MarketView for February 8

Summary 

The Dow notched a seventh straight day of gains on Tuesday, but light volume suggested that investors don't believe the more than five-month rally has the legs to keep going. Surprisingly strong sales by McDonald's was responsible for both increased optimism and the rise of the Dow Jones industrial average, despite what turned out to be the quietest day of trading so far in 2011. Total volume was about 17 percent below last year's daily average, coming in at just a total of 6.99 billion shares on the three major exchanges, well below last year's daily average of 8.47 billion shares.

McDonald's shares rose 2.6 percent to $75.36 after its January same-store sales exceeded expectations, led by a rebound in European demand

Weakness in energy shares limited gains by the S&P 500 and Nasdaq indexes after China, the world's second-biggest energy consumer, raised interest rates for the second time in six weeks. The move pressured commodities on fears of lower demand but had little market impact outside that sector..

In extended trading, Walt Disney rose 3.2 percent after it reported first-quarter earnings and revenue that exceeded expectations as consumers traveled to its theme parks and businesses bought up ad time on its TV networks.

Domestic sweet crude for March delivery settled down 0.6 percent.

Merger activity continued for a second straight day with Kindred Healthcare planned of RehabCare Group in order to create a post-acute healthcare services company. Kindred Healthcare rose 28.3 percent to $25.00 and RehabCare was up 45.5 percent to close at $37.05.

On the downside, Teva Pharmaceutical closed down 5.4 percent at $52.02 after the company reported results that did not meet Street expectations. At the same time, Avon posted a steeper-than-expected decline in quarterly earnings, sending the company’s shares down 3 percent to close at $28.47.

European stocks fell from 29-month highs in the wake of the China rate increase, with the pan-European FTSEurofirst 300 index of top shares ending off 0.1 percent at 1,176.28 points. However, because of the gains in the U.S. markets the MSCI world equity index ended up 0.35 percent at a new 29 month high.

China Raises Interest Rates...Again

China raised interest rates on Tuesday for the second time in just over six weeks as it attempts to protect its fast-expanding economy against stubbornly high inflation that threatens to unsettle global markets. This is the third rate increase since China began a monetary tightening cycle in earnest in October. It announced the last rate rise on December 25.

The timing was a surprise, coming on the final day of China's Lunar New Year holiday. However, the move was not unexpected. The increased monetary tightening was necessary as Beijing attempts to rein in price pressures and ward off a property bubble in an economy that grew at a double-digit pace last year.

Benchmark one-year deposit rates will increase by 25 basis points to 3 percent, while one-year lending rates will also be raised by 25 basis points to 6.06 percent, the People's Bank of China said. The changes go into effect on Wednesday. At the same time, Chinese officials have insisted that inflation will be controllable and domestic investors have priced in only gradual tightening.

Although annual inflation slowed in December, food prices have increased sharply. Nonetheless, concerned that the tighter monetary policy will dampen demand in a country whose growth helped lift the world out of the global financial crisis, commodity markets fell after the central bank announcement. Oil, metals and grains prices recovered late in the day as a response to the belief that the increase in rates will not slow the country's hunger for raw materials.

Chinese stocks could, in fact, rise slightly when the market re-opens on Wednesday to catch up with Asian counterparts that have rallied during China's week-long holiday.

Wary of raising rates too high, China has leaned most heavily on quantitative tools in its tightening, forcing banks to lock up more of their deposits as reserves seven times over the past year and also ordering them to lend less. Beijing has also imposed a slew of measures to target property prices that have stayed stubbornly high. The country's leaders, acutely aware of public anger over unaffordable housing, have said they would not tolerate property inflation and speculation.

Excessive cash in the economy, partly stemming from China's huge trade surplus, is a root cause of fast-rising prices, and Beijing hopes that higher rates will encourage savers to keep more of their money in banks and also weigh on demand for mortgage loans. Anti-inflation talk from the central bank in recent months has primed investors for more policy tightening and, even with the latest move; many believe further tightening is in the cards.

A stronger currency would be another weapon against inflation, reducing the cost of imported goods. However, Beijing is expected to keep the yuan to its path of gradual appreciation, frustrating critics from the United States to Brazil who say an undervalued exchange rate gives Chinese firms an unfair advantage in global trade.

While tighter policy may have tapped the brakes on the Chinese economy and taken a toll on the domestic stock market, which has dropped 12 percent since hitting a 2010 high in November, the country's slowdown will likely be moderate. If anything, Beijing's move to tighten policy at a time when U.S. and euro zone interest rates are at record lows is a mark of confidence within the country that its economy is remarkably strong and stable.