MarketView for January 14

 

 

Summary

 

The S&P 500 managed to chalk up its seventh consecutive week of positive numbers with a rally led by the banking sector amid healthy volume after encouraging financial results from JPMorgan. Approximately 8.1 billion shares traded on the major exchanges, a number that was only slightly less than last year's estimated daily average of 8.47 billion shares.

 

The financial sector helped to offset economic reports that showed soft December retail sales and consumer sentiment that was down somewhat due to rising gasoline prices. Looking ahead into next week, the market's resilience will be tested when a number of banks report results.

 

However, if JPMorgan Chase is any indication of what we can look forward to then next week should be one for the record books. JPMorgan’s shares added 1 percent to close at $44.91 after the banking giant reported stronger-than-expected fourth-quarter earnings. Its stock is up 5.9 percent in the first two weeks of the year.

 

For the week, the Dow Jones industrial average is up 1 percent, the S&P 500 is 1.7 percent higher and the Nasdaq composite chalked up a gain of1.9 percent. The financial markets will be closed on Monday for Martin Luther King Jr. Day.

 

The S&P Midcap 400 index broke its all-time closing record, rising 0.7 percent to 931.07. The index includes companies with market capitalizations of about $750 million to $3.3 billion.

 

Higher gasoline prices helped send December consumer prices up at the fastest pace in a year and a half. At $3.09 a gallon, gasoline is the highest since October 2008. Consumer spending noticeably slowed in 2008 as gasoline prices spiked. The high gas price also weighed on consumer sentiment in early January, according to a Reuters/University of Michigan survey.

 

Intel, a component of the Dow, fell 1 percent to $21.08 a day after it posted better-than-expected quarterly earnings and forecast strong revenue for the coming quarter. For the third consecutive quarter, shares of the chipmaker moved in the opposite direction of the S&P 500 a day after it reported earnings, casting a shadow over the chipmaker's long-standing ability to influence the market.

 

Economic News Remains Positive

 

According to a report released on Friday by the Commerce Department, the economy closed out 2010 on a softer note than expected, with rising gasoline prices eroding consumers' purchasing power in December even as the higher prices helped lift retail sales. Retail sales rose 0.6 percent last month, the Department announced on Friday. The sixth straight monthly increase showed consumers doing their part to support recovery, even though the data was a bit weaker than had been forecast by economists.

 

A separate report on Friday from the Federal Reserve indicated that industrial output rose 0.8 percent in December, the largest gain since July, as a cold weather snap pushed utility production sharply higher.

 

A rise in gasoline prices last month helped lift the Consumer Price Index by 0.5 percent, the largest gain in 1-1/2 years, although prices gained just 0.1 percent excluding volatile food and energy costs, the Labor Department reported on Friday.

 

The rise in gasoline prices weighed on consumer sentiment, while another report showed business inventories grew much less than expected in November as sales kept up a strong pace.

 

The seemingly overwhelming supply of economic data appeared to be in line with other recent signs that the domestic economy strengthened somewhat in the final months of the year, although the pace of growth fell short of what is needed to make a big dent in unemployment.

 

In December, sales declined at electronics and general merchandise stores, but those drops were offset by increases in sales of gasoline, building materials and automobiles. Sales for all of 2010 reversed two years of contraction with the biggest gain in more than a decade.

 

A strengthening of global demand, especially in fast-growing emerging economies, has lifted commodity prices and has led to a quickening in U.S. overall inflation. The 1.6 percent increase in gasoline station sales last month reflected the rise in prices at the pump. Average gas prices rose about 20 cents in December to $3.05 a gallon.

 

That increase chilled consumer sentiment in January and raised inflation expectations, according to the Thomson Reuters/University of Michigan survey. However, optimism on the future rose.

 

Overall consumer prices rose 1.5 percent from the same month a year ago, while core consumer prices gained 0.8 percent in 2010, the slowest calendar year increase on record dating to 1958.

 

Fed Not Ready to Change Policy

 

The U.S. economy needs a far better footing before the Federal Reserve reverses its current policy, and even more stimulus may be needed if the housing market hampers the rebound, a top Boston Federal Reserve Bank President Eric Rosengren said on Friday.

 

Rosengren, in his first speech of the year, again endorsed the Fed's QE2 bond-buying program as a way to boost a recovery that until only recently looked "anemic."

 

"There will be a time when these aggressive actions need to be reversed, but first we need to get the economy on a much more solid footing," Rosengren, who this year rotated out of a voting slot on the Fed's policy-setting panel, said in prepared remarks.

 

"Even with a relatively robust recovery, it will take several years before we attain full employment and an inflation rate close to a long-run expectation of 2 percent."

 

Core inflation is now running at about 1 percent, down from 2.5 percent before the recession triggered by the financial crisis. Meanwhile, unemployment is at a still-high 9.4 percent.

 

The Fed embarked on the $600 billion round of Treasury securities purchases in November, an unprecedented move that garnered much criticism from those worried it would eventually spark a sharp run-up in inflation.

 

Rosengren said the Fed had the tools and commitment needed to address any long-term inflationary pressures, adding he expects core inflation to remain below 2 percent over the next four years. He also predicted GDP growth of 3.5 percent to 4.0 percent over 2011, noting that, over the past several weeks, "we have been getting economic data consistent with a somewhat happier new year."

 

Rosengren, seen as well to the "dovish" end of the Fed's policymakers' spectrum, said housing was a key in deciding when the Fed would begin to reverse its stimulus plan.

 

"If housing-related growth is not going to boost the recovery this time around, we may need policy -- particularly monetary policy -- to continue playing a stimulative role," he said, adding housing was unlikely to provide as much support as in previous rebounds.

 

With rates near zero for more than two years, the Fed launched a "quantitative easing" program of asset purchases, meant to kick-start lending. The latest, $600-billion round of easing is known as QE2.

 

Corporations Want a Lower Tax Rate…So Who Doesn’t

 

Chief financial officers from a number of multinational companies met with Treasury Secretary Timothy Geithner on Friday to complain about the tax code under which they supposedly pay the steepest rate in the industrialized world. Therefore, they want the rate decreased to enable them to compete more effectively against their foreign-based competitiors.

 

"We are encouraged by today's meeting and look forward to a fruitful dialogue with the administration and Congress on how to level the playing field for American businesses through a more modern tax code," Frank Calderoni, chief financial officer of Cisco Systems, said in a statement after the meeting.

 

Obama administration officials agree that the tax rate is too high. However, they say a corporate tax revamp must be "revenue neutral," so a rate cut will have to be offset by new revenue. Government officials point out that companies typically do not pay the full 35 percent rate, thanks to a myriad of deductions and credits that help them chip away at their rate.

 

The meeting is a first in series the administration intends to hold on the topic. Any reforms would have to pass in Congress and could take years. A big point of debate revolves around what portion of profits is taxed.

 

The United States is alone among its Group of Eight peers in collecting taxes on profits earned worldwide. Most other countries impose levies on domestically earned income only, under what is called a "territorial" system. Companies get tax credits to avoid double taxation, but executives say it does not fully offset the extra cost.

 

President Barack Obama's deficit commission recommended last month that the United States move to a territorial system. It also said many big corporate deductions and credits should be eliminated.

 

A move to a territorial system would primarily benefit big multinational companies -- leaving companies that derive more sales from the United States with fewer relative benefits. That could cause a rift in the business community.

 

In another wrinkle, many businesses are not organized as traditional corporations at all. Taxes on these companies, many known as S-corps, flow through to individual shareholders who pay their individual income tax rate. Thus leaving the top individual rate at 35 percent could cause another fissure among those executives who would not see a benefit in a corporate tax cut.

 

Representative Dave Camp, the Republican chairman of the House of Representatives' tax-writing Ways and Means committee, believes a tax code overhaul should address individual and corporate rates for this reason. Camp will kick off the first of many expected hearings on Capitol Hill on the issue next week.

 

JPMorgan Earnings Up 47 Percent

 

JPMorgan Chase eported a greater-than-expected 47 percent increase in quarterly earnings and struck an upbeat tone that lifted the shares of major U.S. banks reporting next week. According to the banking giant, loan demand and trading profit could grow this year, increasing optimism that revenue for other major banks will also recover.

 

The bank's shares rose 2.2 percent to $45.42, their highest since April, and they were one of the biggest percentage gainers on the Dow an hour before the close of the market.

 

Profit and revenue were stronger than expected, even though the bank raised earnings by 30 cents a share by releasing $2 billion of reserves previously set aside to cover credit card losses. Wall Street broadly interpreted the results as indicating underlying strength, but some critics questioned whether the release of reserves distracted investors from the still-difficult economic circumstances weighing on the bank's main consumer business.

 

JPMorgan is also still wrestling with the aftermath of the mortgage crisis and put aside another $1.5 billion to cover legal settlements mainly linked to U.S. home loan foreclosures.

 

Chief Executive Jamie Dimon set a positive tone on a call with analysts. JPMorgan could start to increase its dividend, which the bank trimmed to an annual 20 cents during the crisis, to about 75 cents to $1 a year once regulators give the go-ahead, likely at the end of March, he said.

 

JPMorgan, the second-largest domestic bank by assets, increased its loan book by $2.4 billion in the fourth quarter, a rise of 0.35 percent from the third quarter. Economists are scrutinizing banks' loan books for indications of growth, which would suggest broader economic improvement.

 

Like other banks, JPMorgan said throughout last year that it was seeing patchy pick-up in loan demand, mainly from middle-market and small businesses. Dimon told analysts that demand for credit appeared to be strengthening this year. "Our early indicators are that we will continue to see loan growth this year," he said.

 

Dimon also shrugged off recent decreases in trading volume across Wall Street, especially in fixed-income, which has been a key engine of Wall Street profits for the last decade. JPMorgan's fixed income trading revenue fell 8 percent from the third quarter, but Dimon said that 2011 could be good for trading.

 

"So far this year, (trading has) started off pretty good," Dimon said, adding that sluggish revenue in the business is not a long-term problem for Wall Street.

 

The positive outlook for trading helped lift shares of Goldman Sachs and Morgan Stanley 2.4 percent and 1.9 percent, respectively. Goldman reports results on Wednesday and Morgan Stanley on Thursday.

 

Similarly, with JPMorgan reporting that its credit card business had improved, shares of credit card companies American Express and Capital One Financial jumped 3 percent and 3.5 percent respectively. Bank of America, which has a large credit card business and is due to report earnings on January 21, rose 3.4 percent.

 

JPMorgan had fewer bad loans across all of its businesses, with the result that it released just over $2 billion in reserves, equivalent to 34 cents a share and more than double the expected release, analysts at Morgan Stanley wrote in a report.

 

Fourth-quarter earnings increased to $4.8 billion or $1.12 per share, from $3.3 billion, or 74 cents per share, a year earlier. Revenue rose 6 percent to $26.7 billion on a managed basis, which adjusts for an accounting change for off-balance sheet entities. That was higher than the $24.37 billion expected by analysts. JPMorgan said on Friday it would issue new debt after reporting results.

 

The investment banking unit reported that revenue rose 26 percent to $6.21 billion in the fourth quarter but that full-year investment banking revenue fell 7 percent from 2009. The unit's compensation expense per employee, a measure of how investment banking bonuses will fare, dropped 2.7 percent to $369,651.

 

JPMorgan still has to acquiesce to changes in financial regulation, including rules that limit its revenue from debit card fees, and with litigation related to soured mortgages it sold to investors and homes it may have improperly foreclosed on.

 

The New York bank's shares have lagged the overall banking sector over the past 12 months, up 1 percent from January 14, 2010.  Many of the banks with the biggest credit issues have experienced the biggest share rallies over the last year. The bank's shares are trading just above book value of $43.04 and JPMorgan is generating a return on equity of 11 percent. By one rule of thumb, its shares should be trading at about 1.1 times book value, or $47.34, nearly 4 percent above their current level.