MarketView for March 26

 

 

Summary 

 

The Nasdaq closed out the day back in positive territory year-to-date, as increasing optimism took hold on the idea that the economy's worst days are behind us. This new found optimism percolated throughout the Street after the latest government reports on the economy were less dire than had been expected. The S&P 500 is now up 23.1 percent since it hit a 12-year low on March 9. At the current pace, the S&P 500 could have its largest monthly gain in 22 years.

 

Helping the day's bullish activity was Best Buy after the company reported both results and an outlook that topped market estimates, reinforcing views of rising consumer demand and driving up other retailers. Best Buy shares closed out the trading day up 12.6 percent. Wal-Mart was also among the top performing retailers, with its shares rising more than 2 percent to $52.76.

 

Large cap technology stocks pushed the Nasdaq into positive territory for the year, after Goldman Sachs reiterated its "buy" rating on Research In Motion writing to clients that it expects the company to post fourth-quarter results in line with Street expectations. RIM’s shares ended the day up 4.9 percent to $45.04. Undaunted, Apple rose 3.2 percent to $109.87.

 

Stocks rose even as Thursday's report on Gross Domestic Product indicated that the economy contracted at its fastest pace since 1982 in the fourth quarter. However, the decline was slightly less than expected. Corporate profits in the fourth quarter fell by the largest margin since 1994, while the number of workers collecting state unemployment benefits rose to a record high in the latest week.

 

Two of the worst performers this year, homebuilders and banks, also extended their gains on Thursday. Toll Brothers ended the day up 4.3 percent to $19.96, while D.R. Horton rose 8.7 percent to $10.93.

 

Natural resources companies showed some life along with higher commodity prices. Shares of Nucor chalked up a gain of 5 percent to $41.09 and U.S. Steel was up 5.4 percent to $24.74. Wall Street was also relieved to see increased demand for the newest offering of $24 billion of government debt after a poor auction a day earlier raised fears the government would have trouble funding its plans to help the economy recover.

 

Fed Hints Recession May Be in Final Stages

 

Top Federal Reserve officials hinted on Thursday that the long U.S. economic downturn could be in its final throes, although the early stages of recovery will likely be far from stellar. At the same time, government officials were divided on whether the Fed's current stance of aggressively pumping money into credit markets poses a major risk of sending inflation well beyond tolerable limits.

 

Dallas Fed President Richard Fisher, who terms himself the most pessimistic member of the Federal Open Market Committee at present, said the Fed's aggressive rescue efforts should soon stem the decline in growth. Weakness could be tempered after the current quarter, which is likely to match the annualized contraction of 6.3 percent in gross domestic product seen for the dismal final quarter of 2008, Fisher said.

 

Gary Stern, Minneapolis Fed President, said that at least a mild recovery could take hold by mid-year before healthier growth kicks in during 2010. "Many pieces are now in place to contribute to improvement in financial market conditions and in business activity," Stern said. "There is reason to think that improvement is not too far off."

 

Jeffrey Lacker, Richmond Fed President, offered recent increases in U.S. retail sales, lower gasoline prices and steady wages as signs for hope on the economy. It is reasonable to expect the economy to hit bottom later this year and then begin a gradual recovery, Lacker said.

 

Still, Dennis Lockhart, Atlanta Fed President made it clear that, "One month does not make a recovery, so we have to be careful not to react too strongly.”

 

Some financial markets participants fear the Fed's provision of huge amounts of liquidity to support the economy will fire up inflation when the economy eventually recovers. The Fed's balance sheet now stands at more than $2 trillion. As recently as mid-September 2008 it stood at about $1 trillion. Just last week, the Fed vowed to provide the economy with an additional $1.15 trillion, partly by buying government bonds for the first time since the 1960s.

 

Charles Plosser, Philadelphia Fed President said that the composition of the balance sheet, as much as its size, troubled him and voiced support for buying Treasury bonds. Bond purchases are "more neutral in their effects on the allocation of credit" than a number of other Fed programs which have targeted specific corners of the credit market, he said.

 

Lacker, who along with Plosser is one of the Fed's biggest inflation hawks, seemed anxious to secure a commitment to run down the balance sheet as soon as possible. "Such a large increase in the monetary base cannot be left in place indefinitely without creating quite sizable inflation pressures," he said. "Choosing the right time to withdraw that stimulus will be a challenge and I believe it will be very important to avoid the risk of waiting too long."

 

Still, Stern, the Fed's longest-serving regional bank president, was less worried, saying the central bank had "ample time" to withdraw excess liquidity when the time was right. "The relation between growth in the money supply and the path of prices holds in the long run, over periods of at least five and, more likely, 10 years," Stern said.

 

In the short run, most officials agree that the Fed is buying some needed insurance against the threat of deflation resulting from the downturn in global economic activity. Inflation expectations had remained "pretty stable" in recent months, and the Fed's big balance-sheet blow-out would ensure that "deflation doesn't become an issue," Plosser said.

 

Lacker concurred. "I am confident that we can prevent outright deflation by expanding our monetary policy stimulus if need be."

 

As they are left to mop up the worst financial crisis in seven decades, some Fed officials concede that signs of an impending meltdown went unnoticed for too long.

 

"Most in the financial community, including those of us at the Federal Reserve, failed to either detect or act upon the tell-tale signs of financial system excess," Fisher said.

 

Stern, meanwhile, termed the mortgage providers Fannie Mae and Freddie Mac were "poster children" for regulatory action taken way too late.

 

Without timely responses to financial crises, the costs to the real economy grow and grow, Stern said. "You want to deal with these things as quickly, and forcefully, as you can."

 

The Regulation Noose Is Tightening

 

Wall Street faces curbs on risk taking and the prospect of lower profits under sweeping proposals to prevent a repeat of the credit crisis. The Obama administration's plan to rewrite financial rules, announced on Thursday, would create a single regulator to monitor any firm whose failure could threaten the financial system, while also tightening rules for big hedge funds and private equity firms.

 

U.S. Treasury Secretary Timothy Geithner told Congress "comprehensive reform" was needed to prevent a repeat of the current credit crisis, the most virulent since the 1930s. "Not modest repairs at the margin, but new rules of the game."

 

The proposals Geithner presented also require large, interconnected institutions to hold more capital, provide for derivatives to be traded on an exchange, and give the government authority to shut down troubled financial firms.

 

Under the plan Geithner has laid out for the House of Representatives Financial Services Committee, one entity would be responsible for ensuring systemic stability over both major institutions and critical payments and settlement systems. Many lawmakers have considered giving the Federal Reserve that role. Currently, a variety of regulators control different parts of the banking system, and some participants in insurance and other sectors largely fall between the regulatory cracks.

 

"We have a moment of opportunity now. We don't want to waste this opportunity," Geithner said. "We need to act."

 

Securities and Exchange Commission Chairman Mary Schapiro, whose agency came under harsh criticism for not seeing the current crisis coming, said the agency should not be sacrificed in order to set up an overarching regulator. "Even as attention focuses on reconsidering the management of systemic risk, investor protection and capital formation ... cannot be compromised," she told lawmakers.

 

In one key move, Geithner said hedge fund advisers and others who control big pools of capital like private-equity funds and venture capital firms should be forced to register with the SEC. Geithner used the example of American International Group to make the point that companies like insurers were taking huge risks on exotic products like credit default swaps that were barely understood by some market participants.

 

"Let me be clear: the days when a major insurance company could bet the house on credit default swaps with no one watching and no credible backing to protect the company or taxpayers from losses must end," Geithner said.

 

He promised "unparalleled transparency" for the market for derivatives related to stocks, bonds, currencies or other financial instruments or risks. Dealers would have to clear derivatives contracts through central counterparties so they could be monitored.

 

Geithner wants large firms to be required to hold more capital than other financial companies, and would face tougher liquidity, counterparty and risk-management rules. The systemic risk regulator would get powers to order prompt corrective action if capital levels decline, similar to the power the Federal Deposit Insurance Corp has for banks.

 

Despite the strong prescriptions to increase scrutiny, the administration signaled some flexibility on accounting. For example, so-called fair value accounting rules will be reviewed to try to identify changes that could reduce wild swings in profit and capital levels as markets move up and down. Similarly, accounting for loan loss reserves might be revised to ensure firms are setting aside enough money to get through rough economic spots without collapsing.

 

Administration Plans To Help The Automotives

 

President Obama said on Thursday that his administration would unveil in the coming days the next part of its plan to help the troubled domestic auto industry, provided the companies push ahead with sweeping restructurings.

 

The signal of additional federal support prompted a rally in General Motors Corp shares and came as the embattled automaker announced that 12 percent of its U.S. hourly workers had accepted buyouts.

 

Auto sector shares rallied across the board and GM jumped more than 14 percent as Obama's comments bolstered expectations that while the government would demand tough concessions from creditors and shareholders, it would not force GM and Chrysler into bankruptcy.

 

"What we're expecting is that the automakers are going to be working with us to restructure. We will provide them some help," Obama said at a town hall meeting conducted at the White House for viewers on the Internet.

 

"I know that it is not popular to provide help ... to auto companies," he said. "If they're not willing to make the changes and the restructurings that are necessary, then I'm not willing to have taxpayer money chase after bad money."

 

GM and Chrysler face a March 31 deadline for action on a request for up to $22 billion in additional emergency loans to help them ride out the weakest auto sales in three decades. On a combined basis, the two automakers have relied on $17.4 billion in loans from the U.S. Treasury to stay in operation since the start of the year.

 

The request for additional funding, which is being reviewed by a White House panel, hinges on the companies' ability to win concessions from the United Auto Workers union and creditors. As part of its efforts, GM said on Thursday that 7,500 U.S. hourly workers represented by the UAW had accepted buyout offers and would be off its payroll by April 1.

 

Including the latest round of buyouts, GM has cut 60,500 jobs since 2006, more than half of its domestic factory. Separately, Chrysler said it would extend a buyout program that it offered to all its 26,000 U.S. hourly workers last month. GM and Chrysler have also won pending contract changes from the UAW intended to help them cut hourly wage costs to the level of Japanese automakers' operating plants in the United States.

 

But both automakers have yet to reach related deals with the UAW that would allow them to pay the union in stock rather than cash for half of their remaining obligations to a trust fund for retiree health care, Voluntary Employee Beneficiary Association.

 

GM bondholders also face pressure to write off two-thirds of the more than $27 billion they are owed in exchange for stock in a recapitalized company. Advisers to GM bondholders met with Rattner and the autos task force earlier this month, but complained as recently as Sunday that they had been shut out of ensuing talks with both U.S. government representatives and the GM executives.

 

Standard & Poor's said in a research note that Thursday's rally in GM shares was "unwarranted" because of lingering risks of stock dilution or bankruptcy. However, higher share prices could help GM as it negotiates a debt-for-equity swap with bondholders and the UAW, it added.

 

A White House spokesman said Obama has been frustrated with the auto industry for some time, and said the president believes industry executives have made bad business decisions over several years.

 

GM and Chrysler, which lost a combined $39 billion last year, have been hit by a deepening downturn in sales, which fell by more than a third in January and February and hit their lowest levels in 27 years.