MarketView for April 2

 

 

Summary 

 

Although the day’s trading volume was relatively light, nonetheless the Street started off the second quarter with a strong rally on Monday as the S&P 500 index hit a new four-year high. For the S&P 500, Monday marked its highest close since mid-May 2008. The Dow Jones industrial average scored its highest close since December 31, 2007, while the Nasdaq once again finished at levels not seen since late 2000. Driving the momentum was the latest manufacturing data both domestically and from China.

 

The Institute for Supply Management (ISM) index of manufacturing activity rose to 53.4, a number that exceeded the Street’s forecasts. At the same time, China's Purchasing Manager index reached an 11-month high.

 

The data helped lift energy and basic materials stocks as crude oil and commodity prices climbed. Chevron rose 1 percent to $108.30, while Alcoa led the Dow higher chalking up a 1.5 percent gain to close at $10.17.

 

Coty offered to buy Avon Products for $23.25 a share, a 20 percent premium over Friday's closing price. Avon ended the day up 17.3 percent to close at $22.70. Apple helped lift the Nasdaq, rising 3.2 percent to $618.63, while Home Depot limited the Dow's advance by falling 0.6 percent to $49.99.

 

A report in Europe showed the region's manufacturing sector shrank for an eighth straight month in March, highlighting the difficulties in getting the euro zone's economy on track.

 

Equity markets will be closed for the Good Friday holiday, which could create lighter volume and increase volatility this week. Despite the holiday, the government will release the March payrolls report on Friday. With that in mind, investors could be hesitant to make big bets ahead of the data. Approximately 6.46 billion shares changed hands on the three major equity exchanges, well below last year's daily average of 7.84 billion shares.

 

Manufacturing Rises as Construction Spending Declines

 

The pace of growth in manufacturing increased last month, even as measures of new orders and exports eased, underscoring how the economy is recovering at a gradual clip. 

 

The Institute for Supply Management (ISM) said its index of national factory activity rose to 53.4 from 52.4 in February, topping economists' expectations of 53.0. The ISM report showed prices paid eased to 61.0 from 61.5 after a jump the month before. Higher oil and gasoline prices have caused worries businesses and consumers could start to feel squeezed.

 

It was a rebound for the manufacturing sector after the pace of growth unexpectedly slowed in February despite signs of increased hiring. Even so, the forward-looking gauge of new orders was modestly weaker in March, easing to 54.5 from 54.9. A measure of exports also fell to 54.0 from 59.5, a potential sign of the impact of a weaker Europe.

 

The ISM index has been stuck in a tight range in the low 50s since last summer, pointing to steady, though slow, growth for the sector. In contrast, the euro zone's manufacturing sector contracted for an eighth straight month in March, with the downturn spreading to the core economies of Germany and France. Factory activity in China strengthened but was far from robust.

 

The employment index rose to its highest level in nine months at 56.1 from 53.2. The Labor Department issues a comprehensive look at the job market in its March nonfarm payrolls report on Friday, which is expected to show manufacturers added 20,000 jobs last month.

 

Construction Eases

 

Construction spending suffered its biggest drop in seven months in February, prompting some economists to lower their sights for first-quarter growth. Data from the Commerce Department indicated that construction spending fell 1.1 percent to an annual rate of $808.86 billion, the lowest level since October as investment in private and government projects fell.

 

The second straight month of declines in construction outlays could prompt the Street to lower their growth estimates for the first quarter, which were raised on Friday following better-than-expected consumer spending data for February. Overall construction spending was up 5.8 percent compared to February 2011.

 

Private construction spending fell 0.8 percent, declining for a second straight month. Spending on residential projects was flat. Investment in multifamily residential projects rose 2 percent, while single family outlays fell 1.5 percent. Private nonresidential construction fell 1.6 percent, also dropping for a second month in a row.

 

Spending on public sector construction declined 1.7 percent in February as weak outlays on state and local government projects offset a 1.9 percent rise in investment by the federal government. Meanwhile, spending in January was revised to show a much bigger 0.8 percent fall instead of the previously reported decline of just 0.1 percent.

 

Some on the Fed Opposed to Further Easing

 

Two Federal Reserve policymakers on Monday signaled little appetite for further monetary steps to stimulate U.S. growth in an economy that is gradually strengthening.

 

"It's not overwhelmingly robust," Dallas Federal Reserve President Richard Fisher said in an interview. "It's positive; it's moving in the right direction, it is gaining momentum." Fisher said the Fed should not act too hastily to reverse its ultra-loose monetary policy stance, rather it should wait for more conclusive evidence that the recovery will endure. "I think it's a little bit premature to talk about tightening here," he said.

 

Meanwhile, St. Louis Fed President James Bullard was quoted as saying that, "Typical estimates suggest inflation should have remained low or even moved lower during 2011," in a speech in Beijing. One explanation may be that the global gap between actual growth and employment and full economic potential -- which is narrower than that of the United States, and may even be positive -- is affecting prices, he said.

 

Global factors could be keeping U.S. inflation at higher levels than would normally correspond with the sluggish pace of U.S. recovery, pointing to his reluctance to support any further easing.

 

"The weighted average of the output gaps for advanced economies and emerging economies may be positive," Bullard said. "This may suggest upward, not downward pressure on U.S. inflation."

 

On Tuesday the Fed will release the minutes from its March meeting, which should cast some further insight into how actively the Fed is considering any further easing. The central bank meets next on April 24-25.

 

Fisher made it clear he is opposed to more steps, unless the economy unexpectedly faltered, and said the timing of any rate rise will depend on how the economy develops.

 

"The question is ... will we go from job creation to growth in final demand. I think we are proceeding along that path, but I think we have a ways to go," said Fisher, who currently does not vote on policy.

 

In contrast to the cautionary note by Bullard on the price outlook, Fisher said there was no sign of "dramatic inflationary pressures despite the gas pump" because higher gasoline prices have been partly offset by lower prices for other items.

 

But Bullard raised questions about using the domestic output gap to argue that inflationary pressures are absent domestically. In a globalized economy, policymakers need to consider global output, where there appears to be more constraints on capacity, he said.

 

In response to questions, Fisher made it clear he felt the Fed has taken all the steps it should to stimulate the economy.

 

"You know where I come down, I think we have done enough," he said. "There is so much liquidity in the system, why would we add more, unless we had a crisis on our hands or something that is happening where we are seeing significant slippage in the economy?"

 

The best course for central bank policymakers is to be patient and monitor the strength of the recovery, Fisher said. "I think we should sit, wait, watch and look, if the economy continues to improve, see how we will exit," he said.

 

Fisher said the Fed was not going to let inflation get out of control and said investors need to realize they can't count on an endless supply of monetary easing.

 

"A lot of investors ... have counted on us to provide the tailwind rather than just doing the hard work that one needs to do in order to ascertain underlying valuation," he said.

 

"I think the easy part for those that just rode on the jet stream of Federal Reserve accommodation is over. ... They should now go to work and do their analysis," Fisher added.

 

Avon Rejects Takeover Offer

 

Coty disclosed on Monday that it had offered $10 billion for Avon Products but that Avon, which is grappling with sliding sales and a bribery probe, rejected the bid as too low and "opportunistic".

 

Combining Coty, maker of Stetson aftershave and Beyoncé fragrances, with Avon, the world's largest direct seller of cosmetics, would give Coty less reliance on fragrances and a bigger share of growing overseas markets.

 

Avon, known for its iconic "Ding Dong, Avon Calling" commercials of the 1950s and 1960s, said in its most recent annual report, released in February, that developing markets accounted for more than two-thirds of its sales.

 

Coty said in a statement on Monday that it made its offer public after unsuccessfully trying to engage Avon in merger talks. It said it had no intention of making a hostile bid.

Coty said it was willing to raise its bid, provided it was given access to Avon's financial records to decide whether a higher offer was warranted.

 

Less than an hour after Coty went public with its unsolicited bid, Avon issued a statement saying the $23.25 per share offer "substantially undervalues" the company. It is a 20 percent premium over Friday's closing price of $19.36 and a dollar higher than a previous offer.

 

Investors and analysts predicted that Coty would raise its price, following the classic playbook in deal making. Avon, which is searching for a replacement for Jung, said a new CEO would create "greater opportunity" to increase its value.

 

Avon said in December that Jung, who has been CEO since 1999, would step down. Jung will stay on as executive chairman after her successor takes the helm.

 

The company has had declining sales in markets like the United States, Brazil and Russia. Its famous army of "Avon ladies" sales representatives is shrinking because of uncompetitive commissions and stiff competition.

 

Avon has also been bedeviled by heavy competition from drugstores in the United States, aggressive pricing by rivals in Eastern Europe and inadequate ordering systems that have frustrated representatives in Brazil, its biggest market.

 

Coty, a fast-growing privately held company, is confident it can line up the necessary financing to pull off the acquisition of a company with sales nearly three times greater than its own and retain its investment grade debt rating.

 

Late on Monday, Standard and Poor's Ratings Service said that it had put Avon's ratings, including its 'BBB' corporate credit rating and 'A-2' short-term rating, on CreditWatch with negative implications. S&P said one of the reasons for its action was that it believed if a deal was reached, it would include "meaningful additional debt".

 

As of Friday, Avon was worth about $8.3 billion, down from an all-time peak of $21.8 billion in June 2004.

 

Fragrances accounted for 57 percent of Coty's $4.1 billion in sales in its year ended June 2011. The bulk of its sales come from Europe and North America, and it has largely missed out on China's ravenous demand for Western brands. Still, overall revenue was up 17 percent last fiscal year.

 

In addition to expanding its cosmetics market, Coty said Avon's direct sales model would help Coty's beauty brands.

 

Coty has grown substantially through deals aimed at diversification. In 2010, it acquired Philosophy, a maker of personal-care products, from buyout firm Carlyle Group for $1 billion. It also bought a majority stake in Chinese skin-care company TJoy Holdings, with its distribution network and infrastructure that would help Coty's other products in that market.

 

Avon's sales have plummeted in the last few years in China, where it got a direct selling license in 2006. Avon has also been conducting an internal probe into whether it broke the Foreign Corrupt Practices Act to get that license. The U.S. government announced its own investigation last year.