MarketView for November 3

 

 

Summary 

 

It was a volatile day on Wall Street on Wednesday, after the Federal Reserve detailed a plan to breathe new life into the struggling economy. Both the Dow Jones industrial average and the Nasdaq closed at levels not seen since 2008, while the S&P ended at a six-month high. The gains were preceded by volatile session as the Street awaited the Fed’s announcement. The Fed’s announced a plan to buy $600 billion in Treasurys was greater than had been anticipated but less than many had been hoping for.

 

The S&P 500 index is up about 14 percent and has broken through its 200-week moving average, which was seen signaling further gains, as Wall Street continued to bet on the Fed's action and Republican gains in Tuesday's elections, two suppositions that came to pass and ended some of the market's uncertainty. The Nasdaq ended at its highest since June 2008 while the Dow closed at its highest since September 2008. The S&P 500 closed at its best level in six months.

 

The CBOE Volatility index .VIX, a favored gauge of investor anxiety, fell 9 percent after rising earlier. The change in direction "indicates... that traders feel the Fed support under the market remains firm.

 

Qualcomm saw its share price gain 8.3 percent to close at $49.49 in extended-trading after it reported fourth-quarter revenues that exceeded expectations. Whole Foods Market was also in the winner’s column, closing up 8 percent to $44.34 after the market's close on a higher-than-expected profit.

 

In company news, both Aetna and WellPoint rose after posting higher-than-expected quarterly earnings and raising their full-year earnings guidance. Aetna closed out the day up 2.9 percent at $30.48, while WellPoint was up 0.5 percent to close at $56.05. At the same time, Time Warner fell 1 percent to $32.07 after the media company reported its third-quarter results.

 

Housing stocks were also lower after Pulte posted an adjusted third-quarter loss that widened from the prior year. The stock lost 7.7 percent to $7.45.

 

In economic news, the services sector grew more rapidly than expected in October and factory orders posted their largest gain in eight months. A separate report indicated that private employers added more jobs than expected in October.

 

Volume on the exchanges was light, with about 6.92 billion shares being traded on the New York Stock Exchange, the American Stock Exchange and Nasdaq, well below the year-to-date daily average of 8.73 billion shares.

 

The Fed Makes Its Move

 

The Federal Reserve on Wednesday launched a fresh effort to support a struggling economy, committing to buy $600 billion in government bonds despite concerns about the program.

The decision takes the Fed into largely uncharted waters and is aimed at further lowering borrowing costs for consumers and businesses still suffering in the aftermath of the worst recession since the Great Depression.

 

According to the Fed’s statement, it plans to purchase about $75 billion in longer-term Treasury bonds per month through the end of June 2011 and could adjust purchases depending on the recovery. At the same time, critics within and outside the central bank fear the Fed's policy will lead to high inflation and worry that low interest rates in the United States risk fueling asset bubbles abroad.

 

However, with the economy expanding at only a 2.0 percent annual pace in the third quarter of this year and the jobless rate seemingly stuck around 9.6 percent, the Fed feels it has to do more to stimulate business activity. In the Federal Reserve's post-meeting statement, it described the economy as "slow" and said employers remained reluctant to create jobs. They also called inflation "somewhat low."

 

"Progress toward (our) objectives has been disappointingly slow," the Fed said, referring to its dual mandate to maintain price stability and foster maximum sustainable employment.

 

With 14.8 million Americans unemployed, factories operating well short of capacity, and inflation well below the range the Fed would prefer, some officials at the central bank see the risk of a vicious deflationary cycle where consumers hold off on purchases, choking off economic growth.

 

The overall size of the bond buying program was slightly larger than the $500 billion that many analysts had looked for, though the pace of monthly buying fell short of expectations for something around $100 billion. While doubts lingered about the ability of bond purchases to kick start a moribund economy, there was a sense in the market that the Fed was open to doing more if the recovery remains sluggish.

 

Nearly 90 percent of the Fed's purchases will be of Treasuries with maturities ranging from 2-1/2 to 10 years, the New York Fed said, adding it would temporarily relax a rule limiting ownership by the Fed of any particular security to 35 percent. It said holdings would be allowed to rise above that threshold "only in modest increments."

 

In response to the most severe financial crisis in generations, the Fed has already reduced overnight interest rates to near zero and bought about $1.7 trillion in U.S. government debt and mortgage-linked bonds. Those purchases took place when the financial markets were largely paralyzed. Now, economists and Fed officials alike are divided over how effective the new program will be

 

Kansas City Fed President Thomas Hoenig, along with other Fed officials, are concerned that further bond purchases could do more harm than good by providing tinder for inflation that will ignite when the recovery finally gains traction. Hoenig voted against the action, his seventh straight dissent.

 

The impact of Fed monetary easing overseas has been significant. With the prospect of a long period of ultra-low returns in the United States, investors have flocked to emerging markets, pushing those currencies higher. Developing economies, worried about a loss of export competitiveness, have cried foul.

 

The Bank of Japan, which meets on Thursday and Friday, is also poised to launch a new round of bond buying. The European Central Bank and Bank of England also meet this week, but are expected to leave policy on hold.

 

The Fed's policies also have repercussions for liquidity in Treasury bonds, the world's largest sovereign debt market where investors historically seek safe-haven from market stress. The Fed already owns roughly 12.5 percent of all outstanding Treasury bonds and notes. If it were to buy $1 trillion more, as some economists expect it eventually will, the portion of its holdings compared with all outstanding Treasuries could jump to 27 percent.

 

A group of bond dealers that advises the U.S. Treasury expressed concerns about the possibility that a shortage of bonds could cause market disruptions, according to minutes from its November 2 meeting released on Wednesday.

 

Job Growth Data Exceeds Expectations

 

Economic data released on Wednesday by payrolls processor ADP Employer Services, indicated a slow-paced economic recovery was beginning to gain some momentum, even as the Federal Reserve launched fresh action to spur growth and create jobs.

 

According to ADP, private employers added 43,000 jobs, more than twice as many as expected, during October, after laying off workers the previous month. Meanwhile, the dominant services sector expanded for a 10th straight month. A third report showed orders received by domestic factories increased in September by the largest margin in eight months. September's job losses were revised to 2,000 from the 39,000 originally reported.

 

The larger-than-expected gain in private hiring suggested a more comprehensive government report on employment due on Friday could show a slightly larger increase in jobs in October than expected. Separately, the Institute for Supply Management said its index of non-manufacturing activity rose to 54.3 last month from 53.2 in September. A figure above 50 signals expansion.

 

Furthermore, the data this week indicated acceleration in manufacturing activity in October, allaying fears of a sharp slowdown in the sector, which has been leading the recovery. A separate report from the Commerce Department showed orders for manufactured goods increased 2.1 percent in September after being flat in August.

 

Signs of a slight tick up in economic activity were also evident in domestic auto sales, which recorded their fastest growth pace so far this year during the month of October.

 

Freddie Mac Back at the Well

 

Freddie Mac, the second-largest provider of U.S. residential mortgage funding, on Wednesday said a faltering housing market resulted in a $4.1 billion third-quarter net loss and another draw from the Treasury to maintain positive net worth. Freddie Mac in a quarterly regulatory filing also warned it may face significant costs related to snags in the foreclosure processes at major loan-servicing companies.

 

Freddie Mac's third-quarter loss included a $1.6 billion dividend payment on senior preferred stock purchased by the Treasury since the financial crisis and housing slump pushed the mortgage buyer into conservatorship in late 2008. Its quarterly loss narrowed from $6 billion in the previous three-month period.

 

It has requested $100 million from Treasury under its preferred stock purchase agreement, which would increase taxpayer outlays so far to $64.2 billion.

 

Freddie Mac's struggle to put losses on loans originated during the housing boom behind it have been challenged by a sputtering economy, and fresh problems in clearing the backlog of delinquent borrowers and the homes they leave behind through foreclosure.

 

Delays in selling repossessed properties raise Freddie Mac's costs of carrying the homes, while the expenses tied to fixing faulty servicing may also rise, it said.

 

The inventory of homes owned by Freddie Mac increased 66 percent in the first nine months of the year to 74,910 properties as homeowners could not get their loans modified or sell their homes. At the same time, acquisitions of foreclosed properties may slow due to problems at loan servicers, it said.

 

Expenses on Freddie Mac's portfolio of homes it owns through foreclosure increased to $337 million from income of $40 million in the previous quarter.

 

"In cases where foreclosure is unavoidable, we are working with the industry to protect the integrity of the foreclosure process," the company said in its statement.

 

Freddie Mac also expressed frustration with servicers and lenders that have failed to answer demands to repurchase faulty loans in a "timely manner." Nearly a third of the $5.6 billion in requests to repurchase loans that did not meet underwriting standards were outstanding more than four months, it said.

 

Credit loss provisions were little changed at $3.7 billion after factoring for an accounting adjustment.

 

The housing market has grown increasingly reliant on funding from Freddie Mac and rival Fannie Mae, with both reporting improvements in the quality of loans they guarantee. Lawmakers plan to reform their taxpayer-supported status, but are loathe to undo government ties with the housing market as private investors remain skittish of offering financing to homeowners.

 

Freddie Mac said it would likely continue to rely on its credit line from the Treasury, but that its costs of obtaining that aid were rising. It has paid $8.4 billion in dividends to Treasury, or 13 percent of its capital draw. Net interest income rose to $4.3 billion last quarter, up from $4.1 billion, it said, which was offset by the credit losses and a $1.1 billion derivative loss.