MarketView for August 31

 

 

Summary   

 

Stock prices fell off the wagon on Monday, the result of concerns regarding the health of the global economy that came on the heels of a sell-off in Chinese equities. Energy shares led the decline after the sharp drop in China's main stock index increased worries over a potential rebound in global energy demand as oil fell below $70 a barrel. Among energy stocks, shares of Chevron closed down 1.2 percent to $69.81 and Exxon Mobil closed down 0.8 percent at $69.56.

 

The Shanghai Composite index .SSEC fell nearly 7 percent to a three-month low on fears that China's government is trying to moderate economic growth and choke off some speculation in its stock market by tightening bank lending. Stocks in China have risen steadily, up 91 percent for the year at one point, despite the global recession. Commodity prices often got a boost from an increased demand from China.

 

Financial stocks, which had enjoyed a strong rally last week, changed their course on Monday after a number of bearish notes from analysts. In addition, Barron's recommended profit-taking in Citigroup and said the shares of AIG were overpriced after gaining more than 50 percent last week. Citi closed down 3.8 percent at $5.03, while AIG dropped 10.7 percent to $44.88.

 

The weakness in energy and financial stocks overshadowed the news of two large mergers on Monday. Walt Disney agreed to buy Marvel Entertainment for $4 billion, while Baker Hughes said it would buy BJ Services for $5.5 billion. Marvel shares closed up 25.4 percent to $48.46, while BJ Services' stock was up 4.6 percent at $16.15.

 

Also on Monday, the Institute for Supply Management-Chicago's business barometer rose to 50.0 in August. The level was higher than expected, and was on the dividing line between growth and contraction in the sector.

 

Despite the day's lackluster performance, the Dow ended August up 3.5 percent, while the S&P 500 advanced 3.4 percent and Nasdaq gained 1.5 percent.

 

Trading is expected to be light this week but there are still several important reports on the economy that could sway the market one way or the other. For example, the most closely watched data will come from the government's monthly jobs report on Friday. Last month's report showed an unexpected dip in the unemployment rate and Wall Street is anxious to see whether the rate continues to fall. If fewer jobs are being lost, consumers might start to feel comfortable spending again and help get the economy back on its feet.

 

As is always the case, the Street is concerned about the month of September. Traditionally, September is the worst month of the year for stocks. Since 1929 the S&P 500 index has lost an average 1.3 percent for the month. Yet, in the 14 Septembers that followed the end of down markets, the index has gained about 2 percent.

 

Nonetheless, it was about a year ago that the market slide turned into a plunge with the mid-September collapse of Lehman Brothers that combined with the freeze in credit markets had everyone realizing just how serious this recession was.

 

Economy Is Picking Up

 

A number of reports released on Monday indicated that business activity accelerated during the month of August, thereby indicating that the economy is beginning to expand. For example, one report pointed out that a year-long decline in economic activity in the Midwest ended in August as new orders and production rose sharply, potentially a harbinger for the national economy.

 

The Institute for Supply Management (ISM) Chicago business barometer came in with a reading of 50.0 for August, the dividing line between growth and contraction, from 43.4 in July. Wall Street economists had expected a rise to only 48.0.

 

It is likely that part of the increase in new orders id directly attributable to the government's "cash for clunkers" program, which resulted in a number of auto plants having to increase output in order to meet the sudden demand for new vehicles to replace gas-guzzlers. The auto sector plays a larger role in the Chicago region economy than it does nationally, although the Chicago area index, which covers both the service and manufacturing sectors, is often viewed as a bellwether of national trends.

 

A similar index covering the heavily industrialized Milwaukee region rose to 56 in August from 45 in July, while the Dallas Federal Reserve Bank said factory activity in Texas declined at a slower pace. Meanwhile, business activity in New York City, which tends to be driven by trends in the financial sector, expanded in August for the first time in three months, thanks to increased purchases and a slowdown in layoffs.

 

The National Association of Purchasing Management-New York's index of business conditions rose to 55.3 in August from 48.3 in July. Improvements in purchasing volume and employment conditions signaled the worst of the city's downturn might be ending, the group said.

 

The regional surveys showed employment remained soft despite the brighter outlook, consistent with concerns over a lack of new jobs being created. The ISM-Chicago's employment index contracted for a 21st consecutive month. Increased hiring is seen as critical to getting a consumer-led recovery under way. The U.S. unemployment rate was 9.4 percent in July. Economists expect a report on Friday to show it rose to 9.5 percent in August.

 

Still, the Conference Board said online job vacancies advertised in August rose by 169,000, or 5 percent, offering a glimmer of hope for job seekers. "The August increase is good news, showing what we hope will be a continued improvement in job demand this fall," said Gad Levanon, senior economist at the industry group.

 

However, New York Federal Reserve Bank President William Dudley told CNBC television that it was too early to talk about curtailing the Fed's long-term security purchases while the economic recovery is still so fragile. "I think it's a little premature ... the economy still isn't growing very fast and we do have a very high unemployment rate," he said.

 

Fed Not Ready To Cut Back Yet

 

New York Federal Reserve Bank President William Dudley said it is too early to talk about curtailing the central bank's long-term security purchases while the U.S. economic recovery is fragile.

 

"As financial conditions improve, which seems to be the trajectory, it's a legitimate point to consider what you want to do in terms of your purchase programs," Dudley told CNBC in an interview broadcast on Monday.

 

"My own personal view is I think it's a little premature to be so confident that you want to pull all these things back right now because the economy still isn't growing very fast and we do have a very high unemployment rate."

 

Dudley's comments show a divergence of views on the Fed's interest-rate setting Federal Open Market Committee. Richmond Fed Bank President Jeffrey Lacker said last week the Fed should consider curtailing its purchases of $1.45 trillion of mortgage agency debt by the end of the year. Buying the full amount might provide more of an economic boost than would be necessary in a recovering economy, he said.

 

Dudley declined to be pinned down on whether he will oppose cutting the purchases short. But he said he would be reluctant to surprise markets, which expect the Fed to follow through with its buying pledge.

 

"Market expectations are very, very important, and the market expects us to complete these programs, to do the full amount," Dudley told CNBC television. "To contradict that market expectation, I think, is a pretty high hurdle."

 

The Fed cut rates to zero in December and has pumped hundreds of billions into the financial system to combat the worst recession in 70 years. With signs of recovery in housing and manufacturing, the Fed has said the downturn appears to be leveling out. However, it said any recovery is likely to be sluggish with unemployment, which was at 9.4 percent in July, painfully high for a while.

 

Dudley said he is confident the U.S. central bank can withdraw its massive economic stimulus measures without allowing inflation to take hold.

 

"I'm completely committed to taking away the punch bowl at the right time," he said. "I have no desire whatsoever to see inflation get out of control."

 

The Fed has a range of options to prevent inflation even with the massive amount of money it has put into the financial system, Dudley said. "We have tools to manage our balance sheet so that we're not going to have an inflation outcome, bad inflation outcome," he said.

 

The Fed's next policy-setting meeting is September 22-23. It has pledged to keep interest rates exceptionally low for an extended period to bolster the economy, but has already begun to taken some small steps toward exiting its aggressive stimulus measures.

 

The Fed said it would end its program of buying $300 billion of longer-term Treasury securities by the end of October. It also said it would shrink the size of short-term cash auctions in September.

 

At the same time, sensitive to pockets of economic weakness, the Fed moved to boost credit to the ailing market for commercial real estate by extending an emergency lending program to mid-2010.

 

Crude Down 3.8 Percent

 

The price of crude oil fell 3.8 percent to below $70 a barrel on Monday, primarily over concerns that any reduction in Chinese bank lending would reduce the pace of economic recovery and have an adverse effect on any potential rebound in global energy demand.

 

Domestic sweet crude futures for October delivery settled down $2.78 per barrel at $69.96, after having fallen as low as $69.13 in intraday trading. In London, Brent crude settled down $3.14 per barrel at $69.65.

 

China's key stock index fell 6.74 percent on Monday to a three-month low over concerns that China's government is trying to moderate economic growth and choke off some speculation in its stock market by tightening bank lending. Concerns over the Chinese economy, the world's second largest oil consumer, weighed on other Asian stock markets as well.

 

OPEC meets to review output on September 9 in Vienna. Several ministers and officials from the group have said it is likely to leave output targets unchanged. Even though OPEC agreed to 4.2 million barrels per day of supply curbs late last year, and has kept output targets steady so far in 2009, actual production has been rising in recent months, according to industry surveys.

 

In a further sign of that trend, Abu Dhabi, the main producer in the United Arab Emirates, an OPEC member, will lift supply to Asia in October, the state oil firm said on Saturday. Despite the indications of higher supply from some in OPEC, oil has rallied from a low of $32.40 in December, the weakest price in nearly five years, to a 2009 high of $75 a barrel last week.

 

Double Dip Recession Unlikely

 

A weekly measure of future U.S. economic growth slipped in the latest week, though its yearly growth rate surged to a 38-year high that suggests chances of a double-dip recession are slim.

The Economic Cycle Research Institute, a New York-based independent forecasting group, said its Weekly Leading Index for the week to August 21 fell to 124.4 from a downwardly revised 124.9 the prior week, which was originally reported at 125.0.

 

However, the index's annualized growth rate soared to a 38-year high of 19.6 percent from a downwardly revised 17.4 percent the prior week, a number which was originally 17.5 percent. It was the WLI's highest yearly growth rate reading since the week to May 28, 1971, when it stood at 20.5 percent.

 

"With WLI growth continuing to surge through late summer, a double dip back into recession in the fourth quarter is simply out of the question," said ECRI Managing Director Lakshman Achuthan, reinstating the group's recent warning to ignore negative analyst projections. He added that the index was pulled down this week due to higher interest rates.

 

Achuthan has recently projected that the recovery is moving at a stronger pace than any the United States has seen since the early 1980s

 

Disney Acquiring Marvel

 

Walt Disney is acquiring Marvel Entertainment for $4 billion in a deal that would add characters like Iron Man, Spider-Man and the Fantastic Four to its entertainment empire.

 

Disney is striking the biggest media deal of the year so far, one that will unite the Incredible Hulk and Mickey Mouse, at a time when the media business is struggling on all fronts. Marvel has a stable of wildly popular characters that it has brought to the big screen in home-run films like "Iron Man."

 

A sequel, "Iron Man 2" is due to hit the theaters next year, while "Thor," "Spider-Man 4" and the first "Avengers" movie are slated for a 2011 release. For Disney, the acquisition addresses a key investor concern of how it plans to increase its coverage of the young male marketplace.

 

Marvel’s audience is surprisingly broad. It transcends gender and age and has real potential worldwide. However, it does skew a bit towards boys than many of Disney’s current characters and movies. Disney has long been a blockbuster brand with girls thanks to characters like "Hannah Montana," "Cinderella" and "Snow White," but has struggled to achieve the same kind of success with boys.

 

Disney has agreed to pay $50 per share in cash and stock for Marvel, a premium of 29 percent to Marvel's closing stock price of $38.65 on Friday. The deal has been approved by the boards of both companies. Marvel shareholders would receive a total of $30 per share in cash plus approximately 0.745 Disney shares for each Marvel share they own.

 

The deal is expected to close by year-end, and is expected to add to Disney earnings in two years.