MarketView for May 28

 

 

Summary  

 

Wall Street ended the month on a negative note on Friday as stock prices s fell and all the key equity indexes closed out the day in negative territory, capping off their worst month in over a year. It did not help matters that Fitch downgraded Spain's credit rating, which in turn reignited worries over euro-zone debt issues. The downgrade was the latest setback in a month in which the S&P 500 fell more than 8 percent on concerns the euro-zone debt woes would escalate into a global financial crisis.

 

Fitch cut Spain's credit rating by one notch, stating that the country's economic recovery will be more muted than the government forecast due to its austerity measures.

 

For the month, the Dow was down 7.9 percent, the S&P fell 8.2 percent and the Nasdaq lost 8.3 percent. The declines were the worst for the Dow and S&P since February 2009, while the Nasdaq suffered its worst monthly drop since November 2008.

 

For the week, the Dow was down 0.6 percent, the S&P 500 gained 0.2 percent and the Nasdaq was up 1.3 percent.

 

The downgrade follows similar cuts in ratings earlier this month of Greece and Portugal as those nations attempt to grapple with debt problems by implementing austerity measures. The downgrade also pushed stock prices lower as stocks had fallen earlier after data showed consumer spending was unexpectedly flat last month and growth of U.S. Midwest business activity slowed more than expected.

 

Data from the Commerce Department showed April was the first month since September that consumer spending did not increase, but the largest gain in real disposable income in nearly a year gave hope that spending will resume in coming months.

 

A separate report showed business activity in the Midwest grew less than expected in May after scaling a five-year high in April. An employment gauge in the Institute for Supply Management-Chicago's survey slipped.

 

Investors also took advantage of the opportunity to book gains before a long holiday weekend and after a rally in the previous session. The markets will be closed on Monday for the Memorial Day holiday.

 

The listed shares of BP Plc shed 5.4 percent to $42.95 after the company's chief executive officer said some progress had been made in its bid to plug the leaking Gulf of Mexico oil well, though it could still take 48 hours to conclude whether it has been fully successful.

 

Apple was among the few bright spots, rising 1.5 percent at $257.16 after the iPad tablet computer debuted outside the United States and Bank of America-Merrill Lynch raised its price target on the stock by $25 to $325.

 

The Thomson Reuters/University of Michigan Surveys of Consumers showed consumer sentiment rose a bit in May from April but was roughly unchanged from levels since February, while the one-year inflation expectations index also climbed to its highest since October 2008.

 

Fitch Cuts Spain’s Debt Rating

 

Fitch cut Spain's credit rating by one notch on Friday, sending markets lower and capping a horrible week for a government struggling to convince investors it can solve its economic woes and avoid a Greek-style debt crisis.

 

Fitch Ratings linked the downgrade to AA+ from AAA to the record levels of household and corporate debt in Spain, as well as mounting public debt, which it said would act as a drag on economic growth.

 

Because the Spanish economy is far bigger than Greece's, a crisis there would have far more serious implications for the 16-nation euro zone and global growth.

 

Fitch is the second agency to cut its rating on Spain after Standard & Poor's downgraded the country last month. In addition to the debt woes, Fitch cited the inflexibility of the labor market and the cost of restructuring Spain's network of unlisted savings banks as hurdles to recovery.

 

The Spanish economy hit a wall when a housing bubble fueled by cheap credit burst. It was the only major economy in Europe not to emerge from recession last year.

 

The Spanish government said on Friday that talks with unions to agree an overhaul of labor market rules were not going well and that if necessary it would push a reform of workplace laws through parliament.

 

Unions have threatened a general strike if Socialist Prime Minister Jose Luis Rodriguez Zapatero's government pushes ahead with a reform to cut the cost of hiring and firing without their consent.

 

In order to reassure markets about the country's long-term solvency, the government was set to make a last-ditch attempt to clinch a deal in three-way talks at the weekend that will also include employers.

 

The prospect of industrial strife piles further pressure on Zapatero, whose government averted a bullet on Thursday by winning passage of a 15 billion euro ($18.4 billion) austerity package by a single vote in parliament.

 

A week after cutting its 2011 growth forecast to 1.3 percent from 1.8 percent, the government on Friday revised down its growth estimates for 2012 and 2013 to 2.5 percent and 2.7 percent, respectively.

 

Unions, which are already set for a public sector strike over pay cuts, have threatened a broader walkout to block a reform of rigid labor market rules that economists say is needed to put Spain on a solid economic footing.

 

The unions are traditional allies of the Socialists, and have until recently held back from big protests, like those seen in Greece, despite an unemployment rate of around 20 percent.

 

Unions, which represent less than 20 percent of the workforce, are already set for a one-day strike over public sector pay cuts for June 8.

 

Unlike Greece, Spain's level of public debt remains low at under 70 percent of gross domestic product (GDP). But debt markets fear that without labor reform, unemployment will stay high, pushing the government down an unsustainable fiscal path.

 

The government's austerity drive aims to reduce the budget deficit to 9.3 percent of GDP this year and to 6 percent in 2011, down from 11.2 percent in 2011.

 

Mediocre Economic Reports

 

Consumer spending unexpectedly stalled in April after six straight months of gains, but rising income and consumer confidence pointed to solid consumption this quarter. Although Friday's data was mixed, it still illustrated a picture of an improving domestic economy at a time when a fiscal crisis in Europe casts a shadow over recovery in that region.

 

The debt crisis, sparked by Greece's huge budget shortfall, has caused havoc in global financial markets. It has raised fears spending cutbacks by some governments in Europe could slow the world economy and push some countries back into recession.

 

While consumer spending was unchanged in April, real disposable income recorded its biggest gain in nearly a year, the Commerce Department data showed. Income was boosted by a combination of an improving labor market and tame inflation.

 

Separately, the Thomson Reuters/University of Michigan's index of consumer confidence edged up to 73.6 this month from 72.2 in April. Even more encouraging, a measure of consumers' expectations on the outlook for the economy over a 12-month horizon was the highest since January.

 

Employers have added jobs for four straight months and analysts expect a report next Friday to show the trend continued in May. A Reuters survey forecast payrolls grew 503,000, though at least half of the gain would be related to government hiring for the decennial census.

 

Another report indicated that manufacturing activity in the country's Midwest region slowed slightly this month after scaling a five-year high in April. The Institute for Supply Management-Chicago report came ahead of Tuesday's release of data on overall U.S. manufacturing activity. Manufacturing has been the main driver of the economy's recovery.

 

U.S. government debt prices rallied, while the dollar surged against the euro. Securing a stronger recovery is a key goal for President Barack Obama as tough tests loom for his fellow Democrats in November's congressional elections. Voters are in anti-Washington mood over the recent recession, Wall Street's role in the crisis, job losses and the weak housing market. The Democrats' majority control of Congress is at stake.

 

Despite weakness in April, look for strong spending in the second quarter as a firming labor market boosts household incomes and tame inflation bolsters spending power.

 

Government data on Thursday showed real consumer spending rose at a 3.5 percent annual rate in the first quarter, more than double the 1.6 percent pace in the fourth quarter. Last month, personal income rose 0.4 percent and inflation-adjusted, after-tax incomes increased 0.5 percent in April, the largest gain since May 2009. With spending flat and income rising, the saving rate climbed to 3.6 percent from 3.1 percent in March.

 

A key inflation gauge monitored by the Federal Reserve rose 1.2 percent in the 12 months to April, the smallest rise since the period through September. The combination of tame inflation and excess capacity in the economy, even as the recovery gains traction, means more room for the U.S. central bank to hold benchmark interest rates ultra low for an extended period.