MarketView for May 15

 

 

Summary 

 

Stock prices fell on Friday, led by energy shares and oil prices as concerns over weak demand, overshadowed some reassuring economic data. Several economic reports released on Friday, consumer prices and sentiment, reinforced hopes that the recession was easing and gave the market an early lift, but it was short-lived, as investors took cues from stumbling oil prices.

 

Chevron and Exxon Mobil were among the largest downturns on the Dow Jones industrial average as crude oil futures settled down $2.28 per barrel, or 3.9 percent, at $56.34 over increasing pessimism regarding the outlook for global energy demand. Chevron lost 2 percent to $65.88 and Exxon dropped 0.9 percent to $69.11.

 

JPMorgan Chase closed down 1.8 percent at $34.91, another drag on the Dow as investors tried to assess the sustainability of the rally from the bear market low and how deep a correction stocks could see. The S&P 500 is up 30.5 percent from a 12-year closing low hit two months ago, but it ended its worst week since the rally began.

 

The Nasdaq fell 3.4 percent for the week, breaking a nine-week winning streak. The S&P 500 lost 5 percent and the Dow shed 3.6 percent. Options expiration added to the day’s volatility. Equity options and some options on stock indexes stop trading at Friday's close and expire the next day. Typically, options expiration is orderly, but some volatility may occur as players unwind positions against stock and index products.

 

The CBOE volatility index .VIX, considered to be Wall Street's fear gauge, rose 5.6 percent.

 

General Motors indicated on Friday that it plans to drop approximately 1,600 dealers as it tries to cut billions of dollars in operating costs and debt before an expected bankruptcy filing at the end of May. GM's shares ended the day down 5.2 percent to close at $1.09. GM’s announcement comes on the heels of Chrysler announcing it will closet 789 dealerships by early June.

 

Consumer prices were unchanged for April, while consumer confidence in May pushed to its highest level since Lehman Brothers' collapse last September. That report, along with industrial output that declined at a slower pace, gave more signs that the recession's worst phase may be abating.

 

However credit card data was not so cheery, indicating that defaults rose in April to record highs, with Citigroup (and Wells Fargo posting double-digit loss rates as the economy shed more jobs. Citigroup closed out the day down 2 percent to $3.48 and Wells Fargo was off 3.2 percent at $24.87.

 

Despite recent optimism about the economic outlook, it is becoming rather clear that the economic recovery will occur but that the road to recovery with not be without a few potholes.

 

Latest Economic Data Encouraging

 

The latest economic data released on Friday was somewhat encouraging as it offered up  additional evidence that the recession's worst phase may be over, with April consumer prices unchanged and industrial output declining at a slower pace than in March.

 

Signs that the 17-month-old recession may be nearing an end helped push consumer confidence in May to its highest since the collapse of investment bank Lehman Brothers last September. Further dissipating the gloom, the contraction in New York state factory activity eased this month.

 

According to the Labor Department, the Consumer Price Index was flat last month, as expected, after edging 0.1 percent lower in March. Compared with the same period last year, consumer prices fell 0.7 percent, the biggest 12-month drop since June 1955.

 

Rising unemployment is eroding household income and undercutting consumer demand. The virtual absence of demand and the general slack in the economy have robbed companies of pricing power, keeping inflation low and increasing concerns about a possible dangerous downward spiral in prices.

 

The CPI report offered something to think about both for those who are worried about falling prices and those who are concerned about the risk of inflation as a flood of money to stimulate demand flows through the economy.

 

Although the headline inflation figure was flat, core prices, which exclude food and energy items, rose 0.3 percent after gaining 0.2 percent in March. That increase was driven largely by a second consecutive large increase in the cost of tobacco as a government excise tax went into effect, and a gain in new vehicle prices, which have risen for four consecutive months despite the slump in sales.

 

The rise in new vehicle prices is likely to dissipate soon, due to steps by auto makers Chrysler and General Motors to slash their dealer networks leading to liquidations of new vehicles at distressed prices.

 

A separate report from the Fed indicated that production at factories, mines and utilities fell 0.5 percent last month, the sixth consecutive monthly decline, but a more modest drop than in recent months. A month earlier, output slid 1.7 percent. The industry capacity utilization rate, a measure of slack in the economy, fell to 69.1 percent in April, the lowest level on records dating back to 1967.

 

Meanwhile extended auto plant shutdowns could mean industrial output will resume a steeper pace of descent. Chrysler has closed its 30 plants since filing for bankruptcy last month and GM plans some extended closures this summer.

 

In another report, the New York Federal Reserve Bank said its New York State index of manufacturing activity rose to minus 4.55 in May, its highest since August 2008, a month before Lehman's collapse triggered a deep global slump.

 

Fed Hopeful

 

The economy has pulled back "from the edge of the abyss" but the recovery will be very slow as Americans' find an equilibrium between the often voracious consumption of past years and a new-found focus on savings, Federal Reserve policy-makers said on Friday..

 

Adding support to the economic outlook, the threat of resurgence in inflation is "meek" for now and the U.S. central bank has kept recent deflationary pressures at bay, Richard Fisher, president of the Dallas Federal Reserve Bank, said.

 

"I envision a slow recovery. Not a V-shaped snapback, nor even a U-shaped one, but a very slow slog as we find a more sensible and sustainable mix between consumption and savings and investment," Fisher said.

 

The recovery will likely be shaped like a "check mark" with a very slow upward tilt, Fisher told reporters after his speech, while noting that "there's always a risk of some exogenous shock." Still, the initiatives taken by the Fed since 2007, and especially in the past year, have "prevented us from falling into the chasm of an economic depression," he said.

 

Gary Stern, president of the Minneapolis Fed, was also optimistic and also credited the Fed for the turnaround. Stern said the brighter picture is due to the Fed's actions to cut interest rates and pump vast amounts of money into financial markets, some stabilization in consumer spending, and improved credit market conditions.

 

"I think that here have been a number of more favorable developments in recent months that suggest we are nearing the bottom of the recession," Stern said.

 

He said the initial stages of the recovery are likely to be "subdued" as Americans deal with a multi-trillion dollar decline in household wealth.

 

Fisher agreed. "Consumers are rebalancing ... we're going to have to drive our economy to a lesser degree by consumption, and what that means is a slower path to recovery as we find that balance."

 

Neither Stern nor Fisher is a voting member of the Federal Open Market Committee, the Fed's policy setting-body, in 2009. Stern, the Fed's longest-serving regional president, has announced he will retire this summer.

 

Fisher, who recently termed his outlook for the economy the gloomiest of that among his Fed colleagues, seemed more upbeat on Friday. "There are, as many have noted, some 'green shoots' that have begun to sprout that will help end the contraction in output and set the stage for a recovery," he said.

 

Positive elements include an apparent slowing in the pace of job losses, a pick-up in sales at trucking companies, and a less severe decline in new orders cited by purchasing managers.

 

At the same time, gradual healing in the financial markets has been marked by a recent "dramatic" decline in the London interbank offered rate, which is the most widely used benchmark for short-term interest rates. The drop in Libor has enlivened housing markets and interbank lending, and will make the next wave of resets to adjustable interest rate mortgages easier to digest, said Fisher.

 

"I was worried about that bubble of resets," he said. "We've driven mortgages down. Libor has come down. It's very important." Ultimately, lower mortgage rates will help push housing demand back up, he said.

 

Fisher told reporters he had been thanked in a coffee shop last week by a homeowner who had just reset her mortgage rate to 4.3 percent from 6.7 percent. "It's very unusual for a banker to be thanked for anything these days," he quipped.

 

Fisher termed the near-term inflation outlook "meek" and said the U.S. central bank had also beaten back deflationary pressures that had loomed until recently.

 

The economy's wide "output gap," or the gulf between current and potential production, was key, he said. "It is doubtful that inflation will raise its ugly head until employment and capacity utilization tighten."

 

Still, the Fed must plan appropriately to reverse the monetary initiatives that have flooded credit markets with billions of dollars to help jump-start the economy, or risk igniting inflation later, Fisher said.

 

The FOMC "can ill afford to be perceived as monetizing that debt, lest we come to be viewed as an agent of, rather than an independent guardian against, future inflation," he said

 

As well implementing a panoply of credit programs, the Fed has held its key interest rate near zero since December and suggested the rate will stay extremely low for some time.

 

Stern, meanwhile, warned that authorities should tread lightly in strengthening financial oversight and avoid stifling innovation with overly restrictive measures. But he said reforms just wait for the financial situation to stabilize.

 

FDIC Disputes Saying It Will Replace Bank CEOs

 

The Federal Deposit Insurance Corp disputed on Friday a report that said Chairman Sheila Bair believes some bank CEOs will be replaced in the next couple of months as regulators assess lenders' financial strength. The FDIC said the Bloomberg News report, which cited a television interview to be broadcast this weekend, was "misleading."

 

"Chairman Bair said that management changes could happen based on the capital plans that an institution must submit to the government," the FDIC said in a statement. "She did not refer to CEOs specifically and the comment was in the context of capital plans submitted by the institutions. Chairman Bair also did not suggest the federal government will remove the bank CEOs."

 

The FDIC also submitted a copy of the interview transcript.

 

"Management needs to be evaluated," Bair said on Bloomberg TV. "Have they been doing a good job? Are there people who can do a better job," Bair said. Asked about some managers being replaced, Bair replied, "Yes," according to the report.