MarketView for December 8

 

 

Summary 

 

The major equity indexes moved a bit higher on Wednesday as gains in financial and technology stocks offset declines caused by a recent surge in bond yields. However, volume was light with about 7.9 billion shares traded on the Big Board, the AMEX and the Nasdaq, well below the year-to-date moving average of 8.63 billion.

 

Shares of banks stocks are up about 10 percent since the start of the month as benchmark yields are now high enough to make lending and trading more profitable. For example, JP Morgan Chase ended the day up 2.6 percent to close at $40.27.

 

Yields reached a six-month high this week after the initial deal reached in Washington to extend tax cuts fueled concern about inflation and the government's debt burden. By the same token, the higher bond yields capped gains on the major stock indexes as they make it more expensive for consumers and businesses to borrow, while stocks and the dollar have moved in opposite directions of late. A rise in yields and the dollar could also draw money away from equities.

 

Technology shares helped lift the Nasdaq, led by semiconductor stocks after solid outlooks from Texas Instruments and Novellus Systems. Texas Instruments ended the day up 1 percent to close at $33.75, while Novellus chalked up a gain of 2 percent to close at $32.40.

 

McDonald's was the day’s worst drag on the Dow Jones industrial average, falling 2 percent to $78.74 after reporting weaker-than-expected global sales for November.

 

The S&P faces resistance at the 1,228 level, which represents the 61.8 percent Fibonacci retracement of the 2007-2009 bear market slide, a key technical indicator. The level was confirmed as strong resistance Tuesday after the index broke through during the session but closed below it.

 

It is likely the market will trade sideways for a few days before mounting an upward move heading into the year's end. Steady economic improvement should fuel stock gains through 2011. However, international concerns could limit advances in the second half of the year.

 

Fear Sends Bond Prices Lower

 

Treasury prices fell sharply on Wednesday for a second straight day, sending yields to a six-month high. The reason was that the deal to extend tax cuts elicited once again the never fully dormant fears of inflation and of a continually rising budget deficit.

 

The sharp dip in prices brought some buyers to the table in an auction of $21 billion of reopened 10-year notes, which was part of $66 billion of coupon-bearing securities sales this week. Bond prices rebounded somewhat from their lowest levels of the day following the sale.

 

Still, sentiment remained strongly bearish heading into the sale of $13 billion of reopened 30-year bonds on Thursday.

 

A proposal to extend Bush-era tax cuts is expected to aid economic growth by as much as 1 percentage point next year. But the long-term cost to the government from falling tax receipts has spooked bond investors and resulted in a disappointing three-year debt auction on Tuesday.

 

Some investors fear such a tax move could result in more bond purchases by the Federal Reserve, which would boost the government's deficit and stoke price inflation.

 

Though the sell-off in Treasuries has certainly been vicious, so far it appears to be a bond market correction from historically low yields rather than the beginning of a sovereign debt crisis like the one that has raged in the euro zone this year.

 

For example, the cost of insuring Treasury debt in the credit default swap market was little changed at around 40 basis points, or $40,000 per year for five years to insure $10 million in Treasuries. However, Treasuries were on track for the largest two-day sell-off since September 2008.

 

Adding to the bearish sentiment was the unwinding of hedges by mortgage investors and weak demand at a 4 billion euro auction of two-year German government debt.

 

The bond market is stuck in negative territory, as it attempts to find stability after breaching a series of key technical supports in recent days. Given the swiftness and magnitude of the sell-off, it is impossible to predict where the market will bottom.

 

Treasury 10-year notes were trading 1-9/32 lower in price for a yield of 3.29 percent, up from 3.13 percent late on Tuesday. If the bond market deteriorates further, the yield on a 10-year note could test support at the 3.30 to 3.32 percent level. On the other hand, a market rebound could make the 10-year yield test resistance at 3.10 percent, its 200-day moving average.

 

Gold Down Sharply

 

Gold prices were down more than 1 percent for a second consecutive day on Wednesday as an extended drop in Treasury prices setoff serious profit-taking from bullion's record run by those seeking higher returns.

 

Benchmark Treasury yields jumped to a six-month high for a second straight day, after a deal in Washington to extend tax cuts fueled fears of a swelling budget deficit. The dollar also gained, buoyed by hope of improving U.S. economic growth as the effective tax stimulus filtered through.

 

The combined effect of those factors drove profit-taking in precious metals, sensitive to both interest rates and the dollar. Gold is up 26 percent this year, while silver, which fell in tandem on Wednesday, is up almost 70 percent.

 

Spot gold traded at $1,382.79 an ounce, down 1.3 percent, at 2:33 p.m. EST (1933 GMT), having earlier fallen by as much as 2.1 percent to a one-week low of $1,371.45. U.S. gold futures for February delivery settled down $25.80 at $1,383.20 an ounce.

 

Technical selling also accelerated the decline in silver prices, which had jumped to a 30-year high above $30 an ounce, but investment interest remained high as the world's largest silver-backed exchange-traded fund hit another record high. Silver fell 1.1 percent to $28.34 an ounce, resulting in the gold/silver ratio to stabilize at  nearly a four year low.

 

Gold has lost some safe-haven appeal as, for the first time in weeks, euro zone debt concerns were placed on the back burner and investors focused on U.S. economic fundamentals in a thinning market.

 

Gold hit an all-time high at $1,430.95 an ounce on Tuesday, but has now fallen by about 4 percent after the rally ran out of steam.

 

Holdings in the No. 1 SPDR Gold Trust remained steady despite weaker gold prices, while the world's largest silver ETF, iShares Silver Trust, said its holdings hit another record at 10,941.34 tons by Wednesday.

 

A rally in the dollar, after the proposed extension in U.S. tax cuts prompted a spike in bond yields on Tuesday, which in turn raised the cost of holding gold to non-U.S. investors.

 

While gold has shaken off its traditional inverse relationship with the dollar, this has not been the case this week, when the negative correlation has strengthened.

 

The rise in Treasury yields was seen as being supportive to the dollar in the near term, while the tax deal itself could lift growth next year and lessen the case for bigger monetary stimulus by the Federal Reserve.

 

Summers Makes Plea for Tax Cut

 

In one of his last acts in his job as a top economic advisor, Larry Summers stated that failure by the Congress to pass a tax cut deal soon would "materially increase" the risk of the economy stalling and a double dip recession,.

 

Summers, who is leaving his post as Obama's top economic adviser this month, said Obama's deal with Republicans to extend Bush-era tax cuts for the middle class and the wealthiest Americans would provide more fiscal support for the economy than most observers expected only weeks ago.

 

"Failure to pass this bill in the next couple weeks would materially increase the risk that the economy would stall out and we would have a double-dip," Summers said.

 

"As much as we regret the elements in it that do not seem to us to be a good use of public resources, on balance the benefits to the economy make this a very worthwhile deal," he said.

 

The deal includes a continuation of unemployment insurance -- a key White House demand.

 

Summers said the president wanted to continue the popular Build America Bonds program this year or next year. He'd like to see them go forward," Summers said.

 

Republicans have said they will block the program in their tax deal with Obama. White House spokesman Robert Gibbs said it was not currently part of the deal.