MarketView for January 3

 

 

Summary 

  

Wall Street stocks kicked off 2012 with a rally on Tuesday after an indication that manufacturing activity and construction spending picked up considerably, thereby signaling that the economic recovery continues to gain steam. The broad S&P 500 index closed at its highest level since late October as traders, with cash on hand for the New Year, welcomed better-than-expected German and Chinese economic data.

 

The upbeat response was reinforced by our domestic economic data indicating that construction spending and factory activity exceeded the consensus. However, trading volume was below normal. Only about 7 billion shares changed hands on the three major equity exchanges, as compared with last year's daily average of about 7.84 billion shares.

 

Materials companies and financials, the lagging sectors in 2011, were among Tuesday's market leaders. U.S. Steel gained 6.5 percent to close at $28.17 after losing more than half its market value in 2011.

 

The manufacturing sector had accelerated growth in December with the data indicating the strongest pace for that sector since June, while construction spending in November surged to the highest in nearly 18 months.

 

Some of the S&P 500's worst performers last year rallied on Tuesday. But at the same time, McDonald's, the largest gainer in 2011 among Dow components, fell 1.5 percent to $98.84.

 

First Solar, down 74 percent in 2011, rose 6 percent to $35.79 and Netflix, off more than 60 percent last year, was up 4.3 percent to close at $72.24.

 

Also adding investors' mood was German unemployment, which declined more than had been forecasted.

 

Indexes held on to gains after minutes from last month's Federal Reserve meeting said a number of Fed officials believed economic conditions could well warrant a further easing of monetary policy.

 

Among declining stocks, Exelon Corp fell 3 percent to $42.07 after a downgrade from Macquarie, while other utility shares followed suit as natural gas futures hit their lowest intraday price since September 2009. S&P utilities, the best performers last year among the top ten sectors on the S&P 500, fell 1.7 percent.

 

Investors, looking to put cash to work after a tough year in 2011, were also encouraged by data from China and Germany suggesting improvement in those major economies. The broad S&P index has risen more than 10 percent from its November 25 close.

 

Barclays Capital downgraded Intel and other semiconductor stocks, predicting a "volatile" year for the group as an inventory correction extends into the first quarter. At the same time, JPMorgan upgraded its recommendation for Cisco Systems, sending shares of the Dow component up 3.1 percent to $18.59.

 

3M is acquiring Avery Dennison's office and consumer products unit, the companies said. Avery Dennison rose 1.8 percent $29.19, while 3M added 2.2 percent to $83.51.

 

The markets also appreciated the news that China, the world's largest consumer of metals, avoided economic contraction in December.

 

ISM Number at Six Month High

 

According to a report released Tuesday morning by the Institute for Supply Management, during December manufacturing grew at its fastest pace in six months, thereby closing out 2011 with a late-in-the-year rally. At the same time while a rise in new orders suggested good momentum in 2012, an industry report showed on Tuesday.

 

According to the ISM, its index of national factory activity rose to 53.9, the best showing since June, from 52.7 in November. An index reading above 50 indicates expansion.

 

The new orders component, which economists consider a leading indicator of future activity in the sector, rose to 57.6 from 56.7, while the employment component jumped to 55.1 from 51.8.

 

Meanwhile, data due out on Friday is expected to show the U.S. economy added 165,000 new jobs in December, but also a slight rise in the jobless rate to 8.7 percent.

 

Another report showed a rise in private and public projects lifted construction spending to its highest level in nearly 18 months in November, one more indication that the economy is picking up speed.

 

Small business borrowing also improved in November, nearing a four-year high, according to the most recent Thomson Reuters/PayNet Small Business Lending Index.

 

However, the economy is still far from making a full recover, in part the housing market is still in the doldrums and unemployment remains at an elevated level. In a note to clients, Goldman Sachs said it expects "growth in 2012 to look broadly similar to 2011," bumping along at a below-trend pace. High oil prices, they said, could also slow the pace of expansion.

 

Crude oil rose above $110 a barrel on Tuesday as tension between Iran and the United States stirred fear of a possible disruption to oil supplies from the Middle East.

 

Europe's debt crisis may also mean trouble for U.S. growth and the manufacturing sector in particular. Deep spending cuts and tax hikes across Europe to deal with large deficits almost guarantee a euro zone recession which will result in some degree of impact on our economy.

 

The United States is one of the few major countries where manufacturing is holding up. While Canadian factory output rose last month, the euro zone's industrial sector suffered its fifth consecutive month of contraction in December, while Asian factories had a weak month to end the year. In Britain, December capped the worst quarter for the manufacturing sector in more than two years.

 

Construction Spending Increases

 

According to a report by the Commerce Department Tuesday morning, construction spending rose to what was nearly a 1-1/2 year high in November as investment in public and private projects rose solidly, cementing expectations of strong economic growth in the fourth quarter. Construction spending increased 1.2 percent to an annual rate of $807.1 billion, the highest level since June 2010. Spending in October was revised to a 0.2 percent fall, after initially reported as a 0.8 percent rise.

 

Overall construction spending was up 0.5 percent compared to November 2010.

 

Private construction spending rose 1.0 percent, advancing for a fourth straight month. Spending on residential projects increased 2.0 percent, with solid gains in both multifamily and single family homes.

 

The housing market is showing some signs of recovery, with builders breaking more ground on new projects to meet growing demand for rental apartments. It is becoming less of a drag on the economy and is expected to significantly add to growth in 2012.

 

Private nonresidential construction was flat in November after declining 0.6 percent the prior month. Spending on public sector construction rebounded 1.7 percent in November as outlays on federal projects jumped 5.3 percent after dropping 7.5 percent in October. State and local government spending rose 1.3 percent after falling 1.2 percent the prior month.

 

New Information Coming From the Fed

 

The Federal Reserve on Tuesday said it would begin publishing forecasts on the path of interest rates later this month, a significant milestone in Ben Bernanke's push for greater policymaking transparency. The move is meant to better align bets in financial markets with the views of policymakers at the central bank, and it could show that rates will be on hold for longer than previously expected.

 

The Fed has held the overnight federal funds rate close to zero since December 2008. In statements after its last four policy meetings, it has said it expected to keep rates ultra-low until at least the middle of 2013. However, policymakers have chafed at a pledge that was both tied to the calendar and static, and many investors think rates will be on hold for even longer.

 

In minutes from its December 13 meeting, released on Tuesday, the Fed said it will publish projections for the path of the federal funds rate along with its regular quarterly economic forecasts after its next meeting on January 24-25. It also said officials would provide forecasts for the first rate hike.

 

The minutes said a number of Fed officials believed economic conditions could "well" warrant a further easing of monetary policy, and an enhanced communications framework could make any policy shift more effective. Meanwhile, a few others believed further stimulus would be a bad idea, a sign of the ongoing tussle at the central bank over whether the U.S. economy needs more help.

 

At its December meeting, the Fed warned that turmoil from Europe's debt crisis posed a major risk to the U.S. economy and it left the door open to further steps to boost growth, even though it noted a somewhat stronger labor market.

 

Publishing rate path forecasts is likely to cool any financial market anticipation that modest improvements in the economy might mean a step by the Fed to tighten financial conditions could be drawing nearer.

 

Some officials worried the central bank's current pledge that rates would stay ultra-low until at least the middle of 2013 might have to be adjusted before long, according to the minutes.

 

In publishing rate forecasts, the Fed is following the example of other central banks, including Sweden and Norway, and taking a step toward the greater policy transparency that Chairman Ben Bernanke had promised when he took office in 2006.

 

The minutes, however, made no reference to the possibility of the adoption of a formal inflation target, one of Bernanke's long-cherished objectives and one that some analysts had speculated could be achieved soon.