No shock and awe, market tumbles

IN THE past week, investors had their hopes pumped up and then punctured by European Central Bank president Mario Draghi.

By InvestSMART · 4 Aug 2012

By InvestSMART ·
4 Aug 2012

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IN THE past week, investors had their hopes pumped up and then punctured by European Central Bank president Mario Draghi.

Leading up to Thursday night's ECB policy meeting, Mr Draghi had raised expectations by pledging to do "whatever it takes" to keep the eurozone from splintering. His comments inspired a rally on the Australian market, which by Tuesday had surged 3.5 per cent.

By yesterday, however, a chunk of those gains had been erased after Europe's central bankers failed to deliver the expected "shock and awe".

Instead, they chose to keep rates on hold, and Mr Draghi appeared simply to reiterate his earlier stance. Europe's market dropped 3 per cent, US stocks shed 0.7 per cent, and the Australian market followed their lead, falling 1.1 per cent yesterday.

For the week, the benchmark S&P/ASX 200 Index rose 11.8 points, or 0.3 per cent, to close at 4221.5.

What's next for Europe? Analysts say things are likely to follow a predictable course: there will be renewed action in troubled "periphery" bond markets particularly Spanish and Italian bond markets as traders test the resolve of Europe's governments and the ECB's commitment to supporting the euro. So, expect the roller-coaster to continue.

But Westpac chief currency strategist Robert Rennie believes the latest developments in Europe are better than investors realise.

In a note to clients yesterday, he said that since Mr Draghi's first meeting as the ECB president late last year, he had cut the bank's interest rate by 0.25 percentage points he had announced two 36-month, long-term refinancing operations he had cut the collateral requirements for Europe's banks and cut their reserve ratio from 2 per cent to 1 per cent he had cut the deposit rate to zero (something the US Fed has not dared do) and, on Thursday, he took some "notable steps towards proper quantitative easing", one of which opened the possibility that the ECB might relinquish its seniority status in future bond buying programs.

"Overall, there was probably enough [from the ECB meeting] to reduce the risk of a eurogeddon but not enough to satisfy buyers of risky assets," Mr Rennie wrote. "[But] with the fullness of time, markets will come to understand that there are deep and meaningful developments afoot at the ECB."

Locally for the week, Telstra was up 6? at $4.02, hitting $4 for the first time in four years, as the telco started to benefit from its recent involvement with the national broadband network, as well as mobile and broadband growth.

BHP Billiton fell 12?, to $31.30, after the $US2.84 billion write-down in the value of its US shale gas assets.

CSL dropped $1.98 to $40.28 after the head of the blood products and vaccines maker said he would leave the company next year, ending

23 years in the job.

Consolidated Media rose 5? to $3.44 after News Ltd won regulatory approval for its acquisition of ConsMedia.

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Frequently Asked Questions about this Article…

What triggered the recent market tumble after an earlier rally?

Investors rallied earlier in the week after ECB president Mario Draghi pledged to do “whatever it takes” to protect the eurozone, pushing the Australian market up about 3.5% by Tuesday. Markets then gave back gains when the European Central Bank kept rates on hold and did not deliver the expected “shock and awe.” Europe’s market fell about 3%, US stocks lost 0.7%, and the Australian market dropped about 1.1% on that reversal.

How did the ECB meeting affect Australian markets and the S&P/ASX 200 index?

The ECB decision to hold rates knocked global sentiment and saw the Australian market follow Europe and the US lower (around a 1.1% fall on the day). For the week the S&P/ASX 200 benchmark rose 11.8 points (0.3%) to close at 4,221.5.

Will volatility in Europe continue and what should investors expect from eurozone bond markets?

Analysts expect more volatility: traders are likely to test the resolve of governments and the ECB, especially in troubled “periphery” bond markets such as Spain and Italy. The article describes the outlook as a continued roller‑coaster rather than a quick, smooth resolution.

What actions has Mario Draghi and the ECB already taken, and why do they matter to investors?

According to Westpac strategist Robert Rennie, since Draghi became ECB president the bank has cut its main rate by 0.25 percentage points, announced two 36‑month long‑term refinancing operations (LTROs), eased collateral requirements for banks, cut the reserve ratio from 2% to 1%, set the deposit rate to zero, and taken steps “towards proper quantitative easing” (including opening the possibility the ECB might relinquish seniority in future bond buying programs). Rennie says these actions reduce the risk of a euro collapse but may not yet satisfy buyers of risky assets.

What did Robert Rennie mean by “steps towards proper quantitative easing,” and how should investors read that?

Rennie pointed to recent ECB measures (long‑term refinancing, lower collateral requirements, lower reserve ratios and a zero deposit rate) as notable moves toward quantitative easing. He suggested these steps reduce systemic euro risk, but markets may take time to fully appreciate them and risk appetite for risky assets may remain muted until the ECB takes further action.

Why did Telstra shares jump and what drove the stock to $4.02?

Telstra rose about 6% to $4.02 — hitting $4 for the first time in four years — as the telco started to benefit from its involvement with the national broadband network (NBN) plus growth in mobile and broadband services.

What caused BHP Billiton shares to fall sharply this week?

BHP Billiton fell about 12% to $31.30 after announcing a US$2.84 billion write‑down in the value of its US shale gas assets, which directly hit the company’s reported value.

Why did CSL and Consolidated Media shares move this week?

CSL dropped $1.98 to $40.28 after the head of the blood products and vaccines maker said he would leave the company next year, ending 23 years in the job. Consolidated Media rose about 5% to $3.44 after News Ltd won regulatory approval for its acquisition of the company.