MarketView for August 5

 

 

Summary  

 

Stocks closed out their worst week in more than two years on Friday in a volatile session that saw the major indexes whip back and forth before the S&P 500 ended down less than a point, while the Dow Jones industrial average chalked up again in excess of 60 points. For the week, the Dow fell 5.8 percent, the S&P 500 was down 7.2 percent and the Nasdaq was off 8.1 percent.

 

More than 15.9 billion shares -- or more than twice the daily average volume -- traded in the busiest day in more than a year as investors plowed into cash-rich mega-cap stocks that had been beaten down in recent days as the market dropped.

 

The market's swings on Friday were fast and furious, with the Dow covering 416.41 points from its session high to its intraday low as share prices see-sawed sharply, with major indexes down as much as 2 percent at times. The S&P 500 is now down 12 percent from its April 29 closing high.

 

The dollar weakened broadly as investors showed a little more appetite for risk-taking. But gold prices rose in a sign risk-aversion had far from fully dissipated.

 

The intense selling this week reflects frustration with sluggish economic growth and politicians' inability to address pressing concerns over high public debt in Europe and the United States. Markets have been looking to European officials for guidance as to how the region's debt crisis will be managed. Part of the loss of confidence stemmed from an inadequate response to the growing threat to large euro-zone economies Spain and Italy and banks' exposure to their troubled debt.

 

Italian Prime Minister Silvio Berlusconi said his country will introduce a constitutional principle of a balanced budget in an effort to reduce debt levels. The European Central Bank was ready to buy Italian and Spanish bonds if Berlusconi commits to bringing forward specific reforms. Exchange-traded funds tracking Italian and Spanish stocks rose. The iShares MSCI Italy Index jumped 5.5 percent, while the iShares MSCI Spanish Index advanced 6.5 percent.

 

Options volume hit a record; a sign investors were protecting their portfolios from further declines. The CBOE Volatility Index or VIX, Wall Street's so-called fear gauge, rose as high as 39.25 earlier, its highest level since May 2010, but ended at 32, up 1.1 percent.

 

Meanwhile, non-farm payrolls data showed a gain of 117,000 jobs in July compared with a forecast for an increase of 85,000, while the country's unemployment rate dipped to 9.1 percent last month from 9.2 percent in June, the Labor Department reported.

 

Among individual stocks, Bank of America and Citigroup continued their declines, with both stocks hitting a new 52-week low. Bank of America shares fell 7.5 percent to $8.17, off a 52-week low at $8.03, and Citigroup dropped 3.9 percent to $33.44, off a 52-week low at $31.81.

 

But a possible S&P downgrade of U.S. debt after the market close pressured stocks throughout the day.

 

U.S. Credit Rating Cut

 

The United States lost its AAA credit rating from Standard & Poor's on Friday in an unprecedented reversal of fortune for the world's largest economy. S&P cut the long-term U.S. credit rating by one notch to AA-plus on concerns about the government's budget deficits and rising debt burden. The move is likely to raise borrowing costs eventually for the American government, companies and consumers.

 

"The downgrade reflects our opinion that the fiscal consolidation plan that Congress and the Administration recently agreed to falls short of what, in our view, would be necessary to stabilize the government's medium-term debt dynamics," S&P said in a statement.

 

The decision follows a fierce political battle in Congress over cutting spending and raising taxes to reduce the government's debt burden and allow its statutory borrowing limit to be raised.

 

On August 2, President Barack Obama signed legislation designed to reduce the fiscal deficit by $2.1 trillion over 10 years. But that was well short of the $4 trillion in savings S&P had called for as a good "down payment" on fixing America's finances.

 

Treasury bonds, once undisputedly seen as the safest security in the world, are now rated lower than bonds issued by countries such as Britain, Germany, France or Canada. The outlook on the new U.S. credit rating is "negative", S&P said in a statement, a sign that another downgrade is possible in the next 12 to 18 months.

 

The impact of S&P's move was tempered by a decision from Moody's Investors Service earlier this week that confirmed, for now, the U.S. Aaa rating. Fitch Ratings said it is still reviewing the rating and will issue its opinion by the end of the month.

 

S&P's move is also likely to concern foreign creditors especially China, which holds more than $1 trillion of U.S. debt. Beijing has repeatedly urged Washington to protect its U.S. dollar investments by addressing its budget problem.

 

The downgrade could add up to 0.7 of a percentage point to U.S. Treasuries' yields over time, increasing funding costs for public debt by some $100 billion, according to SIFMA, a U.S. securities industry trade group.

 

S&P had placed the U.S. credit rating on review for a possible downgrade on July 14 on concerns that Congress was not adequately addressing the government fiscal deficit of about $1.4 trillion this year, or about 9.0 percent of gross domestic product, one of the highest since World War II.

 

The unprecedented downgrade of the nation's AAA credit rating by a major ratings agency comes only 15 months before the next presidential election where the downgrade and the debt will be top issues for debate.

 

Payroll Numbers Improve

 

Job growth accelerated more than expected in July, tamping down fears the economy was sliding into a fresh recession and easing pressure on the Federal Reserve to provide more support for the weak economy. Nonfarm payrolls increased 117,000 after slowing abruptly in the past two months, Labor Department data showed on Friday.

 

The unemployment rate dipped to 9.1 percent from June's 9.2 percent, but that was because discouraged job-seekers gave up the search for work. Still, the report was heartening after a rush of disappointing data over the past week.

 

The private sector accounted for all the jobs created in July, with business payrolls rising 154,000 from June's 80,000 increase. Government payrolls dropped 37,000, a ninth straight monthly decline.

 

While private employers showed a renewed appetite to hire last month, there are worries their enthusiasm might have been dampened by the ugly fight between Democrats and Republicans in Congress during talks to raise the country's debt limit, which came to a head in late July and early August.

 

With the exception of government, job gains were spread across the board last month. Factory payrolls rose 24,000 after climbing 11,000 in June, with most of the gains in the auto sector. Construction added 8,000 jobs after dropping 5,000.

 

The drop in government jobs was almost entirely due to a government shutdown in Minnesota. Still, about half a million government jobs have been lost over the past two years as state and local governments have tightened their belts.

 

Average hourly earnings rose 10 cents, the largest increase since November 2008 and good news for spending. Over the past year, earnings are up 2.3 percent, the biggest 12-month gain since October 2009. The tenor of the report was also helped by revisions showing 56,000 more jobs were added in May and June than first thought.

 

A separate report showed consumer credit rose $15.5 billion in June, the biggest gain since August 2007 and another hopeful sign for the economy.

 

But the jobs data showed the labor market still has a steep climb to regain health. The economy needs to create at least 150,000 jobs a month to keep the unemployment rate from rising further, and only two million of the 8.7 million jobs that were lost during the recession have been recovered.

 

President Barack Obama on Friday renewed a call for an extension of a payroll tax cut and emergency unemployment benefits to help support the economy. Republican opponents offered a prescription of budget cuts and easier regulation.

 

"There is no contradiction between us taking some steps to put people to work right now and getting our long-term fiscal house in order," Obama told veterans in Washington. "The more we grow, the easier it's doing to be to reduce our deficit."

 

The nation's borrowing limit was raised this week in a deal that relied on spending cuts, fueling concern the economy could weaken further. The spending pull-back and scheduled expiration of the payroll tax cut and emergency jobless aid could reduce gross domestic product growth by more than a percentage point next year. The fiscal tightening comes at a time when the Federal Reserve has a limited arsenal to defend the economy.

 

Fed policymakers, who meet on Tuesday, have said they want to see how the economy fares before taking any further action, and the data fit with their forecasts for a pickup in growth.

 

Goldman Sachs on Friday lowered its third-quarter GDP growth estimate to a 2.0 percent annual rate from 2.5 percent, but even that would mark a step up from a tepid second quarter. Many other analysts have trimmed forecasts this week as well.

 

Consumers Borrow More

 

Consumers borrowed more money in June than during any other month in nearly four years, relying on credit cards and loans to help get through a difficult economic stretch. According to a report on Friday by the Federal Reserve, consumers increased their borrowing by $15.5 billion in June. That's the largest one-month gain since August 2007. And it is three times the amount that consumers borrowed in May.

 

Credit card use rose by $5.2 billion -- the most for a single month since March 2008 and only the third gain since the financial crisis. A category that includes auto loans rose by $10.3 billion, the most since February.

 

Total consumer borrowing rose to a seasonally adjusted annual level of $2.45 trillion. That was 2.1 percent higher than the nearly four-year low of $2.39 trillion hit in September.

 

Borrowing is usually a sign of confidence in the economy. Consumers tend to take on more debt when they feel wealthier. But an increase in credit card debt could also signal that people are falling on harder times. At the same time, consumers have been struggling this year with high unemployment, scant raises and steep gas prices. For the first six months of the year, the economy grew at an annual rate of only 0.8 percent. That's the weakest stretch since the recession officially ended.

 

While many consumers leaned on their credit cards in June, a separate report this week showed they cut spending that month for the first time in 20 months. However, hiring has picked since then. Employers added 117,000 jobs in July, and the unemployment rate ticked down to 9.1 percent, the Labor Department said Friday. The figure was the best in three months. And the job totals for May and June were revised up.

 

Still, twice as many jobs are needed to lower the unemployment rate. The July figures are barely enough to keep up with the population growth.

 

Households began borrowing less and saving more when unemployment spiked during the Great Recession. Many have resisted pulling out their credit cards in the two years since the downturn ended.

 

It is unlikely that consumers will load up on debt the way they did during the housing boom in the middle of the last decade. During that period, Americans felt wealthier and more willing to take on increased debt because of the soaring value of their homes. The Federal Reserve's borrowing report includes auto loans, student loans and credit cards. But it excludes mortgages and loans tied to real estate.