MarketView for January 26

 

 

Summary

 

The major equity indexes slipped on Thursday in what could be a possible warning of weakness ahead. Driving the downturn were weaker-than-expected home sales figures and a group of mixed earnings reports tempered the market's recent buying interest. With the S&P 500 index up nearly 5 percent for the year, there is some talk that the markets are due for some sort of a retrenchment. Wall Street has advanced in recent weeks as economic data raised expectations that the economic recovery is picking up steam.

 

Stocks began the day higher, helped by the Federal Reserve's statement on Wednesday that it planned to keep interest rates near zero, at least until the end of 2014, a support for buying of risky assets. Stocks also rose early after data showed orders for durable manufactured goods rose more than expected in December, while unemployment benefit claims last week rose only moderately. However, gains were short-lived. The losses among the Dow Jones Industrial Average stocks were limited by Caterpillar, which rose 2.1 percent to $111.31. The heavy equipment maker posted a jump in quarterly earnings that far exceeded Street expectations.

 

Housing-related stocks led the reversal after sales of new single-family homes fell for the first time in four months in December. It followed Wednesday's soft pending home sales report and dented optimism that housing may have reached a bottom. Banks, which stand to benefit from a recovery in housing, also fell. SunTrust ended the day down 5.2 percent to close at $20.50 after Deutsche Bank lowered its rating on the stock.

 

AT&T posted a $6.7 billion quarterly loss, in part on a break-up fee for its failed T-Mobile merger. The shares fell 2.5 percent to $29.45 and were the primary reason the telecom sector was the worst of the S&P's 10 sectors.

 

3M also supported the Dow after it reported higher-than-expected quarterly earnings as demand from industrial and transport markets offset weak sales to makers of consumer electronics. The shares rose 1.2 percent to $87.58.

 

Amgen fell 1.6 percent to $68.08 and weighed on the Nasdaq after the world's largest biotechnology company said it would pay more than $1 billion to buy Micromet, a deal that would give it access to the company's novel cancer treatment technology.

 

This is one of the busiest weeks of earnings season, with 117 S&P companies expected to report. According to Thomson Reuters data, 59 percent of the 152 companies in the S&P 500 that have reported earnings exceeded analysts' forecasts, down from the 70 percent rate in recent quarters at this stage.

 

About 7.9 billion shares exchanged hands on the three major exchanges on Thursday.

 

Long-term Unemployment Trend Remains Positive

 

The number of people seeking unemployment benefits rose last week by 21,000 claims to a seasonally adjusted 377,000 claims, up from a nearly four-year low the previous week. But the longer-term trend is pointing to a healthier job market. Applications have trended down over the past few months. The four-week average has declined to 377,500. When applications fall consistently below 375,000, it tends to signal that hiring is strong enough to lower the unemployment rate.

 

The economy has added at least 100,000 jobs for six straight months. And the unemployment rate has declined to 8.5 percent, its lowest in almost three years.

 

The number of first-time unemployment applications rose 21,000 last week, the Labor Department said. Applications had plummeted two weeks ago to their lowest level since April 2008.

 

Unemployment applications have been particularly volatile this month because employers have cut temporary workers hired for the holidays. The department adjusts for seasonal trends. However, doing so accurately can be difficult. Yet, underneath all the volatility, applications have leveled off in recent weeks.

 

Still, the Federal Reserve forecasts only gradual declines the unemployment rate. The Fed predicts the unemployment rate could fall as low as 8.2 percent by the end of 2012. The economy will likely expand about 2.5 percent this year.

 

The job market has a long way to go before it fully recovers from the damage of the Great Recession, which wiped out 8.7 million jobs. More than 13 million people remain unemployed. Millions more have given up looking for work and so are no longer counted as unemployed.

 

Durable Goods Orders Rebound

 

New orders for manufactured goods rose in December and a gauge of future business investment rebounded, indicating that the economy ended the year with more momentum than previously thought. Durable goods range from toasters to big-ticket items like aircraft which are meant to last three years and more.

 

According to a report released by the Commerce Department, orders for durable goods rose 3.0 percent last month. Part of that increase was likely due to a surge in orders at aircraft builders such as Boeing.

 

The report also indicated that companies might be willing to invest the $2 trillion pile of cash they amassed in recent years.

 

Non-defense capital goods orders excluding aircraft, a closely watched proxy for business spending plans, climbed to a higher-than-expected 2.9 percent. It had declined the previous two months.

 

In addition, shipments of non-defense capital goods orders excluding aircraft, which go into the calculation of gross domestic product, rose 2.9 percent after declining 1.0 percent in November.

 

The overall increase in orders was buoyed by an 18.9 percent surge in orders for civilian aircraft. Boeing received 287 orders for aircraft during the month, according to the plane maker's website, up from 96 in November.

 

Increased consumer spending and efforts by companies to restock their shelves likely led the U.S. economy to accelerate at the end of 2011 although many economists expect some of that strength to wane early this year.

 

New Home Sales Decline

 

According to a report released Thursday morning, new single-family home sales were unexpectedly lower in December for the first time in four months and the median home price dropped, dampening some of the hopes the housing sector will boost the economy this year. According to the Department sales decreased 2.2 percent to a seasonally adjusted 307,000-unit annual rate

 

The housing market remains constrained by high unemployment, falling prices and an oversupply of unsold homes following a bust that triggered the 2007-09 recession.

 

Sales fell in two of the country's four regions, including a 10.1 percent drop in the South, where most new homes were sold. The median sales price for a new home fell 2.5 percent to $210,300 last month, the biggest drop in four months. Compared to December last year, the median price was down 12.8 percent.

 

There were a record low 157,000 new homes on the market last month and at December's sales pace, it would take 6.1 months to clear them, up from 6.0 months in November. For all of 2011, sales were down 6.2 percent from the prior year, with 302,000 new single-family homes being sold.

 

New Action by Fed More Likely than Possible

 

The Federal Reserve has moved closer to embarking on a new round of quantitative easing after Chairman Ben Bernanke highlighted a grim outlook for the economy. Bernanke on Wednesday opened the door a bit wider for the Fed to return to buying securities in the months ahead to buttress a weak recovery and keep inflation from slipping too far below its newly adopted 2-percent target.

 

The Fed's announcement that it was unlikely to raise interest rates until at least late 2014, more than a year beyond its previous guidance, immediately pushed down Treasury bond yields and Bernanke's comments to the media raised expectations of a further round of so-called quantitative easing, or QE3.

 

Barring an unexpected pick-up in inflation or the U.S. economy suddenly kicking into a higher gear, Bernanke said it was logical that the Fed should look at ways to do more to help.

 

"The framework makes very clear that we need to be thinking about ways to provide further stimulus if we don't get improvement in the pace of recovery and a normalization of inflation," he told a quarterly news conference.

 

The Fed in late 2008 slashed interest rates to near zero and has since bought $2.3 trillion in long-term securities in an unprecedented drive to spur growth and revive the economy after the worst recession in decades. Yet the recovery has been slow and the outlook issued by the Fed on Wednesday was bleak.

 

With core inflation now at 1.7 percent and Fed officials forecasting unemployment to stay above 8 percent this year, many analysts took Bernanke's comments to mean QE3 is all but inevitable.

 

The Fed has trained its sights on the stalled housing market in recent months, so any move to QE3 is most widely expected to involve buying mortgage securities to help bring down further already record-low mortgage interest rates.

 

However, Bernanke may wait until the end in June of the Fed's "Operation Twist", which involves selling short-term bonds and buying longer-term ones in its $2.9 trillion portfolio to push down long-term interest rates further. He may also want to wait until the market has absorbed his sweeping changes in communications policy which included the Fed adopting an explicit inflation target and releasing the interest rate projections of its policymakers for the first time on Wednesday.

 

Buying more mortgage-backed securities would drive down longer-term rates on mortgages with a view to countering what remains a drag on a U.S. economy still struggling to emerge from the worst recession in generations. Nonetheless, the objections from a heavy round of MBS purchases could be just as fierce as that provoked by the Fed's second round of quantitative easing which was announced in November 2010.

 

QE2, which targeted Treasuries, attracted sharp criticism from Republicans who warned it could fuel inflation and crimp the Fed's ability to tighten policy eventually, and who accused Bernanke of going beyond the central bank's mandate. Foreign countries were not happy with the Fed's previous bond-buying programs, stating that they artificially weakened the U.S. dollar and hurt their exporters. Brazil's finance minister talked of a "currency war."

 

The political pressure on the Fed may prove too heavy. Nonetheless, 12 of 18 primary dealers, the large financial institutions that do business directly with the Fed, have indicated that the central bank will undertake further quantitative easing.