MarketView for February 12

 

 

 

Summary 

 

China’s increase in the reserve requirement for its banking industry raised fears the global recovery could face additional hurdles, sending share prices lower across the board. Friday’s announcement marked the second such rise in as many months. The concern is that China, which has been spearheading the world's economic recovery, might be pulling back too soon. Even so, Wall Street ended above the day's low point on the belief that the European Union would come up with a clearly defined plan to aid debt-laden Greece and restore confidence in countries using the euro. Euro zone finance ministers are scheduled to meet on Monday when U.S. financial markets will be closed for Presidents Day.

 

Meanwhile, much of the day’s decline involved the shares of large manufacturers and commodity-related companies, many dependent on Chinese demand. For example, Alcoa Inc fell 2.2 percent to $13.28, while conglomerate United Technologies Corp shed 1.5 percent to $65.69 and General Electric fell 1.4 percent to $15.55.On the Nasdaq, bargain-hunting in technology helped send that index into positive territory by the closing bell. Earlier on Friday indexes had fallen more than 1 percent.

 

Markets also fell on weaker-than-expected consumer sentiment data. The Reuters/University of Michigan Surveys of Consumers said its preliminary index of sentiment for February was 73.7. Nevertheless, the major stock indexes ended the week higher, halting a four-week string of declines, thanks in part to investors scouring for shares in the beaten-down sectors, particularly technology. Both the Dow and the S&P 500 rose 0.9 percent, while the Nasdaq climbed 2 percent.

 

The Nasdaq's top performers included Research in Motion, which rose 3.1 percent to $71.33.

The top drag on the Dow was 3M, which fell 1.4 percent to $79.18 after Bank of America-Merrill Lynch said it expected slower growth from the manufacturer in the coming cycle.

 

Ingersoll-Rand, which makes climate-control systems, shed 7.8 percent to $31.26 after it reported fourth-quarter earnings that missed Street expectations and gave a first-quarter profit view that was below consensus.

 

Consumer Sentiment Down

 

Consumer sentiment slipped in early February, with high unemployment expected to continue and with most looking for no gain in income or home values in the year ahead, the Reuters/University of Michigan Surveys of Consumers showed. According to the survey, the preliminary index of sentiment for February was 73.7, down from 74.4 in late January but up from 56.3 a year ago. The survey's gauge of current economic conditions was 84.1 in early February, the highest since March 2008. It was up from 81.1 in late January.

 

However, the survey's barometer of consumer expectations dipped to 66.9, down from 70.1 in late January. The index of consumers' 12-month economic outlook fell to 79 from 84 in late January. The survey's 1-year inflation expectation index eased to 2.7 in early February from 2.8 in late January. The five-to-10-year inflation measure eased to 2.8 from 2.9 late last month.

 

Crude Oil Futures Decline

 

Crude oil futures fell more than 2 percent toward $73 per barrel on Friday after a report by the Energy Information Administration indicated that crude oil crude stocks rose by 2.4 million barrels last week, while gasoline inventories rose more than forecast and distillate supplies fell by less than expected. Sweet domestic crude for March delivery fell $2.02 to $73.30 per barrel, after settling 76 cents higher at $75.28 a barrel on Thursday. Brent crude for the new front month of April fell $1.90 to $72.22.

 

Oil in New York had traded as low as $72.66 earlier in the session after a blow to the energy demand outlook by China's surprise decision to increase banks' reserve requirements for the second time this year. Few in the market were expecting the Chinese central bank's move on Friday, which will raise the requirements from the end of this month.

 

Rapid growth and development in China, the world's second largest energy consumer, has boosted oil prices in recent years. All growth in oil demand this year is expected to come from China and other emerging economies.

 

The EIA data had been delayed until Friday from its usual Wednesday release because of the severe snowstorms that have swept the East Coast. A report from the American Petroleum Institute (API) on Tuesday showed U.S. crude inventories jumped by 7.2 million barrels to 337.6 million last week.

 

China Raises Bank Reserve Requirement

 

China raised the level of reserves banks must hold for the second time this year on Friday, spooking financial markets on the eve of its New Year holiday by showing it was intent to curb lending and inflation.

 

Although there had been some speculation that the People's Bank of China would push the reserve requirement ratio higher after an increase last month, few thought the second rise would come so soon. As a result, markets were rattled by fears that monetary tightening in the world's third-largest economy would be more aggressive than had been reckoned on, potentially denting global growth. The news buoyed the dollar. Stocks and oil fell, while European and U.S. bonds jumped.

 

The reserve requirement increase should not be construed as serious tightening, because it only goes some distance to mopping up cash injected in the economy before the Chinese New Year, a week-long holiday which begins on Saturday. But that did not diminish the surprise, particularly since China on Thursday had reported an unexpected slowdown in consumer price inflation in January to 1.5 percent from a year earlier.

 

The dip in inflation is likely to be temporary because of seasonal factors, but markets had still interpreted it as a sign that the central bank could proceed more gradually with tightening after last year's ultra-loose pro-growth policies.

 

This week's data also showed that, for all the government's insistence that banks control their pace of lending, Beijing has still been struggling to rein in credit. Banks lent 1.39 trillion yuan ($203.4 billion) in January, the third-largest monthly total on record.

 

With the reserve requirement increase, China's biggest banks will now have to put 16.5 percent of their deposits on hold at the central bank, crimping their ability to lend.

 

 

The 50 basis point rise, which comes into force on February 25 after the New Year's holiday, will drain about 300 billion yuan. Nonetheless, the Chinese economy remains awash in cash after a record surge of 9.6 trillion yuan in bank lending last year. On top of that, the central bank injected a net 604 billion yuan ($88.6 billion) in open market operations over the past three weeks, and a raft of bills are due to mature in March.

 

Even more important than interest rate increases in the Chinese economy, Beijing is also expected to step up its so-called window guidance to get banks to slow their lending. The central bank all but confirmed this week that it would take a raft of tightening steps in the coming months, when it pledged to "normalize" monetary conditions. That could be a bitter pill for global markets to swallow. China powered to 8.7 percent growth last year, by far the strongest of any major economy, driving demand for everything from Chilean copper to Australian iron ore.

 

Worries that China's tightening might dampen global economic growth were compounded on Friday by weak European data and the struggle to sort out Greece's debt crisis. Central bankers outside China are also being forced to grapple with the impact of Beijing's policy choices. The Reserve Bank of Australia surprised markets last week by skipping an interest rate rise, noting that China's tightening is a factor.

 

Buffett’s Train Leaves the Station

 

Warren Buffett's train has left the station, and millions are joining him for the ride.  Berkshire Hathaway on Friday completed its roughly $26.4 billion purchase of Burlington Northern Santa Fe, issuing new shares and paying out $15.87 billion of cash. Berkshire is also now part of the Standard & Poor's 500 index of large U.S. companies. It will begin trading on that index on Tuesday.

 

The addition of Omaha, Nebraska-based Berkshire is expected to generate about $14 billion of buying demand. Indeed, trading in Berkshire stock was extremely heavy on Friday, as more than 219 million Class B shares changed hands. The B shares rose 21 cents, or 0.3 percent, to $76.90, while the Class A shares rose $772.60, or 0.7 percent, to $115,722.60.

 

Buying into Berkshire means that you are buying into a $173 billion behemoth that owns some 80 different businesses. Businesses that include everything from Geico car insurance to Dairy Queen ice cream to Fruit of the Loom underwear. Berkshire also owns tens of billions of dollars of blue-chip stocks.

 

Buffett has repeatedly warned not to expect Berkshire to perform as well as it did decades ago, when it was smaller. Back then, growth in book value per share, the difference between assets and liabilities, which Buffett prefers using to measure performance, routinely trounced the S&P 500.

 

In Buffett's first 44 years at Berkshire, book value per share increased an average 20.3 percent a year, while the S&P 500 including dividends rose 8.9 percent. Berkshire still usually beats the index, but by smaller amounts. It has also lost its triple-A credit ratings. Buffett's wisdom is also less of a commodity.

 

The world's second-richest person now appears on TV and speaks out more regularly, such as last month when he expressed dismay with how Berkshire holding Kraft Foods had structured a proposed merger with Cadbury. Moreover, Buffett turns 80 in August. Though he has not said when he might step down or who will succeed him as chief executive, other than that one person is ready to do so, he is moving near the end of his career. Nonetheless, Berkshire shares are up about 13 percent since S&P on January 26 said they would enter the S&P 500. And shares could rise further next week if index investors who have yet to amass enough of them keep buying.

 

Berkshire was able to join the S&P 500 after last month splitting its "Class B" stock 50-for-1, which lowered its share price to below $70 from around $3,400. This allowed more Burlington Northern shareholders to swap their stock for Berkshire stock if they chose. But it also added the liquidity that S&P demands for S&P 500 components.

 

Berkshire's Class A shares trade well above $100,000. The cash-and-stock acquisition of Burlington Northern valued the company at $100 per share. Berkshire already owned 22.6 percent of the Fort Worth, Texas-based company.

 

Insurance remains Berkshire's largest business area, and Berkshire this month became the biggest shareholder of Munich Re, the world's largest reinsurer. Buffett's largest previous acquisition was Berkshire's 1998 takeover of the reinsurer General Re. He admitted to paying full price for Burlington Northern. "Maybe when I hear that choo choo, I get carried away," Buffett was given to say sometime back.

 

Greece In Worse Shape Than Previously Thought

 

Greece's economy shrank more than feared last quarter and the government on Friday sharply revised down its figures for the previous three quarters as well, increasing doubts about its ability to resolve its debt crisis.

 

Euro zone sources preparing for meetings of the region's finance ministers next Monday and Tuesday said ministers would not discuss specific ways of supporting Greece. Ministers will focus instead on pressing Athens to implement steps it has promised to cut its budget deficit. The lack of debate on a concrete aid plan suggested European governments remained unable to decide how to stop the crisis from hurting financial markets' faith in the euro zone.

 

Greek Prime Minister George Papandreou, saying his country had become "a guinea pig in a battle between Europe and the international markets," blamed bickering among European Union bodies for delaying support for his country.

 

"There was a lack of coordination among the various bodies of the EU. The Commission, the member states, the ECB, and even differences of opinion within these bodies," he told a televised cabinet meeting.

 

Underlining political obstacles to a rescue for Greece, a poll published on Thursday indicated 71 percent of people in Germany, which as the euro zone's richest member is key to any bailout, rejected the idea of financial aid for Greece.

 

The euro sank to a fresh eight-month low of $1.3529 against the dollar on Friday, while spreads for the government bonds of Greece and other heavily indebted states in the south of the zone widened.

 

Greece's gross domestic product contracted 0.8 percent in the fourth quarter from the previous quarter, much deeper than the 0.5 percent forecast in a Reuters survey, the government announced.

 

Just as damaging to confidence were the large revisions to shrinkages in past quarters: the first-quarter 2009 fall was changed to 1.0 percent from 0.5 percent, the second quarter to 1.9 percent from 1.2 percent, and the third quarter to 2.5 percent from 1.7 percent on an annual basis.

 

It is common for governments to revise GDP figures but large inaccuracies in Greek economic data -- some of them apparently deliberate and politically motivated -- have fueled its debt crisis by angering investors and Greece's EU partners.

 

The latest data suggests Greece's economy shrank around 2 percent over last year; that implies lower-than-expected tax revenues, hurting the government's efforts to slash the deficit. A deep recession could also make Greek public and private sector unions, which have embarked on a series of one-day strikes to protest against austerity measures, even less willing to accept wage and spending cuts mandated by the government.

 

In an effort to prevent speculation about an eventual debt default by Greece, EU leaders pledged at a summit on Thursday to take action "if needed" to protect financial stability in the euro zone -- an unprecedented undertaking to bail out a euro zone member if that proves necessary. But markets were disappointed by the vagueness of the pledge, which contained no details of what form the aid might take or when it might be disbursed.

 

The premium investors demand to hold 10-year Greek government bonds, rather than benchmark German Bunds, increased sharply on Friday to 302 basis points, from 275 bps late on Thursday. In addition to the lack of agreement between EU member states on how to handle Greece, one reason for the vagueness of the summit's declaration appeared to be disagreements between politicians and ruling parties within countries such as Germany.

 

Berlin worries that helping Greece financially would set a precedent, making it liable for any future bailouts of weak states in the south of the euro zone. In addition to Greece, markets have been speculating about Portugal and Spain.

 

Retail Sales Gain Ground

 

According to a Commerce Department report released on Friday, retail sales rose 0.5 percent as consumers stepped up spending not only on essential goods but luxury items as well. Optimism over the increase was tempered by a separate report showing that consumer sentiment ebbed slightly early this month.

 

Retail sales are being closely watched to determine whether consumers can sustain the economy's recovery once government stimulus and the boost from restocking by businesses wanes. Not only did the January sales increase come in above the expected 0.3 percent, but, sales data for December and November were revised upward as well. Compared to January last year, sales increased 4.7 percent.

 

Core retail sales, which correspond most closely with the consumer spending component of the government's gross domestic product, rose 0.8 percent after falling 0.3 percent in December. Consumer spending rose at a 2 percent annual rate in the fourth quarter.

 

A second report from the Commerce Department showed business inventories slipped 0.2 percent in December after rising 0.5 percent in November. The decline was smaller than the government had estimated when it released figures on fourth-quarter economic growth last month and, together with upward revisions to retail sales, would offset the negative impact on fourth-quarter GDP from a bigger than expected trade deficit.

 

Motor vehicle and parts purchases were flat last month, after rising 0.1 percent in December. Excluding motor vehicles and parts, retail sales rose 0.6 percent in January after slipping 0.2 percent the prior month.

 

Electronics and appliance stores saw a rebound in sales and consumers continued to splurge on sporting goods, hobby-related items, books and music last month. Sales at general merchandise stores rose 1.5 percent in January, the biggest gain since February 2009.

 

One Way Or The Other Says Volcker

 

Paul Volcker said his proposed banking rules would force Goldman Sachs and other banks to give up their bank charters if they want to continue proprietary trading.

 

"The implications for Goldman Sachs or any other institution is, do you want to be a bank?" Volcker, a former chairman of the Federal Reserve, told the Financial Times. "If you don't want to follow those (banking) rules, you want to go out and do a lot of proprietary stuff, fine, but don't do it with a banking license."

 

Last month, Obama proposed barring banks from betting in financial markets with their own money, known as proprietary trading. Called the "Volcker rule," the proposal aims to prevent banks from taking risks that drag them to the brink of failure. The proposal sent shares of major banks tumbling.

 

Goldman Sachs could be impacted by the Volcker rule because of its substantial proprietary trading operations. Goldman executives have repeatedly said they have no interest in shedding their bank charter.

 

Goldman and Morgan Stanley became bank holding companies in 2008 at the height of the financial crisis, giving them access to the Fed's emergency lending facilities but also subjecting them to greater regulatory scrutiny and new capital requirements.