MarketView for May 20

 

 

Summary  

 

Ouch! Wall Street was hit hard on Thursday with share prices were down across the board on growing fears that the efforts to tackle its sovereign debt crisis will fall short, jeopardizing the global economic recovery. The correction comes on the back of a stream of negative news ranging from worries over Greece's debt crisis to Germany's unilateral decision this week to ban naked short-selling.

 

Selling picked up speed late in the day and indexes closed around their session lows after the Senate voted to end debate on the sweeping overhaul of financial regulation, thereby allowing a final vote on the bill later on Thursday or Friday.

 

The S&P 500 finished down 12 percent from its April 23, 2010, closing high, ending below its 200-day moving average, a sign the momentum downward could build.

 

Banks and commodity-related stocks, which are more sensitive to economic cycles, were among the hardest hit. The June oil futures fell 2.7 percent, or $1.86, to settle at $68.01 a barrel in volatile trade on the day of its expiry.

 

Dell provided little in the way of comfort. After the bell Dell reported stronger-than-expected earnings, but warned of volatile global currencies and components shortages. Its shares fell 3.1 percent to $13.88 in after-hours trading. In regular trading, Dell had fallen 4.4 percent to end at $14.32.

 

May options and some options on stock indexes will stop trading at Friday's close and expire on Saturday, which may increase volatility. The Chicago Board Options Exchange Volatility index closed at its highest since March 2009. The VIX ended at 45.79, up 29.6 percent. In a sign of heightened fear, 2.5 million puts have traded across all the exchange traded funds, which is three times the normal and about 51 percent of the total put volume.

 

Disappointing economic data on the domestic front also contributed to the downdraft. The number of workers filing new applications for unemployment benefits unexpectedly rose last week for the first time since early April.

 

The index of leading economic indicators slipped last month for the first time since March 2009, while factory activity in the U.S. mid-Atlantic region accelerated less than expected in May.

 

Large manufacturers' shares ranked among the heaviest weights on the Dow, with Caterpillar down 4.5 percent at $58.67 and 3M down 3.5 percent at $79.62.

 

The correction could be healthy for a market that surged as much as 80 percent from the March 9, 2009, closing low. However, if worries over the recovery's sustainability persist, it will be difficult for stocks to bounce back.

 

The S&P 500 closed less than 6 points above the intraday low of 1,065.79 hit two weeks ago on Thursday, May 6, during the worst of the so-called "flash crash" that has left investors on edge. On that day, the Dow fell nearly 1,000 points late in the day in its biggest ever intraday point drop amid a suspected trading glitch, and then retraced some of that loss to end down 3.2 percent.

 

In a rare bright spot, shares of healthcare revenue management company Accretive Health Inc and Internet marketing company Reach Local rose sharply in their market debuts. However, both companies raised significantly less in proceeds than planned. Accretive Health rose 12.9 percent from its IPO price to close at $13.55 and Reach Local gained 15.2 percent to $14.98.

 

Europe Could Have Side Effects on U.S.

 

Europe's debt crisis poses a "potentially serious" risk to our economic recovery because it threatens global credit markets and large American banks, a top Federal Reserve official said on Thursday. Fed Governor Daniel Tarullo said Europe's debt woes, if not contained, could cause financial markets to freeze and spark a global crisis akin to the market meltdown of late 2008.

 

Until last week, Fed officials had been playing down the possible impact to the United States from Europe's turmoil.

 

"The European sovereign debt problems are a potentially serious setback," Tarullo told two congressional subcommittees.

 

Thursday marked another turbulent day in global financial markets. U.S. stocks plunged nearly 4 percent and investors fled from risky assets around the world. The euro, which this week hit a four-year low, was again under pressure, and the cost of inter-bank dollar borrowing hit a fresh 10-month high.

 

Investors' anxiety still centers on Greece, but fears have grown that even the roughly $1 trillion emergency fund put together by the European Union and International Monetary Fund will not be enough to solve Europe's debt problems.

 

"Investors are aware that this package cannot ultimately relieve the need for real, and likely painful, fiscal reforms in the euro area," said Tarullo.

 

The remarks were an unusually detailed pronouncement on economic matters from a Fed governor who tends to focus on regulatory issues.

 

"If sovereign problems in peripheral Europe were to spill over to cause difficulties more broadly throughout Europe, U.S. banks would face larger losses on their considerable overall credit exposures," Tarullo said. "In addition to imposing direct losses on U.S. institutions, a heightening of financial stresses in Europe could be transmitted to financial markets globally."

 

To some extent, financial markets are already showing signs of increased strain, buttressing the view of those who believe the Fed will likely leave U.S. interest rates near zero percent until sometime next year.

 

The U.S. economy has been recovering relatively quickly since hitting a bottom in the summer of 2009. Gross domestic product, the broadest measure of total economic output, jumped at a 3.2 percent annual rate in the first quarter.

 

In conjunction with the European stabilization package, the Fed reopened foreign exchange swap lines with central banks in Europe, Canada and Japan to ensure dollar funding would steadily be available to banks. Tarullo told lawmakers the Fed is not planning to do anything else to tamp down the turmoil.

 

"We don't have any other actions under consideration," he said in response to questions.

 

The Fed came under intense criticism for its role in propping up financial firms during the U.S. crisis, and lawmakers questioned Tarullo closely about why the Fed needed to become involved in the European crisis.

 

Economic Data Causes Concern

 

New claims for state jobless benefits unexpectedly rose last week for the first time since early April, suggesting the labor market recovery may have hit a speed bump. Although the data released on Thursday showed manufacturing activity rose in the nation's mid-Atlantic region in May, new orders and employment slipped. A separate gauge of the economy's prospects dipped for the first time in 13 months in April.

 

Initial claims for state jobless benefits increased 25,000 last week to 471,000, the highest level in five weeks, the Labor Department said. Markets had expected a drop to 440,000. The claims data fell in the survey week for the closely watched employment report for May, and would normally be seen as suggesting weak jobs growth. However, the relationship between claims and payrolls has weakened, and it is possible we will have reasonable pace of job creation during May.

 

Meanwhile, the Philadelphia Federal Reserve Bank said its index of mid-Atlantic business activity rose to 21.4 from April's 20.2, a touch below market expectations for 22.0. A reading above zero indicates expansion in manufacturing. However, the sub indexes showed weakness in employment and new orders.

 

In a third report, the Conference Board said its index of U.S. leading economic indicators, which aims to gauge the economy's future strength, slipped 0.1 percent last month, surprising analysts who had looked for a 0.2 percent gain.

 

The Fed's quarterly "central tendency" forecasts released on Wednesday showed greater optimism on the U.S. growth outlook among policymakers, who predicted gross domestic product would rise around 3.2 percent to 3.7 percent this year.

 

The manufacturing-led recovery has been plagued by stubbornly high unemployment, creating a political headache for President Barack Obama and his fellow Democrats. The near 10 percent unemployment rate could cost the Democratic Party its majorities in both houses of Congress in November's elections.

 

New applications for unemployment benefits have been falling only slowly, even though payrolls have now grown for four straight months. Analysts believe this implies only a gradual improvement in the jobless rate once it peaks.

 

But there was some good news in the claims report. The number of people still receiving benefits after an initial week of aid fell to its lowest level in since late March in the week ended May 8. And for the first time since November 2009, the number of people receiving benefits fell below 10 million.

 

Crude Down Sharply

 

Crude oil prices fell for the seventh time in eight sessions on Thursday on worries that fiscal problems in Europe could stifle global economic growth and energy demand. The expiring June contract on the New York Mercantile Exchange tumbled nearly 3 percent, briefly touching a nine-month low, in thin trade as remaining open interests were either rolled to the next month or sold, in an effort to avoid physical delivery.

 

Crude futures for June delivery settled down $1.86 at $68.01 a barrel, down more about 22 percent from the 19-month high of $87.15 hit on May 3. In equities markets, a drop of 20 percent usually indicates a bear market.  Investor caution also battered the rest of the oil complex, with the July contract, which becomes the front month on Friday, down $1.68 to $70.80 a barrel.

 

The June premium to the July contract widened to $2.79, from $2.61 at the close on Wednesday. In London, July Brent crude futures fell $1.85 to end at $71.84 a barrel, after touching $70.20, the lowest since February 9.

 

Further pressure on oil came after industry data provider Genscape said that crude stored at the delivery hub in Cushing, Oklahoma, rose 500,000 barrels in the week to May 18. The Energy Information Administration on Wednesday reported that stocks at the Cushing delivery point rose 900,000 barrels to a record 37.9 million barrels in the week to May 14.

 

Crude prices this week have fallen below the $70 to $80 a barrel range that many members of the Organization of the Petroleum Exporting Countries have said is fair for both producers and consumers. But OPEC officials have stopped short of calling for any immediate steps to prop up the market.