MarketView for May 24

 

 

Summary  

 

It was another difficult day on Wall Street on Monday as the Dow Jones industrial average fell to its lowest point since February 10 as Europe's banking difficulties continued to plague the markets. In particular, the Street became uneasy over the news that the Bank of Spain took over a small savings bank, CajaSur, over the weekend, thereby increasing anxiety over the possibility that the EU’s debt problems will spread across the pond to the United States.

 

As a result of the those “difficulties,” financial shares were among the day's largest decliners, with Wells Fargo ending the day down 4.7 percent to close at $28.71 after Goldman Sachs cut its rating on the shares to "neutral" from "buy."

 

Those latest concerns regarding Europe's debt crisis prompted another sell-off of the euro, which dropped 1.5 percent to $1.2383 in late New York trading.

 

Nonetheless, there were some pockets of strength, especially within the tech sector. Apple closed up 1.8 percent at $246.76 after Morgan Stanley raised its price target on the stock by $35 to $310 and added the company to its "Best Ideas" list. Google gained 1.1 percent to close at $477.16 after Citigroup added the Internet search engine to its top picks live list, writing that the recent correction in its stock price created the most compelling risk-reward opportunity in the large-cap Internet sector.

 

Some deal activity in the tech and health sectors also caught the Street’s attention. IBM said it plans to buy Sterling Commerce from AT&T for approximately $1.4 billion in cash, while Gentiva Health Services agreed to acquire Odyssey HealthCare for approximately $1 billion. IBM slipped 0.8 percent to $124.45 and AT&T lost 1.7 percent to $24.43. Both IBM and AT&T are Dow components. In contrast, Odyssey rose 38.7 percent to $26.75, and Gentiva closed up 13.1 percent at $29.17.

 

The latest economic data indicated that sales of previously owned homes hit a five-month high in April prior to the expiration of the federal home buyer tax credit. However the inventory level of homes available also increased.

 

Fed Not Selling Any Time Soon

 

The Federal Reserve is not preparing to sell-off any of the billions of dollars of assets it acquired in 2009 until it has started raising interest rates in a strong recovery, according to the Fed’s 2009 annual report released on Monday.

 

"The Federal Reserve currently does not anticipate that it will sell any of its securities holdings in the near term, at least until after policy tightening has gotten under way and the economy is clearly in a sustainable recovery," the Fed said.

 

The annual report recapped comments about asset sales the Fed has made in reports after meetings and in speeches by policymakers.

 

After the Fed cut interest rates to near zero in December 2008, it started buying mortgage-related debt to provide additional stimulus to the flagging economy. In so doing, the Fed more than doubled the size of credit it has made available to the economy to about $2.3 trillion from about $900 billion.

 

Most Fed officials agree they should return the Fed's balance sheet to pre-crisis size and eventually sell the $1.4 trillion in mortgage-finance agency debt and mortgage-backed securities that it has acquired, minutes from its April meeting released last week showed.

 

Agency debt and mortgage-backed securities are maturing or are being prepaid at a rate of $100 billion to $200 billion a year, the Fed said in the annual report. Nonetheless, the Fed reiterated the point that active sales could occur, "when the economic recovery is sufficiently advanced," and the Fed comes around to the idea that it is time to remove some liquidity.

 

The Cause May Never Be Known

 

The latest word on the Street is that regulators may never know what caused the recent market crash given that to date they have not found, or are telling if they have, evidence that would point to trading errors or system malfunctions that triggered the brief free fall.

 

More than two weeks after the Dow Jones Industrial average lost nearly 700 points in minutes before recovering, regulators and exchange operators are still searching for answers. The CFTC and the SEC have been forced to set aside long-standing differences over jurisdiction.

 

For more than a year their respective chairmen have worked together on new derivatives rules and were thrust back into the spotlight after the market crash. SEC and CFTC commissioners met on Monday for the third time since the CFTC was created in the 1970s.

 

CFTC Commissioner Michael Dunn also said in an interview that "it's going to be difficult for us to understand totally what happened," adding it was likely several factors were responsible for the market swing. A CFTC official told a panel exploring the crash the initial findings showed the "flash crash" was not so much the cause of a single event, but a confluence of events that led to the dislocation in liquidity.

 

The regulators have been analyzing the events, including links between declines in the prices of stock index products such as E-mini S&P futures contracts and the role so-called "stub quotes" played in the market crash.

 

Many of the trades that were canceled after the May 6 plunge are tied to stub quotes, which can often be as low as a penny. In some cases, many venues do not need a market maker, leading some firms to jump in to act as one, an SEC official said.

 

The SEC's director of trading and markets Robert Cook added that changing or even eliminating the use of stub quotes could lead to changes in market orders.

 

Regulators and the major exchange operators are expected to soon create a circuit breaker or mechanism that would pause trading in a individual stock if the stock was in free fall. They are still working on updating existing circuit breakers that would apply across equity and futures markets. Those trading restrictions were not triggered during the brief market crash earlier in May.

 

The SEC will meet on Wednesday to propose rule to improve market surveillance. Currently the dozens of market venues are supervised by exchanges and market regulators such as the SEC, CFTC and the Financial Industry Regulatory Authority. The investigation by regulators into the unexplained crash has been hampered by their inability to see clearly across all markets and obtain trading data from a single source.

 

Both Home Sales and Inventory Rise

 

Sales of previously owned homes hit a five-month high in April as buyers raced to take advantage of the expiring tax credit. To qualify for the federal tax credit, buyers had to sign contracts by April 30 and close on the home by the end of June. Since existing home sales are measured at the time of closing, sales are likely to remain high through next month. The improvement in sales last month was broad-based, with sales of both single-family homes and condominiums and co-ops touching five-month highs.

 

At the same time, the increase in inventory of unsold homes continues to portend that the economic recovery remains anything but rapid. Nonetheless, on a more positive note you could make a strong case that the strengthening taking place in the economy and improving labor market should prop up the housing sector in the absence of more government aid.

 

April sales of existing homes rose 7.6 percent month-over-month to an annual rate of 5.77 million units, the National Association of Realtors said on Monday, beating market expectations of a 5.65 million-unit pace.

 

Despite the surge in sales last month, the inventory of existing homes for sale in April jumped 11.5 percent to 4.04 million units, the highest since July. At April's sales pace, that represented a supply of 8.4 months, compared with March's 8.1 months.

 

Although the Realtors group attributed the rise in the supply of homes on the market to seasonal factors, analysts said the gain in inventory would be a drag on house prices.

 

The national median home price rose 4 percent from April last year to $173,100 -- the highest since September. Prices were up 2.1 percent from March. Foreclosed properties accounted for a third of sales last month, the NAR said. First-time buyers constituted 49 percent of transactions.

 

Data from the Mortgage Bankers Association last week showed demand for loans to buy homes slumped to a 13-year low in the aftermath of the deadline to sign contracts.

 

The National Association of Realtor's chief economist, Lawrence Yun, said there was no strong correlation between mortgage applications and home sales, pointing out that 26 percent of sales last month were cash purchases. Historically, this would be 10 percent or less, he said.