MarketView for August 15

Summary 

Wednesday saw another relatively uneventful day on Wall Street with the S&P 500 index ending a few points higher and extending a rally that seems to be happening in slow motion. The benchmark S&P 500 index finished close to its highest close in three months, but with earnings season winding down and many traders away, volume was light.

For the next couple of days the greatest influence may be the options market, which is seeing heavy volume in August call and put options clustered around the 1,400 level for the S&P 500. If the index closes at or very close to 1,400, those options expire worthless on Friday. That means market-makers have an incentive to try to make that happen, or "pin" the index at 1,400.

The S&P 500 was up seven of the past nine sessions but the volume has been extremely light due to summer holidays and a lack of news from Europe. On Wednesday, about 4.79 billion shares changed hands on the three major equity exchanges, a number that was well below last year's daily average of 7.84 billion shares.

The S&P 500 rallied early in August and reached highs not seen since early May in anticipation that central banks in the United States and the euro zone will take action to stimulate their respective economies in September.

Shares of Deere lost 6.3 percent to $75.10 after the world's largest agricultural equipment maker reported a lower-than-expected quarterly earnings number on Wednesday, citing weak sales in China, India and other emerging markets. Caterpillar was also down, falling 0.3 percent to $87.61 making it the largest drag on the Dow.

Staples was down 14.6 percent to $11.49 as the worst performer on the S&P 500 index after the office supply chain reported lower-than-expected quarterly revenue on weak demand in North America, Europe and Australia, and forecast flat sales for the fiscal year.

In economic data, industrial output expanded 0.6 percent last month, the fastest pace since April. Manufacturing notched another solid advance, hinting at underlying resilience in an economy that has struggled to establish momentum.

The New York Fed's general business conditions index for August missed expectations and contracted for the first time since October 2011. Meanwhile, Labor Department data showed consumer prices were flat in July for a second straight month and the year-over-year increase was the smallest since November 2010.

Data from the National Association of Home Builders indicated that homebuilder sentiment rose in August to 37, its highest level in more than five years, and above the 35 in July.

Inflation Remains Contained

Consumer prices were flat in July for a second straight month and the year-over-year increase was the smallest in more than 1-1/2 years, giving the Fed room to ease policy further to tackle high unemployment. The tame inflation reading leaves the door open to more monetary stimulus from the U.S. central bank, even though data on job growth and retail sales have hinted at a bit of a pick-up in economic activity early in the third quarter.

Other reports on Wednesday showed home-builder sentiment in August hit its highest level in more than five years, while industrial production rose in July. However, a gauge of manufacturing in New York State contracted this month.

The flat Consumer Price Index reading confounded many on the Street where the consensus was for a 0.2 percent gain. In the 12 months to July, the CPI rose 1.4 percent, the smallest gain since November 2010 and down from June's 1.7 percent increase, the Labor Department said.

The core CPI, which strips out food and energy, gained 0.1 percent from June. That was the smallest rise since February and it broke four straight months of 0.2 percent increases. In the year to July, the core index, which is closely watched by the Fed, rose 2.1 percent - the smallest rise in nearly a year.

A second report showed industrial production increased 0.6 percent in July after a 0.1 percent gain in June, offering more hope the economy was improving after growth slowed in the second quarter. The gain in industrial output, combined with surprisingly strong retail sales and a pickup in job growth in July, led to the argument that the Fed's policy-setting Federal Open Market Committee probably does not need to launch a third round of bond purchases this year.

Officials at the Fed meet on September 12-13. Fed Chairman Ben Bernanke's speech at the central bank's high-profile gathering in Jackson Hole, Wyoming, in late August could offer clues on the near-term course of monetary policy. Bernanke used that forum in 2010 to communicate the Fed's intention to pursue a second round of so-called quantitative easing.

In the absence of more bad news from Europe and perceptions of delayed Fed action, U.S. Treasury debt yields rose, extending a two-week trend. The dollar firmed broadly. Stocks on Wall Street ended slightly up, with the benchmark Standard & Poor's 500 index closing less than a point away from a four-month high.

The economy has been hit by fears of sharp cuts in government spending and tax increases in January. A debt crisis in Europe, which has left the euro area economy with one foot in a double-dip recession, has also eroded sentiment.

Industrial output last month was boosted by big gains in utilities production and mining. While manufacturing was up 0.5 percent after a similar rise in June, autos accounted for the bulk of the increase. But with auto sales softening against the backdrop of weak income growth and high unemployment, manufacturers could be forced to scale back production.

Average weekly earnings were flat in July, when adjusted for inflation, and were up only 0.6 percent from a year ago. A third report, from the New York Federal Reserve, showed factory activity in New York state contracted in August for the first time since October 2011.

Last month, inflation was held down by a 0.3 percent drop in energy prices, which offset a 0.1 percent gain in food prices. A drought ravaging much of the country could lift food prices in the coming months, but the impact on inflation should be modest since food accounts for only 14.2 percent of the CPI.