MarketView for March 12

 

 

Summary

 

Defensive names rallied in an otherwise flat day for Wall Street on Monday as the Street focused its attention on Tuesday’s Federal Reserve's monetary policy statement. The Fed’s Open Market Committee statement will be viewed with interest to see whether the Fed plans no new easing of monetary policy, which might make it difficult to extend the rally. Keep in mind that the markets were recently rattled after Fed Chairman Ben Bernanke stopped short of giving a strong signal of more stimuli during congressional testimony.

 

Utilities, consumer staples and telecom were the day's top three sectors. Late Friday, Constellation Energy Group agreed to pay $235 million to settle a probe of its wholesale power trading, clearing the way for its $7.9 billion sale to rival utility Exelon Corp. Constellation rose 3 percent to close at $37.23 while Exelon gained 2.3 percent to close at $39.81.

 

With the day's tiny gain, the S&P 500 has closed in positive territory for the past four sessions. The benchmark index is close to nearly a four-year high set two weeks ago and faces strong technical resistance. The CBOE Volatility Index, closed at 15.64, its lowest level since May 2011.

 

Equities traded modestly lower early in the session as weak data from China cast some doubts over the pace of global economic expansion. Still, gains in groups less tied to growth were enough to offset weakness in cyclical sectors. China's trade balance plunged $31.5 billion into the red in February as imports swamped exports.

 

Materials, energy and financial were the day's weakest groups, with energy pressured by a drop in crude oil prices. Banks declined as a report from the Fed looms on the capital adequacy of the country’s largest lenders. JPMorgan Chase ended the day down 1.2 percent to close at $40.54, while SunTrust closed down 2.5 percent at $21.88.

 

Tidewater's shares fell 5.4 percent to $55.42 after the offshore vessels provider said Sonatide, its partner with Angola's state oil company, will not take up new charters or extend existing ones in the country until the two parties resolve ongoing joint venture talks.

 

Youku was up 27.4 percent to $31.85 after China's largest online video company said it will buy second-ranked Tudou Holdings Ltd in an all-stock deal valued at more than $1 billion. Tudou gained 156.5 percent to close at $39.48.

 

Volume for the day was light, with about 5.15 billion changing hands on the major equity exchanges, a number that was well below last year's daily average of 7.84 billion shares.

 

Greece Plans for Bailout and Swap

 

Greece is set to swap privately held bonds issued under Greek law with new ones worth less than half their original value, just days after the country secured the biggest debt write down in history. The debt-ridden country will also be hoping that its second international bailout will be finalized later when the finance ministers from the 17 euro zone nations meet in Brussels.

 

Securing the write down was one of the most important pre-conditions before funds from the euro130 billion ($172 billion) bailout would be released — without the bailout, Greece faces defaulting on its debts in less than two weeks when a large bond redemption is due. he ministers will be meeting in an atmosphere of relative calm in the markets following Greece's achievement last week in getting the vast majority of its investors to agree to the debt-reduction deal.

 

Greece's bond swap plan received the support of 83.5 percent of private investors, even though the deal will see them face real losses of more than 70 percent on their holdings of Greek debt. Of the investors holding the euro177 billion ($234 billion) in bonds governed by Greek law, 85.8 percent agreed. The deadline for foreign-law bonds has been extended to March 23.

 

As well as being integral to the release of the second bailout, the bond swap, known as the Private Sector Involvement, is considered to be essential to getting Greece's public finances back on track. However, many in the markets think that it won't be enough and that Greece will have to reduce its debt burden further in the coming years. The task facing the country, which is due to hold elections within the next couple of months, is tough.

 

Greece has been locked out of the markets by sky-high interest rates and has been relying on funds from an initial euro110 billion ($145 billion) bailout since May 2010. Despite receiving more than euro70 billion ($92 billion) of the initial rescue loans and passing a series of austerity measures, the country remains unable to service its debts as the economy has plunged into a deep recession. European leaders agreed last October that Greece needed a second bailout if it was to avoid a disorderly default that could have dragged down the euro.

 

Stress Tests of Banks Expected to Show Improvement

 

In another milestone in the banking industry's recovery from the financial crisis, the Federal Reserve this week will release the results of its latest stress tests, which are expected to show broadly improved balance sheets at most institutions. Bank of America, though still coping with the effects of billions in soured subprime mortgages, is expected to pass its stress test.

The findings would be the latest of several signs of renewed strength in the economy, including the unemployment report last Friday that showed that more than 227,000 jobs were created in February.

 

For the financial sector, including traditional banks and Wall Street firms that were at the heart of the panic during the crisis, the recovery has been slow but steady, with some banks recovering much faster than others.

 

Still, while unpleasant surprises are possible, Wall Street is counting on the Fed to find banks largely healthy. That would stand in marked contrast with the holes, in the tens of billions of dollars, found on balance sheets in the first round of stress tests in 2009.

 

The examination is not merely an intellectual exercise. If institutions fall short, they could be required to raise billions in new capital, depressing their shares. If they pass, dividend increases and stock buybacks by the strongest institutions will follow as they did after the second round of tests a year ago, pleasing investors whose banks' stocks still trade at levels far below where they were before the collapse of Lehman Brothers in September 2008.

 

Under the tests, Federal Reserve specialists are trying to predict how capital levels at the 19 largest banks would withstand an economic downturn even more severe than the one that followed the Lehman collapse.

 

In addition to a 50 percent stock market decline and an 8 percent contraction in real gross domestic product, the tests envision an unemployment rate of 13 percent, well above the 10.2 percent peak recorded in October 2009. A surge in unemployment would increase losses for banks on mortgage and credit card debt.

 

If all that were not enough, the Federal Reserve is considering what would happen to bank assets if a market shock hit Europe and reverberated in the United States, gauging the extent of losses that have not loomed large for American institutions, despite the continuing problems in Greece and weaker European borrowers.

 

Regulators are walking a fine line; if they permit the banks to return too much capital that might leave the industry vulnerable in the event of a downturn and lead others to think the industry was returning to its risky ways. On the other hand, a raft of negative results would alarm investors just as calm seems to be returning to the markets.

 

For banks to pass the tests, they must show that their Tier 1 capital ratio - the strictest measure of a bank's ability to absorb financial blows - will be at 5 percent or better, even in the Fed's nightmare case. To raise dividends or buy back stock, the ratio would have to remain above 5 percent, after capital was returned to shareholders. Tier 1 capital ratios for the 19 largest banks have improved since the depths of the financial crisis, rising to 10.1 percent in the third quarter of 2011 from 5.4 percent in the first quarter of 2009.

 

PepsiCo Tries to Pacify Investors

 

PepsiCo announced management changes on Monday that laid out a potential line of succession to its chief executive, Indra K. Nooyi, a move also aimed at addressing investor concerns over its lagging stock price.

 

John Compton, who has been running PepsiCo’s food divisions, including Frito-Lay and Quaker, was named president, a newly created position with responsibility for global categories like beverages and snacks as well as operating functions like procurement, marketing and corporate strategy. Taking Mr. Compton’s place as chief executive of the food division is Brian C. Cornell, a PepsiCo veteran who most recently headed Sam’s Clubs for Wal-Mart Stores Inc. 

 

“John and Brian are superb executives and will both contribute enormously in their new roles to ensure that we compete effectively and efficiently in the global marketplace,” Ms. Nooyi said in a statement.

 

PepsiCo has come under fire of late as an ambitious effort to sell healthier products has reduced returns on capital and failed to generate higher profits. The stock has stubbornly remained at more or less the same price it was when Ms. Nooyi took the helm in 2006, and investors have increased pressure on the board to do something to improve the company’s financial performance.

 

At a snack foods conference last month, analysts made much of the fact that Mr. Compton did much of the talking, while Ms. Nooyi, normally a show stealer, sat quietly on the stage.

 

Neither of the changes announced on Monday appeared to address one of the company’s largest headaches, namely, declining sales in the United States of its signature brand, Pepsi. In September, PepsiCo assigned Albert P. Carey, a 30-year company veteran, to lead its stumbling American beverage business.