MarketView for May 20

Summary 

The major equity indexes were lower on the close on Friday primarily because of euro-zone debt concerns that are likely to make their way into next week's trading setting the stage for more negative numbers, while retailers lost ground after a weak profit outlook from Gap.

The S&P 500 remains hemmed in between technical support at 1,330 and resistance at 1,340, suggesting a lack of direction and keeping the market vulnerable to events such as the uncertain outcome of the euro zone's debt problems. About 6.71 billion shares changed hands on the three major exchanges on Friday, as compared with an average of about 8.4 billion shares last year.

Share prices of large multinationals, which tend to rely heavily on overseas sales, fell in sync with the euro's slide against the dollar as exemplified by 3M, which closed down1.2 percent at $93.56 and weighed on the Dow. The euro lost nearly 1 percent over disagreements on how to handle debt problems in Greece and ahead of a Spanish regional election.

Gap closed down 17.5 percent at $19.22 after radically reducing its full-year profit outlook late Thursday, stating that higher price tags will not be enough to offset rising cotton costs.

In the options market, the predominant activity favored more bearish bets than have been seen over the past month. For the week, the Dow fell 0.7 percent, the S&P 500 chalked up a loss of 0.3 percent and the Nasdaq fell 0.9 percent.

Ahead of May options expiration at Friday's close, traders had exchanged about 669,000 contracts on the S&P 500 index as puts outpaced calls by a factor of 2.10:1.

Oil prices were higher although Exxon Mobil saw its share price fall 0.9 percent to $81.57 and Chevron was down 1.3 percent to $102.57. Within the industrial sector, Caterpillar closed down 0.9 percent to $104.33.

On the upside, Barnes & Noble closed up 29.9 percent to $18.33 after John Malone's Liberty Media corporation proposed buying the company for $1.02 billion. The chain had put itself up for sale nine months ago.

Money from States to Cities Drying Up

To balance their budgets, states are cutting funds they send to local governments, raising concerns about the $2.9 trillion municipal bond market. Fitch Ratings said in a report on Friday that school districts and counties will face their greatest funding reductions from states.

It said cuts in aid can result in "intergovernmental downloading," where the financial burden for a service is shifted from a higher level of government to a lower level.

"Even if a funding source is identified, it may prove insufficient to cover the service that needs to be provided or may not grow at the rate needed to keep pace with expenditure growth," Fitch said.

It added that local governments may not be able to cut programs states stop funding "because of the essential nature or legal requirements of some services." Counties provide most of these services and are more susceptible to "downloading" than cities.

States give heavy financial support to schools -- roughly half of the money school systems use -- and cuts in education funding can be painful because "districts themselves have little if any control over revenue raising," Fitch said.

Most states are in the final days of drafting budgets for next fiscal year, which for nearly all begins on July 1. Conservative estimates put the total budget gap they will have to close at $80 billion. Others say it tops $100 billion.

All states except Vermont must finish their fiscal years with balanced budgets. When the housing downturn, financial crisis and recession first caused their revenues to collapse, they slashed a variety of programs and hiked taxes. With few places left to cut this year, states have begun slowing down the direct transfers and reimbursements they make to local governments, which are already struggling with their own revenue shortfalls and spending demands.

Investors are worried about the implications for the debt they hold, although Fitch noted some local governments have better credit scores than the states in which they are located.

Greece Downgraded Again

Fitch cut Greece's credit rating by three notches on Friday, pushing the country deeper into junk territory, and warned that any kind of debt restructuring would amount to default. Fitch was the second rating agency to warn that it would consider any loss imposed on bondholders as a default after Standard and Poor's said the same earlier this month.

The three-notch cut to 'B+' with a negative outlook takes Fitch's rating into "highly speculative" territory, broadly in line with Standard & Poor's 'B' rating and Moody's 'B1' grade. Both have also warned they could drag it deeper into junk.

"An extension of the maturity of existing bonds would be considered by Fitch to be a default event and Greece and its obligations would be rated accordingly," the rating agency said.

“If private sector 'burden sharing' is coercive, the credibility of EU/IMF policy commitments not just for Greece but also Ireland and Portugal would be severely diminished and affect financial stability across the euro area,” it said.

One year into its European Union/International Monetary Fund bailout, Greece is struggling with weak revenues and a deep recession, fuelling speculation that it will have to restructure its debt to pull itself out of the fiscal mess that triggered a euro zone crisis.

"The rating downgrade reflects the scale of the challenge facing Greece in implementing a radical fiscal and structural reform program necessary to secure solvency of the state and the foundations for sustained economic recovery," Fitch said in a statement.

Greece said the decision was influenced by "intense rumors" in the press at a time when Greece's program was being assessed by its lenders, and ignored new pledges.

"It overlooks the additional commitments already undertaken by the Greek government to meet its 2011 fiscal targets and speed up its privatization program," the Finance Ministry said in a statement.

But Fitch said implementation and political risks have risen as further austerity measures were required to meet the 2011 budget deficit target of 7.5 percent of GDP and warned of more downgrades if the EU and the IMF do not produce a credible plan for the debt-ridden country.

"In the absence of a fully funded and credible EU/IMF program, the rating would likely fall into the 'CCC' category indicating that a Greek sovereign debt default was highly likely," Fitch said.

Fitch said the greater emphasis on privatization has also increased risks the EU/IMF funding may be delayed, as the 50 billion euros in asset sales targeted will be hard to meet. Despite all this, Fitch said it believed the government remained committed to its fiscal program and some assets would be sold by the end of the year. The B+ rating reflects the belief the EU and IMF will come up with fresh funds for Greece and that its bonds will not be subject to "soft restructuring" or "re-profiling."

Standard and Poor's, which downgraded Greece's credit rating further into junk territory to B on May 9, had also warned that any extension of debt bond maturities held by private investors would be viewed as a selective default.