MarketView for August 27

 

 

Summary   

 

Share prices were a bit higher again on Thursday as an early sell-off lost steam, thanks to a rebound in oil prices, and a rally subsequently ensued. As a result, the Dow Jones industrial average posted its eighth consecutive gain, led by Boeing. The aircraft manufacturer ended the day up 8.4 percent to close at $51.82 after stating that its long-delayed 787 Dreamliner would make its first flight by the end of the year.

 

The October future for crude oil settled up $1.06 er barrel at $72.49, after falling as low as $69.83 earlier in the day. ConocoPhillips saw its share price end the day up 0.3 percent to close at $45.73.

 

Once again, trading was dominated by a handful of troubled financial companies. The shares of American International Group were up nearly 27 percent to $47.84 after the new chief executive, Robert Benmosche, indicated that he was not in favor of holding a fire sale of the company’s assets.

 

AIG's stock price has rallied since the beginning of August, initially spurred by the insurance giant posting its first profit in seven quarters. There is also word on the Street that those who shorted the stock are now feeling the classic short squeeze, thereby contributing to a demand for shares as the short sellers try to cover their positions. According to data from the New York Stock Exchange, short interest in AIG fell 2 percent in the first half of August, compared with the end of July. About 18 percent of the stock is held short.

 

Citigroup was up 9.1 percent on the day to close at $5.05 on a report that hedge-fund manager John Paulson is buying the troubled bank's shares.

 

Dell was one of the Nasdaq's top performers, closing up 6.7 percent at $15.65 after reporting better-than-expected earnings and sales just before the market closed.

 

Crude Down on Rising Stock Piles

 

Crude oil futures were settled lower on Thursday, extending hefty losses from the previous session as rising stockpiles of crude oil outweighed the day’s positive economic data. Domestic sweet for October delivery settled down 62 cents per barrel at $71.43. Brent settled down 17 cents per barrel at to $71.65. A key reason was that the Energy Information Administration (EIA) reported on Wednesday that domestic crude stocks were up by 200,000 barrels last week due to a rebound in imports.

 

The increase in stockpiles defied expectations on the Street that we would see a 1.1-million-barrel drop. The result was a reigniting of worries that we will continue to see a soft recessionary resultant demand for crude oil.

 

Oil traders have been taking the opportunity to lock-in profits after crude touched the psychologically important $75 mark this week, resulting in what amounted to an almost 130 percent price increase from the lows at the start of the year.

 

Venezuela's oil minister Rafael Ramirez said OPEC is unlikely to raise output at its September meeting, despite concerns from some quarters that oil prices are too high for a still fragile global economy. OPEC member Nigeria said later in the day it would not push for any change in output at the meeting, scheduled for September 9 in Vienna.

 

Economic News Better Than Expected

 

The economy shrank at a less than expected rate in the second quarter, despite a record drop in inventories. Gross domestic product fell at a 1.0 percent annual rate, unchanged from an estimate last month, the Commerce Department said on Thursday. Economists had expected a steeper 1.5 percent drop after a 6.4 percent collapse in the first quarter.

 

The GDP report showed businesses were more aggressive in reducing inventories than previously thought. Business inventories dropped a record $159.2 billion in the second quarter, instead of the $141.1 billion estimated last month. Stripping out inventories, GDP rose 0.4 percent -- the first gain since the second quarter of 2008.

 

The GDP report showed after-tax corporate profits rose 2.9 percent in the second quarter, reflecting aggressive cost cutting by businesses, after gaining 1.3 percent in the first three months of the year.

 

The sharp drawdown in inventories in the face of weak demand has likely run its course, and the lean level of stocks would provide a springboard for an economic recovery many believe is already under way. The blow from the sharp inventory decline was softened by a smaller-than-initially estimated drop in consumer spending, which accounts for about 70 percent of U.S. economic activity. Consumer spending fell at a 1.0 percent rate in the second quarter. A month ago the department estimated a somewhat steeper decline of 1.2 percent.

 

Wage and salary disbursements fell $235.7 billion in the first quarter, $31.1 billion more than previously thought. Drops in exports and homebuilding that were not as steep as previously estimated also helped minimize the decline in GDP.

 

 Meanwhile, fewer workers filed new claims for jobless benefits last week, a sign the economy was starting to heal. A report by the Labor Department indicated that the number of workers filing new claims for jobless benefits fell by 10,000 to 570,000 last week, suggesting some easing in the pace of layoffs.

 

With unemployment high and rising, there are fears weak consumer spending will restrain the recovery's momentum. Yet, the economy appears to be emerging from its longest and deepest recession since the Great Depression. Richmond Federal Reserve Bank President Jeffrey Lacker on Thursday said "the economy appears to have leveled out and ... we can look forward to better times ahead.

 

The number of workers still on the jobless benefits rolls after claiming an initial week of aid fell to 6.13 million in the week ended August 15, down from 6.25 million the prior week.. It was the lowest level of so-called continued claims since the week ending April 4.

 

Goldman Unmoved but You Should Be

 

Recent reports that Goldman Sachs Group gives special trading advice and early access to analyst research to a select few clients, saying the practice is commonplace in the industry, has brought a ho-hum attitude from many investors. It would appear that the knowledge of Wall Street not being a level playing field is so well known that no one appears to be paying much attention to the fact, much less getting excited.

 

The latest revelation came from the Wall Street Journal, which reported on Monday that Goldman hosts a weekly meeting of its research analysts, joined by top clients, to discuss trading ideas. The story raised the issue of favoritism for top Goldman clients, prompting the Financial Industry Regulatory Authority and the Securities and Exchange Commission to commence investigations, the paper said Tuesday.

 

FINRA, the securities industry's regulatory arm, said it was looking into the situation. The SEC has declined to comment.

 

To say that Goldman Sachs is not alone among brokerage firms in favoring their largest and most productive clients with trading tips does not make it right or acceptable. Furthermore, Goldman risks alienating some of its smaller trading clients who do not enjoy access to these so-called trading "huddles."

 

You often hear the comment that sharing tips exclusively with your best customers may not be a "best practice," but it is unlikely to be illegal. Furthermore, is not new that analysts share their thoughts on investments with the firm's most profitable accounts before broadly disseminating the information.

 

Goldman, Wall Street's largest and most profitable bank, has come under scrutiny in recent years. It has been facing a public backlash over its outsized bonus pool and its billions in profit so soon after it repaid $10 billion received last fall from the Treasury's Troubled Asset Relief Program.

 

John Paulson Buying Citigroup

 

Hedge fund manager John Paulson, who bet against financial companies after foreseeing the credit crisis, has been buying Citigroup Inc shares over the past few weeks, the New York Post reported, citing sources.

 

Paulson bought around a 2 percent stake in Citigroup, a source told the paper. An investor with a 5 percent or higher stake in a company would have to make a disclosure with the U.S. Securities and Exchange Commission.

 

Sources told the paper Paulson believes Citigroup's assets are undervalued. A spokesman for Paulson declined to comment to the paper on the hedge-fund manager's investment activities.

 

Paulson's investment moves are monitored by investors after he predicted the implosion of mortgage markets in 2007 and the collapse of banks and other financial companies in 2008.

 

Additional Shifts at Ford

 

Ford said on Thursday it is adding shifts at its truck plants in Michigan and Missouri in response to increased demand for its F-150 pickup trucks and Escape SUVs. Ford's Dearborn, Michigan, truck plant will return to a three-shift operation in September from two shifts, a move that will boost production of F-150 pickup trucks by about 10,000 this year, the company said.

 

Ford is also adding a third shift at its Kansas City assembly plant in Missouri in October, which will increase production of Ford Escape and Mercury Mariner SUVs by 2,400 by the end of October.

 

The actions are part of the automaker's plans announced earlier this month to raise production for the third and fourth quarters after strong sales spurred by the government's "Cash-for-Clunkers" incentives.

 

Ford has set third-quarter North American production at 495,000 vehicles, an addition of 10,000 from prior plans. It plans to produce 570,000 vehicles in the fourth quarter, up 33 percent from a year earlier.

 

The Escape SUV and the Focus sedan were among the top 10 vehicles sold under the "Clunkers" program, while the small Ford Focus sedan ranked third. Ken Czubay, Ford vice president of marketing and sales, said the company's August sales are forecast to top its July results -- which represented its best sales month of 2009.

 

U.S. auto sales rose to their highest level of 2009 in July and analysts have forecast stronger sales for August as consumers rushed to take advantage of the "Clunkers" rebates, which offered up to $4,500 to people who traded in old gas guzzlers for new vehicles.

 

Ratings Companies Diverge Dramatically

 

Major credit rating companies hold diverging views on the state of the junk bond market in 2010. Current forecasts for high-yield bonds show a wide gap between bearish calls from Standard & Poor's, which forecasts a 13.9 percent default rate, and Moody's, which has scaled back its default rate forecast to 3.8 percent by the middle of next year. In recent reports, S&P said it expects the U.S. speculative-grade default rate could even reach as high as 18 percent if economic conditions are worse than expected.

 

Moody's, Standard & Poor's and Fitch have been the targets of intense criticism over the past two years for their role in rating highly complex mortgage bonds and other securities as AAA that later turned out to be junk or worse, thereby contributing to the freeze up of the credit markets.

 

Their views on the high-yield bond market could be a new test. That market is viewed as a key indicator for the health of credit markets, for corporations' access to capital and a harbinger of stability for global credit.

 

However, Standard & Poor’s is negative on more than just junk bonds. S&P Chief Economist David Wyss expects the S&P 500 index to fall by 14 percent by the end of the year.

 

At Moody's, Chief Economist John Lonski commented recently on the positive impact on the economy of the pickup in bond issuance. The company's Moody's Economy.com unit has issued reports forecasting positive GDP in the current quarter and noted signs of recovery in housing, retailing and manufacturing.

 

Moody's said in an August report that the global default rate has increased in every month since December 2007, when it bottomed at 1 percent. The current default rate is now higher than the peak of 10.4 percent reached in 2001, but below the 12.2 percent peak reached in 1991.

 

Looking ahead, Moody's predicts that the global default rate will peak at 12.2 percent in the fourth quarter before declining sharply to 4.4 percent by July 2010. Moody's added that the default rate will not peak in Europe until 2010, when it reaches 12 percent in the first quarter.

 

Fitch Ratings has not published its forecast for next year, but said the high yield default rate may end this year between 15 and 18 percent.