Overnight: Equities Yield

By Greg Peel

I suggested yesterday Australian bank stocks might catch a bid on the rebound in US bank stocks overnight and indeed the financials sector rose 0.8% yesterday, although there was a little more to the story.

Bank of Queensland ((BOQ)) reported full-year earnings yesterday and while profit was lower, clearly the market had feared worse, hence a share price rise of 2.2%. This would have perhaps provided some relief for the big end of town. Magellan Financial Group ((MFG)) announced at its AGM yesterday the chairman and CEO would be swapping roles, and for some reason that was worth 7.8%.

(There was also an upgrade by Credit Suisse, see Australian Broker Call Report yesterday).

The star sector of the day was nonetheless materials (+1.0%), and in particular producers of alumina. The announced indefinite closure of a Norwegian owned smelter in Brazil, responsible for either 3% or 5% of global alumina production depending on who you ask, has sent alumina/aluminium prices soaring and the prices of Alumina Ltd ((AWC)) and South32 ((S32)) up 10.8% and 7.3%.

Dragging on the sector yesterday were the same gold stocks that surged on Wednesday thanks to a big overnight jump in the A$ gold price. Wednesday night saw the gold price give back half, so yesterday local gold stocks responded similarly. St Barbara ((SBM)) fared worst with a -3.9% fall having also provided a production update.

Energy (+1.2%) continued to enjoy rising oil prices and the talk of hundred dollar oil.

But it all could change today.

Yesterday the index opened strongly to be up 40 points by 11am, despite the futures suggesting only a 9 point open. This morning the futures are down -27 points.

Australia’s trade surplus rose to $1.6bn in August from $1.55bn in July when a fall to $1.45bn was forecast. Exports rose 15.3% in value against a mere 0.4% rise in import value. The surprise in exports did not come from the usual suspects – iron ore and coal – but from exports of rural goods (+3.3%) and services (+2.6%). The rural goods result seems a surprise given the drought, but that impact has been felt in cereals while the fall in supply of well-nourished animals has pushed up the value of meat and wool exports.

Growing Chinese demand is also a factor.

The Aussie dollar did not respond to the increased surplus yesterday as it is under the spell of rising US rates at present. Interestingly, the Aussie is down another -0.5% overnight to under 71 despite the US dollar index also being lower.  The lower Aussie is helping to underpin the local stock market but there’s only so much difference the currency can make.

Bonds Bite Back

Concern over rising US bond yields began on Wednesday night on Wall Street. The big “beat” on the private sector jobs number for August sparked equity euphoria initially – further evidence of superior economic strength –the Dow rose by 178 points, and US banks led the broader market.

But then someone pointed at the US ten-year bond yield and the mood changed. It traded up through the previous high of 3.12% to 3.16%, suggesting the long-awaited breakout had finally occurred. Good for the banks – yes – but not necessarily so good for everyone else.

The Dow closed up 50 points.

Last night that same yield rose to 3.23% and suddenly Wall Street decided to panic. All year now the question has been “What might stop Wall Street’s relentless run” and the most common answer has been “If the ten-year shoots through to 3.25-3.5%.” It would not imply the Fed has got it wrong, it would simply imply the days of cheap finance are over.

At over 3%, the yield on the “risk free” government ten-year is greater than that of the average dividend yield on the S&P500, which is typically more like 2%. A lot of the gains on Wall Street post-GFC have been supported by share buybacks financed through historically cheap borrowing. Increase the risk-free rate and latter year valuations of corporate earnings expectations are reduced, ceteris paribus, on a discounted cash flow basis. The most exposed to such valuation reductions are those stocks trading on elevated PE ratios.

See: FANG.

The Dow traded down from the open and continued to slide as bond yields rose, to be down -350 points by mid-afternoon. Only then did the ten-year yield pull back, ultimately to 3.20%, allowing stock indices to recover some ground to the close.

The US bank sector continued to rise but almost every other S&P500 sector fell except, funnily enough, utilities, but that sector had already been creamed all week on rising yields.

Energy has been a star of late but last night the EIA revealed US crude supplies surged last week. It was also revealed that Saudi Arabia and Russia had met outside OPEC and agreed to increase their production to offset lost barrels from Iran. The WTI price fell -2%.

The big loser on the day was nevertheless the Nasdaq, which is overweight high-multiple FANG and friends. It fell -1.8%. The Russell small cap fell -0.5%.

Exacerbating FANG falls was news the Chinese have been using a tiny processing chip to infiltrate close to 30 US companies, including the likes of Apple and Amazon. While this is unwelcome for those particular companies, from a broader perspective it suggests another setback in any possible trade war resolution.

So in summary, Wednesday night’s excitement turned to “lock in those profits now!” as that which Wall Street has been fearing all year is beginning to transpire. Yet the fact the major indices did manage to recover some ground before the close begs the question of just how far can US stocks fall back? The key will likely be earnings season, which begins in a couple of weeks.

Commodities

The alumina/aluminium story still has legs. Moves in other base metals were minimal.

Following a week of ups and downs, gold has found sanctuary at the familiar 1200 mark.

The oils were the biggest losers.

Despite the US dollar index falling -0.3%, the Aussie is down -0.5% at US$0.7074.

Today

The SPI Overnight closed down -27 points or -0.4%. The sector to watch today will be energy.

The consumer sectors will also be in the frame as August retail sales numbers are released.

US non-farm payrolls tonight. A hot read on wage inflation could really set off a tumble in bond and stock prices.

HT&E ((HT1)) goes ex today.

Note that summer time begins in relevant states this weekend, meaning that come Tuesday morning the NYSE will close at 7am Sydney time. The SPI Overnight will continue to close at 7am.

Rudi will connect with Your Money to appear via Skype at around 11.15am and talk share market and brokers.

The Australian share market over the past thirty days…