MarketView for May 13

 

 

Summary 

 

Stock prices fell rather sharply on Wednesday after the release of a gloomy retail sales report had investors once again concerned that maybe the economy's revival is not as far along as had been previously supposed. The overall result was a broad sell-off that accelerated late in the session. Specifically, sales at retailers fell for the second straight month in April, breaking a string of more upbeat reports that had suggested the economic slump was abating and fueling a two-month rally.

 

Retail activity is a closely followed indicator, as consumer spending accounts for roughly two-thirds of the economy. The Street had been expecting to see little or no change or even a small increase in retail sales, excluding autos.

 

Nonetheless, the S&P 500 index remains up nearly 31 percent from the bear market low hit in early March, but it was the third straight day of declines for the S&P, making it the longest slump since the rally's onset. The S&P is now off 5 percent from last Friday's recovery peak. Wednesday's sell-off also caused the S&P 500 to breach some key technical support, ending below 900 for the first time in over a week.

 

Shares of Wal-Mart, a bellwether for the retail sector, fell 1.2 percent to $50.03, while Target lost 4.8 percent to $40.47. Macy's said it expects sales to fall this year as consumers tighten their belts, while Liz Claiborne reported a worse-than-expected loss. Shares of Macy's slid 6.7 percent to $11.52 and Liz Claiborne plummeted 26.2 percent to $4.26.

 

Shares of big manufacturers were also got hurt, with 3M down 4.4 percent at $56.94 and United Technologies off 3.5 percent at $50.61. Those two companies ranked among the top drags among the companies making up the Dow Jones industrial average.

 

Investors also pulled cash out of the financial sector, which has helped lead the recent rally, in favor of more defensive plays, such as pharmaceutical companies. Merck added 2.8 percent to close at $25.67, while Pfizer was up 2.3 percent to $15.27. Both helped cushion the Dow’s decline.

 

Apple was off 4 percent at $119.49 on the Nasdaq and contributed the most to its decline.

Shares of AMD rose 0.7 percent to $4.38 after EU regulators fined Intel for antitrust violations and ordered it to halt illegal practices to squeeze out its rival. Intel closed down 0.5 percent at $15.13.

 

Retail Sales Fall Unexpectedly

 

A report released by the Commerce Department on Wednesday indicating that retail sales slipped 0.4 percent in April after falling 1.3 percent in March, as cash-strapped consumers again held back on purchases, sent investors into a funk as it torpedoed the idea that the economy would soon emerge from recession.

 

Sales dropped despite an increase in the disposable income of some households due to tax cuts and cash transfers linked to the government's record $787 billion stimulus package. A key reason is that householders, whose wealth has been decimated by plunges in house and stock prices, are more likely to save any extra income or pay off debt instead of going shopping.

 

Incomes have also been weighed down by high unemployment, forcing consumers to limit spending for the most part to only necessary expenditures. Hardest hit under those circumstances are luxury stores, such as Liz Claiborne.

 

Excluding motor vehicles and parts, retail sales dipped 0.5 percent in April, compared to a 1.2 percent decline the prior month, the Commerce Department said. Vehicles and parts sales rose 0.2 percent after a 2.0 percent plunge in March.

 

Gasoline sales dropped 2.3 percent in April after tumbling 3.2 percent in March. Sales of electronic goods fell 2.8 percent, while building materials rose 0.3 percent.

 

Commerce Secretary Gary Locke said the fall in sales, despite some improvement in consumer sentiment, showed "just how difficult the economic environment remains."

 

Price of Crude Oil Falls Sharply

 

The price of crude oil fell 1.4 percent on Wednesday as gloom on Wall Street outweighed the impact of a government report showing a surprise drop in. crude and gasoline stockpiles. Domestic sweet crude futures for May delivery settled down 83 cents per barrel at $58.02. London Brent settled down 60 cents per barrel at $57.34.

 

Crude prices have been tracking equities markets closely in recent months as traders look to stocks for signs of an economic recovery that could lift ailing world fuel demand. Industrial oil consumption continues to decline and is unlikely to recover until late this year.

 

Meanwhile, OPEC continues to state that the demand for crude in 2009 will likely be even weaker than previously estimated. Oil's losses came despite a report from the Energy Information Administration showing crude inventories fell by 4.7 million barrels; defying expectations for a 10th straight weekly build. A rally in stock markets during the last few months has helped lift crude almost 80 percent from a January low of $32.70 a barrel.

 

Wall Street Is About To Get Its Wings Clipped

 

Life on Wall Street is about to change fairly radically in terms of regulation and compensation. The Obama administration plans to regulate most financial derivatives linked to last year's market turmoil by requiring standardized over-the-counter derivatives to be cleared through central clearinghouses.

 

Treasury Secretary Timothy Geithner, Securities and Exchange Commission Chairman Mary Schapiro, and Mike Dunn, acting chairman of the Commodity Futures Trading Commission, will brief media on the plan tomorrow.

 

Under current law, over-the-counter (OTC) derivatives are largely excluded or exempted from regulation. The administration wants Congress to amend securities and futures laws to require greater reporting of trading in non-standard OTC derivatives. Besides requiring clearing of standardized OTC derivatives, the plan would let CFTC set limits on OTC derivatives that affect prices on public exchanges. Derivatives cleared by a clearinghouse would be viewed as standardized instruments.

 

Clearinghouses are widely used to bring liquidity into a market and bring trading into the open. Because members of a clearinghouse are obligated to absorb losses, they are expected to carefully gauge risk and set margin requirements on financial instruments. Clearing also shows how much exposure is held by a market participant.

 

Following last year's market turmoil, regulators urged creation of clearinghouses to stabilize the market in credit default swamps, valued in trillions of dollars. The 2008 law that created the Treasury Department's Troubled Asset Relief Program also directed the department to submit a report to Congress on regulation of the OTC swaps market, the heart of the so-called "shadow banking system."

 

The department was required to report on ways to improve "the over-the-counter swaps market and government-sponsored enterprises" and to say "whether any participants in the financial markets that are currently outside the regulatory system should become subject to the regulatory system; and enhancement of the clearing and settlement of over-the-counter swaps."

 

On the compensation front, government regulators are looking at ways to force reforms in compensation practices to discourage excessive risk-taking, which is thought to have sown the seeds of the current credit crisis. Treasury Secretary Timothy Geithner is working with the SEC to seek industry-wide compensation reform.

 

According to Geithner it is important that the financial industry change its compensation practices so they are no longer providing strong incentives for excessive short-term risk taking. In addition, the Federal Reserve is also looking at what regulatory steps could be taken to discourage bank practices that may foster a dangerous level of risk taking.

 

The Obama administration is pushing for a revamp of compensation practices throughout the financial industry, not just at banks receiving government bailout funds.

 

Officials have said financial firms paid executives and employees huge sums of money for actions that resulted in big short-term pay offs but which ended up putting the companies and the financial system as a whole at risk.

 

IBM Remains Optimistic

 

IBM reaffirmed its earnings outlook for this year and 2010, stating that its focus on high-margin software and its geographic diversity would help buffer the impact of a weak economy.

 

Chief Executive Sam Palmisano said on Wednesday that IBM is still targeting earnings of $10 to $11 per share for 2010, slightly above the average Street estimates of around $9.90. The company also repeated its earnings forecast of "at least $9.20" per share in 2009.

 

Chief Financial Officer Mark Loughridge said IBM's targets were possible even if revenue at constant currency, which excludes the impact of currency fluctuations, fell 7 percent in 2009, or was flat in 2010.

 

Over the past decade, IBM has been shifting its focus to software and services from increasingly commoditized hardware. Palmisano said this means it can rely on a steadier stream of revenue, rather than more volatile equipment sales. Software and services account for around 80 percent of IBM's revenue, compared to around 50 in 2000.

 

"We are not like the other companies in the IT industry," Palmisano said at an annual meeting with analysts in New York. "We don't have the dependency."

 

IBM's first-quarter revenue fell 11 percent, or around 4 percent at constant currency, from a year earlier, but cost cuts helped limit the fall in net profit.