MarketView for November 17

 

 

Summary   

 

Stock prices hit 13-month highs on Tuesday as upbeat views from Street analysts on improving prospects for two Dow components offset disappointing holiday spending outlooks from Target and Home Depot. Even so, the underlying tone was negative and more stocks fell than rose.

 

The weak outlooks being projected for the key holiday season weighed on investor psychology because consumer spending accounts for about two-thirds of economic activity and is a key factor in corporate profits.

 

The three major equity indexes initially started lower and then spent the bulk of the session near breakeven until the last half-hour of trading, when gains in the technology and energy sectors helped spur some upward momentum.

 

Shares of Microsoft gained 2 percent to $30, an 18-month closing high, after Morgan Stanley raised its price target on the stock and said it was upbeat on the prospects for Windows 7 and the company's holiday season.

 

Shares of Exxon Mobil rose 0.8 percent to $75.03 after Barclays raised its recommendation on the stock to "overweight" from "equal-weight." Both Microsoft and Exxon are components of the 30-stock Dow Jones industrial average.

 

However, Home Depot fell 2.4 percent to $26.99 after the chain gave a forecast that suggested weaker results at the end of the year and predicted no meaningful recovery until the second half of 2010.

 

Target forecast a holiday quarterly profit that could fall short of Street estimates, stating that early November results showed tepid consumer demand. Target closed down 3 percent at $48.77.

 

Data showing that industrial output rose less than expected in October also held back buying and overshadowed news that the Producer Price Index, a gauge of wholesale inflation, was tame last month.

 

Economic News Tepid

 

Industrial output barely rose last month and wholesale inflation was tame, suggesting a sluggish economic recovery with ample slack to keep inflation under control, thereby reinforcing the Fed's commitment to keep interest rates near zero for an extended period.

 

Industrial output edged up 0.1 percent in October after a 0.6 percent advance the prior month, the Federal Reserve said, as auto manufacturers scaled back following the end of the popular "cash for clunkers" incentive in August.

 

Meanwhile, the Labor Department said its producer price index, a gauge of prices received by farms, factories and refineries, rose 0.3 percent last month, below expectations for a 0.5 percent gain, after a 0.6 percent decline in September. The core number, which excludes food and energy prices, fell unexpectedly by 0.6 percent. It was the largest decline since July 2006, after a 0.1 percent drop in September.

 

Stock prices hit new 13-month highs despite the tepid industrial output data and outlook from Home Depot Target.

 

Treasury Secretary Timothy Geithner told a Senate Foreign Relations Committee hearing the economy was likely to grow at a more moderate rate than in past recoveries as households worked to reduce their debts. High unemployment and untapped industrial capacity after the worst recession in 70 years have suppressed prices, but some fear massive efforts by the government and the Fed to restore growth could ignite inflation.

 

These fears have been heightened by the U.S. dollar's 15 percent depreciation against a basket of currencies since mid-March. Fed Chairman Ben Bernanke said on Monday the central bank was monitoring the U.S. dollar's fall, but economic slack and tame inflation expectations should keep price rises in check.

 

Over the past year, core producer prices have risen 0.7 percent, the smallest gain since the 12 months that ended in March 2004. In October, the core index was held back by a large drop in light truck prices and a fall in the cost of new cars, related to the pricing of new 2010 models.

 

The Fed's report on industrial output underscored the level of inflation-cooling slack in the economy. Capacity utilization inched up 0.2 percentage points to 70.7 percent, a rate that is 10.2 points below its 1972-2008 average.

 

The dollar's decline has raised concerns that investors were shunning U.S. assets, which would make it harder for the Treasury Department to finance its growing debt burden. However, Treasury figures on Tuesday indicated that the two largest foreign debt buyers, China and Japan, had increased their holdings during September.

 

Separately, sentiment among U.S. home builders was steady this month, according to a survey taken before the government extended a popular tax credit for first-time buyers.

 

Tax Credit Will Stabilize Rather Than Support the Housing Market

 

Don't expect the expanded home buyer tax credit to be a permanent crutch for the housing industry. That is not the plan. However, for the moment the support is essential to a recovery in the housing market. Consider for example, the spike in mortgage demand created by the tax credit this summer. It was followed by a plunge as the incentive was set to expire.

 

As the economy emerges from a recession triggered by the housing market crisis, increasing home sales is viewed as essential. Housing and related business account for about 20 percent of the economy, and more sales means more spending on everything from dishwashers to energy-efficient windows.

 

The Obama administration last week extended an $8,000 first-time buyer credit, added a $6,500 provision for move-up buyers and increased income limits. Eligible borrowers must sign contracts by April 30 and close loans by June 30, 2010 instead of closing by the end of this month.

 

Both the credit and another major government action -- the purchase of more than $1.4 trillion in mortgage-related securities aimed at cutting home loan rates -- will now end within weeks of each other. The purchases stop by March 31.

 

Unless the employment picture brightens around that time, housing does not have enough footing to forge a recovery on its own. Up to 400,000 people bought a home for the first time due to the credit, boosting first-time buyers to a record 47 percent of sales over the past year, the National Association of Realtors has said.

 

With the help of the credit, existing home sales will rise 2 percent this year and 13.6 percent in 2010, the group estimates. The housing credit has pulled many a wary buyer off of the fence, but it is not a fix to the troubles that spawned the deepest housing slump since the Great Depression.

 

This is a slow, tentative recovery, evidenced by the most recent reading of builder sentiment of the National Association of Home Builders. Its index remained at a low 17 in November while a reading above 50 indicates more builders view sales conditions as good than poor.

 

Meanwhile, mortgage rates hover near record lows below 5 percent but will start rising as the economy improves and the Federal Reserve stops buying mortgage bonds. These extraordinary life-saving measures raised new-home sales for five straight months before a dip in September and pushed existing home sales to a two-year high.

 

While housing typically slows in winter months and heats up again in spring, sales could be pulled forward this year because of the credit.

 

Consumers are well aware of this: Applications to purchase homes sank last week to a nine-year low, the Mortgage Bankers Association said, as buyers held out in hopes that the tax credit would be revived. Few disagree that affordability is a major lure, with record low borrowing costs and home prices that have tumbled on average by about 30 percent from 2006 peaks.

 

A federal mandate for lenders to alter terms on many failing loans is gaining traction. But just 20 percent of those eligible are in trial modifications, the Treasury said, and it is unclear how many of these will be permanent or successful.

 

Disagreement at Fed

 

There was disagreement among Fed officials on Tuesday regarding the likely pace of the economic recovery and one warned that pockets of weakness must not deter the central bank from withdrawing its extraordinary economic support. Jeffrey Lacker, the president of the Richmond Federal Reserve Bank and an outspoken anti-inflation hawk, said that if officials want to keep inflation in check, they cannot be "paralyzed by patches of lingering weakness, which could persist well into the recovery."

 

The Fed has slashed borrowing costs to near zero percent and pumped more than $1 trillion into the banking system to stimulate the economy. The question of when to begin an exit from those measures is a topic of intense discussion. Lacker said the recovery is solidly under way and he expects the economy to grow at a reasonable pace next year.

 

Two other senior Fed officials, Cleveland Fed President Sandra Pianalto and San Francisco Fed chief Janet Yellen, stressed that the economic recovery will be sluggish. Yellen, however, said that the Fed knows it cannot maintain its easy money policy for too long once the economy has healed.

 

"We all understand very well that we cannot have an accommodative policy for too long. That once these conditions no longer prevail, it is a core responsibility of the Federal Reserve to preserve price stability," she said.

 

Pianalto, who moves into a voting slot on the Fed's Open Market Committee next year, said economic slack was high, bank lending restrained and credit terms tight, echoing a downbeat assessment from Fed Chairman Ben Bernanke on Monday.

 

"Though we have seen some signs that the worst may be over, the housing industry is not out of the woods yet, nor is the broader economy," she told a conference in Columbus, Ohio.

 

The Fed cited "substantial resource slack" after its last policy meeting on November 3-4 as one reason it expects to keep benchmark interest rates ultra-low for an "extended period."

 

With unemployment at a 26-1/2 year high of 10.2 percent and ample idle factory capacity, there is considerable strength to the argument that inflation is unlikely to be a problem anytime soon.

 

Lacker, a Fed voter this year but not next, gave a somewhat rosier outlook, saying he expects the economy to grow at "a reasonable rate" in 2010 as the housing sector recovers and consumers and businesses resume spending. Risks that inflation will fall -- a sign of further economic weakness -- have diminished "substantially" since the beginning of the year, he said.

 

Lacker warned that the risk consumers and businesses lose confidence in inflation stability is greatest in the early years of an economic recovery. Pumping money into the system to spur recovery heightens this danger, he said.

 

"In assessing when we will need to begin taking monetary stimulus out, I will be looking for the time at which economic growth is strong enough and well enough established, even if it is not especially vigorous," Lacker said.

 

The Fed took another small step on Tuesday to wind down its emergency support as financial markets improve. It shortened the maturity of the emergency loans it makes to banks at its discount window, which it had lengthened during the crisis.

 

Yellen joined several Fed officials, a group that includes Bernanke, who have played down concerns the central bank's easy money policy is fueling fresh asset bubbles. Yellen, a Fed voter this year among the most growth-focused "doves," said she sees no sign of a bubble in credit spreads and that she does not think U.S. stocks are overvalued. However, she said the Fed needs to keep an eye on asset markets.

 

A surge of speculative cash into overseas markets has sharpened the discussion among central bank officials on whether and how central banks should react to wild asset price swings. Chinese banking regulator Liu Mingkang said on Sunday that low U.S. interest rates and a weak dollar posed a "new systemic risk" because they were fueling speculation.

 

Bernanke, in a rare comment on the U.S. dollar's value on Monday, acknowledged the currency's slump was causing some prices to rise, even as he said other factors restraining inflation argued for a long period of low rates.

 

European Central Bank President Jean-Claude Trichet on Tuesday said he fully backed Bernanke's comments that the Fed was attentive to changes in the value of the dollar.

"I believe that the strength of the dollar within the set of floating currencies is in the interest not only of the United States, but of the entire international community," Trichet said.

 

Lacker said the Fed would pay attention to the falling value of the dollar, but only insofar as it impacts the central bank's objectives of domestic price stability and sustainable growth.