MarketView for July 23

 

 

Summary

 

Wall Street closed out the week on a very positive note on Friday as investors found renewed faith in the markets after GE raised its dividend. GE gained 3.3 percent in high volume after the company announced that it was raising its quarterly dividend by 20 percent. GE's move also resulted in heavy institutional buying. The wide-ranging impact GE has on the economy, coupled with another round of strong earnings, bolstered investor confidence, sending the S&P 500 index past the key 1,100 level for the first time in a month.

 

The S&P 500 has come close to exceeding that level four times in July but was never quite strong enough. The gain -- along with other chart moves, such as a key break on its daily moving average convergence-divergence, or MACD -- sent a bullish technical signal to investors. The benchmark indicator faces a tough hurdle at its 200-day moving average, a tick above 1,113, and at the midpoint of its 2010 range, near 1,115. Meanwhile, the Nasdaq erased losses for the year and ended flat while the Dow Jones industrial average and S&P 500 continued to remain in negative territory for the year.

 

Honeywell and Ingersoll-Rand posted better-than-expected results and raised full-year earnings views, further allowing investors to push aside fears of a return to negative growth. Honeywell added 2 percent to $43.50 and Ingersoll-Rand gained 1.3 percent to $37.29. Verizon was also a strong positive influence on the Dow after it said its wireless venture added more customers than expected and that land line profit margins exceeded estimates. Its shares were up 3.8 percent at $28.02. Genzyme rose 15.4 percent to $62.52 after Sanofi-Aventis approached the biotechnology company regarding an acquisition.

 

Hoping to ease fears over any impact from the euro zone debt crisis, European regulators assessed how banks would cope with another downturn. Seven of 91 banks failed the tests, fewer than expected, but there was some question as to whether the tests were stringent enough.

 

Deficit Expected to Decline

 

The Obama administration indicated on Friday that the economy had encountered "strong headwinds" and the country's fiscal challenge remained grim. Nonetheless, it lowered an estimate for the budget deficit this year. Outlining the country's fiscal path over the next decade, the White House said the numbers were moving in the right direction but the deficit and debt were too high.

 

"The economy is still struggling; too many Americans are still out of work; and the nation's long-term fiscal trajectory is unsustainable," the White House said in the annual midsession review of President Barack Obama's budget.

 

Investors are focused on debt at a time when European governments are stressing fiscal consolidation. The White House said the country was on track to meet its June commitment in Toronto to the Group of 20 to halve the deficit by 2013.

 

The administration trimmed an expected funding gap in the current fiscal year by $84 billion, to $1.47 trillion, versus the estimate released in February. The gap was seen narrowing to $1.42 trillion in 2011. Republicans jumped on the numbers as proof "Obamanomics" was not working.

 

The review also tweaked White House assumptions about the economy, which have been criticized as overly optimistic in the past. The White House forecast growth at 3.2 percent this year, 3.6 percent in 2011 and 4.2 percent in 2012. Unemployment will only decline slowly, to 8.1 percent in 2012, the year of next presidential election, and stay above 6 percent until 2015.

The forecasts were based on data available through May and finalized in early June.

 

"The most pressing danger we now face is unacceptably weak growth and persistent unemployment, rather than outright economic collapse, and that is a very substantial difference," White House Budget Director Peter Orszag told reporters.

 

Job creation is a vital goal for Obama and will loom large in the November poll, but unemployment has lagged growth and remains at a lofty 9.5 percent.

 

"The U.S. economy still faces strong headwinds," the White House said, citing a weak housing market and doubts about the recovery in Europe, which could sap demand for exports. "The European recovery is at risk because of increased uncertainty while government stimulus is withdrawn, and a further slowdown in Europe would pose problems for the rest of the world whose exports to Europe may be reduced," it said.

 

Britain and Germany have announced austerity plans to reassure investors, contrasting with the U.S. preference of phasing in budget controls going forward. European Central Bank President Jean-Claude Trichet, in an article in the Financial Times on Friday, urged countries using the common euro currency to "implement a credible medium-term fiscal consolidation strategy."

 

In contrast, Federal Reserve Chairman Ben Bernanke argued this week the economy still needed fiscal support and it did not make sense to try to rein in this year's deficit. But he stressed the country needs to curb the deficit over the next 2 to 3 years.

 

Obama signed an $862 billion emergency stimulus last year, which the White House says helped restore U.S. growth. But his subsequent efforts to increase aid to cash-strapped states and small businesses have been thwarted in Congress, mainly by Republicans in the Senate objecting to more deficit spending.

 

U.S. government debt held by the public is projected to rise above 70 percent of gross domestic product in 2012 and reach 77 percent by 2020.

 

Critics warn adding to the deficit could sap investor faith in the administration's commitment to phase in budget controls, risking a sovereign debt crisis here that unnerved European markets earlier this year.

 

Long-term interest rates remain low supporting the recovery by holding down borrowing costs on mortgages and auto loans. But that could quickly change if bond investors take fright. Obama vows to cut the deficit in half by 2013, a promise the larger Group of 20 rich and emerging nations also adopted at a meeting in Toronto last month, and the president has appointed a bipartisan commission to suggest how to tackle the fiscal challenge.

 

Seven European Banks Fail Stress Tests

 

Seven European banks failed stress tests and were ordered to raise their capital by 3.5 billion euros ($4.5 billion), much less than expected. The tests indicate how 91 banks in 20 countries would cope with another recession was released on Friday in a bid to restore investor confidence after the Greek debt crisis spooked markets earlier this year. But it fell on deaf ears. While the modest findings cast doubt on the credibility of the bank tests, it may not matter due to the speed with which the European economy is improving.

 

The survey also showed how much government bonds are marked down on bank books, with Greek debt discounted the most, at 23 percent. The expectation was that five to 10 banks would fail the test, but the estimate was that the capital shortfall could be over 30 billion euros. As expected, no large banks failed the health check.

 

The Committee of European Bank Supervisors (CEBS), a previously little known group with 25 staff at a small London office, which coordinated the process, said its test was more severe than the one the United States ran.

 

Five of Spain's smaller regional lenders, known as cajas, failed the test. Their recapitalization will almost complete a state-funded drive to consolidate the country's network of unlisted savings banks. They need 1.8 billion euros, the Bank of Spain said.

 

Banks in Germany and Greece were also seen as weak spots and in need of restructuring, but state-owned Hypo Real Estate was the only German lender not to pass and state-controlled ATEbank, the only Greek one.

 

The euro ended flat against the dollar after falling initially on questions whether the stress tests were tough enough. German government bond futures fell on relief that they threw up no nasty surprises.

 

European bank shares, up on the week, closed before the results were announced. U.S. stocks were little changed after the stress test and closed higher on U.S. company results. The cost of insuring the debt of most European banks fell.

 

Any bank whose Tier 1 capital ratio falls below 6 percent by the end of 2011 failed the test, and would be expected to raise funds to make up the capital shortfall. Of greatest concern to investors was that government bond losses were only applied to trading books, and not hold-to-maturity bonds, as the test did not consider there was a risk of any sovereign default.

 

Banks' holdings of government bonds were subjected to a 23.1 percent loss on their Greek debt, a 12.3 percent loss on Spanish bonds and a 4.7 percent loss on German debt, all based on 5-year bonds and their value at the end of 2009.

 

The hunt for weak spots in European banking has focused on Spain's regional savings banks, as well as regional German lenders, known as landesbanks.

 

Spain and Germany have set up funds to help weak banks recapitalize and Spain wants more cajas to merge.

 

The Spanish banks to flunk were Banca Civica, Diada, Espiga, Unnim and Cajasur. The worst case scenario included a 28 percent fall in Spanish house prices during 2010-11.

 

Banks that came close to failing with a Tier 1 ratio of less than 7 percent under the most stressed scenario included Germany's Deutsche Postbank, Greece's Piraeus, Allied Irish Banks, Italy's UBI Banca and Spain's Bankinter. The banks that have scraped through may have more of a challenge on their hands because they will likely be the ones the market focuses on.

 

European banks have also already raised about 300 billion euros since the start of the crisis, whereas the U.S. tests kick-started the fundraising.

 

Banks in Ireland, Greece, Spain and Germany have also already received funds or are in the process of doing so, possibly helping them to pass the test.