MarketView for May 16

Summary

The major equity indexes were lower on Thursday, with the downturn accelerating late in the day after several Federal Reserve officials indicated they would be in favor of the Fed easing back on its QE3 program.  Earlier in the day share prices remained relatively unchanged, supported by a gain in Cisco’s shares of more than 12 percent. Cisco’s shares rose12.6 percent to $23.89 after the network equipment maker posted a higher-than-expected quarterly profit and said current-quarter revenue could increase.

Nonetheless, the S&P 500 in dex finished near its session low following the comments from John Williams, the president of the Federal Reserve Bank of San Francisco,  who also said the Fed could end its bond purchases later this year, assuming the labor market continues to grow stronger.

The Fed's purchases of $85 billion a month in bonds has been a significant driver of the rally in equities that has taken indexes to record highs and pushed the S&P 500 up nearly 16 percent this year.

Other Fed officials on Thursday called for the central bank to stop buying mortgage-backed bonds, citing improvement in the housing market.

Dell, in the midst of a takeover battle between activist investor Carl Icahn and its billionaire founder, reported a steep drop in quarterly profit after the closing bell as personal computer sales continued to shrink. The company’s shares fell 0.5 percent to $13.37 in after-hours trading. During the regular session, Dell's stock fell 0.2 percent to end the day at $13.43.

In other news after the close, J.C. Penney reported that operating margins fell sharply in the first quarter while total sales and same-store sales registered double-digit declines - in line with its warning last week. The retailer has gone back to basics with marketing and promotions aimed at winning back customers, who left in droves under the failed strategy of former Chief Executive Ron Johnson.

Early in the day, economic data set a lackluster tone in markets as data from the Philadelphia Federal Reserve showed factory activity in the mid-Atlantic region contracted, while the Commerce Department reported that U.S. housing starts plummeted 16.5 percent in April. New claims for jobless benefits unexpectedly jumped last week.

Wal-Mart fell 1.7 percent to $78.50 and dragged on the Dow after the world's largest retailer posted a quarterly earnings number that missed expectations, with sales down 1.4 percent at stores open at least a year.

Tesla Motors gained 8.7 percent to $92.25 after the electric carmaker said it aims to raise $830 million through a stock-and-debt offering that will be used to repay its U.S. Department of Energy loans with interest. The stock is up more than 50 percent since the company reported earnings last week.

Approximately 6.45 billion shares changed hands on the three major equity exchanges, as compared with the year-to-date average daily closing volume of about 6.34 billion shares.

Discontent Within the Fed

Several Fed officials are calling for the Fed to stop buying mortgage-backed bonds, citing the recent improvement in the housing market. Richard Fisher, President of the Dallas Federal Reserve Bank, was the latest to point to the recent pick-up in home values and housing construction as signs the central bank's purchases of mortgage-backed securities are no longer needed.

"We can rightly declare victory on the housing front and (reduce) our purchases, with the aim of eliminating them entirely as the year wears on," Fisher told the National Association for Business Economics on Thursday in Houston. "I believe the efficacy of continued purchases is questionable."

His thinking leaves him in a minority at the central bank. Regional Fed presidents rotate into voting seats on the policy-setting Federal Open Market Committee, while board members, who tend to be more sanguine about the effectiveness of the Fed's bond-buying stimulus and are permanent voters.

That means Chairman Ben Bernanke generally leads the way and he still appears reluctant to take his foot off the accelerator with the recovery still fragile and inflation heading lower.

Philadelphia, Fed President Charles Plosser said the central bank should dial back its asset buying starting next month, given the improving economic backdrop. "Things are better enough for the Fed to slow the pace of purchasing if we are really serious about the fact that (the purchase program) is scalable," he said.

In a speech late on Wednesday, Richmond Fed President Jeffrey Lacker offered much the same message. "When you look at housing market conditions, I think you could make the case that we should be getting out of mortgage-backed securities," Lacker told reporters after a speech.

Amid the barrage of hawkishness, the Boston Fed's dovish president, Eric Rosengren, welcomed the brighter signals from housing, but said the central bank's aggressive monetary support remains appropriate.

Fed Board Governor Sarah Bloom Raskin was more non-committal, saying it was premature to judge the impact of the Fed's latest actions to spur growth.

"The U.S. economy has continued to recover from the effects of the financial crisis and deep recession, though at a pace that has been disappointingly slow," she said. "The recovery does appear to have picked up steam in some sectors, most notably in housing ... However; federal fiscal policy remains an important source of restraint. She said."

Meanwhile, John Williams of the San Francisco Fed said the central bank could begin easing up this summer and end its bond buys late this year. But he signaled he would prefer to begin with Treasuries, not mortgage-backed bonds.

"It will take further gains to convince me that the 'substantial improvement' test for ending our asset purchases has been met," Williams said at a luncheon sponsored by the Portland Business Journal.

Williams omitted, for the first time in months, his view that Fed asset purchases will probably be needed well into the second half of the year; a move that reflects his growing confidence in his forecast for continued improvement in the labor market.

Williams believes the Fed's housing-bond purchases have a bigger bang for the buck than Treasury purchases, signaling his support for more mortgage-backed bond purchases, even if the Fed decides to trim the overall program.

Lacker and Fisher suggested the recent decline in inflation, which is now running at around half the Fed's 2 percent target, is benign and likely transitory.

Inflation hawks at the Fed worry the sharp expansion in bank reserves could lead to future inflation, even if there are no signs at all of any imminent price pressures. U.S. consumer prices dropped 0.4 percent on falling gasoline prices, the biggest drop since late 2008 during the disruptive aftermath of the Lehman Brothers collapse.