MarketView for May 26

 

Summary  

 

Share prices rose for a second consecutive day on Thursday in a mixed session, with technology and consumer discretionary stocks leading the way after upbeat earnings. The market's ability to sustain an advance ebbed and flowed with developments in the foreign-exchange market and fears over Europe's sovereign debt crisis.

 

The broad S&P 500 was treading water throughout the morning after economic data failed to meet expectations, but once again found support once the euro stabilized against the dollar. Meanwhile, the Nasdaq outperformed other major indexes after NetApp was buoyed by strong results. The tech-heavy index also got a boost from shares of Microsoft, up 2 percent at $24.67 after a prominent investor said its chief executive should resign. The company's board stood by its CEO.

 

The best-performing S&P sector on Thursday was consumer discretionary, helped by Tiffany, up 8.6 percent at $76.04 after the luxury retailer reported its first-quarter results and raised its outlook. Luxury handbag and accessories company Coach rose 5 percent to $63.68.

 

In a sign of rising concern about the economic outlook, Goldman Sachs cut its year-end target for the S&P 500 by 3.33 percent, to 1,450 from 1,500. The lower target represents an upside of almost 10 percent from current levels. The decision by Goldman Sachs to cut its S&P 500 target, one of the highest on the Street, comes after UBS and Citigroup raised their earnings forecast for S&P 500 companies last week, but kept their targets unchanged. That indicates investors are starting to put a greater risk premium on the stock market.

 

Applications for unemployment insurance rose unexpectedly  in the latest week and stayed at elevated levels, while  gross domestic product rose at an annual rate of 1.8 percent in the first quarter, unchanged from the previous estimate and below analysts' expectations for more robust growth.

 

The S&P 500 has fallen almost 3 percent this month due to a string of weaker-than-expected economic indicators. Helping the Nasdaq, NetApp posted better-than-expected results as more cloud computing drove demand for its data storage products. Its shares rose 6.9 percent to $55.31.

 

Hedge fund manager David Einhorn called for Steve Ballmer, the chief executive of Microsoft, to step down. Microsoft's board stood behind Ballmer. Microsoft’s shares rose 2 percent to $24.67.

 

About 6.4 billion shares changed hands on Thursday, a number that was well below the daily average so far this year of 7.64 billion shares.

 

Fist Full of Dollars

 

The more aggressively a bank lobbied before the financial crisis, the worse its loans performed during the economic downturn -- and the more bailout dollars it received, according to a study published by the National Bureau of Economic Research this week.  The report, titled "A Fistful of Dollars: Lobbying and the Financial Crisis," said that banks' lobbying efforts may be motivated by short-term profit gains, which can have devastating effects on the economy.

 

"Overall, our findings suggest that the political influence of the financial industry played a role in the accumulation of risks, and hence, contributed to the financial crisis," said the report, written by three economists from the International Monetary Fund.

 

Data collected by the three authors -- Deniz Igan, Prachi Mishra and Thierry Tressel -- show that the most aggressive lobbyists in the financial industry from 2000 to 2007 also made the most toxic mortgage loans. They securitized a greater portion of debt to pass the home loans onto investors and their stock prices correlated more closely to the downturn and ensuing bailout. The banks' loans also suffered from higher delinquencies during the downturn.

 

What the economists could not determine definitively was the banks' motivation for lobbying. If banks were looking to generate income at society's expense, then it would make sense to curtail their lobbying.

 

If banks were concerned mainly about short-term profit and not thinking about the long-term consequences, then executive compensation practices should be changed, the report said. And if banks just wanted to inform lawmakers, and were overoptimistic about their prospects, it would be more difficult to suggest reforms.

 

However, when the bubble burst it was the banks that spent more on lobbying received "a bigger piece of the cake" from the $700 billion bailout in the fall of 2008. As examples, the report cites Citigroup spending $3 million to lobby against the HR-1051 Predatory Lending Consumer Protection Act of 2001 as well as Bank of America spending $1 million to lobby on banking and housing issues.

 

HR-1051 was never signed into law, nor were 93 percent of all bills promoting tighter regulation from 1999 through 2006. However, two bills that significantly reduced restrictions in the mortgage market became law, the American Homeownership and Economic Opportunity Act of 2000 and the American Dream Down Payment Act of 2003. Citigroup and Bank of America each eventually received $45 billion worth of bailout funds, more than JPMorgan Chase & Co (JPM.N), Wells Fargo & Co (WFC.N) or other large commercial banks.

 

Now that the Dodd-Frank financial reform bill has passed, big banks have been lobbying aggressively against restrictions they believe are too harsh. Among the top items on the industry's lobbying agenda are stronger capital regulations, as well as a Consumer Financial Protection Bureau, new rules on derivatives trading and restrictions on proprietary trading.

 

In an interview with Reuters on Thursday, Igan said her counterparts at the Federal Reserve Board have expressed concern to her that "some of the concepts would get watered down in the process because the financial industry is lobbying hard against them."

On Tuesday, the House Financial Services Committee voted to delay implementation of derivative reform for 18 months. Although few expect any such measure to clear the Senate or be signed by the president, some executives on Wall Street are pressing for slower rulemaking.

 

At an event on Tuesday, Morgan Stanley (MS.N) Chief Executive Officer James Gorman warned that implementing reforms too hastily could "tip the world economies into recession."

 

The economists' report outlined the negative impacts of bank lobbying, but Igan said that this time around, Wall Street's interests may be aligned with the broader economy -- if only by happenstance. She said bank lobbying is "not inherently bad" and current activities may act as a counterbalance to regulators' post-crisis inclination to keep banks on a tight leash.

 

Economic Growth Rate Softens

 

Unexpectedly weak consumer spending hobbled the economy in the first quarter and fresh signs of a slowdown in the labor market pointed to an uphill struggle for the recovery. The economy grew at an annual 1.8 percent rate in the first three months of this year, the Commerce Department said on Thursday, unchanged from an earlier estimate and weaker than most forecasts.

 

A separate report from the Labor Department showed the number of Americans claiming unemployment benefits unexpectedly rose last week by 10,000 to 424,000. However, last week's rise in initial claims suggested the pace of hiring might be slowing. Last week marked the seventh straight week in which claims topped the 400,000 level which economists say is normally associated with steady job growth. Some of the slowdown in growth was linked to bad weather in early 2011 and an 11.7 percent drop in defense spending, trends which are expected to reverse in the second quarter.

 

Holding back an increase in the rate of growth are the rise in jobless claims and a moderation in factory output, which has been hit by disruptions to supply chains after the March earthquake in Japan. Estimates for second-quarter gross domestic product growth currently range between 2.5 percent and 3.5 percent but could be revised down. Recent data, including retail sales and regional manufacturing surveys, all point to soft growth. The economy expanded at a 3.1 percent rate in the October-December period. Economists had expected the first-quarter pace to be revised up to 2.1 percent.

 

Despite the economy's seven straight quarters of expansion, growth has been tepid by historical standards, leaving both the Obama administration and opposition Republicans scrambling for ideas to put it on a faster track. Consumer spending -- which accounts for more than two-thirds of U.S. economic activity -- expanded at a 2.2 percent rate in the first three months of this year, slower than the previously reported 2.7 percent. After rising at a 4 percent clip in the fourth quarter, spending was clipped by high food and gasoline prices, which sent inflation soaring at its fastest pace in 2-1/2 years.

 

The personal consumption expenditures price index rose at an unrevised 3.8 percent rate in the first quarter. That compared to the fourth quarter's 1.7 percent increase. The core PCE index, which is closely watched by the Federal Reserve, advanced at a 1.4 percent rate, the quickest pace since the fourth quarter of 2009.

 

The Fed would like to see this measure close to 2 percent. The slower growth pace means the central bank will be in no hurry to raise interest rates once it concludes its $600 billion, government bond-buying program in June.

 

Although consumer spending pulled back in the first quarter, economists are hopeful that a recent cooling of energy and food prices will ease the burden on household budgets and boost spending. The soft consumer spending overshadowed a $52.2 billion increase in business inventories, which was well above the initially reported $43.8 billion rise.

 

However a decline in vehicle production so far in this quarter because of shortages of parts from Japan could cause a drawdown in inventories and weigh on growth in the April-June period. Motor vehicle output added 1.28 percentage points to first-quarter GDP.

 

The GDP report also showed after-tax corporate profits fell at a rate of 0.9 percent in the first-quarter after rising at a 3.3 percent pace in the fourth quarter. The drop in profits, the first since the fourth quarter of 2008, likely reflected a slowdown in productivity growth as businesses stepped up hiring.