MarketView for August 11

 

 

Summary  

 

Stock prices were somewhat lower on Tuesday, sending all three major equity indexes into negative territory, after a prominent banking analyst warned the sector's fundamentals have yet to improve, and an unexpectedly large drop in wholesale inventories raised worries about an economic recovery. In addition, a report late Monday from the Congressional Oversight Panel, highlighted the risks of toxic assets still on the books of many banks. The Congressional Oversight Panel, a watchdog for the government's bailout program, said toxic loans and securities continue to pose a threat to the financial system, particularly for smaller banks that face mounting losses on commercial real estate loans.

 

Investors were also cautious as a two-day monetary policy meeting by the Federal Reserve got under way on Tuesday. The focus will be on signs from the Fed of an exit strategy from its quantitative easing policy. Also weighing was a report on July retail sales, due Thursday.

 

The drop in U.S. wholesale inventories in June, which was nearly double expectations, suggests that businesses remained skeptical about a return in demand. However, a clearer picture might prevail as earnings reports are due this week from retailers Wal-Mart, J.C. Penney and Macy's. Those reports may provide some insight on whether consumer spending, which accounts for roughly two-thirds of the economy, is stabilizing.

 

Another worrying sign of a still-weak economy came from hedge fund firm Atticus Capital LLC, which told investors that it is closing two of its three funds and would return $3 billion to shareholders.

 

The negative news overshadowed better-than-expected data on U.S. non-farm productivity in the second quarter, which showed worker productivity rose at its fastest pace in six years as hours worked fell much more steeply than output.

 

We May Need To Do More Says Panel

 

The U.S. Treasury Department should consider expanding programs to cleanse troubled assets from bank balance sheets if current efforts fail to restart markets or if economic conditions worsen, the Congressional Oversight Panel reported on Tuesday. In its latest monthly report, the panel said that toxic loans and securities continue to pose a threat to the financial system, particularly for smaller banks that face mounting losses on commercial real estate loans.

 

These banks may need similar stress tests and capital support afforded to larger institutions, the panel added. It also advocated that stress tests for the largest 19 institutions be repeated if the economy worsens beyond the worst-case assumptions used in initial tests conducted in April.

 

Despite improved financial market conditions, the panel said a "continuing uncertainty is whether the troubled assets that remain on bank balance sheets can again become the trigger for instability."

 

In its report, the panel said the Treasury needs to either assure that a robust program is available for handling toxic assets as they go into default or else consider a different strategy for restarting markets for the assets. The critical report comes as the Treasury prepares to launch a significantly scaled-down version of its toxic asset program, a series of public-private investment funds to purchase toxic mortgage securities with $30 billion in government subsidies.

 

Last October, the entire $700 billion U.S. bailout program was aimed at buying up the toxic assets that threatened to bring down the financial system. But due to the plan's complexity and with market confidence rapidly deteriorating, then-Treasury Secretary Henry Paulson quickly shifted gears to use the money for direct capital injections into banks.

 

Since then, Paulson's successor, Timothy Geithner, announced plans to entice private investors to buy "legacy" securities and whole loans from banks. But accounting forbearance that allowed banks to avoid recognizing losses on these assets combined with large institutions' ability to raise capital after regulator "stress tests" in May reduced investor angst over toxic assets.

 

The Congressional Oversight Panel said, however, that smaller U.S. banks faced billions of dollars in losses from delinquent commercial property loans and were far less able to raise capital and absorb losses than their larger counterparts.

 

An analysis done by the panel showed that under a scenario 20 percent worse than assumptions used in the Federal Reserve's stress tests, about 719 banks with assets between $600 million and $100 billion would need to raise some $21 billion in new capital to offset loan losses.

 

"Treasury must be prepared to turn its attention to small banks in crafting solutions to the growing problem of troubled whole loans," the panel said, adding that it should consider using similar stress tests -- along with pledges for additional capital -- on smaller institutions. It said triggers for further supportive actions could come if unemployment remains high and residential foreclosures continued to mount.

 

Productivity Rises Sharply

 

According to a report by Labor Department released on Tuesday, non-farm productivity in the second quarter rose at its fastest pace in six years as companies slashed costs to protect profits, government data showed on Tuesday. The Labor Department said non-farm productivity rose at a 6.4 percent annual rate, the biggest gain since the third quarter of 2003, from a revised 0.3 percent gain in the first quarter. Productivity for the January-March quarter was previously reported as a 1.6 percent gain.

 

At the same time, hours worked plunged at a 7.6 percent rate in the second quarter, the Labor Department said. Unit labor costs, a gauge of inflation and profit pressures closely watched by the Federal Reserve, fell 5.8 percent, the biggest decline since the second quarter of 2000 and were down by a revised 2.7 percent in the January-March quarter.

 

The government also published revisions to productivity for 2006 through 2008 following adjustments to gross domestic product estimates. Compensation per hour rose at a 0.2 percent pace and, adjusted for inflation, was down 1.1 percent, while output fell at a 1.7 percent rate in the second quarter.

 

Compared with the April-June quarter of 2008, non-farm productivity was up 1.8 percent. Unit labor costs fell 0.6 percent year-on-year. Compensation from a year earlier rose 1.3 percent and was up 2.2 percent once adjusted for inflation. Output, measured on a year-on-year basis, was down 5.6 percent.

 

Job Growth Could Remain Weak

 

A gauge of the U.S. job market remained unchanged in July for the third straight month, indicating that employment will remain weak throughout the coming year, a research group said on Monday. The Conference Board, a private research group, said its Employment Trends Index was steady at 88.3 in July, the same level it read for the gauge's May and June revised figures.

The index is now down 20.1 percent from a year ago, according to the group.

 

"This suggests that we are getting closer to the point when employers are no longer cutting their workforce," said Gad Levanon, senior economist at The Conference Board. "However, since we are expecting a weak economic recovery, and given the record number of involuntary part-time workers, many of whom are likely to move to full-time positions before new employees are hired, we do not expect significant job growth over the next year."

 

Wholesale Inventories Continue to Fall

 

The Commerce Department reported on Tuesday that wholesale inventories fell 1.7 percent in June, the tenth consecutive decline sending inventory levels to their lowest point in more than two years. Meanwhile, May's decline was revised to 1.2 percent from the originally reported 0.8 percent.

 

Businesses have been trimming inventories during the recession, with the result that in June, wholesalers' stocks stood at $393.93 billion, the lowest level since $393.49 billion in January 2007.

 

Sales rose 0.4 percent, the second straight increase, which pushed the inventory-to-sales ratio down to 1.26 months' worth from May's 1.28 months'. It was the lowest ratio since October's 1.21 months'. However, sales were down 21 percent from a year earlier, the Commerce Department reported, while inventories were off 10.3 percent.

 

Durable goods, which make up nearly two-thirds of wholesale inventories, were down 1.5 percent in June, while their sales were up 0.7 percent. Stocks of autos and parts fell 1.2 percent, while their sales rose 4.5 percent.

 

Crude Falls Due To Economic Concerns

 

Oil prices fell on Tuesday as doubts resurfaced over the pace of economic recovery after data showed another drop in U.S. wholesale business inventories and the U.S. government revised lower its forecast for global oil demand.

 

The U.S. Commerce Department reported that U.S. wholesale inventories plummeted 1.7 percent in June, and investors worried that businesses were running as lean as possible because of doubts about an economic recovery.

 

The decline, nearly double analyst expectations and the 10th straight monthly drop, pushed inventories to their lowest level in more than two years and weighed on U.S. equity markets.

 

Sweet domestic crude futures for September delivery settled down $1.15 per barrel at $69.45. In London, Brent crude settled down $1.04 per barrel at $72.46.

Optimism that a turnaround in the economy could bolster weak energy demand has helped oil prices recover in the months since crude dropped below $33 a barrel in December.

 

The Energy Information Administration cut its 2009 oil demand forecast, predicting consumption would fall by 1.71 million barrels per day this year, compared with previous estimates of a 1.56-million bpd drop.

 

OPEC forecast that the slow recovery in global consumption and rival oil supplies will shrink demand for its crude next year. In light of weakening fundamentals, the sustainability of current prices will mainly depend on clearer signs of improvement in the global economy," OPEC economists said in a report.

 

Oil prices rose earlier on news that crude imports by China, the No. 2 consumer, had surged by 42 percent in July to a record 4.62 million bpd.

 

Traders were also awaiting weekly American Petroleum Institute inventory data late on Tuesday, followed by weekly U.S. government data on Wednesday. The expectation is that the data will show a 700,000-barrel build in crude oil inventories in the week to August 7, with gasoline inventories down 1.3 million barrels and distillate stocks off by 200,000 barrels.

 

“We Are Getting Back To Normal,” Says Summers

 

White House economic adviser Larry Summers said on Tuesday the foundations for a return to growth had been laid and there were many signs economic life was getting back to normal. Speaking to a conference on social security at the national Press Club, Summers cited large and small signs the financial crisis was easing, even if it will take some time to be able to firmly declare it over.

 

"In more obvious indicators like the stock market, less obvious indicators like credit spreads, the spread between LIBOR and federal funds, forward markets and what they suggest about housing prices...what one sees is a substantial return to normality," Summers said.

 

Summers' address echoed remarks he made last month at the Peterson Institute when he defended the effectiveness of the Obama administration's $787-billion economic stimulus program. As he did then, Summers said the economy was back from the brink of what some feared was potential depression when the Obama administration took office in January. "It is reasonable to say that we are in a very different place," he said.

 

However, he also he said the severity of the crisis that struck the financial system, and hurt the entire economy, was so great that recovery was likely to be slow. "We have a long way to go," Summers said. "The problems were not created in a week or a month or a year and they will not be resolved in a week or a month or a year."

 

He said that now that economic freefall has been contained, it was time to think about the type of recovery that will most benefit the country. Recent expansions were fueled largely by "asset bubbles that drove consumption" in the high-tech industry in the late 1990s and in housing in the early 2000s.

 

Summers suggested past bubble-driven expansions "coincided with important lags in crucial systems within the economy" like improving healthcare and boosting funding for education and energy development. Such lags produced inequality that made downturns more damaging, he said.