MarketView for May 21

Summary 

 

The major equity indexes were up more than 1 percent on Monday, with the S&P 500 snapping a six-day losing streak in a rebound from the largest weekly decline in almost six months. At the same time Facebook essentially collapsed in its second session after a disappointing debut. Nonetheless, tech shares were among the day's largest gainers, due in no small part to the strength of Apple, which ended the day up 5.8 percent to close at $561.28. That lead the Nasdaq to its largest one-day percentage gain since December 2011.

 

Investors are watching the 1,300 to 1,290 range on the S&P 500 as a major support level, the lower end of which was tested last week after the benchmark index had fallen 7.8 percent since the end of April. The bottom of the range coincides with the S&P 500's 10-month moving average.

 

Facebook, which fell short of lofty expectations last week, fared no better on Monday. Facebook's share price fell 11 percent in its second day of trading, falling to $34.03, or well below its $38 issue price.

 

Sentiment improved after G8 leaders gave verbal backing for Greece to stay in the euro and stressed over the weekend that their "imperative is to promote growth and jobs." Greece is expected to hold elections after the country was unable to form a government following its most recent elections.

 

In another factor helping sentiment, China's premier called for additional efforts to support growth on Sunday, signaling Beijing's willingness to take action after a recent series of economic indicators suggested that the world's second-biggest economy will slow further in the second quarter.

 

Facebook shares were expected to face tough trading this week if lead underwriter Morgan Stanley stops supporting the stock and managers listed lower down in the IPO book, who were hoping for an early surge, decide to get out before going underwater.

 

Nasdaq said it plans to implement procedures through which the Financial Industry Regulatory Authority (FINRA) will accommodate orders not executed in Facebook during the social media company's market debut on Friday. Nasdaq shares gained 3.6 percent to $22.78 after falling more than 4 percent on Friday.

 

In earnings news, Lowe's, the world's second-largest home improvement chain, cut its fiscal-year earnings outlook and said demand slowed toward the end of the traditionally strong first quarter. Lowe's shares fell 10.1 percent to close at $25.60.

 

Yahoo ended the day up one percent to close at $15.58 after news that Chinese Internet entrepreneur Jack Ma is buying back up to half of a 40 percent stake in his Alibaba Group from Yahoo for $7.1 billion in a deal that moves the Chinese e-commerce leader closer to a public listing.

 

Volume was light, with about 6.77 billion shares changing hands on the three major equity exchanges, a number that was well below last year's daily average of 7.84 billion shares.

 

China Goes Direct to Treasury

 

According to a report by Reuters but not well reported, China can now bypass Wall Street when buying Treasury debt and go straight to the U.S. Treasury, in what is the Treasury's first-ever direct relationship with a foreign government.

 

The relationship means the People's Bank of China buys U.S. debt using a different method than any other central bank in the world. The other central banks, including the Bank of Japan, which has a large appetite for Treasuries, place orders for U.S. debt with major Wall Street banks designated by the government as primary dealers. Those dealers then bid on their behalf at Treasury auctions.

 

China, which holds $1.17 trillion in U.S. Treasuries, still buys some Treasuries through primary dealers, but since June 2011, that route hasn't been necessary.

 

The documents viewed by Reuters show the U.S. Treasury Department has given the People's Bank of China a direct computer link to its auction system, which the Chinese first used to buy two-year notes in late June 2011. China can now participate in auctions without placing bids through primary dealers. If it wants to sell, however, it still has to go through the market.

 

The change was not announced publicly or in any message to primary dealers. While there is been no prohibition on foreign government entities bidding directly, the Treasury's accommodation of China is unique.

 

The Treasury's sales of U.S. debt to China have become part of a politically charged public debate about China's role as the largest exporter to the United States and also the country's largest creditor.

 

The privilege may help China obtain U.S. debt for a better price by keeping Wall Street's knowledge of its orders to a minimum. Primary dealers are not allowed to charge customers money to bid on their behalf at Treasury auctions, so China isn't saving money by cutting out commission fees.

 

Instead, China is preserving the value of specific information about its bidding habits. By bidding directly, China prevents Wall Street banks from trying to exploit its huge presence in a given auction by driving up the price.

 

It is one of several courtesies provided to a buyer in a class by itself in terms of purchasing power. Although the Japanese, for example, own about $1.1 trillion of Treasuries, their purchasing has been less centralized. Buying by Japan is scattered among institutions, including pension funds, large Japanese banks and the Bank of Japan, without a single entity dominating.

 

Granting China a direct bidding link is not the first time Treasury has gone to great lengths to keep its largest client happy.

 

In 2009, when Treasury officials found China was using special deals with primary dealers to conceal its U.S. debt purchases, the Treasury changed a rule to outlaw those deals. However, at the same time it relaxed a reporting requirement to make the Chinese more comfortable with the amended rule. Another feature of the U.S.-China business relationship is discretion: The Treasury tried to keep its motivation for the 2009 rule change under wraps.

 

Documents dealing with China's new status as a direct bidder again demonstrate the Treasury's desire for secrecy -- in terms of Wall Street and its new direct bidding customer. To safeguard against hackers, Treasury officials upgraded the system that allows China to access the bidding process.

 

The granting to China of direct bidder status may be controversial because some government officials are concerned that China has gained too much leverage over the United States through its large Treasury holdings.

 

Treasury officials have long maintained that U.S. debt sales to China are kept separate from politics in a business relationship that benefits both countries. The Chinese use Treasuries to house the dollars they receive from selling goods to the United States, while the U.S. government is happy to see such strong demand for its debt because it keeps interest rates low.

 

The United States has, however, displayed increasing anxiety about China as a cybersecurity threat. The change Treasury officials made to their direct bidding system before allowing access to China was to limit access to the system to a specially designed private network connection controlled by the Treasury.

 

Evidence of China's growing sophistication as a money manager in the U.S. markets is clear in its expansion of operations in New York. Its money management arm, the State Administration for Foreign Exchange (commonly called SAFE), has an office in Midtown Manhattan and a seasoned chief investment officer -- former Pacific Investment Management Co derivatives head Changhong Zhu -- in Beijing.

 

Facebook Sinks

 

Facebook shares sank 11 percent in the first day of trading without the full support of the company's underwriters, leaving some investors down almost 25 percent from where they were Friday and driving others to switch back to more established stocks.

 

Facebook's debut was beset by problems, so much so that Nasdaq said on Monday it was changing its IPO procedures. That may comfort companies considering a listing, but does it little for Facebook, whose lead underwriter, Morgan Stanley, had to step in and defend the $38 offering price on the open market.

 

Apparently even Morgan Stanley's own brokers were at one point "ranting and raving" about glitches that left unclear what trades had actually been executed.

 

Without a fresh round of defense, Facebook shares ended down $4.20, at $34.03. That was a decline of almost 25 percent from Friday's intra-day high of $45 a share.

 

The drop in Facebook's share price wiped more than $11 billion off of the company's market capitalization -- it became a sufficiently interesting pop culture story that even gossip website TMZ did a brief item Monday morning.

 

Volume was again massive on Monday, with nearly 168 million shares trading hands, making it by far the most active stock on the U.S. market. Nearly 581 million shares were traded on Friday.

 

The drop was so steep that circuit breakers kicked in a few minutes after the open to restrict short sales of the stock, according to a notice from Nasdaq. However, by mid-afternoon on Monday, though, there were indications that investors might be coming back in to Facebook. The stock was well off the lows of the morning, and some market players saw an entry point forming.

 

Still there was a long list of questions -- ranging from whether the underwriters priced the shares too high to how well prepared the Nasdaq was to handle the biggest Internet IPO ever -- and few easy answers.

 

The Nasdaq said Monday morning the changes it was making would prevent a repeat of what happened Friday, when glitches prevented some traders from knowing for hours whether their trades had been completed. The exchange also said it would implement procedures to accommodate orders that were not properly executed last week, which could ultimately lead to compensation for some investors.