MarketView for August 2

Summary  

The S&P 500 turned negative for the year on Tuesday as the Congressional debacle over the debt ceiling concluded and Wall Street turned its attention to the economy. The broad-based index fell for a seventh day and crashed through its key 200-day moving average in an ominous sign for markets.

The seven days of losses mark the longest losing streak since October 2008. The selloff accelerated into the close as volume jumped well above average. The index also broke through its 2-1/2 year uptrend line from its bear market low in March 2009. Thursday was its worst day in a year. At the same time, the Dow Jones industrial average chalked up its eighth down day, although it remained in positive territory for the year.

Industrial and consumer discretionary shares, which are sensitive to signs of weakness in the economy, were among hardest hit. Wall Street's losses followed sharp falls in world equity markets as global manufacturing data this week indicated big industrial economies were on the verge of stalling.

Volume on the major exchanges had approximately 9.7 billion shares changing hands, a number that was well above this year's daily average of around 7.5 billion.

The major banks were also hit hard. Citigroup fell 3.7 percent to $37.04, while Bank of America fell 3.3 percent to $9.49. Gold stocks were a bright spot. The precious metal surged over 2 percent to an all-time high as many scrambled for a safe haven from sliding stock markets.

European debt problems returned to the forefront after French bank BNP Paribas took a $768.3 million write-down linked to Greece's debt woes.

Pfizer reported a second-quarter profit that exceeded expectations by a penny and affirmed its full-year profit view. Nonetheless, Pfizer ended the day down 4.6 percent to $18.14.

Consumer Spending Falls

Consumer spending declined during the month of June for the first time in nearly two years, while incomes were virtually unchanged, a strong indicator that the economy lacked momentum as the second quarter drew to a close.

A report released by the Commerce Department on Tuesday indicated that consumer spending fell 0.2 percent, the first decline since September 2009, after edging up 0.1 percent in May. Adjusted for inflation, spending was flat after a 0.1 percent decline. Incomes rose just 0.1 percent.

The data, which was incorporated in a report on U.S. economic growth on Friday that showed the economy expanded at less than a 1 percent annual rate over the first half of the year, was the latest to underscore the recovery's frail state. At the same time, a report released on Monday indicated that manufacturing activity hit a two-year low in July, which in turn had many prognosticators reducing their growth expectations for the second half of the year. For the third-quarter, the consensus seems to be a growth rate of about 2.5 percent. That is a serious move from the previous estimate of about 3 percent.

Consumer spending is being held back by a 9.2 percent unemployment rate, and the labor market's health could determine how fast the economy recovers its footing. Employment grew by just 18,000 positions in June and a report on Friday is expected to show only a further 85,000 were added in July.

The spending cuts could prove a headwind for the economy. JPMorgan warned that taking into account expiring stimulus, including a payroll tax cut and emergency unemployment benefits, the total fiscal drag could amount to 1.75 percentage points.

The dour data in the last few days have spurred talk the economy could tumble into a fresh recession. However, there were some relatively optimistic economic signs on Tuesday. Motor vehicle sales rose to a 12.2 million annual rate in July from 11.4 million the prior month. Borrowing by small U.S. businesses jumped in June to the highest level in more than three years and a gauge within the spending report showed inflation subsiding.

The so-called PCE price index, which the Fed monitors closely, fell 0.2 percent, its first drop since June. The primary core index, which excludes food and energy costs, rose only 0.1 percent.

Is it Time for the Fed to Act

Pressure is likely building among Federal Reserve policymakers to act in a way that helps to stimulate the economy and could come to a head at the upcoming Fed meeting next week. Yet, the Fed is not expected to announce any new measures at its meeting on Tuesday.

However, behind closed doors, the Fed could be setting the stage for further action, most likely some form of communication that would bolster a promise of low interest rates as far as the eye can see.

Rather than launch a third round of quantitative easing, the Fed is more likely to eventually cement its low-rate vow, perhaps by committing to keep its balance sheet bloated for an extended period or by weighting its securities holdings to longer maturities. Keep in mind that Fed Chairman Ben Bernanke listed communications as first among possible tools in his most recent appearance before Congress.

The Fed completed a second installment of bond buying, or quantitative easing, worth $600 billion on June 30 and policymakers have said they want to see how the economy evolves before taking any further action. However, a series of weak economic data has thrown cold water on hopes for a big pickup in growth in the second half of the year and put analysts on watch for signs that could indicate another recession is brewing.

The Fed revised down its growth forecasts in each of its last two quarterly projections, but even so they look on the high side given the recent run of data, and it is likely to register its disappointment in its post-meeting statement.

While Bernanke is a champion of Fed openness, he may be happy to have three more weeks before he speaks publicly. Some see his scheduled August 26 speech at the annual Fed conference at Jackson Hole, Wyoming, as an ideal setting to flesh out details of the bank's thinking.

After additional information about consumer and business spending and sentiment, as well as inflation, the Fed may be in a better position to signal whether it is ready to take fresh steps to spur growth. He used a speech at Jackson Hole last year to pave the way for the Fed's second round of large-scale bond buying, dubbed QE2, to revitalize the flagging recovery.

For the first time since March, officials will not update their forecasts this week or hold a news conference to put meat on the bones of their terse post-meeting statement.

Within the Fed, officials who skew toward concerns about unemployment believe that if overnight interest rates were at 3 percent, the central bank would not hesitate to deliver a big rate cut. Those officials are likely to advocate additional Fed support for a recovery at some risk of stalling. At the same time, others have been confident the recovery will accelerate and believe policy is loose enough.

Bernanke made clear in recent appearances that despite high unemployment the Fed isn't ready to ease policy, in large part because inflation has climbed quickly this year, and a number of other officials have said the bar to further action is high.

For the Fed to hit its latest forecast of 2.7 to 2.9 percent growth for the year, the economy would have to expand at an average 3.3 percent annual rate over the last two quarters, but the current growth for the second half of the year is in the range of 2 to 2.5 percent.