MarketView for February 21

 

 

Summary 

 

Trading on the equity markets on Tuesday left the major indexes little changed on Tuesday, paring gains after the Dow Jones Industrial Average temporarily  breached 13,000 for the first time since May 2008, as higher oil prices damped prospects for the economy. Greece's securing a bailout to avoid a disorderly default provided some support to stocks, but the news had already been priced in. Fresh highs in oil prices crude futures, up 2.5 percent to a nine-month high of $105.84 per barrel, were mostly riding on concerns over Iran.

 

Since the start of the year, signs of improvement in the economy and stabilization of Europe's debt crisis have driven the Dow up 6.1 percent, while the S&P has climbed 8.3 percent. On Tuesday, the Dow briefly made it above the psychologically key 13,000 number. The S&P 500 ended within two points of the closing high from April 29.

 

Wal-Mart was the biggest drag on the Dow, sliding after its quarterly profit came in short of expectations. Wal-Mart ended the day down 3.9 percent to close at $60.07, erasing most of the stock's gains so far in 2012.

 

The national price of gasoline climbed to $3.59 a gallon in the latest week, the Energy Information Administration said. That did not hurt Chevron whose shares ended the day up 1.6 percent to close at $108.41, giving the Dow its largest boost.

 

Euro zone finance ministers agreed on a 130 billion euro ($172 billion) rescue for Greece to avert a chaotic default after forcing Athens to commit to unpopular cuts and private bondholders agreed to take bigger losses. Even with the bailout, Greece faces a long road to economic recovery. European Union officials said the Greek economy will only return to growth in 2014 after a recession that will shrink output by 17 percent.

 

Some of the day’s better performers included Home Depot, up 0.4 percent at $46.92 after the home improvement chain's quarterly earnings exceeded estimates. Macy's added 1.2 percent to its share price, ending the day at $36.69 as the department store chain posted higher earnings and forecast increased sales this year. Kraft Foods closed up 1.5 percent at $38.57 after the company forecast earnings growth of at least 9 percent this year even as it prunes its portfolio of North American brands.

 

Apple ended the day up 2.5 percent to close at $514.85 after the U.S. International Trade Commission ruled the iPhone maker did not infringe patented technology owned by Android phone manufacturer HTC Corp.

 

After the closing bell, Dell forecast fiscal first-quarter revenue below Wall Street's expectations, sending its share price down 4.7 percent to $17.36 in after-hours trading. Intuit rose 2.9 percent to $59.21 after reporting a rise in quarterly revenue and earnings.

 

Approximately 6.7 billion shares changed hands on the three major exchanges Tuesday, a number that was slightly below the daily average of 7 billion shares.

 

Greek Bailout Done

 

Euro zone finance ministers agreed a 130-billion-euro ($172 billion) rescue for Greece on Tuesday to avert an imminent chaotic default after forcing Athens to commit to unpopular cuts and private bondholders to take bigger losses.

 

The complex deal wrought in overnight negotiations buys time to stabilize the 17-nation currency bloc and strengthen its financial firewalls, but it leaves deep doubts about Greece's ability to recover and avoid default in the longer term.

 

After 13 hours of talks, ministers finalized measures to cut Athens' debt to 120.5 percent of gross domestic product by 2020, a fraction above the target, securing a second rescue in less than two years in time for a major bond repayment due in March.

 

"We have reached a far-reaching agreement on Greece's new program and private sector involvement that would lead to a significant debt reduction for Greece ... to secure Greece's future in the euro area," Jean-Claude Juncker, who chairs the Eurogroup of finance ministers, told a news conference.

 

Greece will be placed under permanent surveillance by an increased European presence on the ground, and it will have to deposit funds to service its debt in a special account to guarantee repayments.

 

The 5 a.m. deal was hailed as a step forward for Greece, but experts warned that Athens will need more help to bring its debts down to the level envisaged in the bailout and will remain worryingly "accident prone" in coming years.

 

By agreeing that the European Central Bank would distribute its profits from bond-buying and private bondholders would take more losses, the ministers reduced Greece's debt to a point that should secure funding from the International Monetary Fund.

 

Italian and Spanish bond yields fell amid relief among investors that a threat to the wider euro zone had been avoided, although expectations of an agreement had been largely priced into foreign exchange and stock markets.

 

"It's an important result that removes immediate risks of contagion," Italian Prime Minister Mario Monti told a news conference.

 

"A nightmare scenario was avoided," said Greek Finance Minister Evangelos Venizelos in Athens. "It is maybe the most important deal in Greece's post-war history."

 

While the deal provides time for the euro zone to put new crisis measures in place over the coming months, it means Greece will struggle for years without economic growth. The austerity measures imposed on Athens are widely disliked among the population and will put pressure on politicians who must contest an election expected in April. And further street unrest could test politicians' commitment to cuts in wages, pensions and jobs. Greece's two biggest labor unions called a protest in Athens on Wednesday.

 

An opinion poll taken just before the Brussels deal showed that support for the two mainstream parties backing the rescue had fallen to an all-time low while leftist, anti-bailout parties showed gains. Conservative leader Antonis Samaras, a strong contender to become next prime minister, said the rescue package's debt-reduction targets could only be met with economic growth.

 

"Without the rebound and growth of the economy ... not even the immediate fiscal targets can be met, nor can the debt become sustainable in the long-term," he said during a visit to Cyprus.

 

Parliaments in three countries that have been most critical of bailouts - Germany, the Netherlands and Finland - must now approve the package. German Finance Minister Wolfgang Schaeuble, who caused an outcry by suggesting that Greece was a "bottomless pit," said he was confident it would be passed.

 

Many economists question whether Greece can pay off even a reduced debt burden, suggesting the deal may only delay a deeper default by a few months.

 

Swedish Finance Minister Anders Borg said: "What's been done is a meaningful step forward. Of course, the Greeks remain stuck in their tragedy; this is a new act in a long drama.

 

"I don't think we should consider that they are cleared of any problems, but I do think we've reduced the Greek problem to just a Greek problem. It is no longer a threat to the recovery in all of Europe, and it is another step forward."

 

A return to economic growth in Greece could take as much as a decade, a prospect that brought thousands onto the streets of Athens to protest on Sunday. The cuts will deepen a recession already in its fifth year, hurting government revenues.

 

A report prepared by experts from the European Union, European Central Bank and International Monetary Fund said Greece would need extra relief to cut its debts near to the official debt target given the worsening state of its economy. If Athens did not follow through on economic reforms and savings to make its economy more competitive, its debt could hit 160 percent by 2020, said the report.

 

"Given the risks, the Greek program may thus remain accident-prone, with questions about sustainability hanging over it," the nine-page confidential report said.

 

Dutch Finance Minister Jan Kees de Jager, one of Athens' most strident critics, told Dutch news agency ANP he had bargained hard for the permanent monitoring mission. "This program is not something to cheer about," he said.

 

The accord will enable Athens to launch a bond swap with private investors to help put it on a more stable financial footing and keep it inside the euro zone. About 100 billion euros of debt will be written off as banks and insurers swap bonds they hold for longer-dated securities that pay a lower coupon.

 

Private sector holders of Greek debt will take losses of 53.5 percent on the nominal value of their bonds. They had agreed to a 50 percent nominal write down, which equated to around a 70 percent loss on the net present value of the debt. Greece said it would legislate to allow it to enforce losses on bondholders who do not take part voluntarily.

 

Euro zone central banks will also play their part. A Eurogroup statement said the ECB would pass up profits it made from buying Greek bonds over the past two years to national central banks for their governments to pass on to Athens "to further improve the sustainability of Greece's public debt."

 

The ECB has spent about 38 billion euros on Greek government debt with a face value of about 50 billion euros.

 

The private creditor bond exchange is expected to launch on March 8 and complete three days later, Athens said on Saturday. That means a 14.5-billion-euro bond repayment due on March 20 would be restructured, allowing Greece to avoid default.

 

The vast majority of the funds in the program will be used to finance the bond swap and ensure Greece's banking system remains stable; some 30 billion euros will go to "sweeteners" to get the private sector to sign up to the swap, 23 billion will go to recapitalize Greek banks.

 

A further 35 billion or so will allow Greece to finance the buying back of the bonds. Next to nothing will go directly to help the Greek economy.

 

Has Anybody Noticed Small Cap Stocks

 

What if a major stock index jumped to an all-time high, but most investors didn't notice? That's the awkward situation the Russell 2000 index of small-capitalization stocks could find itself in. The broad cross-section of smaller U.S. companies is up an eye-popping 36 percent since early October.

 

Despite Friday's slip of 0.2 percent, to 828.68, the Russell 2000 is just 4.2 percent below the record high of 865.29 it hit last April. The blue-chip Dow Jones Industrial Average isn't far behind, off 8.6 percent from its record high in October 2007.

 

But the Russell's record run has had a tough time attracting new believers in small-cap stocks. Small-cap mutual funds have suffered an exodus of $15.9 billion since the end of April, according to Morningstar. Assets at U.S. small-cap exchange-traded funds are down by $4.4 billion.

 

So what explains the Russell 2000's ascent? As with other U.S. stock classes, few investors these days are actively trading small-cap stocks, which typically have a market value of about $2 billion or less.

 

Trading volumes on Wall Street have been light for months, hedge funds and investment banks have pared down their trading operations, and the small investors that exited the market after the 2008 financial crisis are hesitant to jump back in-least of all to the riskier small stocks that make up the Russell. As a result, the few remaining investors and traders are having an outsize impact on small-cap share prices amid the recent improvement in the U.S. economy.

 

Prices for small-cap stocks tend to move more dramatically than larger stocks, in part because they are smaller, less liquid and more sensitive to changes in economic performance. So the market's overall rise has been especially good for small stocks. Smaller companies also are generally less exposed to Europe's debt crisis and fears of a sharp slowdown in China.

 

But the air is starting to get thin. Because of the Russell 2000's surge, the small-cap index now trades at about 18.2 times forward per-share earnings, according to data from investment manager Heartland Funds. That is 43 percent higher than the S&P 500's price-to-earnings ratio of 12.7. Historically, the Russell has traded at a premium of about 30 percent to the Standard & Poor's 500-stock index.

 

Other warning signs include technical indicators that suggest small-cap stocks might have run up too fast. Some are also concerned that small-cap stocks could suffer down the road should the Federal Reserve ease off on its low-interest-rate policy, which has pushed investors into riskier assets like commodities and small-cap stocks.

 

All of that has some investors worried that the powerful rally could reverse itself sharply.

 

However, there is little to fear. Because many of these companies get most of their revenue from the U.S., they should be attractive to global investors looking for havens as long as the U.S. economy doesn't stumble, these investors contend.

 

Oil Prices Continue to Rise

 

Oil prices remained above $104 Tuesday but retreated from recent highs after European leaders agreed to lend Greece euro130 billion ($172 billion) to avoid a debt default. By early afternoon in Europe, benchmark crude was up $1.33 to $104.57 per barrel in electronic trading on the New York Mercantile Exchange. On Monday it traded at $105.44, the highest since May. The contract last settled on Friday when it rose 93 cents to $103.24 per barrel in New York. In London, Brent crude was down 23 cents at $119.82 per barrel on the ICE Futures exchange

 

European Union officials agreed early Tuesday to hand Greece a second massive bailout to help save it from bankruptcy. Private bondholders will take a 53.5 percent loss on their holdings which, along with tough austerity measures, is hoped will lower Greece's debt level to about 120 percent of gross domestic product.

 

Crude is up from $96 earlier this month and $75 in October as signs of an improving U.S. economy bolstered investor confidence. However, analysts are concerned higher fuel costs could stifle consumer spending and undercut economic growth.

 

Prices were also boosted by the psychological effects of Iran's Monday announcement that it would cut off oil shipments to France and Britain in retaliation for an EU embargo taking effect in July over Tehran's disputed nuclear program.

 

In other energy trading, heating oil added 1.02 cents to $3.1991 per gallon and gasoline futures rose 1.79 cents to $3.2055 per gallon. Natural gas slid 6.3 cents to $2.621 per 1,000 cubic feet.

 

Fed’s Message Lost in Politics

 

In mid-2011, with the U.S. economy at risk of a new recession, top Federal Reserve officials began to explore a different way to shore up the recovery: looking for fixes for the battered housing market. The central bank had just wrapped up $2.3 trillion in bond purchases in an unprecedented attempt to snap the United States out of its economic blues.

 

But its efforts were being frustrated. With nearly one in four Americans owing more on their mortgages than their homes were worth, millions remained locked out of credit markets and unable to reduce the cost of their loans. The Fed's board in Washington gathered a task force of around 30 staff and put them to work far from the public gaze on ways to turn around the worst housing slump in generations.

 

More than six months later, the central bank surprised lawmakers with a string of proposals, including deploying the firepower of the massive U.S. housing finance agencies Fannie Mae and Freddie Mac to help struggling homeowners.

 

However, rather than spurring fresh debate among decision-makers in Washington on how to fix the housing market, the Fed put itself in the sights of Republicans angry at what they saw as election-year meddling, an intrusion on Congress' turf and a veiled attempt to further the Obama administration's agenda.

 

"I was truly taken aback when just recently, as you know, the Fed issued an unsolicited white paper ... on housing policy where, if you didn't advocate for, you certainly mirrored much of the positions of this administration," Republican Representative Scott Garrett told Fed Chairman Ben Bernanke.

 

"Why would you issue such a paper when we don't ask for it?"

 

Bernanke was in an uncomfortable spot, and he issued what amounted to a rare public apology at the February 1 hearing.

 

"We were trying to provide pros and cons, analysis, background -- I'm sorry if you think we went too far," he said.

 

Fed officials were taken aback by the hostile reaction. They say they intended their work to be a good-faith effort to pinpoint policy changes that could help the shell-shocked economy. The 33 percent plunge in U.S. house prices since 2006 has wiped out an estimated $7 trillion in wealth.

 

Their political miscalculation may have undermined one of their main hopes: building bipartisan consensus around ideas that could get the housing market off the ropes. In other words, the Fed ran headlong into a culture clash between its own cerebral, deliberative norms and the sound-bite driven, polarized election-year political environment on Capitol Hill.

 

The interest-rate sensitive housing sector usually helps lead economic recoveries, but this time was different. Two years after the economy bottomed out, even with interest rates around record lows, housing remained in the tank.

 

As Fed officials studied how long it took for credit to recover after recessions, they were struck by parallels between the residential mortgage markets of today and the commercial mortgage markets that went bust in 1991. Then, it took 10 years to achieve a full recovery.

 

Bernanke, first appointed by Republican President George W. Bush, is acutely aware of the risks to the Fed's independence from appearing to take political sides. He had already drawn political fire for bailing out banks during the financial crisis, and for courting inflation and veering into fiscal policy with the Fed's bond buying.

 

Republicans viewed the housing white paper as another instance of Fed overreach.

 

Among other ideas, the central bank suggested that Congress and regulators could expand the scope of government-run Fannie Mae and Freddie Mac to help more homeowners refinance. The firms have already been propped up with $169 billion in taxpayer aid, making them a target of fierce criticism from Republicans angry at the government's role in the economy.

 

The agencies would likely have to accept more near-term losses as the cost of fostering a stronger housing recovery but they would eventually benefit, the Fed said.

 

"The unveiling of your staff's housing white paper ... treads too far into fiscal policy, and runs the risk of being perceived as advocacy for particular policy options," Republican Senator Orrin Hatch wrote to Bernanke.

 

Bernanke stressed that the white paper - one of only a handful the Fed has produced in recent years - was drawn up in response to inquiries from Capitol Hill and elsewhere.

 

Last October, at a closed-door meeting with Senate Democrats, Bernanke was pressed on housing. He told lawmakers the central bank would likely soon have ideas to share, according to two senators he spoke with.

 

The release of the report, however, took months as it got caught in the Fed's internal vetting process. Bernanke paid careful attention to every detail, and penned his own letter to attach to the paper.

 

Former Fed Governor Mark Olson said the central bank likely felt a duty not only to dig into what was holding back a housing recovery, but also to share its findings.

 

"When you've assembled research like that, it has limited value if you keep it to yourself. The value is putting it out for public discussion and hopefully implementation," he said.

 

Fed Governors Elizabeth Duke and Sarah Raskin oversaw the effort. Duke, a Bush appointee, was a former community banker who had seen what could happen when banks became saddled with foreclosed properties. Raskin, appointed by Obama, was a former state banking regulator who had focused on mortgage servicing issues since joining the Fed.

 

An assistant director of research at the Fed, Karen Pence, led the group of staff which combined economic and regulatory skills. Pence had studied the rise in mortgage defaults and investigated subprime mortgages in two papers published in 2009.

 

"We as a nation currently have a housing market that is so severely out of balance that it's hampering our economic recovery," Duke told a Fed housing conference in September.

 

In her remarks, which aired some of the proposals eventually included in the white paper, she called for eliminating the obstacles that were preventing millions of homeowners from refinancing into cheaper mortgages, a signal of support for an Obama administration plan to revamp the government's main refinancing initiative.

 

She also suggested making it easier for Fannie Mae and Freddie Mac - which along with the Federal Housing Administration own about half of all foreclosed properties in the United States - to convert those units into rentals, an approach the Obama administration was already considering.

 

Other officials had begun to consider bolder and more controversial steps.

 

New York Fed President William Dudley was getting an earful from business leaders during trips in the region about how housing was weighing down local economies. After a trip to the Hudson Valley towns of New Paltz and Fishkill, Dudley ordered his staff to mount a full-court press on housing last spring.

 

Aware the Fed was studying converting bank-owned properties into rental units, Dudley had his researchers focus on other questions, including the more radical possibility of chopping the amount of outstanding debt owed by some homeowners. That idea, which is anathema to many conservatives, has been credited as one of the issues that spawned the Tea Party.

 

But it was another policymaker, Fed Governor Daniel Tarullo, who revealed the depths of the central bank's concerns. "Housing continues to hang like an albatross around the necks of homeowners and the economy as a whole," he said in October. Tarullo said it was time for the central bank to consider buying more mortgage-backed bonds to lower mortgage rates as it had done in 2009 and 2010.

 

When the Fed sent its white paper to Congress on January 4, it identified three key housing market weak spots: far too many vacant homes, tight credit and the often slow process for foreclosing upon borrowers unable to pay their mortgages.

 

Its panoply of policy options included the idea of renting bank-owned properties that Duke had discussed, as well as the controversial proposal of allowing Fannie Mae and Freddie Mac to refinance loans they had not backed.

 

As the white paper's release roiled the political waters, Dudley went a step further. Two days after its publication, he went public with a call for Fannie Mae and Freddie Mac to cut the size of loans for homeowners who owed more than their homes are worth but who had kept up with their payments. It was a proposal that was not only deeply opposed by Republicans but one which the regulators of the massive finance firms had already rejected out of concern it would drive up further the cost of their bailout by taxpayers.

 

Dudley rebutted a central argument of some conservatives: that loan forgiveness would bail out irresponsible borrowers. "The problem was that these purchases occurred near the peak in the market and now many of the buyers have suffered an adverse life shock such as unemployment or illness ... this is just the bad luck associated with the timing of the purchase and an exceptionally weak jobs market," he said.

 

"Punishing such misfortune accomplishes little."

 

On the same day, Duke also pressed the case laid out in the white paper, and suggested the regulator for the two government-sponsored enterprises (GSEs), the Federal Housing Finance Agency, was being short-sighted.

 

"Policymakers should at least consider policies that take into account the role the GSEs could play in hastening the healing of the housing market rather than focusing entirely on minimizing losses to the GSEs," she said.

 

The timing of the paper and the calls for action were politically jarring given that the White House, with an eye on November's elections, was on the verge of launching its own latest efforts to help the housing market escape its morass.

 

The negative reaction was swift.

 

"This extraordinary political intrusion ... is a clear attempt to provide intellectual cover for politicians to spend more taxpayer money to support housing prices," the Wall Street Journal said in an editorial.

 

Pressed at his congressional hearing on why Duke and Dudley were effectively advocating for specific policy positions, Bernanke distanced the Fed from their remarks, saying they were simply presenting their personal points of view.

 

However, Bernanke has not given up on pressing the case for action. On February 10, he called again on Congress and regulators to consider steps to help spur a stronger housing recovery, although he offered no specifics and avoided discussing the more politically controversial white paper suggestions.

 

Some Fed officials have said that if the central bank sees the need to provide further, direct help to the economy, it might buy more mortgage-backed bonds.

 

Wal-Mart’s Bottom Line Shrinks

 

Wal-Mart's price cuts hurt its fourth-quarter earnings number and it plans to trim prices further in the coming months, a move that is expected to keep shrinking margins. The company's shares, up more than 29 percent since August, fell 4.2 percent in early trading, erasing the gains seen so far in 2012.

 

Wal-Mart's quarterly profit and sales fell short of Wall Street expectations. While price cuts helped bring in more customers during the crucial holiday season, those customers did not spend as much as investors had hoped.

 

Wal-Mart has been lowering prices and bringing back a wider variety of items to woo shoppers on limited budgets who started to shop at dollar stores and elsewhere. Traffic at those stores rose after six quarterly declines, showing that such efforts, as well as bringing back a holiday layaway plan, brought in shoppers.

 

Wal-Mart posted a 1.5 percent increase in sales at stores open at least a year. It was the second quarter in a row that same-store sales rose after nine consecutive quarterly declines. The expectation had been for an increase of 1.8 percent. Domestic same-store sales were expected to be flat to up 2 percent, compared with a 1.8 percent drop a year earlier.

 

Operating income growth at Wal-Mart grew at a slower rate than sales. Gross profit margin declined 13 percentage points at Wal-Mart and 33 percentage points overall as the company cut costs and pushed those savings into lowering prices.