MarketView for March 25

 

 

Summary

 

The major equity indexes were in the black for the third straight day on Friday, giving the S&P its best weekly performance since early February, but volume remained light. Approximately 6.56 billion shares changed hands on Friday, making it the second-lowest transaction volume of the year. Daily average volume is about 8.04 billion shares. For the week, the Dow gained 3.1 percent, the S&P climbed 2.7 percent and the Nasdaq advanced 3.8 percent.

 

Helped by a rise in tech shares after an upbeat outlook from Oracle, the S&P 500 index chalked up its best week since early December. But low volume, and the market's uncanny ability to withstand bad news, spurred questions about the rally's strength. The CBOE Volatility Index .VIX posted its second-worst seven-day run as investors shed anxieties about the global tumult.

 

Oracle's shares closed up 1.6 percent at $32.64, making it the Nasdaq's most actively traded issue, a day after the company projected a rise in new software sales for its current fiscal quarter. The outlook fueled hopes that a global resurgence in tech spending remains intact, prompting at least 12 brokerages to raise their price targets on the stock.

 

Also helping out the tech sector was Accenture. Its shares ended the day up 4.5 percent to close at $54.29 after the technology outsourcing and consulting company raised its outlook.

 

On the downside in tech shares, Research In Motion reported that earnings would slip as it spends heavily to launch its PlayBook tablet. The company's shares ended the day down 11.2 percent to close at $56.89.

 

On the economic data front, the Commerce Department reported that the U.S. economy grew more quickly than previously estimated in the fourth quarter of 2010 as businesses restocked shelves to meet rising demand.

 

Consumer sentiment in March fell to its lowest level in more than a year as gasoline and food prices took their toll.

 

Fourth Quarter GDP Higher Than Expected

 

According to a report released by the Commerce Department on Friday, the economy grew at a faster rate during the fourth quarter than previously expected, but signs of softer consumer and business spending may slow its momentum in early 2011.

 

Another report showed consumers in March were their most down beat in over a year as food and gasoline prices jumped. The consumer sentiment report added to some recent economic data -- excluding employment and manufacturing -- that suggested growth in the first three months of 2011 would at best match the fourth-quarter pace. The Thomson Reuters/University of Michigan index on consumer sentiment fell to 67.5 this month, the lowest since November 2009, from 68.2 in early March and 77.5 in February.

 

The higher fourth-quarter growth estimate reflected stronger business inventory accumulation and spending. Business inventories increased $16.2 billion, instead of the $7.1 billion estimated last month. That was still a sharp step down from the third quarter's $121.4 billion rise. Inventories lopped off a smaller 3.42 percentage points from GDP growth, instead of 3.70 percentage points.

 

Excluding inventories, the economy grew at an unrevised 6.7 percent pace, the fastest rise in domestic and foreign demand since 1998. Domestic purchases grew at a 3.2 percent rate. Businesses are expected to have stepped up restocking of their shelves in the first quarter, which should see inventories make a positive contribution to growth.

 

Business investment was lifted by spending on equipment and software, as well as on structures. Government data on Thursday showed a drop in business spending plans for a second straight month in February, indicating a softening in business investment.

 

Rising fuel prices, boosted by unrest in the Middle East and North Africa, are largely blamed for the expected pullback in growth, although economists expect it will be temporary. As yet, no big impact on the U.S. economy is expected from the devastating earthquake and tsunami in Japan. Treasury Secretary Timothy Geithner on Friday said he was not concerned the disaster in Japan would hurt the U.S. recovery.

 

Inflation expectations over the next 12 months were unchanged from the preliminary March survey, but well above February's levels, suggesting consumers still expected price rises to accelerate.

 

The Federal Reserve so far views the high food and energy prices as transitory, but Chairman Ben Bernanke said he would act to ensure an inflationary psychology does not take root.

 

Several Fed officials on Friday described the economy as being on a firmer footing and said the Fed was unlikely to extend its $600 billion government bond buying program when it ends on June.

 

The government also reported on Friday that corporate profits increased 3.3 percent in the fourth quarter after rising 0.2 percent in the prior period. Those solid profits should encourage businesses to step up hiring. For the whole of 2010, corporate profits grew 20.4 percent, the most since 2004.

 

Consumer spending -- which accounts for more than two-thirds of U.S. economic activity -- grew at a 4.0 percent rate in the fourth quarter instead of 4.1 percent. It was still the fastest in four years and an acceleration from the third quarter's 2.4 percent rate.

 

After adding to growth, trade was expected to become a drag in the first quarter as imports picked up again. Government spending subtracted from GDP growth in the fourth quarter, a status quo that was expected to prevail in the near-term as the boost from the $814 billion stimulus package wanes.

 

QE2 Likely To End

 

It appears from the comments of several Fed officials that the Fed is unlikely to extend its bond-buying program with the economy now on firmer footing. In fact, one official was given to comment that the Fed will have to raise rates and sell assets in the "not-too-distant future."

 

Philadelphia Fed Bank President Charles Plosser for the first time detailed his preferred approach to reversing the Fed's easy money policy to prevent future inflation, driving the 10-year U.S. Treasury yield higher on Friday.

 

The Fed has kept short-term interest rates near zero since December 2008 and has bought more than $2 trillion in long-term securities to push borrowing costs down further and boost recovery from the Great Recession. At the Fed's most recent policy-setting meeting, policymakers unanimously voted to continue the bond-buying program begun last November which is slated to end in June.

 

"Following through on that to the tune of $600 billion, like we've said, I think is appropriate," Chicago Fed President Evans told reporters at the regional bank's headquarters. "I personally don't see as many needs for a further amount, as I probably thought last fall."

 

Evans comments, along with those of Atlanta Fed President Dennis Lockhart who said on Friday that "it's a high bar" for the Fed to do more, suggest the debate at the Fed has moved away from a consideration of further easing.

 

Minneapolis Fed President Narayana Kocherlakota told reporters in Marseille on Friday that the economy would need to worsen "materially" for the bank to consider further bond-buying.

 

Speaking in New York, Plosser said the economy has gained "significant strength and momentum" since the summer. "If this forecast is broadly accurate, then monetary policy will have to reverse course in the not-too-distant future and begin to remove the massive amount of accommodation it has supplied to the economy," said Plosser, one of the central bank's biggest inflation hawks.

 

"Failure to do so in a timely manner could have serious consequences for inflation and economic stability in the future," said Plosser, a voter on the Fed's policy-setting committee this year. Plosser's preferred exit strategy would see interest rate hikes coupled with asset sales, he said.

 

"By tying sales to interest rate decisions, it allows the process for selling assets to be conditional on economic outcomes in ways that are familiar to market participants," he said.

 

Evans, who like Plosser has a vote on the policy-setting committee this year, suggested that the Fed would not quickly move to tighten its extraordinarily loose monetary policy, and would likely try to keep its balance sheet steady once active bond-buying stopped.

 

That would require the Fed to continue to reinvest proceeds of maturing securities in new purchases, as it has been done for some months now.

 

"It is natural to expect there would be some period of time between when the $600 billion is completed and an assessment in the change of the trajectory," he said. After a period of what could be some months, he said, the Fed could stop reinvestments, a "modest step" toward tightening that probably not be followed quickly by other steps unless the economy was outpacing expectations.

 

Evans and Plosser both said the earthquake and nuclear crisis in Japan and the rise in oil prices because of turmoil in the Middle East pose a risk to the U.S. recovery -- but said they expected this risk to be small and short-term.