MarketView for August 25

 

 

Summary   

 

Share prices moved higher on Tuesday sending all three major equity indexes back into positive territory as economic data and the renomination of Federal Reserve chief Ben Bernanke reassured investors and offset concerns about red ink in the federal budget.

 

The positive news overshadowed government forecasts that the U.S. national debt will nearly double over the next 10 years due to a slow recovery from the worst recession since the 1930s, and higher spending on retirement and medical benefits.

 

The three major indexes closed at 2009 highs, although they were off the year's intraday highs reached after the stronger-than-expected economic data. However, in a repeat of Monday's action, the momentum of the day fell off somewhat during afternoon trading.

 

The broad S&P 500 index briefly hit a 10-month intraday high. It remains on track for its sixth straight monthly gain.

 

The Conference Board's August index of consumer confidence well exceed Street expectations, while the S&P/Case-Shiller home price index rose for a second consecutive month in June, suggesting a recovery in two sectors crucial to a rebound in U.S. economy.

 

The consumer data and earnings news helped drive retail stocks higher. Chico's FAS, which reported solid results, gained 7.6 percent to $12.79, and close-out retailer Big-Lots rose 6.5 percent to $25.60. Macy's was up 3.5 percent at $15.85.

 

Home builders' shares were higher, with Lennar up 2.8 percent at $14.97 and KB Home chalking up a gain of 3.3 percent at $18.08. Pulte Homes, the country’s largest builder, rose 3.5 percent to $13.06.

 

Investors welcomed President Barack Obama's decision to keep Bernanke as Fed chairman.

A decline in the price of oil weighed on energy shares.

 

On the downside, energy shares dragged on the market with the domestic front-month crude future’s price retreating 3 percent, or $2.32, to settle at $72.05 per barrel after a recent rally.

Exxon Mobil helped limit the Dow's gains, falling 0.9 percent to $70.68, while Murphy Oil was down 2.6 percent to close at $59.11.

 

Economic Data Points Toward Recovery

 

Larger-than-expected gains in housing prices and consumer confidence added to the hypothesis that the economy is emerging from the longest recession since the 1930s. Specifically, single-family home prices rose for the second month in a row in June and consumer confidence jumped in August.

 

In addition, President Barack Obama nominated Ben Bernanke to a second term as chairman of the Federal Reserve, removing some niggling doubt from investors' minds. The move promised a consistent approach to monetary policy in the years ahead.

 

The day’s developments helped buffer the blow of projections for the U.S. budget deficit to reach its highest level in 2009, relative to the total economy, since World War Two.

 

The Conference Board, an industry group, said consumer confidence climbed to a reading of 54.1 in August from 47.4 in July, handily beating forecasts, on an improved outlook for the job market and the overall economy. The rise sent the index to its highest level since May.

 

The weak labor market remains a sticking point to recovery, and especially a revival in consumer spending. Even the Fed has conceded the likelihood of a "jobless recovery," with the unemployment rate staying high long after growth resumes.

 

Americans saying that jobs were "hard to get" in August dropped to 45.1 percent from 48.5 percent but only 4.2 percent said jobs were plentiful.

 

Other data supporting recovery hopes came from the Standard & Poor's/Case-Shiller housing price index. The housing market is considered a critical component to an economic recovery. Prices of single family homes rose by 1.4 percent in June from May, after moving up by 0.5 percent in April, suggesting that the housing slump is easing.

 

The Case-Shiller 10- and 20-city indexes are down by 54.3 percent and 45.3 percent, respectively, from their 2006 peaks. June's improvement was broad based, with 18 of 20 metropolitan areas logging gains for the month.

 

Separately, the Federal Housing Finance Authority reported that home prices rose by 0.5 percent in June, according to its seasonally-adjusted monthly index, while prices fell by 0.7 percent in the second quarter.

 

The nonpartisan Congressional Budget Office (CBO) on Tuesday gave updated projections on the likely U.S. budget deficit in fiscal 2009 and beyond. The CBO forecast a fiscal 2009 deficit at $1.59 trillion, or 11.2 percent of projected gross domestic product, falling to $1.4 trillion or 9.6 percent of GDP in 2010. It gave a 10-year deficit forecast of $7.14 trillion against $9.1 trillion.

 

Separately, the White House raised its forecast for the budget deficit between 2010 and 2019 to a total of about $9 trillion.

 

A Good Day for Freddie and Fannie

 

Shares of government-controlled mortgage lenders Fannie Mae and Freddie Mac rose sharply for the second straight day on Tuesday after attracting the attention of day-traders looking to turn a quick profit with these low-priced household names.

 

Fannie Mae was up as much as 24 percent to $2.12 while Freddie Mac gained about 14 percent to a high of $2.34 in morning trading. Although both were essentially nationalized by Uncle Sam to prevent them from going under last fall, Fannie Mae shares have more than doubled since starting the year at 76 cents. Freddie Mac shares have almost tripled in value from 73 cents.

 

The U.S. government seized Fannie and Freddie last September after they reported huge losses caused by plummeting U.S. house prices. For better or for worse, then, some see the mortgage lenders following the rebound of the banking sector.

 

Options markets were also very active Tuesday. During the first 45 minutes of trade, about 61,000 call options changed hands in Fannie, more than three times its average daily volume and nearly five times the number of puts. Heavy call demand shows that investors expect Fannie and Freddie stock to rise.

 

Fed Continuity Continues

 

President Barack Obama nominated Ben Bernanke to a second term as Federal Reserve chairman on Tuesday, aiming for continuity at a time when the economy is just beginning to exit from the worst recession since World War II.

 

The decision, while widely expected, was welcomed by financial markets around the globe because it removed uncertainty at a delicate juncture in the economy's recovery. Obama interrupted his vacation on the Massachusetts island of Martha's Vineyard to make the brief announcement with Bernanke at his side.

 

"Ben approached a financial system on the verge of collapse with calm and wisdom; with bold action and outside-the-box thinking that has helped put the brakes on our economic freefall," Obama said.

 

Bernanke's four-year term expires in January and the president had not been expected to make an announcement until later this year.

 

With growing signs the U.S. economy is slowly recovering, thanks in large part to Bernanke's efforts, the Fed chairman should have little difficulty winning confirmation from the Senate again.

 

Obama decided to nominate Bernanke a month ago, after consulting Treasury Secretary Timothy Geithner and White House chief of staff Rahm Emanuel. Lawrence Summers, Obama's top White House economic adviser and a former U.S. Treasury secretary who had been mentioned as a possible candidate for the top job at the Fed, also recommended Bernanke's nomination. Apparently, Bernanke was told in the Oval Office last Wednesday.

 

Obama is counting on Bernanke to nurse the economy back to health at a time when unemployment, home foreclosures and bank failures are still mounting. The Fed chairman has pushed U.S. interest rates to near zero and flooded financial markets with hundreds of billions of dollars to stem a credit crisis and turn back recession.

 

Bernanke, widely respected as a top scholar on the Great Depression, now faces the challenge of pulling back the Fed's extraordinary support for the economy without setting back hopes for a recovery.

 

"We have been bold or deliberate as circumstances demanded, but our objective remains constant: to restore a more stable economic and financial environment in which opportunity can again flourish, and in which Americans' hard work and creativity can receive their proper rewards," Bernanke said.

 

Democrats control the Senate, but Bernanke, a Republican, has faced criticism from lawmakers in both parties who say he has gone too far in extending Fed support that will be difficult to unwind, threatening future inflation.

 

Senate Banking Committee Chairman Christopher Dodd vowed a "thorough and comprehensive" hearing to consider Bernanke's nomination. But he appeared to endorse a second term for the Fed chairman, saying he was "probably the right choice." Senate Majority Leader Harry Reid said Bernanke's renomination sent the right signal to financial markets and he expected the Senate to reconfirm him.

 

Mitch McConnell, the Republican leader in the Senate, said the confirmation hearings would be an opportunity to question Bernanke about the cumulative impact of the administration's trillions of dollars in new spending and borrowing.

 

Crude Futures Fall Sharply

 

The price of September crude futures for domestic sweet crude fell 3 percent on Tuesday on profit-taking from a rally that had culminated in a 10-month peak earlier in the day. Sweet crude settled down $2.32 per barrel at $72.05, down from a high of $75, in the largest percentage loss since August 14. Brent crude settled down $2.44 at $71.82.

 

Oil prices were up early in the trading day after economic reports showed increased consumer confidence and higher home prices in the world's largest energy consumer that added to a string of encouraging economic indicators.

 

There was additional support from the announcement that Ben Bernanke had been renominated as chairman of the Federal Reserve. Oil extended losses slightly after settlement in the wake of a report from the American Petroleum Institute showing a surprise 4.3-million-barrel build in U.S. crude stocks last week. The U.S. Energy Information Administration will release its report on nationwide petroleum stockpiles on Wednesday.

 

National Debt Remains Major Challenge But Numbers Vary

 

The national debt will nearly double over the next 10 years, government forecasts showed on Tuesday, challenging President Obama's economic and healthcare agendas. The White House midsession budget forecast and the non-partisan Congressional Budget Office both forecast that government revenues will be crimped by a slow recovery from the worst recession since the 1930s Great Depression, while spending on retirement and medical benefits soars.

 

The White House projected a cumulative $9 trillion deficit between 2010 and 2019, while the CBO pegged the total at $7.1 trillion because it assumed higher revenues as tax cuts expire. The spending for stimulus programs to get the country rolling again could push the national debt, now more than $11 trillion, to close to $20 trillion. The debt is the total sum the government owes, while the deficit is the yearly gap between revenues and spending.

 

However, both the White House and CBO anticipate that the deficit, now at its highest level as a percent of economic output since World War Two, will decline relatively swiftly in the next three years as growth resumes and federal bailout programs shrink.

 

White House budget director Peter Orszag said the deficit was too high and cited this as a reason to pass Obama's healthcare overhaul plan. "I know that there will be some who say this report proves that we cannot afford health reform. I think that has it backward," Orszag told reporters on a conference call.

 

The country's fiscal condition is a legacy from former Republican President George W. Bush, who cut taxes while pursuing wars in Iraq and Afghanistan. Nonetheless, spending on retirement and health benefits must be put under control as millions of Baby Boomers retire.

 

The White House forecasts a record $1.58 trillion deficit in fiscal 2009, matching the numbers of the CBO, while it shows the deficit at $1.5 trillion in 2010, a touch higher than the $1.48 trillion projected by CBO.

 

The estimates for the current fiscal year were reduced from earlier forecasts because of lower anticipated spending on financial bailout programs as markets have stabilized. The White House has withdrawn a $250 billion "placeholder" budget request, while the CBO estimates that actual TARP outlays this year will be $203 billion less than anticipated.

 

However, both estimates show annual deficits staying above $500 billion every year until 2019, compared with a then-record $459 billion last year. The White House shows the gap averaging 5.1 percent of gross domestic product per year through 2019, compared with 3.2 percent last year.

 

By 2019 the ratio of national debt to gross domestic product will rise to 69 percent from 48 percent in 2009 the White House said, closely tracking CBO's estimates.

 

The CBO and OMB typically end up with different numbers because of differing accounting methods and variations in key assumptions. The CBO employs a baseline method that only takes into account policies that have already become law.

 

The administration's forecasts can reflect the economic impact of policies it hopes to implement, even if they have not yet been approved by lawmakers. For example, the CBO assumes the there would be no "patch" for the Alternative Minimum Tax, meaning millions more Americans would have to pay higher taxes even though Congress has agreed to a temporary reprieve every year to prevent this happening. CBO also assumes Bush's tax cuts will expire at the end of 2010.

 

Had the White House used the CBO's methods it would have arrived at a much lower 10-year deficit figure of $6.3 trillion, the congressional budget experts said. Conversely, a CBO estimate built on the White House's methods would likely reach a higher figure than the administration's $9 trillion.

 

Orszag said that the White House numbers also assumed that some of the Bush tax cuts would be extended. Obama has pledged not to raise taxes on U.S. households earning less than $250,000 a year.