MarketView for November 15

 

 

Summary

 

The major equity indexes were a bit higher on Tuesday as Italy made some progress on the formation of a new government, while better-than-expected reports on the U.S. economy did their part to add some confidence to the markets. So it was no surprise that those companies sensitive to economic growth led the rally, with technology and industrials the best performers. Apple rose more than 2.5 percent, up for only the second day in the last eight.

 

However, despite Tuesday's advance and after posting gains in five of the last six weeks, the S&P 500 is flat for the year and trapped in a tight range. The index could find tough technical resistance as it tries to continue its upward trend on Wednesday.

 

Markets have spooked by the euro zone's debt crisis and the possibility that the EU economy could spiral out of control. Borrowing costs spiked again in Italy. France, until now not viewed as problematic, also was hit by higher bond yields.

 

Mario Monti, Italy's prime minister-designate, is expected to complete the process of forming a government in less than three days, much faster than normal, as Italy races to ward off a major financial and political crisis that has pushed its borrowing costs to untenable levels. With Italian benchmark bond yields closing above 7 percent and Spanish and French yields also higher, any market stability could evaporate if Italy's plans to form a new cabinet doesn't calm debt markets.

 

Retail sales rose broadly in October, and a gauge of manufacturing in New York state advanced in November, suggesting the economy could maintain momentum through the fourth quarter and thereby reduce the seemingly never ending fears of another recession.

 

The euro fell against the dollar, which has of late been an indicator of a declining stock market. The decoupling from this correlation could confirm the momentary shift in focus to the U.S. economy.

 

When Italian bond yields rose above 7 percent last week, the S&P 500 fell nearly 4 percent in one day. U.S. stock market trading has been marked by heightened volatility recently as much of it has been tied to news and market moves out of Europe.

 

In earnings news, Wal-Mart’s quarterly profit number missed expectations as the economy continues to weigh on its domestic customer base. Wal-Mart saw its share price end the day down 2.4 percent to close at $57.46.

 

About 6.3 billion shares changed hands on the major equity exchanges, a number that was far below the year's current daily average of about 8 billion shares.

 

There Are Signs of Life

 

The economy showed signs it maintained speed into the fourth quarter as retail sales increased in October and a gauge of manufacturing in New York state rose this month for the first time since May.

 

Other data on Tuesday showed muted price pressures at the wholesale level. That should provide the Federal Reserve scope to give more aid to the economy in the face of an increased threat to the recovery from Europe's debt crisis.

 

Retail sales increased 0.5 percent in October, the Commerce Department said, after they rose 1.1 percent the prior month. The fifth straight monthly gain beat economists' expectations for a 0.3 percent increase.

 

The stronger tone of the economy was further enhanced by a report from the New York Federal Reserve Bank showing factory activity in New York state grew in November for the first time since May as shipments improved even though new orders fell.

 

The survey of manufacturing plants in the state is one of the earliest monthly guideposts to U.S. factory conditions, though it accounts for only a small slice of the overall manufacturing sector, which has been a key pillar of the recovery.

 

The data supported recent reports suggesting the economy was gaining traction after stumbling in the first half of the year. Economists at JPMorgan said growth in the current quarter was tracking close to a 3 percent annual pace after expanding at a 2.5 percent rate in the third quarter.

 

A third report showed the Producer Price Index, a measure of prices received by farms, factories and refineries, fell 0.3 percent on weak gasoline and motor vehicle prices. It was the first drop in four months. Excluding volatile food and energy, core wholesale prices were flat.

 

Despite a strengthening economy in the last few months, the recovery is not yet out of the woods, with analysts warning that Europe is almost certainly facing recession.

 

"If you were going to make a list of downside risks to the economy, the sovereign debt issues in Europe, the banking issues in Europe, are at the top of everybody's list of identifiable threats," White House Council of Economic Advisers Chairman Alan Krueger said at an event sponsored by the Wall Street Journal.

 

With the outlook for Europe darkening, economists believe the Fed will want to move to safeguard the U.S. recovery, although officials at the central bank continue to differ over the threshold for further action.

 

October's rise in retail sales suggested consumer spending would support growth in the fourth quarter, though economists worry that much of the spending is being funded from savings.

 

Wal-Mart Chief Executive Mike Duke said the retail giant's domestic customer base was still worried about jobs and only one in 10 mothers taking part the survey view the economy as "good." With food prices rising more quickly than most wages, some shoppers were concerned about holiday meals, the company said.

 

Retail sales last month were supported by pent-up demand for motor vehicles. Still, even excluding autos, sales rose 0.6 percent, the largest increase in seven months.

 

There were also gains in sales of sporting goods, electronics and appliances, and building materials. But clothing store sales posted their largest decline since December 2010 and receipts at service stations fell, reflecting weak gasoline prices.

 

France Is Now Under Pressure

 

France was pressured financially on global markets Tuesday, reflecting fears that the euro zone's second largest economy is being sucked into a spiraling debt crisis. Global stocks and the euro fell as Italian bond yields climbed back to unsustainable levels on doubts that Italy's Mario Monti and new Greek leader Lucas Papademos, unelected technocrats without a domestic political base, can impose tough austerity measures and economic reform.

 

European Central Bank President Mario Draghi has predicted the 17-nation currency bloc will be in a mild recession by the end of the year, a view underlined by data showing the economy barely grew in the third quarter and faces a sharp downturn.

 

Italy's 10-year bond yield was back above 7 percent, pushing its borrowing costs to a level that helped to trigger the fall of Silvio Berlusconi's government last week and is widely seen as unsustainable in the long term.

 

Spain's Treasury is facing yields not seen since 1997 as it tries to sell 12- and 18-month treasury bills.

 

French 10-year bond yields rose about 50 basis points in the last week, pushing the spread over safe haven German bonds to a euro-era high of 173 basis points. There are 100 basis points in a percentage point. French banks are among the biggest holders of Italy's 1.8 trillion euro public debt pile.

 

The urgency of resolving the debt crisis was underscored by a think-tank report saying that triple-A rated France should also be "ringing euro zone alarm bells" as it could not make rapid adjustments to its economy.

 

Meanwhile, fears are growing in the United States that Europe's debt crisis is mushrooming into a wider systemic problem. Alan Krueger, chairman of the White House Council of Economic Advisers, said the European debt crisis was the leading risk to the U.S. recovery.

 

Treasury Secretary Timothy Geithner said Europe had a difficult task in boosting the creditworthiness of some of its economies while also boosting growth.

 

"That's a difficult balance and you can see they're struggling with it but I think they're gradually making progress," he told a conference sponsored by the Wall Street Journal. "This is absolutely within Europe's capacity to solve and it's within their ability.

 

"We are helping both directly and indirectly through a range of things you know about, financially, and we have a lot of useful lessons from our experience."

 

At the same time, Greek conservatives set themselves on a collision course with the European Commission, refusing its demand to sign a pledge to meet the terms of a bailout designed to save Greece from bankruptcy and safeguard the euro zone.

 

New premier Papademos looks certain to sail through a confidence vote Wednesday, but members of the New Democracy party, a key player in his crisis coalition, said they would not bow to "dictates from Brussels" to give written guarantees. New Democracy leader Antonis Samaras says he is opposed to measures that fail to help Greece grow its way out of trouble.

 

With the survival of the 17-state currency zone in its current form now at risk, EU governments have until a summit on December 9 to come up with a bolder and more convincing strategy, involving some form of massive, visible financial backing.

 

Geithner restated the U.S. view that the European Central Bank should play a bigger role, while acknowledging the objections of Germany, the EU's main paymaster, to any step that limits ECB independence or its mandate to fight inflation:

 

"There are lots of ways for the central bank to play a more effective supportive role in resolving this without violating the obvious constraints we respected here ... for (the central bank's) independence and making sure the central bank is not providing a direct source of financing for governments."

 

Many analysts believe the only way to stem the contagion for now is for the ECB to buy up large quantities of bonds, effectively the sort of 'quantitative easing' undertaken by the U.S. and British central banks.

 

The debt crisis is likely to make matters worse in the next months with nations such as Italy, Greece, Ireland, Portugal and Spain forced to adopt unpopular spending cuts to stop the bond market driving them toward default. Furthermore, there is no visible growth strategy in place to counter those austerity measures.

 

After a disastrous week for the euro zone's third biggest economy, Italy's Monti secured a breakthrough when Angelino Alfano, secretary of Berlusconi's People of Freedom (PDL) party, emerged from talks with Monti saying moves to form a government would succeed.

 

The prime minister-designate said he would present the results of his consultations to the president Wednesday, hinting he had cleared any obstacles to forming a government.

 

"I would like to confirm my absolute serenity and conviction in the capacity of our country to overcome this difficult phase," Monti said.

 

His technocrat-led cabinet has the job of speeding reform of pensions, labor markets and business regulation to put Italy's finances on a sustainable path. Italy must refinance 200 billion euros ($273 billion) of bonds by the end of April.

 

Germany and France posted solid growth in the third quarter, according to new data. But countries on the front line of the crisis fared much worse, for overall growth of just 0.2 percent. The current expectation is for bleaker times within the core economies of the EU, with a likely fall into recession in the fourth quarter.