MarketView for December 22

 

 

Summary

 

The S&P 500 index chalked up another 14-month high on Tuesday, the result of momentum from the latest report on existing home sales that indicated both a recovering housing market and increased the optimism on the Street with regard to the strength of the economic recovery. As a result, housing stocks led the way up. Shares of D.R. Horton closed up 3.8 percent at $11.15, while Toll Brothers chalked up a 4.5 percent gain to close at $19.21.

 

 According to a report released on Tuesday by the National Association of Realtors (NAR), existing home sales rose 7.4 percent to an annual rate of 6.54 million units, making it the fastest rate of increase since February 2007. At the same time, October sales were revised lower to a 6.09 million pace from 6.10 million units. Compared to November last year, sales of existing homes were up 44.1 percent, the largest annual gain going back to 1999.

 

Any sign of stabilization in housing adds to positive investor sentiment. It was the fallout from that sector's downturn that recently drove the economy into its worst recession since the 1930s and propelled the unemployment rate the current 10 percent rate.

 

The Nasdaq hit a 15-month high, buoyed by technology bellwethers. IBM rose one percent to $129.93 after the company reported a 10-year outsourcing deal valued at $83 million. Microsoft was up one percent at $30.82 despite losing a patent suit. Apple was up 1.1 percent at $200.36, not far below its 52-week high set on October 21.

 

After the closing bell, shares of Micron Technology rose 2.2 percent to $9.62, the result of the company reporting its first positive quarterly earnings number in more than two years. The black ink was the result of rising demand and prices for memory chips.

 

During Tuesday's regular session, the CBOE Volatility Index or the VIX, fell below a key psychological level of 20 to its lowest level since August 2008, falling 4.6 percent to close at 19.54.

 

Earlier in the session, the S&P 500 hit a technical milestone, surging to an intraday high of 1,120.27. The index failed to hold that level, but it did reach a 14-month closing high. Market technicians have said a breakout in the S&P 500 above the 1,120 level would signal more gains for the broader market and could help the S&P 500 take aim at the 1,200 level. The S&P 500 is up 65.3 percent since its 12-year closing low on March 9. For the year, the S&P 500 is up 23.8 percent.

 

Year-end window dressing, where portfolio managers sell losers and buy winners that have gained recently, added some additional fuel to the rally.

 

Boeing gave the Dow one of its biggest lifts, rising 1.5 percent to $55.10 after it bought a stake in a plant that assembles the fuselage for its 787 Dreamliner.

 

Treasury Prices Continue Downward

 

An improving economy sent long-term interest rates higher for the third straight day on Tuesday. Treasury yields rose as their prices fell in response to news that sales of existing homes rose last month. The NAR report gave investors more reason to keep buying riskier assets including stocks, and less reason to hold on to defensive investments like government debt.

 

The yield curve, the market measure that reflects the difference between the yields on two-year and 10-year Treasurys, widened further as investors sold longer-term bonds. Investors have been selling long-dated bonds in anticipation that a healthier economy will bring higher inflation, which undermines the value of fixed-income securities.

 

Two-year Treasurys did not feel the pain as much, held up by expectations that the Federal Reserve will hold to its plans to keep short-term interest rates low for the time being. The disparate movements in Treasurys sent the gap between those rates up to 2.84 percentage points, from 2.81 Monday.

 

The current trend in the bond market is indicative of both an improving economy and a long-overdue pullback in Treasurys, which have been rallying in recent months and pushing long-term interest rates to very low levels.

 

The price of the 10-year note fell 21/32 to 96 26/32 in light trading late Tuesday. Its yield rose to 3.76 percent — its highest level since August — from 3.68 percent late Monday. The yield was as low as 3.48 percent late last week. The price of the two-year note fell 3/32 to 99 22/32, sending its yield up to 0.92 percent from 0.87 percent. The 30-year bond fell 29/32 to 96 4/32. Its yield rose to 4.62 percent from 4.56 percent. The yield on the three-month T-bill rose to 0.06 percent from 0.05 percent. Its discount rate was 0.07 percent.

 

The cost of borrowing between banks was unchanged. The British Bankers' Association said the rate on three-month loans in dollars — the London Interbank Offered Rate, or Libor — remained at 0.2488 percent.

 

Economic Outlook Continues to Improve

 

Sales of previously owned homes reached their highest level in nearly three years last month, the latest sign the economic recovery was gaining steam after growing below expectations in the third quarter. According to the latest report by the Commerce Department, the gross domestic product grew at a 2.2 percent annual rate in the third quarter instead of the 2.8 percent pace reported last month. The department also said after-tax corporate profits grew 12.7 percent in the third quarter, a little softer than the 13.4 percent estimated last month. It was still the largest gain since the first quarter of 2004.

 

The housing market, the main trigger of the recession, is stabilizing and will likely lead to increased demand for goods by consumers. Even more heartening, the decline in home prices is fading. A separate report from the Federal Housing Finance Agency showed home prices rose 0.6 percent in October from September.

 

While the expansion in GDP in the July-September period was not as vigorous as had been thought, it was still the fastest pace since the third quarter of 2007 and ended four straight quarters of declining output.

 

Growth was boosted by government stimulus, including the popular cash for clunkers program and a tax credit for first-time home buyers. However, debate continues over the sustainability of the recovery once government support wanes.

 

Yet, recent data, including retail sales, business inventories and trade figures, strongly indicate the pace of growth has gained speed in the fourth quarter. Last week, the Fed gave a cautiously upbeat economic assessment and promised to hold overnight lending rates near zero for an "extended period" to aid the recovery.

 

While the economy has turned the corner, the effects of the recession continue to reverberate. Ford Motor Co said on Monday it was offering its 41,000 U.S. factory workers buyouts and early retirement offers in a bid to reduce its payroll costs and achieve profitability by 2011.

 

Growth in the third quarter was held back by weak business spending. A slightly more aggressive liquidation of inventories than previously estimated also was a factor in the downward revision to the GDP figures.

 

In addition, nonresidential building activity dropped 18.4 percent, rather than 15.1 percent, a reflection of the troubles in the commercial property market. A widening trade gap also weighed on growth. Consumer spending was revised down slightly, to a 2.8 percent gain from 2.9 percent, but it still helped to offset the drag from the steep drop in business investment.

 

While businesses continued to whittle down their inventories, the pace at which they liquidated stocks slowed sharply from the second quarter, adding nearly 0.7 percentage point to third quarter growth. The deep inventory cuts of the recent quarter should lay the groundwork for a pickup in production. 

 

OPEC Trying To Crack Down

 

OPEC agreed on Tuesday to keep supply curbs unchanged but faces a battle to crack down on those in its ranks who are failing to comply with quota restrictions if it wants to drain the current glut of global fuel inventories. OPEC has seen crude prices almost double since the start of the year after it sliced output when recession hit fuel demand.

 

Oil prices traded just below $73 a barrel on Tuesday, near the center of the $70-$80 range that many in OPEC say they prefer. "At between $70 and $80, everyone is happy," Saudi Oil Minister Ali al-Naimi said. "The current price is good for consumers, producers and investors."

 

OPEC's biggest producer, Saudi Arabia has made clear that it does not want to risk letting fuel prices get out of hand for fear of stunting a fragile recovery in world economic growth.

 

However, Naimi expressed concern over the poor discipline shown by some OPEC members in observing quota restrictions. This has pushed up inventories in industrialized consumer nations to 60 days worth of demand. Stricter adherence to the 4.2 million barrels-a-day (bpd) of reductions in force throughout 2009 would skim inventories to levels more acceptable to producers.

 

Asked for his opinion on compliance, Naimi said: "We expect more."

 

OPEC's official communique read: "Member countries repeated their commitment to their individually agreed production allocations." But it has little in its armory to ensure that happens other than an appeal to self-interest.

 

"We always ask them to at least try to implement the decision that has been taken," said OPEC Secretary-General Abdullah al-Badri said. "We can't really force countries to adhere 100 percent, but we always encourage them to comply."

 

OPEC estimates show that Saudi and its Gulf allies Kuwait and the UAE are at or near full compliance with output cuts. But Angola, Nigeria and Iran have made little or no contribution. Compliance peaked in February at about 80 percent but has since slipped to 60 percent, adding about 800,000 bpd or 3 percent to OPEC supplies over the past nine months.

 

Iraqi Oil Minister Hussain al-Shahristani said OPEC could mop up excess inventory simply by sticking to agreed limits. "If the members restrict themselves to agreed levels of production that would eliminate more than more than one million barrels a day from the market," said Shahristani. "There's no need to revise the agreement, we just need to comply with it."