MarketView for May 27

 

Summary

 

All the major equity indexes moved higher on Tuesday as the S&P 500 index chalked up a second straight record close, due in no small part to the latest round of merger activity and as expectations for rate cuts by the European Central Bank stoked investors' appetite for equities.

 

ECB chief Mario Draghi said on Monday the bank must be "particularly watchful" for any negative price spiral in the euro zone. His comments increased bets that the bank was ready to cut rates next week to counter low inflation and weak lending in the euro zone, keeping asset purchases as an option.

 

The day’s economic data also supported equities. Orders for durable goods, meant to last three years or more, unexpectedly rose in April, and consumer confidence perked up in May, backing views of a rebound in economic growth.

 

The Russell 2000 and Nasdaq Composite outperformed other major indexes on Tuesday, as they did handily last week, indicating a rotation out of small caps and growth shares could be over. The Russell rose 1.4 percent, its fourth straight advance and sixth gain in the past seven sessions.

 

Shares of Hillshire Brands, known for sausages and lunch meats, surged 22.1 percent to $45.19 after poultry producer Pilgrim's Pride offered to buy Hillshire in a $6.4 billion deal. Shares of Pinnacle Foods, which Hillshire plans to buy, slid 5.4 percent to $31.48. Pilgrim's Pride gained 1.7 percent to $25.52.

 

Pfizer shares added 0.4 percent to $29.61 a day after the pharmaceutical giant walked away from its bid to buy AstraZeneca for nearly 70 billion pounds ($118 billion). U.S.-traded AstraZeneca shares fell 0.3 percent to $72.05.

 

Volume was light on Tuesday, with about 5.38 billion shares changing hands on the major equity exchanges, a number that was less than the 5.8 billion share average so far this month, according to data from BATS Global Markets.

 

Durable Goods Number Surprises

 

The Commerce Department reported Tuesday morning that durable goods orders rose unexpectedly during April. However, a decline in a measure of business capital spending plans could temper expectations for a sharp rebound in economic growth this quarter.

 

According to the Department, orders increased 0.8 percent as demand for defense capital goods surged and orders for fabricated metal products, transportation equipment and electrical equipment, appliances and components rose.

 

Durable goods are designed to last three years or more. Orders advanced by a revised 3.6 percent in March. Non-defense capital goods orders excluding aircraft, a closely watched proxy for business spending plans, fell 1.2 percent after rising by a revised 4.7 percent in March, which was the largest gain since November.

 

Core capital goods shipments fell 0.4 percent last month. Shipments of core capital goods are used to calculate equipment spending in the government's GDP measurement. They increased 2.1 percent in March.

 

While the durable goods report is volatile month-to-month, it added to weak industrial production data in suggesting some cooling in factory activity. The Institute for Supply Management's survey of national factory activity also showed a slowing in new order growth in April.

 

Businesses are placing fewer orders while working through a stockpile of goods amassed in the second half of 2013. Last month, durable goods inventories rose 0.1 percent after increasing 0.2 percent in March.

 

Orders for defense capital goods jumped 39.3 percent, the largest rise since December 2012. Transportation equipment rose even as bookings for civilian aircraft and automobiles fell. Orders excluding transportation rose 0.1 percent after increasing 2.9 percent in March.

 

There were declines in orders for machinery, primary metals and computers and electronic products. The durable goods report could cause economists to trim expectations for a sharp rise in growth in the second quarter after the economy sputtered in the first three months of the year.

 

Consumer Confidence Rises

 

Consumer confidence rose in May as consumers saw the economy, including the labor market, in a better light, according to a private sector report released on Tuesday.

 

The Conference Board, an industry group, said its index of consumer attitudes rose to 83 in May from a downwardly revised 81.7 in April. The index for April was originally reported as 82.3.

 

The expectations index rose to 84.8 in May from a downwardly revised 83.9 in April, while the present situation index increased to 80.4 versus an upwardly revised 78.5 last month.

 

Consumers saying jobs are "hard to get" slipped to 32.3 percent from 32.8 percent, revised from 32.5 percent in April.

 

Krugman Warns ECB

 

Nobel laureate Paul Krugman challenged the ECB on Tuesday to act to stop the euro zone slipping into Japan-style deflation, saying it risked sitting still while the economy became "persistently depressed".

 

Speaking at the ECB's inaugural Forum on Central Banking, Krugman suggested the euro zone could sleep walk into Japan-style deflation - a challenge to which European Central Bank President Mario Draghi will have an opportunity to respond to at the conference in Portugal later on Tuesday.

 

It would be easy to convince oneself there is no problem, Krugman said, adding: "There is not that explosive downward dynamics in the euro area, or in the United States.

 

"But then there has never been explosive downward dynamics in Japan either, and yet we do think that Japan has had a persistent deflation problem."

 

The ECB is getting increasingly uncomfortable with the euro zone's persistently low inflation, which has been stuck in what Draghi has called the "danger zone" below 1 percent for seven months.

 

Opening the ECB's Sintra Forum, billed as the European version of the Federal Reserve's renowned Jackson Hole conference, Draghi said on Monday that there was a risk of disinflationary expectations taking hold.

 

His comments came after he said at the ECB's May meeting that the Governing Council was "comfortable with acting next time" - its June 5 policy meeting - but wanted to see updated economic projections from the bank's staff first.

 

Since then, data has confirmed a slight increase in euro zone inflation in April to 0.7 percent, from 0.5 percent the previous month, but also shown that the economy grew much less than expected at the start of the year.

 

Krugman said a fully-fledged deflation was very rare.

 

"If you are only going to get really ... compelled to do something when it turns into a 1933-type deflationary spiral, you are not going to get that and yet you are going to be sitting there with an economy that is persistently depressed, because inflation is too low," he said.

 

He renewed his call for central banks to target a higher inflation rate than, for example, the ECB's goal of just below 2 percent, to avoid getting trapped in a period of low inflation.

 

Olivier Blanchard, the International Monetary Fund's chief economist, had suggested a 4 percent target.

 

The ECB is preparing a package of policy options for its June meeting, sources have told Reuters, including cuts in all its interest rates and targeted measures aimed at boosting lending to small- and mid-sized firms (SMEs).

 

Five people familiar with the measures being prepared have detailed plans involving a potential rate cut, including the ECB's deposit rate going negative for the first time, along with the targeted measures aimed at boosting lending to SMEs.

 

Service Sector Expands

 

The services sector expanded in May at its fastest rate since March 2012 as employment creation accelerated, financial data firm Markit said on Tuesday. According to Markit, its "flash" services Purchasing Managers Index hit 58.4 in May compared with April's final reading of 55.0. A reading above 50 signals expansion in economic activity.

 

The services sector added employees at the fastest rate since January, with the employment sub-index at 53.1, up from 51.2 last month. New business growth for the services sector was at its fastest since February 2011.

 

Markit's "flash" composite PMI, a weighted average of its manufacturing and services indexes, hit 58.6 in May versus a final reading of 55.6 in April, marking the fastest rate of private sector output growth since April 2010.

 

According to Tim Moore, senior economist at Markit, "May's flash services PMI survey is a further signal that the US economy has regained momentum through the second quarter of the year." He said the survey should help alleviate concerns that the first quarter slowdown reflected underlying sluggishness in the economy.