MarketView for December 20

 

 

Summary 

  

Stocks rallied nearly 3 percent on Tuesday as investors bought surging banks, homebuilders and networking companies, though low volume was seen as amplifying the market's move. Investors jumped on a banking sector that was already riding high, extending gains after Fed released new capital proposals that turned out to be less onerous than the market feared. As a result, JPMorgan Chase rose 5 percent to $32.22, while Wells Fargo added 4.6 percent to $26.47.

 

Homebuilders also gained on strong housing figures. The Dow Jones home construction index rose 6 percent, led by Pulte, the second-largest U.S. homebuilder, up 10 percent at $6.15, and MDC Holding, up 7.3 percent to close at $17.35.

 

Networking companies completed the grab bag of diverse sectors seeing the biggest gains. Those stocks rallied after AT&T dropped its bid for T-Mobile, the Deutsche Telekom unit, as investors anticipate spending on wireless equipment will accelerate. Meanwhile, Alcatel-Lucent rose 13 percent to $1.57, while Juniper Networks was up 9.1 percent to $19.76. AT&T rose 1.3 percent to $29.11.

 

After the market closed, shares of Oracle fell 7.7 percent to $26.92 in extended trading. The company reported software and hardware sales that missed its own forecasts.

 

Housing starts and permits for future construction surged to a 1-1/2 year high in November as demand for rental apartments rose. The news reinforced the view that the U.S. economy will continue to see moderate growth.

 

Cyclical industries like materials were among the day's top gainers, though all 10 S&P sectors rose more than 1.5 percent.

 

The day was the best one for the S&P 500 since November 30, and narrowed the index's losses for the year to 1.3 percent.

 

Headlines and fluctuating European bond prices continue to spark high volatility. Stocks will be prone to large swings this week on expected low volume due to the upcoming Christmas and New Year's Day holidays.

 

About 6.83 billion shares changed hands on the three major equity exchanges, a number that was below last year's daily average of 8.47 billion shares.

 

Short-term financing costs for struggling Spain more than halved as banks lapped up debt at an auction. The firepower is apparently coming from the European Central Bank's first-ever three-year funding tender on Wednesday. Investors hope banks will use the cheap funding to buy debt of fiscally troubled EU nations.

 

Investors have been focused on how the large southern European economies will refinance debt next year if financing costs remain excessively high. Any sign yields may be easing is seen as a positive for markets.

 

The S&P 500 has gained an average of 1.6 percent in the last five days of the year and the first two days in January since 1969, according to the Stock Trader’s Almanac. The phenomenon is often referred to as a Santa Claus rally. Occasions when the market does not rally during those dates often precede a bear market, the Almanac says.

 

Sharp Rise in Housing Starts

 

Housing starts and building permits hit a 1-1/2 year high in November as demand for rental apartments rose, indicating that the housing market is probably entering a tentative recovery. Tuesday's data, which also showed gains in groundbreaking for single-family homes, was the latest sign of a quickening of an economic recovery that still faces risks both at home and abroad.

 

According to a report by the Commerce Department, housing starts were up 9.3 percent to a seasonally adjusted annual rate of 685,000 units, the highest level since April last year. New permits for future construction increased 5.7 percent to a 681,000-unit pace in November, the highest since March 2010.

 

The data helped to raise the shares of KB Home, Pulte Group and Lennar.

 

Falling house prices and tight lending standards have pushed Americans away from homeownership, lifting demand for rental units and boosting construction of multifamily homes in the process. The rental vacancy rate dropped to 9.8 percent in the third quarter from a peak of 11.1 percent in 2009. While the home ownership rate edged up in the quarter, it was coming off a 13-year low.

 

The increase in home building last month raised optimism that the sector, which has already become less of a drag on the economy, will add to U.S. gross domestic product next year. If so, it would be the first increase since 2005, before the housing bubble burst.

 

Residential construction, however, accounts for only about 2.5 percent of GDP, so any lift is likely to be small. However, it is estimated that an additional 100,000 housing starts would add about 250,000 new jobs.

 

Home building has grown for two straight quarters. A report on Monday showed builder optimism scaled a 1-1/2 year high in December, and data later this week is expected to show increases in sales of both previously owned and new homes.

 

However, a full recovery for the sector, which triggered the 2007-09 recessions, is likely years away given a glut of unsold homes, weak prices, high unemployment and tight credit. Housing starts remain less than a third of the 2.27 million rate peak reached in January 2006.

 

Last month, starts of multi-family homes surged 25.3 percent to a 238,000-unit rate, and groundbreaking for projects with five or more units hit the highest level since September 2008.

 

Single-family home construction -- which accounts for a much larger portion of the market -- rose 2.3 percent to a 447,000-unit pace.

 

Permits were boosted by a 13.9 percent jump in the multi-family segment. Permits for buildings with five or more units were the highest since October 2008. Permits to build single-family homes rose just 1.6 percent.

 

Fed to Follow Basel

 

The Federal Reserve proposed new capital and liquidity rules for the largest U.S. banks that would roll out in two phases and not likely go further than international standards. The plan issued on Tuesday closely follows statements the Fed has made in recent weeks to calm Wall Street concerns that U.S. standards may be more aggressive than those from other nations, putting U.S. banks at a disadvantage.

 

The Fed said that both the capital and liquidity requirements in last year's Dodd-Frank financial oversight law would be implemented in two phases. The first phase would rely on policies already issued by the Fed, such as the capital stress test plan it released in November. That stress test plan will require U.S. banks with more than $50 billion in assets to show they can meet a Tier 1 common risk-based capital ratio of 5 percent during a time of economic stress.

 

The second phase for both capital and liquidity would be based on the Fed's implementation of the Basel III international bank regulatory agreement. That standard brings the Tier 1 common risk-based capital ratio requirement to 7 percent, plus a surcharge of up to 2.5 percent for the most complex firms.

 

One area still unclear is how much the surcharge will be for banks that are above $50 billion in assets but are not designated as globally systemic.

 

The rules, once finalized, will apply to all banks with more than $50 billion in assets, including Goldman Sachs, JPMorgan Chase and Bank of America. Most large U.S. banks already meet the Basel III requirements scheduled to fully go into effect in 2019.

 

For its liquidity requirements, the Fed is waiting on the Basel Committee on Banking Supervision to flesh out its own liquidity recommendations before setting out U.S. requirements. The central bank said it initially would hold U.S. banks to a qualitative liquidity standard.

 

Under the Fed plan, banks would have to assess, at least once a month, what their liquidity needs would be for 30 days, for 90 days, and for a year, during a time when markets are stressed. They would be required to have enough liquid assets to cover 30 days of operations under these circumstances.

 

The proposals released on Tuesday are aimed at ensuring that financial firms have enough capital and liquid assets on hand to weather a future financial crisis. During the 2007-2009 crisis, taxpayers put up $700 billion to bail out the financial system, partially through capital injections into banks.

 

The rules will be out for public comment until March 31, 2012, giving Wall Street time to argue that being forced to keep so much cash on hand it will hurt lending and the economic recovery.

 

Executives, including JPMorgan Chief Executive Jamie Dimon, have complained that regulators are littering the financial landscape with rules, without properly analyzing their economic impact.

 

The rules proposed will not only apply to the largest U.S. banks. They will also cover any financial firm the government identifies as being important to the functioning of financial markets and the economy.

 

The government has yet to decide which non-banks, such as insurance companies and hedge funds, meet this standard.

 

When such companies are designated, the Fed said it may "tailor" the rules, which were drafted mostly with banks in mind, to better fit that particular company or industry.

 

The law also requires the Fed to write tougher standards for foreign banks with operations in the United States. Fed officials said on Tuesday they would release those proposals soon, and that they would apply to about 100 firms.

 

The Fed rules also try to limit the dangers of big financial firms being heavily intertwined. It would limit the credit exposure of big banks to a single counterparty as a percentage of the firm's regulatory capital.

 

The credit exposure between the largest of the big banks would be subject to an even tighter limit.

 

Further, the Fed proposal requires banks to bolster their capital if it appears they are heading into trouble, such as being overexposed to risky assets.

 

The rule outlines four phases of this "remediation" process that a bank or other large financial organization would go through if it hits certain triggers signaling weakness.

 

If a bank does not bounce back after following through on requirements such as a capital boost, the regulators could then restrict dividends, compensation, or even recommend the institution be seized and liquidated.

 

The Fed did not provide details about how much of the remediation process would be made public.

 

Spain’s Borrowing Costs Fall Decisively

 

Short-term financing costs Spain more than halved on Tuesday as banks lapped up debt at an auction, with much of the purchasing power said to come from cut-rate money to be lent by the European Central Bank.

 

The euro zone's debt dilemma remained on view in Greece, however, where borrowing costs rose to 4.68 percent for just 3 months. The Greek debt agency owes 1.3 billion euros ($1.7 billion) of the short-term debt.

 

Demand for the 3- and 6-month Spanish Treasury bills was high, with more than 18 billion euros offered for 5.6 billion euros sold, above the targeted amount of 3.5 billion to 4.5 billion euros.

 

It appears that Spain is already in its second recession in three years and the sluggish economy and high deficit have put it at the center of the euro zone debt crisis. The main concern is that if it needs a bailout it would stretch available funds and political will.

 

Rating agency Fitch said last week a comprehensive solution to the euro zone debt crisis is beyond the region's reach and warned six of its economies, including Italy and Spain, could be hit with credit downgrades in the near future.

 

Fiscal prudency by Spain's outgoing Socialists and the promise of further cuts by the incoming center-right government has helped ease jitters and draw a line between it and the euro zone's third largest economy Italy.

 

Spain also has some room to maneuver, with no major debt redemptions until April while Italy faces coupon payments of around 100 billion euros in the first four months of 2012.

 

The ECB will offer euro zone banks loans of up to 3 years on December 21 at a rate of around 1 percent in an unprecedented move to fend off a credit crunch that could stall the currency bloc's economy. Demand for ECB's one-week funds was subdued on Tuesday as banks positioned themselves for its three-year loan operation.

 

Spanish bond yields have tumbled from euro-era highs since the ECB announcement with some traders using prospects of a large take-up at the 3-year tender to square short positions before the end of the year. A carry trade is market jargon for borrowing at a lower rate to get returns elsewhere at a higher one. The ECB tenders are probably only been part of the story, say economists.

 

On Monday, Spain's Prime Minister elect Mariano Rajoy pledged deep spending cuts in his first address to the new Parliament after his People's Party (PP) trounced the Socialists in the November election, though gave few details.

 

On Tuesday, the Spanish Treasury sold 3.7 billion euros of 3-month paper for 1.735 percent, after an average yield of 5.11 percent in November, at a bid-to-cover ratio of 2.9, up from 2.8. The 6-month bill sold for an average yield of 2.435 percent, down from 5.227 percent, with 1.92 billion euros sold and demand outstripping supply by a factor of 4.1, after 4.9 a month earlier.

 

While average yields were down from a month earlier, and around 30 basis points lower than levels seen in the secondary markets before the auction, the Treasury was still paying more than 150 basis points above pre-crisis levels on both bills. ($1 = 0.7682 euros)