MarketView for November 12

 

 

Summary 

 

Wall Street ended a five-week winning streak on Friday as the threat of rising interest rates in China prompted investors to book profits and reassess bullish positions in equities. The worry of the day was tighter credit in China that will in turn curb demand for commodities, driving down energy and natural resource stocks, the two sectors that were the worst performing for the day among the companies making up the S&P 500 index.

 

For the week, the Dow Jones industrial average and the S&P 500 each lost 2.2 percent and the Nasdaq fell 2.4 percent. The two sectors that did the worst were financial and information technology. Stocks have stalled in recent sessions after a two-month rally that climaxed last week, when the Dow and Nasdaq hit levels not seen since the collapse of Lehman Brothers in September 2008.

 

Reflecting the concerns, the CBOE Volatility Index .VIX jumped 10.6 percent to 20.61, the first time the index has closed above 20 since late October. The CBOE Nasdaq 100 Volatility Index .VXN also rose, closing up 16.4 percent to 22.55.

 

The S&P 500 fell below its 20-day moving average on Friday for the first time since September 1 but managed to close above it, in a sign that there is a floor just above 1,194 that could provide strong technical support.

 

December crude oil futures fell 3.3 percent on Friday and copper was off nearly 3 percent. That weighed on cyclical stocks, with Alcoa, the Dow's second-largest percentage loser, falling 2.3 percent to close at $13.49.

 

Among the Dow's other major decliners, Exxon fell 1.2 percent at close at $70.99, while Caterpillar fell 1.7 percent to close at $81.04.

 

This is the second time the index shied away from the 1,228 area, and its chart could be drawing a bearish "double top" formation. After the last retreat from that level in April, the S&P 500 started a correction that took it down to its July lows.

 

The Shanghai Composite Index fell 5.16 percent, notching its biggest percentage loss in over a year on the likelihood China's central bank was set to raise rates to tackle inflation, a move that could pressure future growth.

 

In the last hour of trading, options traders were busy making short-term hedges as the market declined. Put trading surged in the SPDR S&P 500 fund weekly options that expired after the close,

 

Boeing was the Dow's top percentage loser, shedding 3.5 percent to $63.09 after Sanford C. Bernstein cut its rating on the stock to "market perform," citing more potential delays for its 787 Dreamliner.

 

Worries that Ireland may default on its debt as well as declines in commodity prices and an unexpectedly weak outlook from Cisco Systems helped cloud the market's outlook, though some investors said the underlying trend is strong. On the upside, Intel rose 1.5 percent to $21.53 after the company raised its dividend 15 percent.

 

Consumer Sentiment Rises

 

Consumer sentiment rose more than expected in early November and hit its best level since June, helped by a slightly better economic outlook and early holiday sales the Thomson Reuters/University of Michigan's preliminary November reading on consumer sentiment showed, According to the report, the index came in at 69.3, up from 67.7 in October. The reading on the overall index was just above the 68.2 average of the last four months but below the post-recession high of 76.0 from June, according to the report.

 

Unemployment, at 9.6 percent, is seen as one of the biggest drags on the economy, even though recent data has suggested small signs of economic improvement. Weekly jobless benefit claims, reported on Wednesday, hit a four-month low.

 

The sentiment survey's one-year inflation expectations measure also gained, edging up to 3.0 percent from 2.7 percent last month, and hit its highest level since May. Speculation about higher inflation has risen with the Federal Reserve's announcement last week that it would buy more debt in an effort to boost the economy.

 

Early holiday retail sales, however, helped consumer sentiment in recent weeks. Consumer spending typically accounts for about two-thirds of all domestic economic activity.

 

Retail sales data for October is due out on Monday. Some retailers have been cautiously optimistic about holiday spending so far, with J.C. Penney on Friday being the latest to forecast a rise in same-store sales during the holiday quarter.

 

The survey's barometer of current economic conditions rose to 79.7 from October's reading of 76.6, also above a forecast of 77.0. Like the sentiment reading, it was the best level since June.

A gauge of consumer expectations rose to 62.7 from 61.9 in October. But it was below a forecast for 63.5.

 

Dissention within the Fed Continues

 

The new round of cash the Federal Reserve is pumping into the economy to spur job growth could create bubbles that do the very opposite, some Fed officials are warning. Dallas Fed President Richard Fisher suggested this week that a bubble is already forming in private equity, with cheap debt fueling high-priced deals in an echo of the torrid days of leveraged buyouts before the subprime credit crisis cut off financing in 2007.

 

Fisher, who argued against the Fed's decision earlier this month to buy $600 billion in Treasuries to boost the recovery, said on Monday he is concerned about signs of "speculative activity" in buyouts, along with stocks, bonds and commodities.

 

He singled out private equity giant Carlyle Group's recent agreement to buy telecoms firm Syniverse Technologies, saying the price paid rivaled the lofty price tags common in the "pre-crash craze."

 

"As you know, buyout people do not typically acquire companies with a plan to expand the workforce, but instead with an eye to tighten operations, drive productivity, rejigger balance sheets and provide an attractive payback, usually in shorter time than under normal corporate horizons," Fisher said.

 

Carlyle agreed to pay a premium of 30 percent for Syniverse. Private equity firms raise funds from investors such as pension and endowment funds, and pledge to invest that capital over a certain number of years. They typically aim to buy underperforming companies using a large amount of debt, fixing them up and selling them at profit.

 

Such leveraged buyout deals practically vanished after the credit crisis wiped away access to cheap financing, but have been returning as debt markets and the economy have improved. Deals today are much less debt-heavy than they were before the crisis, with firms so far this year paying an average of 42 percent of the deal price in cash, compared with 29 percent in 2007, industry figures show.

 

But some buyout firms, which raised billions when times were better only to find they could not put the money to work, are under pressure to spend the dollars before their investment periods come to an end. There is also greater incentive to buy and sell assets this year, ahead of an anticipated tax hike.

 

Kansas City Fed President Thomas Hoenig, who dissented at every Fed meeting this year and called on the U.S. central bank to raise, not lower, borrowing costs, has also warned that further Fed easing may fuel bubbles. But Fisher's comments took the issue further by focusing on a single industry that soared high before stumbling badly in the financial crisis.

 

Now cheap debt is back, with junk bond yields at their lowest since October 2007, Fisher noted.

 

Easy borrowing terms have resurfaced as well. Madison Dearborn funded a payout to its partners just five months after its $915 million leveraged buyout of plastic and steel maker BWAY Holdings with a $150 million bond that had a feature common in the pre-crisis buyout boom -- it allows a cash-strapped borrower to make interest payments by simply taking out more debt.

 

In another sign of possible overheating, prices have also jumped. Average purchase prices in 2007 were 9.7 times pre-tax earnings; Carlyle's Syniverse deal was about 9.5 times. And executives at some buyout firms have begun to highlight rising valuations as a disincentive to doing deals.

 

"It's much harder to find things of attractive value," Blackstone Group COO Tony James said. "There are some good companies being sold, but we just can't get to the prices that are required." Money is instead being invested in "very high proprietary content," James said, referring to deals that are created by Blackstone rather than bidding in auctions.