(WEDNESDAY 26TH OCTOBER - JAMES GERRISH - 7.25am)...The DOW JONES lost -207pts overnight while the S&P 500 fell -2%. European mkts were all lower (FTSE down +0.41%, German DAX closed, French CAC off -1.43%) while locally, the SPI FUTURES mkt is pricing a lower open down -37pts when trading kicks off here this morning.
Yesterday, the S&P/ASX 200 lost -27pts or 0.64% to close at 4227
DOW JONES - Some weakness in the States overnight due to a number of factors. 1. Concern that any major plan coming out of Europe tonight might not eventuate given European Finance Ministers cancelled a meeting overnight and there were comments suggesting that there was still 'a lot of work to be done'. 2. A number of companies that reported overnight missed expectations including UPS and Amazon. 3. Economic data was weak overnight with Consumer Confidence printing well below even the most bearish of expectations.
Technically, we want to see the DOW do some work around this 11600/700 region so it sets up a solid base in what could prove to be a new trading range.
S&P/ASX 200 - A pretty lackluster day yesterday with the mkt floundering around resistance. Our main focus here is seeing a breakout from that down trending resistance line obvious in the chart.
CONSUMER CONFIDENCE - a woeful print overnight in the States showing that consumers are still a tentative bunch and this is largely based on continued softness in the housing mkt. This is understandable when a families largest asset has fallen so much and although there are signs of bottoming, there certainly hasn't been any type of upside momentum. Until we see this trend, consumers are likely to remain subdued in the US.
We have previously discussed the role of Consumer Confidence data as a contrarian indicator of the stock mkt - kind of a graphical representation of the Buffet philosophy of buying when others are fearful etc. So the fact its still printing low levels isn't really a massive concern and as data from Goldman Sachs has shown, more often than not, its a strong pre-cursor to an equity mkt rally.
Can we make sense of whats happening in Europe & what it will mean from a mkts perspective?
We wrote about our view yesterday as being...
At the height of bearishness, it seemed investors were focused on 1. US Recession. 2. Hard landing in China (commodities bubble burst). 3. European Armageddon. We think the US recession is a myth, we think the landing in China will be soft rather than hard and we have no idea what the outcome will be in Europe (but are hopeful).
So to answer the question posed above, our base case is that no one really knows what the outcome will be, not even the 17 EU leaders that are going to nut it out tonight so that obviously ads some risk over the next couple of trading days. Coppo (recent entrant into the Stockbroking Hall of Fame) in the Goldmans afternoon report yesterday put some relevant thoughts around this question which, in the absence of a crystal ball is probably as sensible answer as well get.
- So the reasoning goes that we have rallied +10% thus we should look to sell some stocks here as (1) mkt resistance is at 4300 & (2) the rally is +10% in a short period of time & (3) everyone has been buying into the Euro Conference and if it disappoints then they'll all sell it all the way back down.
- The mkts have rallied hard in the last 2 weeks, no doubt about it, but the US and Aust were down about -20% just a few weeks ago from where they were 4 months ago on worries about GFC2 about to begin. -
The mkts were worried about Armageddon if the Europeans did not address their issues. But the packages coming - even if they are not the 'silver bullet' all would like - they only have to convince mkts that a financial meltdown of Europe is not imminent = if they at least do that the downside is limited & may provide a spring board for a totally unexpected rally.
- Also the rally in the last 2 weeks has come via the course of least resistance, in that it has rallied on very light volumes. Normally you;d say that is bad but in this case most have held back waiting for Euro clarity & if it comes you could see real volume get behind a decent end of year rally. Thus the theory that everyone has been positioning themselves for a positive European situation is false.
Source: Goldman Sachs Afternoon Market Report - Tuesday, October 25, 2011 - Richard Coppleson
INFLATION..and interest rates
One of the biggest data prints we've had all year is the Consumer Price Index (CPI) that is due out this morning at 11.30am. This will pretty much determine whether we get a rate cut on Melbourne Cup day or they hold off til December (or beyond).
The mkt is expecting +0.6% for the headline and core figure and if annualized, that's 2.4% - well and truly at the mid point in the RBA target range of 2-3%. If we print at this level, I'd be backing a cut in November but there would be skeptics so the mkt may not have much of a reaction. Anything lower than 0.6% adds weight to a cut while I think if we print 0.7% or higher, we won't see a cut until December at the earliest.
So from a mkts point of view, we want to see a print 0.6% or lower (but not too low) which brings into play a cut which is going to be supportive of equities.
GOLD
Finally some love came back into the gold pits overnight with the metal being bid strongly. We retain the view that the longer term structural reasons for Gold at higher prices haven't changed (debasement of currencies, inflation etc etc) and that the recent weakness has come on profit taking rather than anything else. From a technical standpoint, clearly the strong trend hasn't yet faltered.
IRON ORE PRICES
The Iron Ore price has come under significant pressure recently and was down sharply again overnight - trading at $138.50 a tonne. The monthly chart below doesn't show the most recent data but it does show where the price has come from. A significant fall and shows why we should be cautious of holding pure play iron ore stocks.
Here is what we wrote about Iron Ore stocks and FMG in particular back on the 3rd October....worth a revisit.
Fortesque Metals (FMG) reported strong production figures on Friday and are on track to ship 55 million tonnes of Iron Ore this year. They have plans to increase this to 155 mtpa by 2014 en route to 350 mtpa.
The Iron Ore price currently sits around $160 a tonne while FMG is getting the Ore out of the ground and shipping it for about $50 a tonne. To put this into context, it mines about 100,000 tonnes a day worth about $20 million. A cash cow you'd call it and if Iron Ore prices stay at these levels, FMG at $4.42 looks massively cheap.
But what if Iron Ore doesn't stay at these levels? FMG is only exposed to the one commodity and has one export destination (at this stage). It has about $4 billion in debt and the expansion plans will dramatically increase this amount.
If China does slow to 5% growth, demand for Iron Ore will fall at a time when production has been ramped up aggressively. FMG is not alone with its expansion plans, RIO TINTO is even keener to grow earnings from Iron Ore while BHP is also in the mix.
I want to make it abundantly clear, that I am a believer in the growth story in China and other emerging nations. I personally think that Iron Ore prices will stay at elevated levels for some time (al- be- it probably lower than where they are today), and that Australian resource stocks will prove to be a good investment over time.
My main point here though is that its essential to understand to possible risks of an investment. I would be reluctant to put a clients retirement next egg in a company with such reliance on a signal commodity and growth story, that is going to dramatically increase its debt position.
If China slows, Europe's debt issues escalate and debt markets seize, FMG is not a company I'd like to own. Food for thought!
MODEL PORTFOLIO UPDATES
No changes
Telstra Corp (TLS)
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Telstra Corporation Provides Annual Debt Issuance Program Prospectus 25-Oct-11 09:27
Telstra Corporation provided its Annual Debt Issuance Program Prospectus which was lodged with the United Kingdom Listing Authority on 24 October 2011. The Prospectus includes a full year and operations review - June 2011; a Directors' report; and a financial report.
AUSTRALIAN STOCK PRICES OVERNIGHT
In New York, News Corp fell by US$0.52 to US$17.15, equivalent to A$16.45, A$0.26 below its last close on the ASX.
ResMed fell by US$4.33 to US$27.37, equivalent to A$2.63, A$0.02 above its last close on the ASX.
In London, Rio Tinto fell 71.0 pence to £33.03, A$1.09 lower in Australian currency terms.
BHP-Billiton fell 35.5 pence to £19.61, A$0.54 lower in Australian currency terms.
Henderson Group Plc was unchanged at £1.22.
