MarketView for October 5

 

 

Summary   

 

The major equity indexes returned to positive territory on Monday, after a four-day losing streak, as optimism about upcoming earnings gathered steam and data showed the economy's critical services sector expanded for the first time since August 2008.

 

Financial stocks rallied, and were the top gainers among stocks on the S&P 500 index. A key reason was that Goldman Sachs upgraded the large-cap bank sector. It said share prices for companies in the industry didn't reflect their earnings power. Wells Fargo gained 6.9 percent to $28.09. JPMorgan Chase ended the day up 4.6 percent at $43.80, making it the top gainer on the Dow Jones industrial index.

 

The Institute for Supply Management's index for the U.S. services sector rose to 50.9 in September, crossing the 50 threshold that indicates expansion and topping expectations. The services sector represents about 80 percent of the U.S. economy.

 

The market posted its second straight week of losses last week after weak data, including reports on jobs and factory orders, raised doubts about the strength of the recovery.

 

The release by Alcoa of its results for the third quarter on Wednesday marks the unofficial start of the third-quarter earnings season. Shares of Alcoa rose 4.7 percent to $13.42.

 

Brocade Communications Systems rose 18.8 percent to $9.09 after The Wall Street Journal reported that the network equipment maker had put itself up for sale, citing sources familiar with the matter.

 

Service Sector Expands

 

According to the latest report by the Institute for Supply Management released on Monday, the service sector of the economy expanded in September for the first time in more than a year, thereby creating jobs in banking and restaurants and once again adding fuel to the idea that the economy is finally healing after doubts cast by recent poor data.

 

The ISM services index rose on Monday to 50.9 last month, beating expectations of 50.0, the dividing line between growth and contraction. The bullish news on the economy contrasted with monthly payrolls data on Friday from the U.S. Labor Department that showed employers unexpectedly cut more jobs in September than in August, underscoring the fragility of the U.S. economy's recovery from its worst recession in 70 years.

 

The services sector represents about 80 percent our domestic economic activity, including businesses such as banks, airlines, hotels and restaurants.

 

In other data, the job market strengthened in September for the first time since January of last year, according to the Conference Board. The Conference Board said its Employment Trends Index edged up to 88.5 in September from an upwardly revised 88.2 in August, originally reported at 88.1. The board's survey looks at a range of indicators for job growth ahead, including temporary hiring, industrial production and the percentage of respondents who say they find jobs hard to get.

 

The "road to recovery is definitely going to be bumpy and may last unusually long, given the depth of the recession we have experienced," said Gad Levanon, senior economist at The Conference Board. The index is now down 15.6 percent from a year ago.

 

Crude Prices Rise

 

The price of crude oil moved higher on Monday, as data showing a marked improvement in the services sector raised hopes of an economic recovery and lifted markets. Sweet domestic crude for November delivery settled up 46 cents per barrel at $70.41. London Brent settled down 3 cents per barrel at $68.04.

 

Slumping fuel demand in the United States and other developed countries sent crude off record highs over $147 a barrel last year. Traders have been looking to macroeconomic data and equities markets for signs of a potential end of the recession that could boost consumption and draw down high oil inventories.

 

Further pressure on prices came from easing tensions in Iran and Nigeria, which had lent support to prices at times in recent years. Both Iran and the United States described recent talks over Tehran's nuclear program as productive, with the OPEC nation allowing United Nations inspectors into a uranium enrichment plant.

 

In a further easing of tension, the last prominent Nigerian militant leader agreed to halt fighting in the oil-producing Niger Delta and surrendered his weapons on Sunday.

 

The Energy Information Administration (EIA) is scheduled to release its weekly report on Wednesday, while the American Petroleum Institute's report is scheduled for Tuesday.

 

Proposed Derivatives Rules Already Weakening

 

Airlines to agribusiness would be exempt from new rules on compulsory clearing of derivatives transactions under a bill in Congress aimed at tightening oversight of the financial system. The draft bill from Representative Barney Frank, chairman of the House of Representatives Financial Services Committee, was being circulated among lawmakers on Monday amid concern that an effort to regulate the over-the-counter (OTC) derivatives market could hurt nonfinancial firms that use it.

 

The $450-trillion OTC derivatives market, used to hedge against risk and speculate on prices, is widely blamed for amplifying the 2008-2009 financial crisis and authorities worldwide are debating approaches to regulating it.

 

Nonfinancial firms ranging from rural electric cooperatives to airlines have voiced concerns about capital and liquidity constraints they might face if they too had to front collateral to meet margin requirements involved in centralized clearing.

 

Frank's bill exempts derivative swaps from new rules requiring centralized clearing, meant to bring more visibility to the market, if "one of the counterparties to the swap is not a swap dealer or major market participant." Exempted transactions would have to be reported to authorities, under the bill.

 

In late August, Commodity Futures Trading Commission (CFTC) Chairman Gary Gensler, whose agency will play a key role in policing OTC derivatives, proposed more OTC derivatives face mandatory clearing, including non-financial firms or so-called end users.

 

Frank said last week his committee will deal in mid-October with OTC derivatives legislation. He predicted the panel would move a bill to the House floor by the end of the month. His committee will hold a public hearing on Wednesday on reform of the OTC derivatives market. The Senate has not yet taken up the issue, on which debate is likely to continue for several months.

 

In addition to exempting some end users from compulsory clearing, the Frank bill would empower regulators to ban swaps deemed "abusive" or bad for market stability and participants.

 

Further, it would require the CFTC to make public aggregate data on swap trading volumes and positions. It would authorize the CFTC to set position limits on commodity contracts, and on swap contracts "that perform or affect a significant price discovery function," said a bill summary obtained by Reuters.

 

In deciding if a swap has a price-discovery function, the CFTC would have to look at price linkage, arbitrage and other factors, while the agency could exempt any swap or transaction from position limit requirements, the summary said.

 

The Securities and Exchange Commission (SEC), another key regulator, could set limits on the size of positions in any security-based swap, with similar latitude on exemptions. The SEC would also have to publicize "aggregate data on security-based swap trading volumes and positions."

 

The Frank draft begins to narrow the terms of a months-old debate about how to categorize portions of the sprawling OTC derivatives market and what to do with each category.

 

Requiring central clearing of all derivatives market contracts could tie up valuable capital and constrain the liquidity of companies that use the contracts to hedge their businesses, derivatives users and dealers have warned.

 

Companies use OTC derivatives to customize hedges to their specific exposures when exchange-traded products, which are more standardized, do not reflect their actual risks. Collateral, also known as margin, is posted against these contracts to protect against risk of a counterparty failing.

 

In many cases, companies secure derivative trades with property or other assets. Clearinghouses, however, would require posting of liquid collateral such as cash or short-term government debt, which could come at a much higher cost.