MarketView for June 28

 

 

Summary  

 

The major equity indexes closed out the start of the last week in the quarter at just about where they were at the opening bell on Monday as gains in consumer-related stocks, including tobacco shares, were offset by losses in the energy sector. Shares of Coca Cola and Procter & Gamble were two of the Dow Jones Industrial Average's best performers.

 

Coca-Cola rose 1.6 percent to $51.08 and P&G gained 1.4 percent to $60.62. Driving the shares of companies manufacturing consumer products was an economic report indicating that personal spending rose moderately in May, exceeding expectations, after being flat in April.

 

Tobacco companies rallied after the U.S. Supreme Court rejected the government’s attempt to claim billions of dollars in damages from the tobacco industry. Altria Group gained 3.3 percent to $20.34 and Reynolds American closed out the day up 4.1 percent at $53.45.

 

The spotlight, however, was on the consumer as investors and analysts waited for further evidence that consumer spending, which accounts for two-thirds of economic activity, would show greater strength and propel broad growth.

 

However, an earlier rally during the day hit the skids as a result of weakness within the energy sector, as crude oil futures fell on the increasing likelihood that Tropical Storm Alex is unlikely to disrupt production in the Gulf of Mexico. Exxon Mobil fell 1.1 percent to $58.47.

 

Among the bright spots in the energy sector, Noble, owner of the second-largest fleet of offshore drilling rigs, gained 2.5 percent to $30 after announcing it would buy Norway's privately held Frontier Drilling for $2.16 billion.

 

After the closing bell, 3M gained 1 percent to $79.75 as the diversified manufacturer announced a second-quarter sales forecast in the range of $6.6 billion to $6.75 billion.

 

Consumer Spending Rises

 

The Commerce Department reported on Monday that consumer spending rose moderately in May, even as the rate of savings touched its highest level in eight months, indicating a tepid economic recovery was still intact. The data helped to allay fears that consumers, key to reviving the economy, were retreating.

 

Spending increased 0.2 percent after coming in flat for the month of April, the Commerce Department said. Adjusted for inflation, spending was up 0.3 percent.

 

Households' spending capacity is being restrained by stubbornly high unemployment, but analysts believe it will remain on a solid footing through the year as the labor market steadily improves. Last month, an increase in jobs and longer working hours helped lift incomes. Incomes rose 0.4 percent after gaining 0.5 percent in April, the Commerce Department said. Adjusted for inflation and taxes, incomes climbed 0.5 percent following a 0.6 percent increase the prior month.

 

Payrolls increased 431,000 in May, boosted by the hiring of 411,000 temporary workers to complete the 2010 Census. According to a Reuters survey, employment probably fell 110,000 this month as more than half of the census workers recruited in May were laid off.

 

But private hiring, considered a better gauge of labor market health, likely picked up after unexpectedly slowing in May. This should help to sustain spending and support the fragile economic recovery, analysts say.

 

With incomes outpacing spending, the savings rate rose to 4 percent last month from 3.8 percent in April. Savings increased to an annualized $454.3 billion, the highest level since September.

 

The report on spending showed inflation pressures remain muted. The personal consumption expenditures price index was flat for a second month in a row, while the core price index, which excludes food and energy costs, rose 0.2 percent.

 

The core price index, closely eyed by officials at the Fed, was up 1.3 percent in the 12 months to May. Most officials at the central bank would prefer to see it closer to 2 percent.

 

Bank of International Settlements Warns

 

Governments must slash budget deficits decisively and central banks should not wait too long to raise borrowing costs as side effects from measures prescribed to tackle the global recession may create the next crisis, the Bank for International Settlements said.

 

The global economies, as well as financial markets, were on the mend, though the recovery remained fragile in the advanced economies and in the euro zone the debt crisis put the recovery at risk, the BIS said in its annual report, published on Monday.

 

Global leaders meeting in Toronto agreed to take different paths for shrinking budget deficits and making banking systems safer and Washington in particular has warned against cutting too fast.

 

The head of the BIS said there was no time to waste.

 

"We cannot wait for the resumption of strong growth to begin the process of policy correction," BIS general manager Jaime Caruana told the bank's annual general meeting.

 

"In particular, delaying fiscal policy adjustment would only risk renewed financial volatility, market disruptions and funding stress."

 

Caruana later told a news conference that recently announced fiscal consolidation in some countries together with the publication of bank stress tests in Europe and the support of the G20 for regulatory reforms were important steps forward.

 

The BIS, which acts as a bank to central banks and a discussion platform for policymakers, said reforms of the financial system remained the key to prevent further crises.

 

Caruana said the benefit of making the financial system more resilient through tighter regulation outweighed any short-term growth losses.

 

Top central bankers met at the BIS annual meeting June 26-28 in Basel, following the G20 summit where leaders acknowledged the uneven and fragile economic recovery in many countries.

 

In a reversal from the unity of the past three crisis-era Group of 20 summits, the leaders left room to move at their own pace and adopt "differentiated and tailored" policies.

 

But the BIS warned powerful support measures had strong side effects and said their dangers were starting to emerge.

 

"To put it bluntly, the combination of remaining vulnerabilities in the financial system and the side effects of such a long period of intensive care threaten to send the patient into relapse," the BIS report said. The BIS said if the extraordinary measures were kept in place for too long, policymakers ran the risk of creating "zombie" banks or companies, dependent on direct support.

 

But it acknowledged the tricky situation for policymakers as the stakes were high and the risks from capping lifelines too early loomed large.

 

The banking system was still far from sound, as recent profits from fixed income and currency trading and the low interest rate environment were hard to repeat and not all crisis-related losses may have been booked.

 

"But the longer that policy rates in the major advanced economies remain low, the larger will be the distortions they create, both domestically and internationally," the BIS said.

 

Extremely low real or inflation-adjusted rates altered investment decisions, postponed the recognition of losses, increased risk-taking in the search for yield and encouraged high levels of borrowing, the BIS said.

 

In addition, central bankers may underestimate inflation risks as the crisis may have lowered potential growth rate.

 

Markets have pushed back expectations for rate increases in the United States and in the euro zone in the wake of the Greek debt crisis, and central bankers urged Europe to solve the crisis so as not to endanger uneven global recovery.

 

Challenges for emerging economies were different as they were recovering strongly and inflation was picking up, the BIS said.

 

"Some EMEs could rely more on exchange rate flexibility and on monetary policy tightening," the BIS said.

 

The Greek debt crisis had highlighted that many governments had to consolidate their finances immediately as highly indebted countries would not be able to rescue banks as a buyer of last resort in another crisis.