given it made a December Fed rate rise even less likely. Last night two separate Fedheads provided dovish rhetoric, suggesting it would be best to leave rates on hold until inflation showed signs of a pick-up, and Wall Street’s reaction was to sell.

At least, that was one reason to sell, with the primary reason being escalating geopolitical tensions.

On a combination of dovish Fedspeak and a flight to safety, the US ten-yield broke down last night through its previous low for the year of 2.13%. A -9 basis point drop took the rate to 2.07%.

The US sector that initially benefitted most from the Trump rally were the banks, on the expectation of a stronger economy and higher rates. With rates now at a new low for the year, and thoughts of fiscal policy stimulus seeming distant, the banks were the hardest hit on Wall Street last night. The US yield curve continues to flatten, and a flat yield curve is the enemy of bank margins.

Speaking of matters fiscal, there is growing concern that the debt ceiling deadline may yet prove problematic, even though Wall Street has been expecting that ultimately an eleventh hour agreement would be reached. Already Trump’s Wall was a complication to passing the federal budget through Congress, and now the cost of Harvey will also be a major issue.

Then there’s DACA – Trump’s decision to withdraw the amnesty provided by the former administration to illegal immigrants who arrived with their parents as children and now have the audacity to have jobs and pay taxes, or attend university because they are among some of America’s best and brightest US taxpayers have for many years educated. It is now suggested the fallout from the DACA decision will mean tax reform will again be stalled.

So take your pick: North Korea, monetary policy, fiscal policy, a rush into bonds – all are contributing to this new bout of Wall Street angst. But how long will it last? For so long now any pullback has quickly been met with bargain hunting.

That will probably come down to Kim Jong-un.

Commodities

Gold is up another US$5.60 at US$1339.40/oz with the US dollar index down another -0.3% at 92.32.

Base metal price moves were small and mixed in London but copper is up another 0.5%.

Iron ore rose US30c to US$77.50/t.

If Harvey wasn’t bad enough, it seems he has a sister. Just as US oil refineries are starting to come back on line on the Gulf coast, Hurricane Irma is in the Caribbean and looking nasty. Irma will likely keep Gulf crude production on hold, but the question is as to whether she reaches the coast with force, where it is expected Harvey flooding could yet take weeks to subside.

For now, the oil market is responding to the restart of Gulf refineries, which has sent the gasoline price back to earth. Crude prices fell as stockpiles increased with refineries closed, so now that they’re opening again, West Texas crude jumped US$1.18 to US$48.62/bbl last night. Irma could nonetheless send the price right back down again.

On a combination of upward revisions to today’s GDP result and further weakness in the greenback, the Aussie is up 0.6% at US$0.7995.

Today

The SPI Overnight closed down -30 points or -0.5%.

The GDP data will be released this morning.

The Fed will release its Beige Book tonight.

The local market will again be impacted by ex-divs, with the likes of Insurance Group Australia ((IAG)), Medibank Private ((MPL)) and Healthscope ((HSO)) on today’s list.
 

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