Stock Market Snaps Winning Streak

By: PaddyPowerTrader

Former Deutsche bank star banking analyst Simon Mayo (now with French house Calyon) put a dampener on financials yesterday by voicing his concerns that Geithner's new plan may not offer as much hooray as the markets think. The extension of the deadline for participation in the securities side of the Geithner Plan has spooked some investors. There are also fears that private sector interest in the plan is proving less than the market originally expected, and that the extra two weeks and looser selection criteria are a desperate effort to throw the net wider. But that said, equities still managed to jog to the finish well off their worst levels.

We have seen positive sentiment return to the equity markets since early March, with the S&P 500 (up 24%), Dax (up 20%) and FTSE 100 (up 15%) all reporting strong gains. Much of this recovery has been focused upon selected cyclical sectors, including banks, autos, building materials and non-food retailers.

Today's Market Moving Stories

• The RBA (Aussie central bank) surprised the markets with a 0.25% rate cut overnight taking rates to a 49 year low of 3% after the economy had contracted in Q4 by 0.5%. The board judged there was scope for a further modest adjustment in the cash rate.
• ECB council member from Austria Nowotny stated that the ECB will cut to 1% but draw a line in the sand at that.
• There was mixed news on the state of the UK economy overnight, with an improvement in the services component of the BCC survey offset by a further deterioration on the manufacturing front and strident calls for Government assistance from the auto sector. The BCC also predicted that unemployment could rise as high as 3.2m in 2010, a forecast underlined by a survey for Asda which found that fully 50% of workers fear losing their jobs over the next six months.
• Copper has continued its blistering run into Q2. Cancelled warrants, which are an indication that material will be removed from LME warehouses, have leapt from 25 to 50k and now account for over 10% of total LME stocks. The recent sharp increase in cancelled warrants was largely in Europe, with reports of containers heading to the Far East. This suggests that Chinese demand remains strong.
• Irish banking stocks are getting some sponsorship this morning ahead of this afternoon's austerity budget. The Government is set to announce the launch of a new state agency that will buy billions of euros worth of properties and development land at sharply reduced prices. The asset management company will eventually purchase between €60 and €80 billion worth of property assets and will be run by the NTMA, with finer details to emerge later this week on the proposed plan. Ministers are supporting the agency due to the belief that the banks cannot be “brought back to life” until €56 billion in developer loans are moved off the books. The knock down prices at which these assets will be taken into the agency will dictate any potential additional capital requirements due for the Irish banks, and therefore any further dilutionary effects.
• The IMF is set to revise its forecast of global toxic debt writedowns from $2.2tn to as much as $4tn . It seem that Dr Doom was an optimist as the IMF are now warning of $4trillion of losses from toxic banks “assets”. I recall how people scoffed when Goldman Sachs put a $500bn handle on the problem in the autumn of 2007.
• These estimates keep on rising because the depression is now affecting the prices of some of the more liquid assets, and turning them toxic. Deutsche Bank says US junk bond default rate is to rise to 53% . If true, this forecast would have very serious implications for the financial sector, and could easily prolong our crisis significantly. The default rate level in the Great Depression was “only” 45%. The forecast assumes a recovery rate of zero. Naked Capitalism makes the point that the latter was a pessimistic assumption, but the prevalence of so-called cov-light loans means that recovery is going to be more difficult .
• Billionaire investor George Soros offered a weak prognosis for the space when he called the banking system “basically insolvent”.
• And the Lara Croft of Banking analysts, Meredith Whitney opines that housing prices have another 30% to fall !
• Writing in Vox, Barry Eichengreen and Kevin O'Rourke take a look at industrial production , world trade and stocks markets and find that this recession , from a global perspective, is much worse than the Great Depression, at least so far. Most of the comparisons are US-centric only, and this suggests a milder development today (because the US is not as badly hit as other countries now, and it was worse hit than most countries then).
• Tate & Lyle last night lost a patent infringement case over its sucralose product at the International Trade Commission. The decision, which is binding and final, allows four Chinese manufacturers of sucralose to import into the US. Over time this is likely to have a significantly detrimental impact upon margins for a business which made nearly a quarter of Tate's profits last year.
• US earnings season kicks off in earnest today with Alcoa who are expected to report a first-quarter loss of 58 cents a share. Also today we get Bed Bath and Beyond ($0.44) and Mosaic ($0.25). Both actual earnings and guidance for 2009 are likely to provide a stern test of the markets recent strength.
• It seems that the best way to rob a bank these days is to own one . A fascinating interview.
• Artists give their take on the Great Recession .

Imminent Rights Issues?
The current improved sentiment has opened a window of opportunity for selected “stressed” companies, enabling them to consider undertaking rights issues to repair balance sheets hit by deteriorating earnings. This opportunity had appeared remote only a few weeks ago. Assuming the rally holds for the next few weeks, the market now expects several companies to take advantage of this opportunity to tap equity investors and, whilst this will not solve their structural challenges, it will address their immediate liquidity issues over the next 12-18 months.

There is a strong chance that DSG/Dixons may consider a rights issue . Weak sales are causing falling earnings, which in turn is pressurising the covenants in DSG's bank facility. A rights issue of several hundred million pounds could be dressed up to fund CEO John Browett's turnaround strategy, albeit it would also have the benefit of giving the Company more headroom from its covenants. DSG released a statement indicating that it reviews its capital structure regularly, but no final decision had been taken.

ITV is another candidate for a rights issue as they are under significant earnings pressure due to the impact of the downturn upon its (cyclical) advertising revenues as well as the growth of multi-channel TV. A rights issue of several hundred million pounds would give ITV breathing space to alleviate medium term liquidity concerns as well as the ability to play a lead role in the restructuring of UK free to air broadcasting.

Other names being talked about in a similar vein includes Valeo, GKN, Renault, Tate and Lyle and Rentokil, although in these cases, any rights issue may put renewed pressure on the share price.

Is Gold Losing Its Shine?
When gold first rose above $1000 in March 2008, gold bugs speculated that prices would soon move considerably higher. Forecasts of a return to the inflation -adjusted highs above $2000 seen in the 1980s were (and still are) commonplace. Gold prices have already been driven to record highs over the past twelve months as a safe haven from the global financial crisis. This support may well persist for longer than generally anticipated, but the scope for further gains is now limited.

Gold is now also being touted as a hedge against the risk of runaway inflation , especially following the widespread adoption of quantitative easing (QE). But the chances of an inflation crisis are low. In the current environment, with massive spare capacity throughout the global economy, soaring unemployment and a dysfunctional banking system, it would be very hard for central banks to generate runaway inflation even if they wanted to.

What's more, if QE does succeed in reviving the financial system and rescuing the financial system, even at the cost of somewhat higher inflation , any remaining safe haven support for gold prices would surely evaporate. Other assets which would then be more obviously cheaper (such as equities and corporate bonds) will look much more attractive.

And Finally… America Land Of Opportunity

Disclosures = None

By The Mole
PaddyPowerTrader.com

The Mole is a man in the know. I don’t trade for a living, but instead work for a well-known Irish institution, heading a desk that regularly trades over €100 million a day. I aim to provide top quality, up-to-date and relevant market news and data, so that traders can make more informed decisions”.

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