MarketView for February 26

 

 

 

Summary 

 

Stock prices recovered a bit on Friday, with the key equity indexes ending their best monthly advance since November. On a day marked by light volume as Wall Street was buried in a snowstorm, the falling dollar also boosted the shares of exporters, who benefit from a weaker greenback.

 

Helping out was data indicating that the economy grew slightly more than initially thought in the fourth quarter. But a surprisingly sharp drop in existing home sales in January and weak consumer sentiment in February underscored the uneven nature of the economic recovery.

 

3M led the parade, gaining 0.5 percent to $80.15. JP Morgan Chase, another Dow component, rose 3.3 percent to $41.97. Healthcare stocks also ranked among the day's winners, with Cigna adding 1.2 percent to $34.26. A seven-hour healthcare summit on Thursday did little to budge Republican lawmakers on industry reform.

 

The Dow and the S&P 500 saw their best monthly gains since November, while the Nasdaq locked in its best advance since December. For February, the Dow was up 2.6 percent, while the S&P 500 was up 2.9 percent and the Nasdaq posted a gain of 4.2 percent. Nonetheless, all three indexes were down for the week, following two weeks of gains.

 

A snowstorm that began on Thursday and forced closures of schools and businesses across the Northeast kept a number of traders home, leading to light volume on Friday.

 

On the downside, American International Group closed down 10 percent to $24.77 after it reported a quarterly loss of $8.9 billion, hurt by an increase in its loss reserves and its efforts to repay loans from the U.S. government.

 

GDP Higher Than First Thought

 

According to a Commerce Department report released Friday morning, the economy grew at a rate greater than previously expected during the fourth quarter the Commerce Department reported on Friday. According to the Department’s report, the revised growth was 5.9 percent. However, the question now is whether that growth will continue into this year.

 

The fresh reading on the nation's economic standing was better than the government's initial estimate a month ago of 5.7 percent growth. It would mark the strongest showing in six years. Even so, it didn't change the expectation of much   slower economic activity in the current January-to-March quarter.

 

Roughly two-thirds of last quarter's GDP growth came from a burst of manufacturing — but not because consumer demand was especially strong. In fact, consumer spending weakened at the end of the year, even more than the government first thought.

 

Instead, factories were churning out goods for businesses that had let their stockpiles dwindle to save cash. If consumer spending remains lackluster as expected, that burst of manufacturing — and its contribution to economic activity — will fade.

 

The signs aren't hopeful. Consumer confidence took an unexpected dive in February. Unemployment stands at 9.7 percent. Home foreclosures are at record highs. And many Americans are still having trouble getting loans.

 

Forecasters at the National Association for Business Economics predict the economy will expand at only a 3 percent pace in the first quarter of this year. The next two quarters should log similar growth, they predict.

 

Unlike past rebounds driven by the spending of shoppers, this one is hinging more on spending by businesses and foreigners. Stronger spending by businesses and foreigners contributed to the bump-up in economic growth in the fourth quarter. So did the fact that companies stopped slashing their stockpiles of goods. During the worst of the recession, companies cut inventories at record rates.

 

Businesses increased spending on equipment and software at a sizzling 18.2 percent pace, the fastest in nine years. Foreigners snapped up our exports of goods and services, growing that sector by 22.4 percent pace, the most in 13 years. And the slower drawdown in businesses' stockpiles accounted for nearly 4 percentage points of the fourth-quarter's overall growth, even more than the government first estimated.

 

Consumers, however, lost energy. They increased their spending at a pace of just 1.7 percent, down from a 2.8 percent growth rate in the third quarter. Looking ahead, consumer spending is expected to aid the recovery and not lead it. That's one reason why the recovery is expected to move forward at only a moderate pace of around 3 percent in coming quarters.

 

In normal times, such growth would be considered respectable. But the nation is emerging from the worst recession since the 1930s. Sizzling growth in the 5 percent range would be needed for an entire year to drive down the unemployment rate, now 9.7 percent, by just 1 percentage point.

 

For all of this year, the economy is expected to grow 3.1 percent, according to the NABE forecasters. Though modest, that pace would mark a big improvement from 2009, when the economy contracted by 2.4 percent — the worst showing since 1946.

 

As government stimulus wanes and Federal Reserve economic-support programs end, the economy — especially the fragile housing market — could suffer. Economists say the odds of the economy sliding back into a recession this year are low, but they won't rule it out.

 

In appearances on Capitol Hill on Wednesday and Thursday, Federal Reserve Chairman Ben Bernanke said record-low interest rates are still needed to make sure the recovery becomes firmly rooted and to help ease high unemployment.

 

If gains from inventories and exports are taken out, the economy last quarter grew at just a 1.6 percent pace. And, improvements in the housing market also tailed off at the end of last year — despite massive government support.

 

There's worry inside and outside the Fed about how housing will fare once a homebuyer tax credit ends in the spring and the Fed stops a mortgage-securities buying program that has lowered mortgage rates and boosted sales.

Crude Prices Move Higher

 

The price of crude oil rose by about 2 percent to near $80 per barrel on Friday as higher than expected GDP growth during the fourth quarter helped revive lackluster sentiment. Sweet domestic crude for April delivery settled up $1.63 per barrel at $79.80 after falling $1.83 on Thursday. Brent crude for April settled up $1.42 per barrel at $77.71.

 

A weaker dollar also tends to support oil prices as it makes it cheaper for holders of other currencies. The oil markets have looked to equities and the broader economy for signs of a potential demand rebound as the world economy pulls out of recession. Doubts over the pace of the global recovery and fears that demand has peaked from industrialized nations have tempered optimism in oil markets, with the International Energy Agency (IEA) saying there is more downside risk to demand than upside.

 

Prices have traded in a range between $69 and $84 a barrel since last October, but $80 a barrel is being reinforced as a key resistance level. Prices edged over $80 per barrel to hit a six-week high of $80.51 per barrel on Monday but have since retreated.

 

Inventories of crude oil have increased at a higher rate than previously anticipated last week by 3 million barrels to reach a total of 337.5 million barrels in the week ending February 19, according to data from the Energy Information Administration.

 

Ample supplies have also lessened the market impact of geopolitical tensions over OPEC member Iran's uranium enrichment program. Israel lobbied the United States on Thursday to promote "crippling" sanctions against Iran to curb its nuclear program, but the Obama administration said it did not want to hurt the Iranian people.

 

All Is Not Peaceful at the Fed

 

Two top officials at the Fed offered up divergent signals on interest rates, with one arguing they should remain near zero for at least six months and another wanting to raise them "sooner rather than later." Chicago Federal Reserve Bank president Charles Evans reiterated the central bank's commitment to keep borrowing costs at exceptionally low levels for an extended period, which he defined as lasting three or four Fed meetings or at least six months.

 

"I still think it's going to be an extended period of time that interest rates are going to be low," Evans said. "It's a time of still too much uncertainty. Consumers are being very careful with the labor market situation," he said.

 

The comments echoed those of Federal Reserve Chairman Ben Bernanke who this week told Congress a weak job market and low inflation were likely to warrant exceptionally low rates for some time.

 

However, Thomas Hoenig, the head of the Kansas City Fed and an anti-inflation hawk, said he was worried the central bank's ultra-low rates policy carried some risks of its own. "I don't think it's necessarily in our interest to assure the markets that rates will be zero and they can play the yield curve, because while it has intended effects of assuring the markets that they can invest, it also invites and sometimes incites speculative activity and that's what we have to be careful of," Hoenig said. "One of the issues that I have dealt with is how do we bring interest rates back to a more long-term sustainable level from their extremely low and obviously unsustainable levels," he said.

 

The comments highlight the ongoing internal debate at the U.S. central bank. Bernanke said this he would like to see private demand pick up in the economy before policymakers can be certain the recovery is self-sustaining. One of the issues confronting Fed officials is whether credit markets can operate on their own. Investors have reacted relatively well to the expiration of some key Fed liquidity programs, but it is unclear whether an outright push toward tighter policy might derail the recovery.

 

The Fed is depending on healing financial markets to help support recovery from a painful recession. Evidence of lingering financial malaise will make it harder for policymakers to budge from easy money policies any time soon.

 

A financial conditions framework would likely be useful when evaluating the economic outlook and the conduct of monetary policy, New York Federal Reserve Bank President William Dudley said. "Developments in the financial markets became very important in the conduct of monetary policy," said Dudley, a former partner at Goldman Sachs.

 

Another top policymaker, Minneapolis Fed Bank President Narayana Kocherlakota said different disruptions in financial conditions call for different responses by policymakers. Central bankers might need to act differently in response to a drop in property values than they would if assets became less liquid, Kocherlakota said. No single financial conditions index can capture fluctuations among different types of strains, he argued.

 

Chicago's Evans said proposals to strip the Fed of its regulatory authorities could place it under pressure to use interest rates to curb risky activities.

 

The comments were part of a broader effort by regional Fed officials to convince a skeptical Congress not to remove the Fed's legal authority to regulate large banks. A measure in the Senate aimed at doing just that appeared to be losing momentum, with Richard Shelby, a prominent Republican senator and fierce critic of the Fed, telling reporters on Thursday he was warming up to the idea of allowing the Fed to continue acting as a regulator.

 

Senate Banking Committee Christopher Dodd on Friday echoed that message, telling Bloomberg television the Fed would "not necessarily" lose bank supervision powers, adding that there could be room for compromise.

 

James Bullard, head of the St. Louis Fed, joined the chorus of Fed pleas, arguing in a letter to top senators that the central bank's regulatory function was crucial to its mission as a guarding of financial stability.