MarketView for May 4

 

 

Summary 

 

Weak economic data heightened the anxiety level on Wall Street on Wednesday, with the result that the major equity indexes were lower for the third consecutive day. Recent winners in the energy and industrials sectors were hit hardest, while a key indicator of investor worry rose for a fourth day in what some say is the outset of an extended period of weakness for stock prices.

 

The S&P energy sector, up almost 12 percent so far this year, fell 1.6 percent on Wednesday. Dow component Caterpillar lost 2.2 percent to $110.77 on Wednesday but is still up 18.3 percent for the year.

 

Reports showed activity in the services sector slowed and hiring by private companies was weaker than expected in April. The new orders index in the purchasing managers survey hit its lowest since December 2009. The data also prompted caution before Friday's jobs report for April, one of the most closely watched U.S. economic indicators.

 

The CBOE volatility index rose 2.3 percent to 17.08 for a rise of more than 17 percent over the past four sessions, shifting its near-term momentum to positive for the first time in more than a month.

 

Looking at M&A announcements, Applied Materials offered to buy rival Varian Semiconductor Equipment for $63 per share to get its hands on new technology to meet stronger demand for smartphones and solar equipment. Varian ended the day up 51.3 percent to close at $61.36, while Applied Materials closed down 1 percent at $15.09.

 

Chip gear maker Novellus Systems rose 6.5 percent to $32.92. ConAgra Foods raised its bid for Ralcorp Holdings to $86 a share in cash from $82. Shares of ConAgra rose 3.1 percent to $25.51, while Ralcorp, which owns the Post cereal brand, closed with a gain of 4.9 percent at $87.39.

 

About 8.6 billion shares changed hands on the three major exchanges, the largest volume since March 18 and well above the average 7.74 billion shares traded daily so far in 2011. Nonetheless, average volume this year was still below last year's estimated daily average of 8.47 billion.

 

Economic Data Unexciting

 

The economic recovery continued to appear to be losing some steam as reports on Wednesday indicated a slowdown in the services sector and less hiring by private companies in April. Higher gasoline prices and slower economic growth in the first quarter probably tempered hiring.

 

Worries about rising fuel and commodity prices showed up in the latest gauge of the services sector, which grew at its slowest pace since August 2010, the Institute for Supply Management said. The purchasing managers' index fell to 52.8 last month from 57.3 in March. A reading above 50 indicates expansion in the sector.

 

The new orders index in the April survey fell to its lowest level since December 2009, a worrying sign for the service sector's outlook. The new orders index decreased to 52.7 from 64.1.

 

On Monday, ISM's manufacturing report showed the sector grew a bit more slowly for a second straight month in April. The two indexes taken together are consistent with growth of about 2 percent in real gross domestic product.

 

Beyond the United States, data showed euro zone retail sales fell sharply in March as consumers felt the pinch of high prices. Concerns about the global economic recovery have also emerged as investors anticipate further tightening measures from China.

 

On the labor front, the ADP Employer Services report showed U.S. private payrolls rose by 179,000 jobs last month, less than economists' expectations for a gain of 198,000.

 

Earlier on Wednesday, another report showed the number of planned layoffs at firms fell in April to the lowest monthly amount for the year so far and were outpaced by a rise in plans to hire. Employers announced 36,490 planned job cuts last month, down 12 percent from 41,528 in March, according to a report from consultants Challenger, Gray & Christmas, Inc.

 

Other data showed applications for U.S. home mortgages rose last week, helped by refinancing demand as interest rates fell for the third consecutive week.

 

Rapidly Rising Inflation not in the Cards

 

The United States is not heading into a sustained bout of high inflation, San Francisco Fed President John Williams said on Wednesday, despite a recent surge in energy and food prices that is sparking fears of 1970s-style price rises.

 

While sharp commodities price rises are a "serious concern," prices of some like sugar and cotton are already starting to fall, and slow wage growth is acting as a brake on broader inflation, Williams said in his first public comments since his appointment March 1.

 

Commodity costs make up only a small fraction of the price of most goods, and households see the current inflation bulge as transitory, he said. Those factors mean inflation will likely peak mid-year and then recede, returning by next year to about 1.25 percent to 1.5 percent, he said.

 

The Fed's informal inflation target is 2 percent target.

 

"The economy today faces many pitfalls, but I don't believe that runaway inflation is one of them," Williams said in remarks prepared for delivery. "The risk of a sustained period of high inflation is low."

 

Williams' remarks were in line with expectations for dovish policy views from the Fed's newest policymaker, and with the views of Fed Chairman Ben Bernanke, who has also said commodities price rises are transitory and do not merit a reversal of the Fed's super-easy monetary policy.

 

The Fed has kept interest rates near zero since December 2008 and is nearing completion of a bond-buying program that will add a total of $2.3 trillion in long-term assets to the Fed's balance sheet.

 

The policies have helped reduce high unemployment and kept the economy from falling into deflation, Williams said.

 

They are not the cause of sharply higher world commodity price rises, he said.

 

The "real culprit" is rising demand for materials and fuel from growing emerging economies, and fears of supply disruptions as political turmoil grips nations in North Africa and the Middle East, he said.

 

Economic recovery has been disappointingly slow, with high gas prices dragging on household spending and recent economic data "lackluster." But it has now become self-reinforcing, with "enough forward momentum to overcome these stiff headwinds," he said.

 

Williams said he expects real GDP to grow about 3.5 percent this year, and to strengthen next year. Meanwhile, unemployment should fall to 8.5 percent by the end of this year, from 8.8 percent in March.

 

As the economy strengthens, the Fed is preparing a plan to start removing stimulus when inflation and unemployment conditions merit, he said.

 

The plan includes draining bank reserves and reducing holdings of longer-term securities as well as raising the target policy rate, he said, without specifying a preference for any particular sequence.

 

"Everyone at the Fed has learned the lessons of the '70s and is absolutely committed to making sure nothing like that happens again," he said. "I view a sustained period of high inflation as very unlikely. But if we see signs of it developing, then we will act quickly and we will act decisively to ensure price stability."