MarketView for May 26

Summary  

Wall Street staged yet another late-day reversal on Wednesday as news that China was reassessing its euro-zone debt holdings sent the markets lower near the end of the trading day. The end result was that the Dow Jones industrial average closed below the psychologically important 10,000 mark for the first time since February 8. The S&P 500 has fallen more than 10 percent from a closing high on April 23, putting the benchmark index into correction territory.

According to the Financial Times, representatives of China's State Administration of Foreign Exchange, which manages the reserves under the country's central bank, have been meeting with foreign bankers in Beijing in recent days to discuss the issue.

Large-cap liquid holdings, including Microsoft and McDonald's, led the Dow lower as the software giant's stock dropped 4.1 percent to $25.01 and the fast-food restaurant operator lost 2.7 percent to $66.01. At the same time, Apple, which shed 0.5 percent to $244.11, managed to surpass Microsoft to become the second- largest company in market cap behind Exxon Mobil.

Late-day volatility has been a hallmark during the recent slide on Wall Street, with investors quick to pull the trigger at the slightest provocation. On Tuesday, Wall Street staged a furious rally toward the end of trading to reverse initial declines of more than 3 percent.

The CBOE Volatility index .VIX, or VIX, known as Wall Street's fear gauge, fell more than 13 percent earlier in the session when stocks were gaining. By the close, though, the VIX had shifted gears, rising 1.2 percent to end at its high of 35.02. Earlier in the session, data showed sales of new U.S. homes hit their highest level in nearly two years in April as buyers rushed to take advantage of an expiring government tax credit.

Luxury home builder Toll Brothers gained 0.8 percent to $20.78 after it said its quarterly loss narrowed from the previous year. Meanwhile, orders for durable goods rose in April to their highest level since September 2008.

Economy Strengthens

New home sales hit their highest level in nearly two years during April, while orders for long-lasting manufactured goods surged, giving the economy a firmer foundation to resist possible contagion from Europe's debt crisis.

While the data on Wednesday was skewed by a home buyer tax credit and a more-than-doubling in aircraft bookings, it nonetheless remains evident beyond a doubt that the current economic recovery has an underlying strength.

Sales of new U.S. single-family homes jumped 14.8 percent to a 504,000 unit annual rate last month, the Commerce Department said. Markets expected a 430,000 unit pace. The increase reflects buyers signing contracts to benefit from a popular government tax credit. A pullback is expected this month. Demand for loans to buy a home has already dropped sharply and held at a 13-year low last week.

Home sales are expected to ebb in the aftermath of the tax credit before trending higher toward the end of the year. Buyers had to sign contracts by April 30 and close the purchase by the end of June to qualify for the federal tax credit. Sales of new home are measured at contract signing. Sales of previously owned homes are recorded at contract closing and are expected to rise through June when the tax credit ends.

Despite the jump in sales last month, the median sale price for a new home dropped a record 9.7 percent from March to $198,400, the lowest since December 2003.

However, the blow from slumping house prices was softened by a record drop in the supply of homes on the market to the lowest level since October 1968. Last month's sales pace left homes available for sale at 5.0 months supply, the lowest since December 2005, compared with 6.2 months in March.

In another report, the Commerce Department reported that durable goods orders increased 2.9 percent last month to their highest level since September 2008, aided by a 228 percent increase in bookings for aircraft. If you exclude transportation, orders fell 1 percent. However, March's gain was revised upward to 4.8 percent from 3.5 percent.

Although the report gave a mixed reading on the factory sector, the upward revisions to several categories in March were a sign of strength in the manufacturing-led recovery that started in the second half of last year. They also implied first-quarter growth figures could be revised higher when the government reports its second GDP estimate on Thursday.

Chinese Euro Holdings Under Review

China is reviewing its euro zone bond holdings because of growing concerns over the deficits in countries including Greece and Portugal, the Financial Times reported on Wednesday. The FT said representatives of China's State Administration of Foreign Exchange, or SAFE, which manages the reserves under the country's central bank, has been meeting with foreign bankers in Beijing in recent days to discuss the issue.

SAFE, which holds an estimated $630 billion (437.2 billion pound) of euro-zone bonds in its reserves, has expressed concern about exposure to the five so-called peripheral euro zone markets of Greece, Ireland, Italy, Portugal and Spain, the newspaper said.

The exact makeup of China's roughly $2.4 trillion in foreign exchange reserves is a state secret, but most analysts estimate it holds about two-thirds in dollar-denominated assets and the rest primarily in euros, Japanese yen, and British pounds.

Chinese Commerce Ministry officials have in recent days expressed concern about how a weakening euro would hurt exports. Premier Wen Jiabao said China stood ready to support European Union and International Monetary Fund plans to stabilize the euro area.

Fears of deeper financial market turmoil make China highly unlikely to take any immediate action to sell off euros, which could protect its reserves but could result in considerably higher collateral damage.

SAFE is highly secretive about its management of foreign exchange reserves, going only so far in public as to say that it pursues principles of safety, liquidity and return.

China Investment Corp, the $300 billion sovereign wealth fund with a mandate to invest reserves more aggressively, told foreign bankers recently that while the euro looked worrisome, dollar and yen assets inspired little more confidence, according to a source in Beijing.