MarketView for January 9

 

 

Summary 

  

The major equity indexes ended the day in positive territory on Monday, in what was once again a light volume session. Much of the reason for the Street’s lack of commitment could be traced to a continuing outflow of caution with regard to this quarter’s earnings season and some key auctions for sovereign debt within the European Union in the latter part of this week.

 

Alcoa ended the day up 0.8 percent to $9.50 in extended trading after the company reported fourth-quarter revenue that exceeded Street expectations, though a sharp decline in aluminum prices helped push the company’s earnings into negative territory.

 

As the first company within the Dow Jones Industrial Average to report results, Alcoa is seen as the unofficial start to the earnings season. In the regular session Alcoa rose 3 percent to $9.43.

 

After breaking out of the gate with strong gains on the first day of trading in January, stocks have been confined to a tight range in daily moves and volume has been low. The S&P 500 faces strong technical resistance as it has been unable to pierce through 1,285, the closing high set in late October.

 

Google closed out the trading session off 4.2 percent at $622.46 after Motorola Mobility Holdings warning of weaker-than-expected financial results raised concerns about Google's pending acquisition of the company. Google was the largest drag on both the S&P 500 index and Nasdaq 100.

 

Months of summits and meetings have still not convinced investors that Europe will avoid messy defaults or a break-up of the euro zone. Debt sales by Spain and Italy later in the week should provide insight about investors' confidence in plans to solve the euro zone financial crisis.

 

After meeting in Berlin, German Chancellor Angela Merkel and French President Nicolas Sarkozy warned Greece it will get no more bailout funds until it agrees with creditor banks on a bond swap and a deal to avert a potential default.

 

Chip makers rallied, after Deustche Bank upgraded the sector. Juniper Networks fell 3.1 percent to $20.85 in after-hours trading after the network equipment maker cut its fourth-quarter outlook, primarily due to weaker-than-expected demand for routers from service providers.

 

Brocade Communications Systems closed up 6.5 percent to $5.77 after Reuters reported the maker of switches and routers had received first-round bids from a handful of potential buyers as the company explores a sale.

 

Traders also await monetary policy announcements from the European Central Bank and the Bank of England due Thursday. Investors are keen to hear ECB President Mario Draghi's latest comments on ways to ease the debt crisis.

 

Fourth-quarter earnings for S&P 500 companies were expected to rise 7.8 percent from a year ago, according to a Thomson Reuters forecast, down from 17.6 percent predicted in July.  The lower revisions were due in part to expected fallout from the euro zone debt crisis and the region's sluggish economic growth.

 

Volume was light with about 5.98 billion shares changing hands on the three major equity exchanges, a number that was well below the daily average of 6.61 billion shares.

 

Alcoa Reports As Earnings Season Begins to Rev Up

 

Alcoa posted a fourth quarter loss due to a sharp decline in aluminum prices, but its revenue exceeded Street expectations and the company gave a positive outlook for global demand for the metal, especially in the aerospace and automotive markets. The largest company forecast 7 percent growth in global aluminum demand this year and said cutbacks in production will result in a global supply deficit of 600,000 tons in 2012.

 

Alcoa added that its growth projection was ahead of the 6.5 percent rate required to meet the company's forecast of a doubling in global aluminum demand between 2010 and 2020. Aluminum demand grew 10 percent in 2011, while prices fell 18 percent.

 

Shares of Alcoa edged higher in extended trading, after gaining 2.9 percent during the day.

 

The first company in the Dow Jones industrial average to report results, Alcoa indicated that its revenue rose 6 percent to $6 billion even as the price of aluminum fell 6 percent in the fourth quarter. Alcoa posted a loss from continuing operations of $193 million, or 18 cents per share, compared with a profit of $172 million, or 15 cents per share in the same quarter of 2010. If you exclude a restructuring charge of $159 million and other items, Alcoa's loss was 3 cents per share.

 

Alcoa said it expects global growth for aluminum in the aerospace industry of 10 percent to 11 percent in 2012, with automotive growing 3 percent to 8 percent. Growth is expected in the transportation, packaging and construction sectors, as well.

 

Alcoa CEO Klaus Kleinfeld projected a rosy picture of the broader economy, saying he expects global demand for aluminum to continue to rise and double by 2020.

 

"We do see an air of confidence returning to the economy," he told business cable network CNBC, referring to rising U.S. consumer confidence and procurement data and falling bond yields in Europe. "Something positive's going on," he said. Aluminum demand should grow 12 percent this year in China, a key market for the company, Kleinfeld said.

 

Home Prices Fall

 

Home prices fell for a fourth straight month in November as distressed sales continued to weigh on prices, data analysis firm CoreLogic reported on Monday.

 

CoreLogic's home price index fell 1.4 percent in November from the previous month. Compared with November of last year, prices were down 4.3 percent, steeper than the 3.7 percent year-over-year decline seen in October.

 

Excluding distressed sales, prices were off just 0.6 percent in November on a yearly basis. Homeowners in danger of foreclosure, or in "distress," often sell their homes at a significantly reduced price.

 

"Distressed sales continue to put downward pressure on prices and is a factor that must be addressed in 2012 for a housing recovery to become a reality," Mark Fleming, chief economist at CoreLogic, said in a statement.

 

Of the top 100 statistical areas measured by population, 77 showed year-over-year declines, down from 80 in October.

 

A Fed Divided - More Bond Purchases Possible

 

The Federal Reserve Bank of San Francisco President John Williams expects that the central bank will need to buy more bonds if his forecast for subpar growth and low inflation comes to pass, the Wall Street Journal reported on Monday.

 

With import price pressures ebbing and wages still under pressure, Williams expects inflation to slow to 1.5 percent in 2012 and 2013 from nearly 4 percent earlier last year, he said in an interview with the Wall Street Journal.

 

He added that he expects subpar economic growth in 2012 at a 2.25 percent annual rate and 3 percent in 2013 and does not consider it enough to bring the unemployment rate much below 8 percent by the end of 2013.

 

"Unemployment is going to be sustained above a reasonable estimate of the natural rate of unemployment, which is closer to 6.5 percent than the 8.5 percent that we have now. That does make an argument that we should have more stimulus," Williams said.

 

On the other side of the coin, St Louis Fed President James Bullard said on Saturday that recent data seems to suggest that the U.S. economic recovery is gaining strength, suggesting that the Fed may not need to buy bonds right now.

 

"I don't think it's very likely right now because the tone of the data has been pretty strong" through the end of 2011 and up to now, St. Louis Fed President James Bullard told reporters after a speech at an economics conference. "We can probably wait and see for now."

 

The Federal Reserve has bought $2.3 trillion in bonds to boost growth. While the Fed has left the door open to further accommodation, the economy has shown signs of accelerating growth in recent months, leaving many to wonder whether the central bank needs to do any more.

 

Bullard's comments show a Fed still divided over the need for more accommodation to ensure a soft recovery does not dissipate or wilt due to an outside shock such as an intensification of the European debt crisis.

 

Foreshadowing a development expected at the Fed's meeting later this month, Bullard said that the Fed's adopting of an explicit inflation target would reassure markets that the central bank will under no circumstances tolerate high inflation to get the economy back on its feet.

 

"If you don't name an inflation target, what you're doing is keeping the possibility of very high inflation in your pocket, which you might take out at an appropriate time," he said. "I think we want to take that possibility off the table," Bullard added.

 

Having an explicit inflation target would permit the Fed to take further action to stimulate growth, if it needed to, without losing its inflation-fighting credibility, Bullard said.

 

The St. Louis Fed President, who is not a voter on the Fed this year, said reasonably strong holiday sales and labor market gains point to an improving economy at least for the next six months.

 

"Now, you do have this risk out there from Europe, but still I think the best forecast for the U.S. is that the momentum will continue into the first half of 2012," Bullard said.

 

Federal Reserve Governor Sarah Bloom Raskin said in a speech in Washington that the Fed must impose monetary penalties on banks over mortgage servicing problems, but did not comment on the outlook for the economy or monetary policy.

 

The diverse remarks show that the Fed is still divided over the need for more accommodation to ensure a soft recovery does not dissipate or wilt due to an outside shock such as an intensification of the European debt crisis.

 

Several Fed officials, including Boston Fed President Eric Rosengren, have urged another round of buying mortgage-backed securities to shore up the depressed housing market, . Williams, who is now a voting member of the Federal Open Market Committee which sets monetary policy, said he is not in favor of increasing interest rates "anytime soon."

 

Europe Gains

 

World stocks and the euro gained on Monday after last week's sell-offs, but worries over Europe's banks persisted and fears over demand for the region's debt at auctions due this week left riskier assets vulnerable to further losses.

 

The euro received a small lift from news that Swiss National Bank Chairman Philipp Hildebrand resigned after a scandal over a controversial currency trade made by his wife. Hildebrand's wife, a former hedge fund trader who now runs a Zurich art gallery, bought 400,000 Swiss francs ($418,000) worth of dollars on August 15, three weeks before her husband oversaw steps to cap the rise of the franc. The euro, which fell to a 16-month low in Asian trade of $1.2666, was 0.5 percent higher on the day at about $1.2760.

 

Against the Swiss franc, for which the SNB maintains a floor of 1.20 francs to the euro, the single currency dipped immediately after the resignation news. The euro hit a session low of 1.2106 francs from around 1.2135 francs beforehand, then recovering to 1.2140 by 1425 GMT.

 

However, most of the attention of the day was focused on a meeting between German Chancellor Angela Merkel and President Nicolas Sarkozy, at which the French leader said they would aim to wrap up negotiations on a planned treaty on closer fiscal union in the euro zone in the days ahead so it could be signed on March 1.

 

German exports rose sharply in November, suggesting fourth quarter gross domestic product for Europe's bulwark economy may be stronger than expected, though its industrial output that month was subdued.

 

In a sign of investor nervousness, Germany was able to sell 3.9 billion euros of six-month treasury bills with a negative yield - the first time this has happened at an auction. This meant buyers preferred to pay the German government to keep their money rather than receive interest.

 

Overnight deposits at the European Central Bank by commercial banks also hit a new record high of 464 billion euros, and traders said the sums could reach half a trillion euros by next week. High deposits indicate banks prefer the safety of the central bank for their funds to higher rates they could get by lending to each other. The liquidity is also depressing rates in the interbank market.

 

Banks are awash with cash after taking an unprecedented 489 billion euros in the ECB's first-ever three-year liquidity operation late last month, and are mulling what to do with the money in the longer term.

 

The MSCI world equity index held onto a slight gain of just 0.2 percent despite a weaker session on Asian markets.

 

In the debt market Italian and Spanish 10-year government bond yield spreads over German safe-haven benchmarks narrowed on Monday, with the market taking a breather after a surge in the two peripheral countries' borrowing costs last week.

 

A busy week of government bond issuance features triple-A issuers Germany, Netherlands and Austria, but most interest will be on sales by Spain and Italy on Thursday and Friday.

 

Italian 10-year paper yielded around 7.13 percent, firmly above the 7.0 percent level widely seen as unsustainable. Spanish equivalent bonds were at 5.74 percent.

 

Debt tensions took the shine off the improving economic picture in the United States and Germany, with a German magazine reporting on Saturday the International Monetary Fund was losing confidence in Greece's ability to clean up its public finances.

 

Also, an adviser to Germany's finance minister told a Greek newspaper a 50 percent write down on Greek debt holdings - a key part of Greece's debt swap deal - was not enough to put the country's huge debt on a viable footing.

 

In commodities markets and both precious and industrial metals lost a little ground. Copper slipped around 0.4 percent to $7,550 a tone, while gold was little changed at around $1,620 an ounce.

 

Brent Crude Futures Down

 

Brent crude futures fell in volatile trading on Monday concerns over the economic health of the euro zone against Iran's threats to shut a key oil-shipping route weighed heavily on the oil markets.

 

February Brent crude futures were 48 cents lower at $112.58 a barrel by 1450 GMT, after gaining more than 5 percent last week. On the New York Mercantile Exchange, February U.S. light crude futures were down 93 cents at $100.63 a barrel, having fallen to lows earlier of $100.54.

 

Tensions with Iran, which has threatened to block the Strait of Hormuz if sanctions imposed by the United States and planned by the European Union affect its exports, continued to lend support to prices after the country confirmed it had started uranium enrichment at its Fordow nuclear plant.

 

Eyes were also on Nigeria, Africa's top oil producing nation, where thousands of people took to the streets to protest the axing of fuel subsidies. Production of Nigeria's average 2 million barrels of crude oil a day appears to have continued in a normal manner despite the strike.

 

The West has plans to use strategic oil stocks to offset most of the 16 million barrels per day of crude passing through the Strait of Hormuz should Iran block it, industry sources and diplomats told Reuters. Specifically, the International Energy Agency may release up to 14 million bpd of government-owned oil stored in the United States, Europe, Japan and other importers, a rate that could be kept up for a month.

 

Such a release is likely to limit the impact of any blockade of the Strait, which is unlikely to last beyond a few weeks, analysts at Morgan Stanley wrote in a report.

 

"If the impact is limited to 10 million bpd for three weeks, or 210 million barrels, this loss could be easily replaced by an SPR (strategic petroleum reserves) crude release until the Strait is reopened," the report said.

 

If the blockade is limited to one month, the impact is unlikely to be dramatic, according to Vienna-based JCB Energy.

 

"If a potential blockade is limited to a maximum of one month, the physical impact would not be that dramatic, given strong IEA action and the fact that most barrels would only be delayed but not actually lost. Prices would still spike in an unpredictable way, depending on the trading community's perception of the situation," JBC wrote in a separate note.

 

India's state-run Hindustan Petroleum Corp will double the volume of Saudi crude it imports in an annual deal beginning in April, a move that could potentially replace some of its Iranian supplies. Two sources said the new deal would be for 60,000 bpd, versus around 30,000 bpd this year.

 

Markets will also be affected this week by the reweighting of the world's largest commodity indexes. This could see funds selling off more than $6 billion worth of U.S. crude futures and buying more than $5.4 billion of Brent crude, analysts estimate, which is likely to create short-term tremors in the market.

 

An expectation of the re-weighting, which was announced two months ago to better reflect market fundamentals, led the closely watched Brent/WTI spread to widen by nearly $3 a barrel last week to near its widest point since mid-November. The spread tightened by 11 cents to $11.96 by 1449 GMT.

 

Here Is a Reversal

 

Blue-chip names like Johnson & Johnson, Pfizer and Peugeot are among firms bailing out Europe's ailing banks in a reversal of the established roles of clients and lenders through repo deals or short-term secured lending.

 

Europe's banks are struggling to secure the cash to fund their day-to-day business and have largely stopped lending to each other for fear Europe's sovereign debt crisis could land any of their peers in trouble.

 

As a result a group of well-known, cash-rich companies with solid cash flows has stepped in the repo market, which provides a form of lending so far almost exclusively in use between banks, and between banks and central banks.

 

The rise in repos means more business for companies such as Euroclear and its main rival Clearstream -- owned by Deutsche Boerse -- as well as Bank of New York Mellon, JP Morgan and State Street.

 

In a repo trade, one party buys collateral from the other, with the obligation to sell it back at a pre-defined later date and for a slightly lower price -- the so-called haircut. That way, the seller provides cash to the buyer. When companies rather than banks engage in repo deals they typically rely on a third party for administering the collateral, in what are known as tri-party repos.

 

The tri-party market grew at 22.3 percent in the first half of last year, a survey by the International Capital Market Association (ICMA) showed, versus only a modest rise in the overall business, further prove that companies are increasingly accessing the market.

 

Repos provide the new financiers with the strict guarantees they need before parting with their cash, answering worries that the crisis has weakened Europe's banks to the extent that they might not be able to pay the money back.

 

At the moment the European Central Bank provides the main lifeline for banks and has pumped hundreds of billions of euros of cash into the market. Unfortunately, the banks are parking most of the money they borrow back at the ECB rather than trusting to lend to each other.

 

They are also paying insurers and pension funds to take their illiquid bonds in exchange for better quality ones, in a desperate bid to secure much-needed cash from the ECB, which only provides cash against collateral.

 

In stark contrast, Europe's biggest companies are sitting on cash amounting to more than $20 billion each in the case of BP and Volkswagen. According to Moody's, a sample of European companies are known to hold approximately $872 billion cash at the middle of 2011. It is typically these very large companies, with reliable cash flows that engage in repo deals with banks.

 

Corporate treasurers are typically extremely wary of talking about their day-to-day cash management, and Johnson & Johnson, Pfizer declined to discuss the matter. Peugeot was not available for comment, while other large companies contacted by Reuters also declined comment.

 

Regulators cracking down on "shadow banking" -- closed-door deals blamed in part for the 2008 financial crisis -- have expressed worries about how opaque the repo market is, and the U.S. Federal Reserve has set up a working group to suggest reforms.

 

The European repo market was worth 6.2 trillion euros ($7.88 trillion) in the first half of 2011, according to ICMA's September survey. The vast majority of business conducted was between banks, and banks and central banks.