MarketView for November 23

 

 

Summary 

 

Share prices continued their slide downward on Tuesday as a result of both escalating tensions in the Korean peninsula and euro-zone debt concerns. The unexpected military flare-up increased the Street’s anxiety level, as evidenced by the CBOE Volatility Index .VIX, Wall Street's fear gauge. It was up 12.3 percent, its largest daily percentage gain in more than three months.

 

Meanwhile, Ireland's unsteady situation hurt the euro, which also had contributed to the selloff of stocks. The equity market's tight link to the euro has broken of late but resurfaces in times of turmoil. Therefore, there is concern over the widening EU debt crisis.

 

The European Union urged Ireland to adopt an austerity budget on time to unlock promised EU/IMF funding, while Irish Prime Minister Brian Cowen rebuffed calls for a snap election and insisted the budget would go ahead as planned on December 7.

 

"Now we have sovereigns in trouble being bailed out by essentially super-sovereigns," U.S. economist Nouriel Roubini told Reuters Insider. "But there's not going to be anybody coming from Mars or the moon to bail out the IMF or the euro zone."

 

The energy sector led the parade downward, falling 1.9 percent as oil futures prices fell 0.6 percent to settle at $81.25 a barrel. Oil giants Chevron and Exxon Mobil, each down about 2 percent, accounted for 15.5 percent of the drop in the Dow industrials.

 

The S&P 500 has found strong support around the 1,175 area. The 23.6 percent retracement of the index's 2010 low-to-high gain, last week's low and its 50-day moving average all coincide near that level.

 

Market reaction was muted to minutes from the Federal Reserve's policy-making panel that showed the FOMC considered even more drastic options to stimulate the economy before it settled on buying $600 billion in bonds in a second round of quantitative easing.

 

Fed officials revised down their forecasts for economic growth next year, and saw unemployment at higher levels than they had the last time they issued official forecasts in June.

 

Data earlier showed the economy grew faster than previously estimated in the third quarter, but a slump in sales of previously owned homes in October indicated the recovery remains too anemic to reduce high unemployment.

 

Third Quarter Growth Revised Upward

 

According to a report released on Tuesday by the Commerce Department, the economy grew faster than previously estimated in the third quarter, but still not enough to address stubbornly high unemployment. Gross domestic product growth was revised up to an annualized rate of 2.5 percent from 2.0 percent as exports, and consumer and government spending were stronger than initially thought, the Commerce Department said in its second estimate.

 

Economists had expected GDP growth, which measures total goods and services output within U.S. borders, to be revised up to a 2.4 percent pace. The economy expanded at a 1.7 percent rate in the second quarter.

 

There are signs economic activity picked up mildly as the fourth quarter started, but growth will likely remain below the 3.5 percent rate that probably needed to appreciably reduce a 9.6 percent unemployment rate.

 

Concerns about the slow growth pace spurred the Federal Reserve early this month to ease monetary policy further through controversial purchases of $600 billion worth of government bonds to drive ultra-low interest rates even lower. The Fed is expected to cut growth forecasts for this year through 2012 when it releases minutes of the November 2-3 meeting later on Tuesday.

 

The government revised third-quarter growth to reflect sturdy consumer, government and business spending. Consumer spending, which accounts for more than two-thirds of U.S. economic activity, grew at a 2.8 percent rate in the July-September period instead of 2.6 percent.

 

It was still the fastest pace since the fourth quarter of 2006 and was an acceleration from the second quarter's 2.2 percent pace. Government spending increased at a 4.0 percent rate rather than 3.4 percent, due to an upward revision in state and local expenditures.

 

Business investment was a touch higher than initially estimated, lifted by much stronger spending on equipment and software, though structures were weak. Business spending increased at a 10.3 percent rate instead of 9.7 percent. That was still a step down from the second quarter's brisk 17.2 percent rate. Spending on software and equipment grew at a 16.8 percent rate instead of 12.0 percent.

 

The contribution from business inventories was surprisingly smaller than initially estimated, the report showed. Business inventories increased $111.5 billion, instead of $115.5 billion in last month's estimate, adding 1.30 percentage points to third-quarter GDP. Excluding inventories, the economy expanded at a 1.2 percent pace rather than 0.6 percent.

 

Revisions to third-quarter GDP growth also reflected import growth that was not as big as initially thought, while exports were a bit stronger. That created a trade deficit that sliced off 1.76 percentage points from GDP growth instead of 2.01 percentage points.

 

Investment in home building was a drag on growth, contracting at a 27.5 percent rate, a touch less than the 29.1 percent decline reported last month.

 

The GDP report also showed after tax corporate profits rose 1.0 percent in the third quarter after growing 3.9 percent in the April-June period. The increase in third-quarter profits was below economists' expectations for 3.6 percent.

 

The report also showed no inflation pressures in the economy. The Fed's preferred inflation measure, the personal consumption expenditures price index, excluding food and energy, rose at an unrevised annual rate of 0.8 percent.

 

That was the smallest increase since the fourth quarter of 2008 and the second-lowest reading since the fourth quarter of 1962.

 

Revisions to third-quarter GDP growth also reflected import growth that was not as big as initially thought, while exports were a bit stronger. That created a trade deficit that sliced off 1.76 percentage points from GDP growth instead of 2.01 percentage points.

 

Investment in home building was a drag on growth, contracting at a 27.5 percent rate, a touch less than the 29.1 percent decline reported last month.

 

The GDP report also showed after tax corporate profits rose 1.0 percent in the third quarter after growing 3.9 percent in the April-June period. The increase in third-quarter profits was below economists' expectations for 3.6 percent.

 

The report also showed no inflation pressures in the economy. The Fed's preferred inflation measure, the personal consumption expenditures price index, excluding food and energy, rose at an unrevised annual rate of 0.8 percent.

 

That was the smallest increase since the fourth quarter of 2008 and the second-lowest reading since the fourth quarter of 1962.

 

Fed Considered More Drastic Action

 

According to the minutes released on Tuesday of the latest Fed open market committee meeting, Federal Reserve officials to considered more radical steps to aid the economy before settling on $600 billion in bond purchases earlier this month.

 

The minutes forcefully showed a resolute but divided central bank. Policymakers sharply revised down their forecasts for economic growth next year and saw unemployment at significantly higher levels than they had in their last forecasts in June.

 

Most Fed officials backed the plan to increase asset purchases in an effort to bring down long-term interest rates and try to boost economic growth. But minutes of both the November 2-3 meeting and a rare, unscheduled video conference held on October 15 showed a wide range of views.

 

Setting the stage for the bond-buying plan, policymakers debated an array of policy choices at the October meeting, including the possibility of targeting a specific level of bond yields, setting an explicit goal for inflation and having Chairman Ben Bernanke hold periodic news briefings.

 

Looking toward the future, Fed officials' estimates for growth in 2011 ranged from 3.0 percent to 3.6 percent, down considerably from June estimates of 3.5 percent to 4.2 percent. Unemployment will remain close to 9.0 percent for much of next year and could still be above 8.0 percent at the end of 2012. They said the jobless rate would still be hovering around an elevated 7.0 percent in 2013.

 

The Fed minutes depicted the November policy move in part as an insurance policy against the threat that already low inflation could fall further, potentially morphing into a corrosive bout of deflation. However, the report offered little guidance on what could lead the Fed to either boost or curtail its buying plans.

 

Not all Fed officials believed the new policy, which has raised controversy at home and abroad, would help lift the economy out of its doldrums, the minutes showed. In fact, several participants believed a further increase in Fed credit to the banking system risked future inflation, the minutes said. The Fed's balance sheet has already expanded to around $2.3 trillion following a number of emergency measures undertaken during the 2008 financial crisis.

 

The Fed's decision to extend its unconventional easing policy, which took it into uncharted waters in economic policy, has been criticized from Republicans and some economists who say it pushes too close to fiscal policy and risks undermining price stability.

 

Overseas, the central bank's decision sparked concerns about excessive currency appreciation and possibly asset bubbles that could come back to haunt the global economy.

 

Fed officials seemed divided on this count. Some saw U.S. dollar depreciation, coupled with firmer asset prices derived from the Fed's policies, as broadly beneficial to domestic economic conditions. Others, however, were less sanguine.

 

"Some participants noted concerns that additional expansion of the Federal Reserve's balance sheet could put unwanted downward pressure on the dollar's value," the minutes said.

 

One particular passage captured the internal divisions that could make it more difficult for the committee to extend its easing policies if it decides to do so. Its current bond-buying program is set to expire at the end of June.

 

"A few participants expected that continuing resource slack would lead to some further disinflation in coming years," the minutes said. "However, a few others thought that the exceptionally accommodative stance of monetary policy, coupled with rising prices of energy and other commodities ... made it more likely that inflation would increase."