MarketView for August 16

 

 

Summary  

 

After three days of gains It was a bit of a down day on Tuesday as  Wall Street retrenched after a meeting between the heads of France and Germany failed to quell fears about the euro zone’s ability to contain the region's sovereign debt woes. Efforts to stem the spreading European debt crisis have been ineffective, a major reason for the equity market's declines in recent weeks. Stocks were unable to rally on Tuesday despite another round of solid earnings and a decision by Fitch Ratings' to keep the AAA credit rating for the United States.

 

German Chancellor Angela Merkel and French President Nicolas Sarkozy detailed plans for closer euro zone integration but they did not include boosting the size of the euro zone's rescue fund or sales of euro bonds. Merkel and Sarkozy said they would propose a tax on financial transactions, which hurt shares of exchange operators.

 

Euro zone worries have weighed heavily on markets, most recently with last week's concerns about the solvency of French banks and the continued uncertainty over the European Central Bank's ability to control sovereign bond yields.

 

Data showed Germany's gross domestic product expanded just 0.1 percent from April to June versus the previous quarter, missing forecasts and knocking regional growth figures below expectations.

 

Financial shares seen as vulnerable to a European fiscal crisis, added to their decline and were the worst-performing sector in the S&P 500, while shares of retailers Wal-Mart and Home Depot both rose after the industry bellwethers exceeded analysts' expectations for quarterly numbers. Wal-Mart ended the day up 3.9 percent to $51.92 after the company said same-store sales turned positive in July. Home Depot saw its shares gain 5.2 percent to $33.12 after the company raised its fiscal-year profit forecast for the second time in three months.

 

Dell saw its share price fall 4.9 percent in after-hours trading after the company reported revenue slightly below analysts' expectations and said sales in the present quarter would be flat.

 

Fitch confirmed the United States' top-notch credit rating less than two weeks after Standard & Poor's downgraded the United States to AA-plus.

 

About 8.2 billion shares were traded on the major equity exchanges, roughly in line with last year's daily average of 8.47 billion shares.

 

Industrial Production – Greatest Gain in Seven Months

 

Industrial production rose at its quickest pace in seven months in July, as motor vehicle output rebounded, further easing fears the economy could slide into recession. Other data showed residential construction, while still depressed, was not a drag on the economy as the second half of the year got under way.

 

Industrial output increased 0.9 percent, the Federal Reserve said on Tuesday, after a 0.4 percent gain in June and well above economists' expectations for a 0.5 percent rise. Manufacturing, which has been the economy's main pillar of support, rose 0.6 percent as motor vehicles production surged 5.2 percent after falling 0.9 percent in June.

 

The economy barely grew in the first half of the year, held back by high gasoline prices and supply chain disruptions from Japan in the wake of the March earthquake. The industrial production data indicated the Japan-induced disruptions to manufacturing were fading.

 

Commerce Department data showed housing starts slipped a less-than-expected 1.5 percent in July to a seasonally adjusted annual rate of 604,000 units as builders broke ground on new multifamily units to meet demand for rental apartments. However, the housing market recovery continues to be hobbled by an oversupply of previously owned homes.

 

A bloated inventory of unsold homes and a weak economy are weighing down on the housing market, whose collapse was the main catalyst of the 2007-09 recession. A large foreclosure pipeline also is not helping, leaving builders with little incentive to break ground on new projects.

 

Sentiment among home builders was steady at low levels in August, a survey showed on Monday, but they were pessimistic about sales over the next six months.

 

But demand for rentals, as Americans shun homeownership because of plummeting home prices and a 9.1 percent jobless rate, is stemming further declines in home construction.

 

Last month, housing starts for multi-family homes rose 7.8 percent to a 179,000-unit rate, and groundbreaking for projects with five or more units was the highest since January. Single-family home construction -- which accounts for a large portion of the market -- dropped 4.9 percent to a 425,000-unit pace. New building permits fell 3.2 percent to a 597,000-unit pace last month. Economists had expected overall building permits in July to fall to a 605,000-unit pace.

 

Permits were dragged down by a 10.2 percent drop in the multi-family segment. Permits to build single-family homes rose 0.5 percent. New home completions increased 11.8 percent to 636,000 units in July, the highest since June 2010.

 

Fitch Says AAA with Stable Outlook

 

Fitch Ratings said on Tuesday it affirmed the United States' top-notch credit rating at AAA, giving the world's largest economy a reprieve after it was downgraded by Standard & Poor's little more than a week ago.

 

Fitch said the outlook for the rating was stable.

 

However, it warned that the United States was falling behind its peers among the AAA-rated nations on fiscal matters and the country had to show tangible results in its efforts to reduce the budget deficit.

 

It said it would review its fiscal projections at the end of November and medium-term economic outlook by the end of the year.

 

"The affirmation of the US 'AAA' sovereign rating reflects the fact that the key pillars of US's exceptional creditworthiness remains intact: its pivotal role in the global financial system and the flexible, diversified and wealthy economy that provides its revenue base," Fitch said in its statement. "Monetary and exchange rate flexibility further enhances the capacity of the economy to absorb and adjust to 'shocks," it said.

 

However, Fitch warned the outlook for the rating depended on the economy and the ability of the political process in Washington to reduce the public debt.

 

Fitch said an upward revision to medium- to long-term projections for public debt either as a result of weaker than expected economic recovery or failure of the joint committee to agree on at least $1.2 trillion in deficit reduction would likely put the United States on negative outlook.

 

"The rating action would most likely be a revision of the rating Outlook to Negative, which would indicate a greater than 50 percent chance of a downgrade over a two-year horizon. Less likely would be a one-notch downgrade," the statement said.

 

Sarkozy and Merkel Are the Key

 

The leaders of France and Germany meet for high-pressure talks on Tuesday to discuss what further measures they can take to shore up investor confidence in the euro zone following a dramatic market sell-off last week.

 

President Nicolas Sarkozy and German Chancellor Angela Merkel are under pressure to show financial markets they are in agreement on doing more to shore up the embattled currency union, or risk watching the euro zone unravel.

 

Many experts believe the only way to ensure affordable financing for the bloc's most financially distressed countries would be for the euro area to issue joint euro bonds. However, officials in Paris and Berlin have tried to play down expectations over the 10 a.m. EDT talks and 12 p.m. EDT news conference, saying euro bonds are not on the agenda, and many analysts cautioned against expecting too much.

 

Ordinary Germans have opposed more help for their weaker neighbors even while their economy has been roaring along. Data on Tuesday showing German GDP barely grew in the second quarter suggests a slowdown is starting to grip there, making underwriting of euro zone debt an even harder sell politically. The German economy grew by just 0.1 percent in the second quarter, while the French economy stagnated.

 

Sarkozy and Merkel had already planned to meet this week to push ahead on their July 21 pledge to come up with new proposals on euro zone economic governance, but the stakes were raised when France was slammed in last week's global market rout.

 

Fearing that the euro zone debt crisis is spreading to the continent's core, investors dumped shares in French banks, which are exposed to Italian debt, as rumors circulated -- denied by rating agencies -- that France's AAA-rating could be at risk.

 

The sell-off was evidence markets were not convinced by a July 21 deal to give new powers to the euro zone's EFSF rescue fund and for Paris and Berlin to come up with proposals on coordinating economic governance by the end of August.

 

The two leaders are expected to discuss holding regular euro zone summits, as France has long sought, ways to improve peer monitoring of fiscal policies or even fiscal harmonization.

 

Issuing euro bonds remains one of the most obvious ways to ensure affordable financing for high-debt members and many experts believe Germany may be forced to eventually back the idea, despite the upward impact on its borrowing costs.

 

Italian Economy Minister Giulio Tremonti said on Saturday that euro bonds would be the best solution to Europe's debt crisis, and Germany's export association said on Monday that all other means of fighting the crisis had run out.

 

Sarkozy, who faces the tough choice of whether to close tax loopholes or trim spending eight months before a presidential election, has interrupted his summer holiday to meet Merkel and key French government ministers this week. He has ordered his budget and finance ministers to find ways to plump up the 2012 budget by several billion euros as France strives to convince investors it will meet its deficit-cutting targets despite disappointing growth. His and Merkel's proposals for tighter euro zone governance will be evaluated by European Council President Herman Van Rompuy, who has been charged with putting together a package on economic coordination for an EU summit in October.