MarketView for January 3

 

 

Summary

 

Wall Street kicked off the New Year with a bang on Monday as the major equity indexes rocketed upward with about 7.7 billion shares traded on the New York Stock Exchange, the American Stock Exchange and the Nasdaq. An encouraging economic outlook for manufacturing around the world was a key reason for the positive nod from the Street. Worldwide economic data set the day’s tone, helping the Dow Jones industrial average and S&P 500 indexes reach new two-year highs, while the Nasdaq 100 index closed at its highest point in nearly 10 years.

 

Financials led the way with Bank of America closing up 6.4 percent at $14.19, after it agreed to pay $2.8 billion to mortgage finance giants Fannie Mae and Freddie Mac to settle claims over soured mortgages.

 

And then there was the "January effect" when the institutions are no longer engaged in year-end window dressing and instead focus on stocks they find attractive. Therefore, it is said that historically, a strong first day sets the tone for the market's performance for the remaining part of the year.

 

Based on data since 1945, if the S&P 500 is up on the first trading day of the year, it ends the year higher 74 percent of the time, with an average annual gain of 10.6 percent. If stocks end the month of January higher, then 73 percent of the time the index rises for the year, based on data since 1929.

 

U.S. stocks ended 2010 with double-digit gains, and the S&P 500 recorded its best December since 1991. The gains marked a recovery to September 2008 levels before the fall of Lehman Brothers.

 

The economic data indicated that the manufacturing sector grew for a 17th straight month in December, while construction spending increased in November to its highest level since June. The global outlook also was bolstered after data showed China's factory inflation cooled in December, while manufacturing in Europe accelerated.

 

The Nasdaq 100's gain was driven largely by Apple, which closed up 2.2 percent at $329.57. Oppenheimer raised its estimates and price target on company. It was the highest close for the index since February 2001.

 

Alcoa gained 2.7 percent to $15.80 after Deutsche Bank upgraded the stock.

 

Crude at 27-Month High

 

Oil prices rose to a 27-month peak on Monday as upbeat global manufacturing data and forecasts for cold weather reinforced optimism about economic and energy demand growth. Manufacturing in the United States and Europe accelerated in December and growth in China and India slowed to a more sustainable level, helping to fuel a move by investors into riskier assets.

 

Sweet domestic crude oil for February delivery settled up 17 cents per barrel at $91.55 per barrel, its highest settlement price since early October 2008, after earlier rising as high as $92.58. In London, ICE Brent crude for February rose 9 cents to settle at $94.84 a barrel, also the highest close since October 2008. Crude oil futures built on their end-of-year rally that left prices up 15 percent for 2010.

 

However, crude oil prices pulled back late in the open outcry session after the Interior Department said it will allow 13 companies to resume deep water drilling in the Gulf of Mexico without an additional environmental review.

 

Strong U.S. heating oil and ICE gas oil futures helped spark the oil futures complex strength, boosted by expectations more freezing weather is on tap for later in January. Total U.S. crude futures trading volume, thinned by the holiday season, was above 396,000 lots with 1-1/2 hours left in post-settlement trading. The 30-day average was 543,282.

 

Total U.S. heating demand this week was expected to be only 0.5 percent above normal, the U.S. National Weather Service said, and heating oil demand 4.3 percent below normal.

 

While oil prices are pushing toward $100 a barrel three years after crude first broke triple digits, analysts say spare production and refining capacity should prevent a repeat of the 2008 run up to $147 a barrel. Analysts believe that OPEC members, especially Saudi Arabia, would likely step in and add production to ensure the economic recovery is not derailed.

 

U.S. crude futures remain in a stubborn contango, whereby prompt oil is cheaper than barrels for later delivery, a market condition that encourages storage. The spread between front-month February and March crude futures had the premium for March crude as high as $1 intraday on Monday. It is possible that positions being rolled into the March contract may have helped curb the gains of front-month futures.

 

Crude Will Not Follow Path of 2008

 

Nearly three years to the day after oil prices first pierced $100 a barrel, they are again threatening to break triple digits on a wave of fund-led optimism, but similarities between 2008 and 2011 end there. Some of the reasons include the fact that oil companies are stepping up spending plans before supply reaches a crisis point; resource nationalism has eased; the dollar has firmed; and concerns that oil production is near peaking have subsided.

 

By far the most compelling reasons, however, are short-term supply fundamentals: There is far more oil in storage, far more fuel capacity at refiners worldwide, and far more idle oil wells that OPEC can reactivate when it chooses, braking the market's rally in a way it could not three years ago.

 

At the same time consumer nations have since built up crude inventories, with stockpiles from members of the Organization for Economic Co-operation and Development now has 60 days of inventory, compared with 53 days in 2008.

 

Oil demand growth jumped 2.2 million barrels per day (bpd) in 2010, the biggest rise in six years, and forecasts are for an additional 1.5 million bpd of use in 2011. Although those gains will increase consumption to beyond the previous record high in 2007, supply has risen far more during the recession after a host of multibillion-dollar projects came to fruition.

 

Members of the Organization of the Petroleum Exporting Countries currently hold 5 million to 6 million bpd of spare oil production capacity to draw on, up to three times the amount the group had at the lowest point in 2008, primarily from top exporter Saudi Arabia. While it is debated as to what price, or under what conditions, OPEC would willingly begin pumping more crude, there is little doubt that doing so would douse prices. In 2008, OPEC said it was effectively pumping flat out.

 

Saudi Oil Minister Ali al-Naimi, OPEC's most influential member, in December reiterated he preferred prices between $70 and $80 a barrel, below current $89 levels and the 26-month peak near $92 hit earlier in the month.

 

And while supply from outside the group is set to rise a marginal 400,000 bpd this year, about one-third the rate of 2010, there have been a host of more positive signs of late. In 2008, non-OPEC output actually fell by nearly 400,000 bpd.

 

Globally, energy companies are expected to raise exploration spending 11 percent this year to the highest level in 25 years, according to a Barclays Capital forecast. That could prevent the kind of upstream supply crunch that resulted from a reluctance to invest five years ago.

 

Further support for non-OPEC production has come from the slower decline of mature fields like Mexico's giant Cantarell, while discoveries in deepwater off Brazil have added some 26 billion barrels of exploitable reserves -- enough to fuel the entire world for about 10 months.

 

Any shortfall in 2011 could also be met by projected higher output from OPEC members such as Nigeria and Iraq, which has no formal production ceiling like other members and expects to add about 400,000 bpd of output during the year, analysts said.

 

The fury of fresh speculative money into oil from investors eager to cash in on the commodities rally that started in 2002 has also been widely blamed for oil's 2008 record run.

 

Similarly speculators, excited by the prospect of higher fuel consumption as the economy recovers, hit a record net long position in December for crude contracts on the New York Mercantile Exchange. However, investors interested in energy and commodities have become more sophisticated since 2008 when many poured cash into simple, long-only funds.

 

Markets now enjoy the largest volume of spare refining capacity in 10 years due to investments in emerging economies such as India, after the buffer narrowed sharply leading up to 2008, stirring concerns about shortfalls.

 

Refiners have also invested in more sophisticated units, allowing them to run a wider variety of crude grades to make the higher quality, lower sulfur products mandated in the United States and Europe. Companies were forced to scramble for better quality crude in 2008 to meet specifications, adding upward pressure to prices.

 

The drop in demand caused by the recession also left nearly 1.4 million bpd of capacity shutdown due to refinery closures at the start of 2010, although some plants are now in the process of being restarted as demand picks up. Even with so many cushions in place, many experts still expect oil to climb higher in 2011 -- just not so spectacularly.

 

Gold Prices Fall

 

Gold closed slightly lower on Monday, easing after an early rally to within $10 of its record, as signs of manufacturing growth prompted selling. Silver also retreated from a 30-year high as an early rally fizzled on the first trading day of 2011.

 

Safe-haven demand for bullion weakened after data indicated that manufacturing grew for a 17th straight month in December. Meanwhile, other recent economic data has indicated that economic growth will likely accelerate further in 2011.

 

Gold futures for February delivery settled up $1.50 an ounce to $1,422.90. COMEX gold volume totaled about 71,000 lots, nearly 60 percent below its 30-day average. As the New Year gets underway, expectations for more bad news on euro zone debt, concerns over potential inflation in developing economies and an increased focus on our deficit could enable the demand for gold and it price to continue upward.

 

These worries can work both ways for gold. A weaker euro, and consequently stronger dollar, typically pressures gold prices, but concerns over sovereign debt are set to support demand for the metal as a haven from risk.

 

The strong inverse relationship between gold and the dollar weakened to such an extent last year that gold prices managed to rise nearly 30 percent at the same time that the dollar rose more than 6.5 percent against the euro.

 

Republicans Want To Starve Financial Reform

 

Republicans in the new Congress could put the budget squeeze on two powerful regulatory agencies to slow President Barack Obama's crackdown on Wall Street. A Democratic-controlled Congress pushed through the Dodd-Frank bank reform laws last year and regulators were counting on a large budget increase to police the $600 trillion over-the-counter derivatives market -- blamed for much of the excess behind the 2007-2009 financial crisis.

 

However, the last Congress failed to deliver on the funding, and that will be even harder to obtain with Republicans taking control of the House of Representatives and increasing their rolls in the Senate.

 

Republican say they want to review the expansion plans of regulators. "Once you turn the money loose, it's a little harder to stop that train," said Representative Randy Neugebauer of Texas, who will head the House Financial Services oversight subcommittee.

 

Before lawmakers agree to dole out funds for the Securities and Exchange Commission and the Commodity Futures Trading Commission, Republicans want more time to study whether the spending is warranted, Neugebauer told Reuters.

 

The delay could give a reprieve to big Wall Street players ranging from Goldman Sachs to BlackRock who, through their lobby groups, have been pressing regulators to slow their furious pace to impose a new rule book on the financial sector called for by the reform law.

 

Republican Representatives Spencer Bachus, the incoming chairman of the financial services committee, and Frank Lucas, the incoming chairman of the agriculture committee which oversees the CFTC, also wrote to regulators urging delay in the rules-making process.

 

"An overarching concern ... is the need to get it done right, not necessarily get it done quickly," they said.

 

The SEC was expecting an increase of 18 percent to its budget for fiscal 2011, which began on October 1, to begin hiring the 800 new employees it needs to enforce the Dodd-Frank law, named after the Democrats who negotiated the reforms, Senator Christopher Dodd and Representative Barney Frank.

 

But lawmakers have so far been unable to agree on overall government funding, and have held the government's budget static at 2010 levels, until at least March.

 

"We will have to take some more steps to cut back," SEC Chairman Mary Schapiro said in an interview last month. "At this stage, it will impact our work.

 

The CFTC, chronically underfunded and understaffed, was looking for a 50 percent increase to its budget, which included plans to hire about 240 people in 2011 to begin enforcing its new oversight of the swaps market.

 

"We may not get more dollars, so what are we going to do next? What's our Plan B?" said Scott O'Malia, a Republican commissioner on the CFTC, in an interview on Monday.

 

Chairman Gary Gensler has said the CFTC will need to hire at least another 160 people in fiscal 2012. Obama will make his budget request for the upcoming fiscal year in February.

 

The CFTC and SEC have been working flat-out to write more than 100 technical regulations required to implement Dodd-Frank. Regulators, however, are not expected to rein in the initial design of their rules due to the current funding squeeze.