MarketView for October 19

 

 

Summary

 

Optimism was high on Wall Street on Monday, the result of several rounds of solid quarterly earnings that sent the major equity indexes well into positive territory. And the mood continued after the session's close with Apple’s shares rising on its results that were released after the close of regular trading. Apple’s shares rose 7 percent in extended trading. Meanwhile, earnings from companies, including Gannett, which exceeded expectations, and positive broker commentary on Caterpillar further encouraged investors looking for confirmation the economy is healing.

 

Gannett rose 8.2 percent to close at $14.06 after the largest U.S. newspaper publisher posted lower quarterly profit, but still beat expectations amid cost cutting. During regular trading, Caterpillar led the Dow Jones industrial average; gaining 6 percent to $57.85 after Bank of America-Merrill Lynch raised its price target to $65 from $52, and increased its 2010 and 2011 earnings-per-share expectations, citing a faster recovery in machinery revenue next year. Caterpillar is set to report results on Tuesday.

 

Texas Instruments also posted quarterly profit and revenue that exceeded Street estimates on better-than-expected chip demand, sending its shares 2 percent higher after the bell. Diversified manufacturer Eaton Corp rose 5.7 percent to $63.89 after it reported profit that beat estimates and said it saw early signs of recovery in its markets.

 

As of noon Monday, 62 companies in the S&P 500 had reported earnings, with 79 percent above analysts' expectations, according to data compiled by Thomson Reuters. This week's earnings include 13 Dow components and 135 companies in the S&P 500.

 

Bernanke Wants a More Level International Playing Field

 

Federal Reserve Chairman Ben Bernanke warned on Monday that Asian export-promotion policies and large domestic budget deficits could refuel global economic imbalances and put efforts to achieve more durable growth at risk, if not curbing them.

 

Bernanke said Asian nations, like China, that enjoy large trade surpluses should discourage excess saving and boost consumption. He also said the United States needed to increase its saving and "substantially reduce federal deficits over time."

 

"To achieve more balanced and durable economic growth and to reduce the risks of financial instability, we must avoid ever-increasing and unsustainable imbalances in trade and capital flows," Bernanke said.

 

He said that while trade imbalances had started to narrow as U.S. households ramped up saving in response to a deep recession that ate at their wealth; he cautioned that the imbalances may resume growing as the global economy recovers and trade volumes rebound.

 

Policies in Asian countries that encourage exports and saving over consumption are a concern, Bernanke said, repeating a long-standing U.S. complaint.

 

"Trade surpluses achieved through policies that artificially enhance incentives for domestic saving and the production of export goods distorts the mix of domestic industries and the allocation of resources, resulting in an economy that is less able to meet the needs of its own citizens in the longer term, he said.

 

U.S. officials have long pressed China to allow its yuan currency to appreciate, which would lessen any price advantage Chinese goods may have in global markets. China has vowed to move toward more currency flexibility, but it has kept the yuan on a tight leash.

 

Bernanke praised China and other Asian nations, saying they "are looking more seriously at rebalancing" than in the past. However, he said the possibility of asset price bubbles emerging in Asia are a concern, and that the risks could be addressed through relaxing currency constraints.

 

"One way to address it would be through some greater exchange rate flexibility," Bernanke said.

 

Nonetheless, he also acknowledged the part the United States must play in addressing global imbalances by increasing savings and embarking on a more-sustainable fiscal path. The performance of the economy and the dollar, which has fallen 7 percent against a basket of currencies this year, will depend on the government's success in controlling its budget deficit, he said.

 

"Our policy-makers recognize that we need to develop a fiscal exit strategy that will involve a trajectory toward sustainability," Bernanke said in response to a question. "That is critically important in order to maintain confidence in our economy and confidence in our currency. I know that is very well understood in Washington," he added.

 

The Fed chairman said that Asian economies had rebounded strongly from the financial crisis, with annualized growth rates in the double digits expected in China, Hong Kong, Korea, Malaysia, Singapore and Taiwan.

 

"At this point, while risks to the economic outlook certainly remain, Asia appears to be leading the global recovery," Bernanke said.

 

Countries with the most open economies, such as Singapore, Hong Kong, and Taiwan took the biggest hits as a result of the financial turmoil, he said. China, India, and Indonesia, which are "among the least financially open" economies, expanded throughout the crisis, he said.

 

While conceding that greater global integration increases vulnerability to world-wide economic shocks, he voiced concern that Asian nations could draw the wrong lesson and said greater openness would promote stronger growth over the longer term.

 

"Protectionism and the erecting of barriers to capital flows should thus be strongly resisted," he said. "Striking a reasonable balance between trade and growth in domestic demand is the best strategy for driving economic expansion."

 

Investors Looking Towards Equities

 

Investors are becoming increasingly confident in investing and holding, according to a client survey by Citigroup. However, a significant proportion of investors still think earnings estimates for 2010 are too high, are worried about public finances, the prospect of rising interest rates next year and a less-than-stellar economic recovery.

 

According to Citigroup's survey of 100 investors, 80 percent are overweight on equities compared to corporate bonds, up from just over 60 percent in July. The report said 62 percent expect to allocate more money to equities in 2010.

 

That optimism is reflected in a rise in S&P 500 forecast levels. Around 64 percent of Citigroup's clients expect the S&P to end the year at between 1000 and 1300, up from a range of 900 to 1200 in July.

 

"In recent meetings with clients, we have witnessed a new enthusiasm almost across the board with members of the investment community citing liquidity, earnings and M&A as reasons to be upbeat for even more gains," wrote Citigroup analysts led by Tobias Levkovich.

 

The information technology and energy sectors are among investors' favorites, according to the report, while there was a "clear disdain" for the utility sector, which historically lags in the early stages of an economic recovery. Since the July report there was a drop off in interest in financials, industrials and materials.

 

Although generally more optimistic about equities, around 60 percent of investors believe the growing U.S. budget deficit will become an issue for markets in the middle of 2010. Most investors believe the Fed will start raising interest rates in the second quarter, with the 10-year Treasury yield hitting 4 to 4.5 percent by the end of the year.

 

"There is some inconsistency in optimistic market expectations amidst concerns around potential policy errors," said Levkovich.

 

Respondents are about evenly split on the direction of the U.S. dollar next year, compared to 62 percent who predicted the dollar would weaken in July. According to the report, 48 percent of those polled said S&P 500 earnings estimates in 2010 were too high compared to 22 percent who said they were too low.

 

Respondents predicted average earnings growth of 16 percent next year. Citigroup predicts earnings growth of 13-14 percent and says the Street view is for 27 percent growth. Many investors expect a U-shaped or "square root" shaped economic recovery, with a short burst of recovery and then flattening out.

 

Housing Aid Launched

 

The administration on Monday launched a program to help the depressed housing market by effectively allowing state and local housing finance agencies to borrow from the Treasury. The initiative, announced as new data showed a downturn in homebuilder sentiment, aims to restart a source of mortgage financing for first-time and low-income buyers that has been largely shut down by credit market gridlock.

 

Described as temporary by the Treasury Department, the Department of Housing and Urban Development and the Federal Housing Finance Agency, the program will allow state and local agencies to issue bonds through government-sponsored mortgage finance giants Fannie Mae and Freddie Mac. Those bonds would then be purchased by the Treasury.

 

"Through this initiative, the administration aims to help ... jump start new lending to borrowers who might not otherwise be served and to better support the financing costs of their current programs," Treasury Secretary Timothy Geithner said in a statement.

 

The U.S. housing market, which was at the epicenter of the global credit crisis, has shown signs of stabilizing, but it has been bolstered by an $8,000 tax credit for first-time buyers. The program is set to expire at the end of November.

 

In a conference call with reporters, federal officials declined to estimate a dollar amount for the new program, but said it would be sufficient to fund "several hundred thousand" new affordable mortgages and provide for the development or rehabilitation of tens of thousands of rental units.

 

U.S. Treasury Assistant Secretary Michael Barr said officials would work to determine a bond issuance ceiling for the program over the next several weeks.

 

"The program levels are really being built from the ground up so we need to have a much more refined idea of demand and eligibility to be able to determine appropriate scaling for the program," Barr said.

 

The federal agencies said the program will not be paid for by taxpayers but will be financed through fees paid by the state and local housing agencies. It uses authorities granted to the Treasury under a housing rescue bill passed in July 2008 -- the same bill that enabled the Treasury to seize control of Fannie and Freddie in September 2008.

 

So far this year, state and local housing finance agencies have only been able to issue about $4 billion in tax exempt bonds, compared to about $16 billion annually about two years ago, said Susan Dewey, executive director of the Virginia Housing Development Authority.

 

"There are some states that have totally shut down their lending programs and haven't been able to lend at all," Dewey said.

 

The officials will need to work quickly to determine the program's size as they have set a December 31 deadline for the Treasury's purchases of bonds under the program. Barr said the bulk of the Treasury's bond purchases would take place in November and December.

 

The plan also aims to help jump start the private lending market for the state and local agencies. Before using proceeds of new mortgage bonds under the program, the state and local agencies must also sell debt to private investors. The Treasury-funded debt must be limited to 60 percent of their total borrowings.

 

Barr said the administration would continue to focus on the housing market as a "critical" component of the economic recovery. He said it was too early to say when the government might be able to begin withdrawing its support for the sector.

 

The looming expiration of the government tax incentives for first-time homebuyers helped turn homebuilder sentiment lower in October after three months of gains. The National Association of Home Builders/Wells Fargo Housing Market Index dipped to 18 from 19 in September, missing market expectations for a reading of 20.

 

In a letter to the Obama administration on Monday, the National Association of Realtors and the Mortgage Bankers Association (NAHB) urged the Obama administration to support an extension of the tax credit.