MarketView for March 7

 

 

Summary

 

The major equity indexes managed to break free of a three-day losing streak on Wednesday, recovering some recent losses after a report indicated that the private sector added more jobs than expected last month. Share prices received an early lift after ADP indicated that private employers picked up the pace of hiring in February. Improving economic figures have helped push the S&P 500 up more than 20 percent from the October closing low.

 

A report from The Wall Street Journal stating that the Fed is considering a new type of mortgage and Treasury bond-buying program also added momentum to the equity markets, particularly the financials. As a result, banking stocks - Tuesday's big losers - were the strongest sector on Wednesday. Morgan Stanley gained 3.2 percent to close at $17.88 following a 5.3 percent drop in the previous session.

 

Investors continued to eye signs of progress in negotiations between fiscally troubled Greece and private creditors that will result in a substantial write-down for Greece's debt costs. Nonetheless, six Greek pension funds are still holding out against joining the deal while eight have agreed to take part.

 

Apple shares were volatile as the company unveiled its latest iPad, which commands upwards of two-thirds of the growing tablet market. Apple shares fluctuated between gains and losses after the reveal, closing up just 0.08 percent at $530.69. Earlier in the session, Apple's stock had gained as much as 1.4 percent to reach an intraday high at $537.78.

 

Shares of Freeport McMoRan Copper & Gold fell 1.1 percent to $38.99 and Newmont Mining slipped 0.9 percent to $56.68 after Indonesia announced new rules to take more profits from vast mineral resources by limiting foreign ownership of mines.

 

Investors kept an eye on oil prices after France voiced skepticism that a planned revival of talks between six world powers and Iran over its nuclear program would succeed. Rising geopolitical tensions could bring war to the region, raise oil prices, and harm the global economy.

 

Volume was light, with about 6 billion shares changing hands on the three major equity exchanges, a number that was below the daily average of 6.9 billion shares.

 

Consumer Credit Up More Than Expected

 

According to the most recent Federal Reserve data, released on Wednesday, consumer credit expanded sharply in January in a generally positive sign for the economy as people borrowed money to buy cars and go to school. However, the report also indicated a decline in credit card usage, which could point to some a restricted outlook for earnings. Total consumer credit grew by $17.776 billion in January.

 

Credit has now expanded for five straight months, a sign households are less uneasy about taking on debt as the labor market slowly heals from the 2007-2009 recession. Non-revolving credit, which includes auto loans as well as student loans made by the government, rose $20.723 billion during the month. That was the biggest increase in dollar terms since November 2001, when credit was surging in the wake of the September 11 attacks in New York and Washington.

 

At the same time, household incomes are posting less impressive gains. After-tax incomes adjusted for inflation fell in January for the second time in three months, the Commerce Department reported last week.

 

The Fed data on Wednesday showed borrowing via lines of revolving credit, which mostly measures credit-card use, fell in January for the first time in five months. It was down $2.947 billion compared to December.

 

Also tempering the optimism of the overall increase in consumer credit, the Fed revised downward its estimate for December's measure of total credit growth by about $3 billion.

 

Optimism Remains – To Some Extent

 

Treasury debt prices eased on Wednesday as optimism Greece would meet a key Thursday deadline for a major debt swap reduced the safe-haven bid for U.S. government debt. Treasuries were also undermined by a private-sector payrolls report which bolstered hopes the U.S. economy was making a solid recovery, although yields remained range-bound at historically low levels.

 

Greece has set a Thursday 2000 GMT deadline for investors to sign up to its bond restructuring designed to trim 100 billion euros off the public debt. Failure to win enough support could result in a disorderly default that would rock markets. The number of private holders of Greek debt taking part in a sovereign bond swap should easily surpass the 75 percent level that Athens had set as the minimum to go ahead with the deal, a Greek finance ministry official said on Wednesday.

 

Benchmark 10-year Treasury notes were trading 7/32 lower in price to yield 1.97 percent, up from 1.94 percent late Tuesday. Yields remain very near the middle of a range of 1.79 to 2.17 percent that has dominated since early November. Thirty-year bonds were trading 19/32 lower in price to yield 3.1 percent from 3.07 percent late Tuesday.

 

According to the ADP National Employment Report, the private sector added 216,000 jobs last month, topping economists' expectations for a gain of 208,000. January's payrolls figures were revised up to an increase of 173,000 from 170,000.

 

The ADP report supported expectations for decent jobs growth when the government reports its February payrolls data on Friday. The median of forecasts from analysts polled by Reuters is for employers to have added 210,000 jobs in February, down from 243,000 in January.

 

Separately, the Federal Reserve bought $1.969 billion of Treasuries maturing February 2036 through May 2041 as part of its current stimulus program, which the financial markets have dubbed "Operation Twist." The central bank is scheduled to buy longer-dated Treasuries again on Thursday and sell shorter-dated securities on Friday, while the overall program is scheduled to last through June.

 

Fed Considering Modified Bond Purchase

 

Federal Reserve officials are considering a novel approach to bond buying aimed at countering some of the worry that another round of asset purchases could fuel inflation, according to the Wall Street Journal.

 

Citing people familiar with the matter, the newspaper reported on Wednesday that should the Fed decide to buy more bonds to boost growth, it could borrow back the money it used to buy those bonds for short periods of time at low interest rates. Doing so would take that money out of circulation, or sterilize it.

 

Representatives from the Federal Reserve and the New York Federal Reserve Bank, which conducts the central bank's bond trading, declined to comment on the report.

 

The Fed is not expected to launch another round of bond buying at a meeting next week. It cut benchmark interest rates to near zero in December 2008 and has bought $2.3 trillion in bonds to push down short- and long-term interest rates low to stimulate growth.

 

However, Chairman Ben Bernanke has signaled that he would consider another round of bond buying to support the fragile recovery if tepid growth and modest labor market gains falter. Many analysts believe the Fed will resort to renewed quantitative easing later this year as higher oil prices and Europe's economic problems weigh on the United States.

 

Fed officials are considering different options should they decide to embark on another round of asset purchases, the report said. Among these is a novel approach in which they would buy bonds, but restrict how investors and banks could use that money. The Fed has tested tools to take money out of the financial system such as reverse repurchase agreements to prepare for the day when the central bank wants to begin to tighten financial conditions.

 

Turtle Tops Hare

 

Today's coda for investing in the market calls for rapid-fire trading and an eye for the next hot sector. The investing heroes in this world are hedge funds such as Renaissance Technologies, which made founder James Simons a billionaire with its computer-driven, high turnover trading. And yet, an informal mutual fund study shows that managers who churn through their portfolios are underperforming those who hold investments for longer periods.

 

The hair-trigger trading strategies used by a number of hedge funds ran into trouble last year, when worries over the budget, European debt crisis, Japanese tsunami and North Africa unrest whipsawed markets and left investors frustrated over when to get in and out.

 

The mutual fund study, from Thomson Reuters' Lipper, examined about 75 categories of funds over various lengths of time, finding that longer-held portfolios outdo about 70 percent of the time those funds holding stocks for only a short period.

 

Low turnover - less than 30 percent a year, or far below the historic average - often exceeds turnover that is four times greater or more, the data showed. A longer holding period is a surprising antidote to the poor returns that plagued hedge funds last year. Many hedge funds are driven by fundamentals, but their holding periods are typically short - at times three days or less.

 

Hedge funds over the past decade turned over an average 35 percent of their positions every quarter at an annualized rate of nearly 140 percent, according to Goldman Sachs research.

 

Data from the New York Stock Exchange shows annual turnover has steadily increased for decades, peaking at an annualized 138 percent in 2008 during the financial crisis. It has since retreated to an annualized 74 percent in January.

 

A look at mutual funds found that portfolios with low turnover outperformed those with high turnover 70 percent of the time over various periods, according to data from Lipper.

 

About 75 categories of funds were examined at one-, three-, five- and 10-year periods, and at turnover ratios of 30 percent or less, 60 percent or less and 110 percent, a level now considered typical in the mutual fund industry.

 

Increased transaction costs and the selling of losers for tax purposes often drag on the performance of portfolios with high turnover. Lengthening the investment time frame in choppy markets will improve the results of investments, advocates say, but it requires a strong stomach to wait for the strategy to pan out.

 

Many investors prefer a story that promises future riches but free cash flow remains the best measure for determining a company's health. Amazon.com, for example, trades at a P/E ratio of 130, far exceeding the average of 20.2 for Internet retailers, even though it is growing only twice as fast as the e-commerce sector has as a whole in recent years, according to Thomson Reuters data. Amazon is spending heavily to expand and warned in January that it may post a first-quarter operating loss.

 

Amazon's stock has gained about 35 percent since the end of 2009 after flat-lining for years. It's off about 26 percent from an all-time high in October. Microsoft rose 4 percent over the three-year span, but is up about 30 percent since October lows. And analysts have panned Microsoft for a lack of new ideas, yet operating income has grown by double-digits the past two years.

 

The market will eventually reward fundamental analysis if a company's profitability is improving and management rewards shareholders through buybacks, increased dividends or debt reduction, Pearl said - but only if cash flow is positive and growing.

 

After the subpar returns in 2011, hedge funds have outperformed so far this year in what has been an eerily quiet market. But many analysts warn uncertainty is likely to return with China's growth slowing and the still-unresolved euro-zone debt crisis encumbering the developed world.

 

A high volatility environment that favored less risky assets snarled the timing of entry and exit points in 2011, making it difficult for thematic bets to pay off. Since the financial crisis hit, the number of days with large swings has been greater than any time since the Great Depression. Swings of 2 percent or more occurred once in every seven trading sessions in 2011, data from research firm Crandall, Pierce & Co show.