MarketView for February 18

 

 

Summary 

 

The major equity indexes moved higher for a third week on Friday, despite growing signals of an overheating market. More than $8 billion flowed into equity funds for the week ended February 16, according to Thomson Reuters Lipper data. It appears that there is a distinct reluctance to move out of stocks, despite falling volume and a narrowing spread between winners and losers.

 

About 7.2 billion shares traded on the three major exchanges, far below last year's estimated daily average of 8.47 billion. However, some are making the argument that the cause of the problem is simply a lack of sellers. With some technical measures pointing to signs of an overbought market, some investors have been braced for a pullback. But the market has for weeks defied those expectations.

 

For most of 2010, retail investors put net cash into mutual funds that invest in fixed-income securities. But with more signs that the economic recovery is strengthening and that the  equity indexes are continuing to rise, there has been a renewed appetite for stocks.

 

Investors poured a net $8.72 billion into domestic. equity funds for the week ended Wednesday, up from $2.04 billion in the prior week, according to Lipper data. Meanwhile, for the week the Dow Jones industrial average and the S&P 500 index gained 1 percent, and the Nasdaq added 0.9 percent.

 

Caterpillar added to the gains of the Dow  rising 2.4 percent to $105.86 after the company indicated that machinery sales through dealers accelerated in the three months through January.

 

Individual companies on the move in response to the latest batch of earnings reports included Brocade Communications Systems, which exceeded estimates and forecast second-quarter earnings above Wall Street's expectations, pushing its shares up 6 percent to $6.38.

 

Intuit reported earnings on Thursday that also exceeded Street expectations and raised its quarterly earnings forecast, sending its shares up 7.3 percent to $54.11.

 

U.S. markets will be closed on Monday for the Presidents Day holiday.

 

Flash Crash Panel Says Overhaul

 

Regulators should stem the growing tide of anonymous stock-trading and consider imposing fees on high-frequency traders, said a panel of experts advising how to avoid another "flash crash." The panel's 14 recommendations for U.S. securities and futures regulators contained far-reaching ideas to overhaul the high-speed electronic market.

 

Yet many of the ideas issued on Friday called only for "consideration" or "further study" -- potentially raising more questions as the first anniversary of the May 6 flash crash nears.

 

Regulators were cautious about some of the boldest recommendations, including new fee structures to encourage liquidity and discourage high numbers of order cancellations.

 

"I do not know where we as a commission would come down on fees," Securities and Exchange Commission Chairman Mary Schapiro told reporters after meeting with the panel.

 

The unprecedented May 6, 2010, market crash sent the Dow Jones industrial average down some 700 points before rebounding, all in a matter of minutes. It rattled investors, exposed flaws in the structure of markets, and set regulators on a mission to fix the system and restore confidence. Since then, individual stocks have experienced what some refer to as "mini" crashes, where shares unexpectedly move on a sudden burst of volume, absent of any news.

 

Prominent technology shares including Apple and Cisco have been halted after breaking through thresholds that automatically halt trading. On September 27, shares of Progress Energy were halted after plunging suddenly to $4.57 a share from $44.57 a share in a fraction of a second.

 

The eight-member panel suggested the SEC consider forcing the banks, hedge funds and others that facilitate stock-trading away from the public exchanges to give investors a better price by a minimum amount. It also said stock pauses and limit-up/limit-down price bands would help reduce investor fears about how markets react in times of uncertainty.

 

The changes would require the SEC and fellow regulator, the Commodity Futures Trading Commission, to take on a massive amount of work at a time when the agencies are straining to carry out the Dodd-Frank financial reform law.

 

"Many market participants spent north of $1 billion a year on technology, and we as an agency only spent $31 million last year, and this year ... are actually cutting that back," CFTC Chairman Gary Gensler told reporters.

 

Some of the recommendations, such as expanding and modifying the "circuit breaker" trading pauses, had been anticipated and mostly endorsed by traders and exchanges such as NYSE Euronext and Nasdaq OMX Group.

 

The exchanges at the center of the breakdown, however, added a new wrinkle to the debate when in the last week they set off a new wave of planned global mergers, including the takeover of Big Board parent by Germany's Deutsche Boerse.

 

The mergers highlight the increasingly interconnected global marketplace, where drops in one region can rapidly trigger plunges elsewhere. The panel wants regulators to consider a so-called "trade at" order routing rule -- something that would hurt the growing ranks of "dark pools" where trading is done anonymously.

 

Some 33 percent of U.S. stock-trading takes place away from exchanges, up from 20 percent four years ago, through "internalizers" such as market-maker Knight Capital, Goldman Sachs, and hedge fund Citadel.

 

A "trade at" rule, which Schapiro on Friday expressed support for, would generally prohibit any of the dozens of U.S. venues and wholesale market makers from executing an incoming order unless they were already publicly displaying the best bid or offer in that particular stock.

 

Another idea would see regulators adjust trading fees so that firms providing liquidity get rebates to help stabilize markets during stressful times.

 

These types of adjustments could revamp the flow of tens of trillions of dollars annually in the markets -- and could take years of hearings and deliberation to settle.

 

Following the flash crash, some lawmakers called for a crackdown on traders who use algorithms to execute complex trading strategies across markets. The CFTC is due to consider new guidance next Thursday for traders on a new ban on disruptive trading practices.

 

Easy Money Not the Cause

 

Federal Reserve Chairman Ben Bernanke defended easy money policies in advanced economies against the charge they are overheating emerging markets, saying factors such as exchange rate rigidity are also to blame. Bernanke did acknowledge that strong capital flows from advanced economies to emerging markets may be having negative spillover effects.

"Capital flows are once again posing some notable challenges for international macroeconomic and financial stability," he said in remarks prepared for delivery to a Banque de France event in Paris before meetings of the finance ministers and central bankers of the Group of 20 leading economies.

 

However, he said that although policy-makers in the emerging markets clearly face challenges, such concerns should be weighed against stronger emerging market growth and steps emerging economies themselves can take.

 

The Fed’s $600 billion bond buying initiative launched in November has stirred harsh criticism from countries around the world. U.S. quantitative easing measures have been attacked for driving down the value of the dollar, hurting emerging economy exports and inflating asset bubbles, and the Fed chairman can expect to hear about it from his counterparts at the summit.

 

Bernanke did not mention inflation concerns directly except to say that strong demand in emerging markets is contributing to global commodity price increases, something which affects the most advanced economies as well.

 

Gradually smoothing global imbalances of trade and investment is a top priority for G20 officials. Officials have set themselves the goal of drawing up a list of indicators to measure imbalances, with the aim of making growth more stable and less prone to cycles of boom and bust.

 

Bernanke said faster growth in emerging markets is one factor driving strong capital flows into those economies. Furthermore, emerging market policy-makers have tools at their disposal -- including exchange rate adjustment and monetary policy -- to prevent overheating, he said.

 

"Countries with excessive and unsustainable trade surpluses will need to allow their exchange rates to better reflect market fundamentals and increase their efforts to substitute domestic demand for exports," he said.

 

The argument that greater currency flexibility is necessary to right imbalances is a recurring theme for U.S. officials who have persistently sought to pressure China to allow its yuan currency to float more freely against the dollar.

 

Many in government have stated that by keeping the yuan weak, the Chinese government is supporting an export-led economy that leads to its large trade surplus with the United States. Therefore, Washington wants to keep the spotlight on the yuan at the G20.

 

Advanced economies are also experiencing the ill effects of strong capital flows into emerging economies in the form of higher prices, Bernanke argued.

 

"Spillovers can go both ways. For example, resurgent demand in emerging markets has contributed significantly to the sharp recent run-up in global commodity prices," he said.

 

Higher prices for food and energy have raised worries about inflation around the world and are prompting many central bankers to consider tightening financial conditions even as some economic recoveries remain shaky. China and India have already raised interest rates to combat inflation, and Britain is under pressure to do the same.

 

Bernanke conceded the need for the United States to begin to implement some form of fiscal restraint as part of improving global balances of trade and investment. Countries with persistently high trade deficits must increase saving and put their fiscal houses in order, he said, a reference to record U.S. budget deficits. Major economies at the G20 were split on how to measure imbalances, with China resisting including measurement of exchange rates and currency reserves, sources said.