MarketView for November 2

 

 

Summary  

 

Stock prices were higher by the closing bell on Monday after another round of solid economic reports but pulled off session highs after a Federal Reserve official's warning about banks' loan losses. The three major indexes had previously risen about 1 percent earlier in the session as stronger-than-expected data on manufacturing and pending home sales spurred a broad-based advance and soothed worries over the recovery's strength. Industrial and materials stocks responded favorably to solid numbers on manufacturing activity.

 

However, the Fed official's critical comments about banks' potential losses on commercial real estate loans caused investors to sell some financial shares. Nonetheless, stocks still managed to close the session with solid gains but could not maintain earlier momentum.

 

In testimony before a congressional committee on Monday, Jon Greenlee, the associate director of the Fed's Division of Banking Supervision and Regulation, said U.S. banks are at risk for sizable new loan losses, particularly on commercial property, and some banks may not have enough capital to fully cushion against setbacks.

 

Federal Reserve officials meet on Tuesday and Wednesday and are expected to signal a willingness to keep their simulative policies in place for some time yet to make sure a self-sustaining recovery takes root.

 

Ford Motor rose 8.3 percent to $7.58 after the company posted a quarterly profit, despite expectations by Wall Street of a loss, as it cut costs and gained market share, prompting Ford to increase its 2011 outlook to "solidly profitable" from break-even.

 

However, Ford’s shares fell 2.9 percent to $7.36 in extended-hours trading after the automaker proposed a credit facility extension and said that it plans to offer $2 billion in convertible notes and may offer up to $1 billion in stock.

 

After the closing bell, tool maker Stanley Works said it will buy rival Black & Decker in a $3.46 billion stock deal.  Black & Decker shares rose nearly 20 percent to $56.57 in extended trading while Stanley Works added 2.9 percent to $46.45.

 

The Nasdaq eked out a slim gain, weighed down by a 5.1 percent drop in the stock of BlackBerry maker Research In Motion. RIM finished at $55.74, down $2.99. It limited the Nasdaq's gains after an analyst told investors to sell the stock because of increasing competition from other smart phone makers.

 

Economic Data Continues To Look Skyward

 

Manufacturing activity hit its highest point in 3-1/2 years last month and pending home sales contracts unexpectedly surged in September, once again helping to set aside fears that the economy's budding recovery would falter. The factory gauge from the Institute for Supply Management on Monday pointed to a brisk growth pace in the fourth quarter and hinted at an improvement in the labor market in October.

 

The ISM's index of national factory activity came in at 55.7 for the month of October, up from 52.6 in September and making it the highest level reached by that index since April 2006. The Street had expected a reading of just 53.0.It was the third straight month the gauge came in above 50, the dividing line between expansion and contraction.

 

While the U.S. economy appears to have pulled out of its deepest recession since the Great Depression, rising unemployment threatens to undermine the young recovery. The data on Monday tempered those worries. Norbert Ore, chairman of the ISM manufacturing business survey committee, said the findings suggest the economy could grow at an annual 4.5 rate in the fourth quarter, up from the 3.5 percent pace in the third quarter.

The manufacturing employment sub index number in the ISM report rose to 53.1 in October, the highest level since April 2006, which suggests that the demand for labor is starting to pick up. It was the first time in 15 months the employment index crossed the 50 threshold to move into growth territory.

 

Unfortunately, the Street remained unfazed by the fact that the ISM's new orders gauge slowed for a second straight month, focusing instead on the steady rise in an inventory index -- which they said was positive for fourth-quarter gross domestic product.

 

In a separate report, the National Association of Realtors said its Pending Home Sales Index, based on sales contracts signed, rose 6.1 percent to 110.1 in September -- the highest level since December 2006 -- as first-time buyers rushed to take advantage of a soon-to-expire tax credit. Pending home sales have now risen for eight straight months, the longest streak since on records dating to 2001, and stand a record 21.2 percent above their year-ago level.

 

A separate report from the Commerce Department that showed spending on construction projects rose 0.8 percent in September buttressed the view that the property sector was stabilizing.

 

The upbeat economic reports lifted share prices and helped them to recoup some of the losses from Friday's steep sell-off. However, at the same time there was an erosion of demand for demand for safe-haven government bonds and the U.S. dollar.

 

Stocks were also cheered by surveys showing manufacturing activity in the euro zone expanded for the first time in 17 months and picked up in Britain and China, indicating a global economic recovery is underway.

 

Meanwhile, President Barack Obama said measures taken by his administration -- including a $787 billion stimulus package -- had pulled the economy back from the brink, but cautioned there was still a long way to go to achieve full recovery.

 

"We just are not where we need to be yet. We've got a long way to go. We are still seeing production levels that are significantly below peak levels. And most distressing is the fact that job growth continues to lag," Obama said.

 

Crude Keeps Moving Higher

 

Oil prices were up more than $1 to top $78 a barrel on Monday as strong manufacturing data from the United States and China stoked optimism for a turnaround in the economy and in fuel demand.

 

Sweet domestic crude for November delivery settled up $1.13 per barrel at $78.13 after dropping $2.87 on Friday. In London, Brent crude settled up $1.35 higher at $76.55 per barrel.

 

Oil prices received an early bump after data showed HSBC's China Purchasing Managers' Index had risen for the seventh straight month in October, to an 18-month high of 55.4, pointing to sustained strength in the giant oil consuming nation's manufacturing sector.

 

Energy traders have closely watched economic data and equities markets this year for signs of a turnaround in the economic crisis that could bolster flagging oil demand.

 

Oil prices also drew some support from a Reuters survey showing output by the Organization of the Petroleum Exporting Countries had declined slightly, although supplies from giant non-OPEC producer Russia reached a new post-Soviet record. OPEC agreed to a series of output cuts last year to help support oil prices, which dropped from a record near $150 a barrel in July 2008 to below $33 a barrel in December due to weak demand.

 

What Will The Fed Do

 

Federal Reserve officials meeting this week must weigh improving economic data against the risk, reinforced by a persistently weak job market that a burgeoning recovery remains on shaky ground. A 3.5 percent annualized jump in third quarter gross domestic product revived debate between analysts who believe a sustainable turnaround is under way, and those who think growth will falter once a heavy dose of stimulus fades.

 

The uncertainty is evident within the Fed itself, with many policymakers emphasizing the hazards in their outlook, even as they vow to vigorously fight any early signs of inflation.

 

With inflationary warning signals largely absent, an immediate shift in the central bank's ultra-easy policy stance, including any tinkering with its pledge to keep interest rates low for an "extended period," appears unlikely.

 

The Federal Open Market Committee, the central bank's policy setting group, meets on November 3 and November 4.

 

The third quarter GDP report on Friday signaled the end of the worst U.S. recession since the Great Depression, but government stimulus, including the "cash for clunkers" incentive for auto purchases and a $8,000 tax credit for first time homebuyers, helped prop the economy up.

 

The Institute for Supply Management's manufacturing index, a widely watched barometer of industrial strength, suggested activity remained robust in October. The measure jumped to 55.7 last month, its highest level since April 2006. It has held above the 50 line that separates expansion from contraction for three straight months.

 

Even the ISM employment index, long in contraction territory, turned positive, indicating the first inklings of a willingness to hire. Despite signs factory activity is picking up, consumers who normally account for around 70 percent of the economy's growth, are facing major challenges. Key is a jobless rate currently hovering at a 26-year high just below 10 percent, which is expected to continue climbing into next year.

 

Coupled with three years of declines in home values, the unfavorable labor market has dampened consumers' appetite to spend. Even for those who have managed to hold onto their jobs, incomes largely remain stagnant or have lost ground.

 

The grim employment outlook raises doubts about whether growth can be sustained when the effects of the government's stimulus program fade.

 

The banking sector, which has regained some of its swagger but remains relatively fragile, is another important consideration for Fed officials.

 

Some banks, like JPMorgan and Goldman Sachs, have returned solidly to profitability and have, controversially, set aside vast sums for bonus payouts.

 

But much of this largess, say analysts, is the product of the government's implicit -- and sometimes explicit -- backing. The perception, cemented after Lehman Brothers' disastrous bankruptcy, that the public sector will not allow a major financial institution to fail, has lowered the cost of borrowing for banks.

 

Losses in the commercial real estate sector, which have been flagged loudly by Fed Governor Daniel Tarullo and a host of regional central bank presidents, suggest the perils of the credit crunch are not yet over for banks. This should make the Fed leery of any sudden policy movements that might unhinge gains made thus far.