MarketView for March 22

 

 

Summary 

 

Cyclical sectors led the major equity indexes lower on Thursday, setting the S&P 500 up for its first negative week in six, after factory data showed a slowdown in both the euro zone and China. The weak data is hardly a surprise for the financial markets, given that a recession in the euro zone is pretty much a given, and after China trimmed its 2012 growth target to an eight-year low of 7.5 percent. Nonetheless, many on the Street were unnerved by the drop in new orders in both regions, which highlighted concerns that an unexpectedly severe downturn could hurt the global recovery.

 

The drop in demand increased the probability of a pullback by the markets after the S&P 500 scored 10 weeks of gains out of this year's 11 weeks so far. The benchmark index is still near four-year highs hit on Monday. Yet, the market could easily come down 3 to 5 percent and still be within the context of an improving economy. Share prices are up sharply this year, due in part to a steady string of better-than-expected economic data. Next week, the S&P 500 could wrap up its best back-to-back quarters since mid-2009.

 

FedEx shares dragged down the Dow Jones Transportation Average after the company warned of a lower outlook, due in part to Europe's weak economy. FedEx ended the day down 3.5 percent to close at $92.50.

 

China's manufacturing sector activity shrank in March for a fifth successive month, while German and French manufacturing suffered a sharp decline in March that even the most pessimistic economists failed to predict.

 

The number of Americans claiming new unemployment benefits fell to a four-year low last week. A separate report showed the index of leading economic indicators, a gauge aimed at predicting future U.S. economic activity, rose sharply in February, pointing to a pickup in growth even as China and Europe retreat.

 

McDonald's fell 1 percent to $95.80 a day after the world's largest hamburger chain said Chief Executive Jim Skinner is retiring after more than seven years at the helm.

 

U.S. Steel was down 5.8 percent to close at $29.47. Alcoa slid 2.4 percent to $10.02 and was the Dow's largest percentage decliner.

 

In contrast to the overall market's declines, Dollar General advanced 3.1 percent to $46.14 after reporting higher-than-expected earnings and sales for the holiday quarter. The stock of the discount retailer, which prices most of its merchandise below $10, earlier hit an all-time high at $46.95.

 

Unemployment Insurance Claims Lower Than Expected

 

The number of Americans claiming new unemployment benefits dropped to a four-year low last week, bolstering hopes a recent pick-up in job growth will prove lasting. Initial claims for state jobless benefits fell 5,000 to a seasonally adjusted 348,000, the lowest level since February 2008, the Labor Department said on Thursday.

 

A separate report on Leading Economic Indicators by the Conference Board showed those indicators rising sharply in February, pointing to strengthening growth. The data suggests a firming up of the economy even as China slows and the euro zone slumps. Firming labor market conditions helped lift the Conference Board's Leading Economic Index 0.7 percent last month. Economists say while unseasonably mild weather has helped underpin the economy, a true labor market recovery was under way.

 

A four-week moving average of new claims, a better measure of trends, declined 1,250 to 355,000. The data covered the survey week for the government's report on March employment. New claims dropped 5,000 between the February and March survey periods, suggesting another month of solid job growth.

 

The claims report showed the number of people receiving benefits under regular state programs in the week ended March 10 after an initial week of aid fell to its lowest level since August 2008.

 

Despite the improving picture, long-term unemployment remains a major problem. About 43 percent of the 12.8 million out of work Americans in February had been jobless for more than six months.

 

A total of 7.28 million people were claiming unemployment benefits under all programs during the week ended March 3, the latest week for which data is available. That was down 142,499 from the prior week.

 

Employers added 227,000 jobs to their payrolls in February, taking the tally for the past three months to 734,000. While the unemployment rate held at 8.3 percent, it has come down 0.8 percentage point since August.

 

The data on Thursday had little impact on the financial markets Wall Street spent the day concerned about the global economy. Other reports showed Chinese manufacturing contracted for a fifth straight month in March, while factory activity in France and Germany declined sharply. In contrast, manufacturing activity continues to expand, thanks to stepped-up motor vehicle production, which has led factories to add more workers and extra shifts.

 

And even the housing market, a major source of pain for the economy, is improving. Home prices as measured by the Federal Housing Finance Agency were down 0.8 percent in January from a year-ago. In contrast, prices in January 2011 had been 4.6 percent lower than the year-earlier month.

 

Other data this week showed sales of previously owned homes at their second-highest level since May 2010 in February, and permits for homebuilding approaching a 3-1/2 year high.

 

Rise in Leading Economic Indicators

 

A gauge of future economic activity compiled by the Conference Board posted a fifth straight monthly increase in February, climbing a healthy 0.7 percent in a sign of gaining economic momentum.

 

The group's Leading Economic Index was up to 95.5 in February on gains that were described as broad-based and potentially signaling more progress on jobs, output and incomes in coming months.

 

"We haven't seen this kind of a run since we were coming out of recession in 2009," Conference Board economist Ken Goldstein said.

 

Household Debt Hurting Economy

 

The economic recovery will remain sluggish for years because many consumers have made little headway in paying down debt, according to new research from a former Federal Reserve economist. Karen Dynan, now a fellow at Brookings Institution, argues that the process of reducing debt, which economists call deleveraging, has been far too slow to lay the groundwork for a more rapid economic rebound.

 

"The most indebted households appear to have made fairly limited progress repairing their balance sheets, suggesting that their consumption could be weak for some time to come," Dynan said in the paper.

 

In particular, Dynan says some 14 percent of Americans would need to reduce their debt load by the equivalent of more than a year's worth of pre-tax income - meaning they would have to curtail spending sharply.

 

"If this deleveraging were accomplished by saving alone, it could mean a fairly drastic cut in consumption for many years for a small but not negligible share of households," she writes.

 

The findings contradict some of the recent optimism on Wall Street, where stocks have rallied on hopes that a raft of better economic data might signal a more rapid growth spurt. U.S. gross domestic product expanded 3 percent in the fourth quarter but is expected to have slowed at the start of 2012.

 

But Dynan's findings cast doubt on the chances of a swift near-term rebound for the consumer-reliant U.S. economy, particularly given ongoing headwinds from Europe's own financial debacle.

 

The U.S. personal savings rate climbed as high as 5.8 percent as the recovery entered its second year in the summer of 2010, but has since waned to 4.6 percent. Data out earlier this month showed U.S. families took on more debt in late 2011 for the first time in 3-1/2 years.

 

Words Do Influence

 

The Federal Reserve's verbal clues on the future path of interest rates are effective at lowering borrowing costs, according to a paper co-authored by a top central bank official.

 

Based on data going back to the mid-1990s, Charles Evans, president of the Chicago Fed, and three other economists, found that markets do indeed listen when the Fed speaks, according to the research, which is to be presented at a Brookings Institution conference on Thursday.

 

The paper from Evans, a vocal policy dove, lends support to the Fed's decision earlier this year to begin publishing policymakers' own forecasts for the path of rates, and to clearly state that the Federal Open Market Committee expects rates to remain near zero until at least late 2014.

 

"It seems possible for the FOMC to change longer term interest rates out of its control by promising to persistently lower the shorter term rates within its control," the paper says.

 

A recent selloff in Treasuries has made it harder to support the argument that the Fed is in full control of long-term interest rates, and has raised some concern that a deeper reversal could be at hand following a prolonged period of rock-bottom rates.

 

Bond prices move inversely to rates. Rates on the 10-year Treasury note have risen about 0.3 percentage point in the last two weeks.

 

However, the Brookings conference paper, co-authored by Jeffrey Campbell, Jonas Fisher and Alejandro Justiniano, indicates the Fed could again assert itself on the Treasury yield curve if it felt the need.

 

"Forward guidance in monetary policy statements has had a significant effect on yields of Treasury notes and corporate bonds since the onset of the financial crisis," the authors wrote.

 

The economists distinguish between guidance that merely reflects prevailing expectations and policy clues that shift the public's assessment on the path of rates.

 

Evans has advocated even more aggressive action than the Fed has taken. In his view, the central bank could allow inflation to rise above its 2 percent target for a period in order to bring down a persistently high jobless rate from the current 8.3 percent.

 

In response to the worst recession since the Great Depression, the Fed not only chopped official interest rates down to zero but also purchased some $2.3 trillion in Treasury and mortgage-linked bonds in an effort to keep down long-term interest rates.

 

FedEx Lowers Expectation

 

 A strong holiday season and mild winter helped FedEx Corp beat Wall Street's profit forecast, but the world's No. 2 package delivery company warned that it had lowered its outlook for the rest of this year due to tepid economic growth. FedEx expects continued below-trend growth globally and a mild Euro-zone recession. Newly released manufacturing indicators for China, Germany and France drove home the faltering pace of recovery. FedEx on Thursday set a fiscal fourth-quarter profit target of $1.75 to $2.00 per share.

 

"The fourth quarter is still very good, but what we're seeing at the moment ... is we just don't have as strong an economy as we would have hoped it would be a year ago," Chief Financial Officer Alan Graf told analysts on a conference call. "The economic environment and the elasticity that we're seeing on our premium services due to high fuel costs are dampening momentum a bit."

 

The company said more expensive fuel was prompting customers to choose to ship goods by truck rather than air to save money.

 

FedEx said on Thursday that net earnings in the third quarter that ended February 29 rose to $521 million, or $1.65 per share, from $231 million, or 73 cents a share, a year earlier. Excluding one-time items, profit rose to $1.55 per share from 81 cents a year ago. On that basis, analysts had expected $1.35 per share. Revenue increased 9 percent to $10.56 billion from $9.66 billion a year ago. Analysts on average were expecting $10.6 billion, on average, according to Thomson Reuters I/B/E/S.

 

FedEx is undergoing a fleet upgrade to improve fuel efficiency, having announced in December that it was buying new Boeing aircraft to replace some aging planes and delaying delivery of others to cut expenses.

 

Graf said FedEx will continue to reduce flight hours and park planes in the desert until economic conditions improve. The massive volume of goods moved by FedEx makes its shipping trends a bellwether of consumer demand and the pace of economic growth.

 

The value of packages FedEx handles in its trucks and planes each year is equivalent to about 4 percent of U.S. gross domestic product and 1.5 percent of global GDP.