MarketView for January 24

 

 

Summary

 

The major equity indexes turned in another lukewarm performance on Tuesday, ending a five-day rally for the S&P 500, as talks to resolve Greece's debt crisis went nowhere and earnings from a number of blue chips disappointed investors.

 

Greece moved closer to the possibility of a chaotic default as talks to restructure the country's debt stalled. However, Wall Street has been less sensitive to the Greek drama of late.

 

Corporate earnings also did not warm the cockles of Wall Street’s heart. Among the day's earnings disappointments were Verizon Communications and Travelers, both of which were among the largest drags on the Dow Jones Industrial Average.

 

Verizon missed the consensus earnings estimate by a penny as its wireless business was hit by the high sales expenses of advanced phones, such as the Apple iPhone 4s. Verizon reported a net loss of $2 billion in the fourth quarter of 2011, despite rising iPhone sales and revenue growth in its wireless business, compared with net income of $2.64 billion in the same quarter a year ago, the company reported on Tuesday. Verizon ended the day down 1.6 percent to close at $37.79.

 

Travelers reported a smaller-than-estimated profit as it released less money from its reserves than a year earlier, but it also announced its largest rate increases in eight years. The shares ended the down 3.8 percent to close at $58, but analysts had expected the decline and called it a buying opportunity.

 

On a more positive note, Apple saw its share price rise 9 percent to $457.12 in after-hours trading after the company reported results that blew past Wall Street's estimates, primarily on a huge increase in sales of iPhones and iPads. Apple's announcement lifted Nasdaq 100 index futures 25.75 points, or around 1.1 percent, late on Tuesday, but the news may not be enough to pull stocks higher on Wednesday.

 

According to Thomson Reuters data, 20 percent of S&P 500 companies have reported earnings, with 58 percent topping Wall Street expectations, down from levels seen before at this point in the earnings season. The average beat rate has been 70 percent. This week is one of the busiest in the quarterly earnings season, with 117 S&P 500 companies due to report.

 

McDonald's reported stronger-than-expected December sales, but its shares fell on investor concerns that the company’s earnings may have exceeded expectations only because of income unrelated to operations. As a result, McDonald's ended the day down 2.2 percent to close at $98.77.

 

The Federal Open Market Committee began a two-day meeting on Tuesday, at the end of which policymakers will start a new practice of announcing their interest rate projections. The Fed hopes the projections, to be released on Wednesday, will give markets and the public greater clarity about its decision-making.

 

About 6.25 billion shares changed hands on the three major equity exchanges on Tuesday, compared with this year's daily average of about 6.6 billion shares.

 

Let’s Make a Deal

 

Greece's private creditors pleaded on Tuesday with European officials who rejected their bond swap offer to hammer together a deal before Athens tumbles into a chaotic default. Athens' hopes for a swift deal with lenders were evaporating after euro zone ministers on Monday rejected creditors' demand for a 4 percent coupon, or interest rate, on new, longer-dated bonds in exchange for existing debt.

 

The country is desperate for a deal to ensure funds from a 130 billion euro rescue plan drawn up by European partners and the International Monetary Fund arrive before 14.5 billion euros of bond redemptions fall due in March.

 

"It's important that all parties recognize how much we have at stake and work together and cooperate to find a solution," said Charles Dallara, who negotiates in the name of private bondholders through the International Institute of Finance.

 

He declined to comment on whether his group would back down on the demand for a 4 percent coupon billed as their "final offer" and said their position was already clear. Greece says it is not prepared to pay a coupon of more than 3.5 percent which would impose steeper losses on its private creditors.

 

Senior euro zone officials suggested they were preparing for another drawn-out battle despite the ticking clock. They want to make sure any debt swap deal does enough to bring Greece's mountainous debts back on track, to avoid the prospect of having to once again stump up funds for Athens.

 

German Finance Minister Wolfgang Schaeuble dismissed talk of the IIF's "final offer" with: "That happens in every bazaar." "You do not need to be impressed by that," he said. "At least I do not."

 

Without a deal, Athens will be forced into a non-voluntary, hard default that could push other weak euro zone members closer to the edge, although experts are beginning to wonder whether the threat of contagion is as severe as it once was after the European Central Bank flooded the banking sector with nearly half a trillion euros of three-year money in December.

 

Standard & Poor's will likely downgrade Greece's ratings to "selective default" whether or not a debt restructuring is achieved with the voluntary buy-in of private creditors, but the ratings agency said the ripples might not spread.

 

"It's not a given that Greece's default would have a domino effect in the euro zone," John Chambers, chairman of S&P's sovereign rating committee, said.

 

The International Monetary Fund is more concerned, however. It cut its outlook for global growth sharply on Tuesday, said the euro zone debt crisis was escalating and dragging down the world economy and called for policies to restore confidence.

 

EU Economic and Monetary Affairs Commissioner Olli Rehn said the two sides remain close to an agreement on a Greek debt swap, which he hoped would come this month rather than next.

 

Caught in the middle between creditors and European partners stepping up a game of brinkmanship, Athens was left clinging on to hope a deal could still be struck in time. It said it had the euro zone's support to complete the talks in the "coming days."

 

"In reality, we are now entering the final stretch," Finance Minister Evangelos Venizelos said in a statement. "I believe everyone has now realized that Greece must be supported in its effort, which is of vital importance not only for us but for the euro zone as a whole and the global economy."

 

With weeks of talks yielding little progress and growing concern that Greece's fast-deteriorating economic prospects mean it will need more aid from partners either way, European policymakers appeared to be more willing to consider the previously taboo option of a so-called "involuntary" debt swap.

 

Both sides have so far firmly stuck to plans for a "voluntary" swap that would avoid insurance against a Greek debt default from being paid out.

 

If no deal comes about, creditors would go towards an involuntary debt swap, once again raising the chances of a messy default.

 

Dallara said he was confident of large-scale participation by bondholders in the swap if the two sides were able to strike a voluntary agreement. He is expected to return to Paris to co-chair an internal meeting of creditors on Wednesday to discuss latest developments in the talks, the IIF said.

 

The bond swap is meant to cut 100 billion euros from Greece's debt burden of over 350 billion, in a bid to ultimately slash its debt from around 160 percent of GDP to a more manageable 120 percent of GDP by 2020. Under the agreement drawn up in October to rescue Greece for a second time, bondholders would take a 50 percent write down on the notional value of their Greek holdings.

 

Sources close to the protracted Athens talks said last week the two sides were converging on an agreement that would see private creditors accepting a real loss of 65 to 70 percent and new bonds with 30-year maturity.

 

Greece is stumbling through its worst post-World War Two economic crisis, with unemployment at record highs and frequent protests against austerity measures demanded by its international lenders as a condition for bailout loans.

 

The country is now in its fifth year of recession and has struggled to push through reforms demanded by lenders.

 

In a sign that Athens' troubles will be far from over even if a debt swap deal was sealed quickly, Schaeuble warned that all Greek political parties must commit to reforms or risk putting the country's latest bailout plan in danger.

 

Greece Is Essentially in Default Says S&P

 

Greece is facing an increasing likelihood of default, even if creditors reach an agreement on a deal aimed at reducing the nation's massive debt load.

 

Even with the write downs being discussed, Greece's debt burden would still be "very high" and the nation's credit rating will remain "very low," said John Chambers, head of sovereign ratings at S&P.

 

Speaking at a Bloomberg sovereign debt conference in New York Tuesday, Chambers said any deal between Greece and private sector investors would "in all likelihood" qualify as a default.

 

The aim of the deal is to slash the nation's debt load to 120% of gross domestic product by 2020 from its current 160 percent. Last week, officials from the European Union, International Monetary Fund and European Central Bank were in Athens to review Greece's finances and start negotiating a second bailout.

 

Greece is facing a €14.5 billion bond payment in March that it may not be able to make without another injection of emergency financing.

 

However, a downgrade may not come for several months. Chambers said the ratings agency isn't expected to lower Greece to a "selective default" rating until the fall.

 

A default could force Greece out of the euro currency union, which would most likely cause the Greek banking system to collapse and plunge the nation's economy deeper into recession.

 

Economists worry that could start the spread of deeper debt contagion in the euro zone but Chambers disagreed. "It's not a given that Greece's default would have a domino effect in the euro zone," he said.

 

Jose Manuel Gonazalez-Paramo, a member of the ECB executive board, downplayed concerns about a default. He said simply "a default should not happen."

 

In the restructuring, Gonzalez-Paramo said "my impression is that we are close to the end of these negotiations." He added that the ECB is not directly involved in the talks, but said he's hopeful "that common sense will prevail."

 

Fed Releases Template

 

The Federal Reserve previewed its new practice of announcing policymakers' interest rates projections on Friday, issuing a table that showed analysts may be able to guess where the policy consensus lies.

 

One blank chart, which extends out to 2016, will show the distribution of expectations for the first policy tightening following years of near-zero interest rates.

 

Another panel, which will show forecasts for the benchmark federal funds rate over time, could give observers the chance to see where individual officials' forecasts lie, although the estimates will not be linked to particular names.

 

Some analysts thought they might be privy only to the range of forecasts, not the distribution of forecasts along that range. When the Fed has released its economic forecasts in the past, the public has had to wait for the release of meeting minutes three weeks later to get that level of clarity.

 

The Fed recently announced its decision to publish official forecasts for rates, in addition to the projections for employment, inflation and growth that they already release quarterly.

 

Pension Charges Hurt Verizon’s Bottom Line

 

The loss by Verizon was primarily the result of the impact of previously announced noncash pension charges, the company said. According to Verizon, revenue increased 7.7 percent to $28.4 billion in the quarter, from $26.4 billion in the same quarter a year earlier.

 

Adjusted for the pension charges, the per-share income was 52 cents, just below the expectations of Wall Street analysts of 53 cents a share. Revenue was right in line with forecasts, according to a survey of analysts by Thomson Reuters.

 

The company said strong sales of smartphones drove its wireless business to its best quarterly growth rate ever, up 13 percent to $18.3 billion in revenue. Verizon sold 7.7 million smartphones in the fourth quarter, 4.2 million of which were iPhones.

 

The company added 1.5 million wireless subscribers over the quarter, bringing its total number of subscribers to 108.7 million. However, profit margins dropped due to the high subsidies that Verizon pays for each new iPhone purchased by customers when they commit to a two-year contract.

 

Wireless carriers subsidize a part of the retail price on most new cellphones in order to attract customers. However, the companies eventually recoup the costs over the duration of a phone’s two-year contract through monthly cellphone bills.

 

Verizon said this week that it had a large lead over its rival AT&T in the race to build out a newer, faster network called 4G Long Term Evolution, or LTE. The company now has LTE networks deployed in 195 markets, compared to AT&T’s 26 markets, and it plans to make coverage from such so-called fourth-generation networks as ubiquitous as its older third-generation networks by mid-2013. Verizon said it sold 2.4 million 4G devices in the fourth quarter.

 

While AT&T was busy pursuing the merger, Verizon made a deal with a consortium of cable companies, including Comcast and Time Warner, for $3.6 billion worth of spectrum.

 

Verizon’s legacy wire line business, which includes traditional hard-wired phone lines, continued to shrink. Quarterly revenue decreased 1.5 percent to $10.1 billion.

 

Verizon’s expansion of 4G will probably create new opportunities for makers of networking equipment, like Cisco, Alcatel Lucent and Juniper, meaning consumers can expect a wave of new devices compatible with the faster network in the coming year.