MarketView for October 16

 

 

Summary

 

Stock prices retreated on Friday as a result of disappointing numbers from General Electric and Bank of America. GE, which sells products from aircraft engines to refrigerators, reported a 20 percent drop in revenue, while Bank of America posted a $1 billion loss as both struggled with still meager business and consumer spending. Bank of America's shares fell 4.6 percent to $17.26, and GE dropped 4.2 percent to $16.08.

 

Nonetheless, the major equity indexes gained for the second straight week with the Dow Jones industrial average chalking up a gain of 1.3 percent for the week, while the S&P 500 was up 1.5 percent and the Nasdaq closed out the week up 0.8 percent. Unfortunately, the Dow slipped from its 10,000 level after breaking that key barrier for the first time in a year earlier in the week.

 

Data showing weak consumer sentiment further pressured the market on Friday and overshadowed an earlier report that showed industrial production rose in September. Meanwhile, Google provided some cheer after reporting earnings and revenue that exceeded forecasts and said it was looking for major acquisitions. Google ended the day up 3.8 percent at $459.85.

 

However, IBM fell 5 percent to $121.64 on a mixed report that came in below  expectations.

 

The market will continue to feel the push and pull as earnings season revs up next week and investors react to individual corporate results. Major companies reporting next week include Apple, Texas Instruments, Caterpillar and Wells Fargo.

 

Industrial Output Rises

 

Industrial production rose in September for a third consecutive month, Federal Reserve data showed on Friday, suggesting the economy closed out the third quarter with surprisingly strong growth.

 

The 0.7 percent increase was much greater than the 0.2 percent advance that economists polled by Reuters had expected. The report also showed August's gain was revised up to 1.2 percent from the originally reported 0.8 percent.

 

For the third quarter as a whole, output advanced at a 5.2 percent annual rate, the first quarterly gain since the first quarter of 2008 and the largest increase since the first quarter of 2005. The figures will likely reinforce the view that the longest recession since the Great Depression ended in the third quarter.

 

Capacity utilization, a measure of slack in the economy, rose to 70.5 percent in September from 69.9 percent a month earlier, although it was still 10.4 percentage points below its 1972-2008 average.

 

Consumer Sentiment Falls

 

Consumer sentiment fell unexpectedly this month on persistent worries that the "dismal" state of personal finances would not recover quickly from the worst recession in decades, a report showed on Friday.

 

The Reuters/University of Michigan Surveys of Consumers said its preliminary index of sentiment for October fell to 69.4, from September's 73.5.

 

That was below economists' median expectation of a steady reading of 73.5, according to a Reuters poll.

 

"While consumers still anticipated gains in the general economy and now think that the unemployment rate is close to its cyclical peak, there has been no improvement in consumers' dismal assessments of their personal financial situation," the report said.

"Indeed, personal finances have undergone the longest and deepest decline in the 60-year history of the surveys, and few consumers expect their finances to improve anytime soon."

 

The report said diverging prospects for the general economy and personal finances would have a negative impact on the pace of the recovery, with consumers eager to increase their savings and pay down debts.

 

Foreign Demand Increases for Long-Term Financial Assets

 

Foreign demand for our long-term financial assets rose in August even though China trimmed its holdings of Treasury securities. Foreigners purchased $28.6 billion more in assets than they sold in August, according to Treasury data released Friday. That followed a net increase of $15.3 billion in July, and $90.2 billion in June.

 

The Treasury Department is auctioning record amounts of debt to cover a deficit estimated to have hit $1.41 trillion for the budget year that ended in September. Some economists worry that if overseas buyers don't keep buying U.S. debt, interest rates could rise.

 

China trimmed its holdings by $3.4 billion to $797.1 billion in August, but still remained the largest foreign holder of Treasury securities. Japan, the second largest foreign holder, increased its holdings of Treasury securities to $731 billion, from $724.5 billion in July. China's foreign holdings of Treasury securities are a direct result of the huge trade deficits the U.S. runs with China. The Chinese take the dollars Americans pay for Chinese products and invest them in Treasury securities and other dollar-denominated assets.

 

American manufacturers argue that the huge dollar reserves China is building up reflect a strategy by the Chinese government to keep its currency artificially low against the dollar to gain trade advantages. A weak Chinese currency makes Chinese goods cheaper to American consumers and U.S. products more expensive in China. However, the administration on Thursday declined to cite China as a currency manipulator in its latest currency report to Congress.

 

Treasury also said Friday that Russia boosted its holdings of Treasury securities in August by 3.1 percent to $121.6 billion. The holdings of oil exporting nations were unchanged at $189.2 billion.

 

Budget Deficit at $1.4 Trillion

 

According to a report released on Friday, the budget deficit hit a record $1.4 trillion in the just-ended fiscal, as the deep recession and a series of bank rescues cut a gaping hole in public finances. Nonetheless, the final number was $162 billion smaller than the White House had forecast in August, but still amounted to 10 percent of total GDP, the most for any budget shortfall since World War Two.

 

In August, the White House had forecast a $1.58 trillion deficit. The figure came in smaller than expected largely because of lower-than-expected spending out of the government's $700 billion financial rescue fund. Still, it was more than three times as large as the $459 billion deficit racked up in the prior fiscal year.

 

For September alone, the deficit came in at $46.6 -- a record for the month that marked the first time ever the United States has seen 12 consecutive months of budgetary red ink. The government normally runs a surplus in September.

 

Rescuing the economy and some of the country's biggest banks from the worst recession since the Great Depression took its toll and the White House has forecast deficits of more than $1 trillion through fiscal 2011.

 

The $787 billion stimulus package Congress passed in February and the financial rescue fund approved last year together accounted for 24 percent of the year's deficit total.

Outlays from the Treasury Department reached $703 billion, exceeding the $647 billion spent by the Defense Department. The Pentagon is typically by far the largest single budget item.

 

In the short term, the state of the budget depends a great deal on the health of the economy. If the recovery is sluggish and unemployment stays high, as some forecasts predict, spending on jobless benefits will remain high and revenues could come in lower than the White House expects.

 

But if growth comes in stronger than predicted and job creation resumes, the gap could be narrower.

 

Peter Orszag, the White House budget director, said that as part of the fiscal 2011 budget policy process "we are considering proposals to put our country back on firm fiscal footing." He did not provide specifics.

 

Senate Budget Committee Chairman Kent Conrad said health care reform that "bends the long-term cost curve" was critically important to putting the country back on a sound long-term fiscal path.

 

The large deficit has pushed up U.S. government debt issuance, which is likely to remain high in the coming years as well. So far, there has been ample investor appetite for U.S. debt, both from domestic and foreign investors, which has helped to keep borrowing costs low.