MarketView for October 27

 

 

Summary  

 

The S&P 500 and the Nasdaq gave in to profit-taking on Tuesday, while a weaker-than-expected consumer confidence reading sparked caution about the recovery of spending. Technology and consumer discretionary shares fared worse than the broader market as investors sold recent winners. The day's declines marked the third straight day of losses for the S&P 500 and the Nasdaq.

 

Baidu, the Chinese Web Search company's stock, fell 11.4 percent to $383.66, making it the second-worst drag on the Nasdaq, behind Apple, which fell 2.5 percent to $197.37. Meanwhile, shares of Google were down 1.1 percent to $548.29, a day after Baidu forecast a sequential decline in fourth-quarter revenue.

 

Yet, the Dow Jones industrial average still managed a small gain as shares of Exxon Mobil and Chevron, both of whom are set to report quarterly results later this week, rose on the back of BP's strong earnings announcement. Exxon Mobil shares ended the day up 2.3 percent, closing at $74.91, while Chevron ended the day up 1.5 percent to close at $76.59 following BP's results.

 

The energy sector also received some momentum from the increase in crude oil prices. On the New York Mercantile Exchange, December crude settled up 87 cents per barrel, or 1.11 percent, at $79.55. At the same time, IBM gave the Dow some additional energy by announcing an increase in its stock-buyback plan to $9.2 billion. IBM shares ended the day up 0.5 percent at $120.65.

 

On the economic front, the Conference Board's index of consumer confidence fell to 47.7 in October, weaker than economists had forecast. The data showed consumers were increasingly concerned about job market conditions.

 

Other data showed home prices rose for the fourth-straight month in August. The Standard & Poor's/Case-Shiller composite index of home prices in 20 metropolitan areas was up more than expected in August.

 

Consumer Confidence Falls Due to Lack of Jobs

 

According to a report released on Tuesday by the Conference Board, consumer confidence deteriorated sharply in October as the worst job market in a quarter century heightened concerns about the future, more than outweighing modest improvements in the housing sector.

 

Despite the stability in house prices, which saw a fourth month of gains in August, a report from The Conference Board suggested Americans are far from upbeat.

 

The industry group's confidence index dived to 47.7 this month from 53.4 in September, the biggest drop in eight months. The report was unequivocally weak, with the expectations index plunging to 65.7 from 73.7.

 

Persistent trouble in the labor market was a major culprit. The proportion of respondents saying jobs were hard to get rose to 49.6 from 47.0 percent.

 

"Consumers' assessment of present-day conditions has grown less favorable, with labor market conditions playing a major role," said Lynn Franco, director of The Conference Board Consumer Center Research.

 

The current conditions indicator fell to 20.7, and is near its lowest level in 26 years. This mirrored the labor market, where the current jobless rate of 9.8 percent is the highest since 1983.

 

However, it appears that home prices, battered by the severe recession in housing, appeared to be finding a footing. The Standard & Poor's Case/Shiller report released on Tuesday indicated that according to its index of house prices in 20 cities rose 1.2 percent. The increase helped moderate the year-on-year price decline, slowing it to 11.3 percent.

 

At the same time, it appears that the popular $8,000 tax break for home buyers that has helped the housing market recover some ground from its worst slump in modern history will be extended.

 

Fed’s Position on Interest Rates Unlikely to Change Short-term

 

With the country still trying to recover from what has now been labeled The Great Recession, the Federal Reserve is unlikely to begin to raise interest rates any time soon. Nonetheless, the financial markets will be watching next week's Fed policy-setting meeting for any hint the central bank is moving closer to withdrawing its extensive support for the economy.

 

However, with unemployment expected to go above 10 percent and factory capacity use near post-World War II lows, there is doubt whether the economy can stand on its own feet if the government were to withdraw its generous spending programs and tax breaks.

 

"The difficult conditions in labor markets and the consequent implications for household incomes are important reasons for my expectation that the recovery in overall economic activity moving into next year will be restrained," Fed Vice Chairman Donald Kohn said two weeks ago.

 

The Fed reduced interest rates to near zero in December. On top of that it has flooded the financial system with hundreds of billions of dollars to pull the economy out of the worst financial crisis and most painful recession in decades.

 

Initially, it said it anticipated exceptionally low interest rates for "some time." In March, it deepened that commitment to "an extended period" -- a pledge it has repeated in every Federal Open Market Committee statement since then.

 

"The committee ... continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period," the policy panel said after its last meeting on September 22-23.

 

The phrase is a critical piece of a statement that officials could dial back to prepare markets for tighter money. However, officials are still nervous about the recovery and appear likely to conclude at their meeting on Tuesday and Wednesday that tinkering now would send a premature signal.

 

A Financial Times story on Friday stating that officials were considering softening the pledge fueled speculation that a rate hike was closer at hand than previously thought. By Monday, interest-rate futures prices implied a rate increase would come in the second quarter of 2010, with borrowing costs hitting 1.25 percent by the year end, although those bets started to come off a bit on Tuesday. Previously, the first hike was seen coming in the third quarter.

 

While shifting the language would give more flexibility, the Fed has yet to offer any public signal indicating that it plans to alter the rate pledge, a step they would likely take to prepare the markets for any shift.

 

Fed Chairman Ben Bernanke said on October 8 that "accommodative policies" would be warranted for an extended period, while Vice Chairman Donald Kohn reminded an audience of the commitment to "unusually low levels of interest rates" for an extended period in his October 13 speech.

 

Both Bernanke and Kohn have said in recent weeks they expect the U.S. recovery to be tepid. A number of Fed officials have said they will be ready to pull back support for the economy when the time is right, but that just because they are talking about it doesn't mean they're about to do it.

 

The New York Fed last week sought to tamp down market anticipation of tightening moves by issuing a statement saying that trial runs of a tool to help the central bank raise interest rates were a test of its capacities, not a signal that a tightening was set to begin.

 

Also, minutes of the Fed's September meeting showed some policy-makers were sufficiently nervous about the recovery to consider expanding purchases of longer-term securities to provide an additional prop.

 

To be sure, softening the pledge language would give the Fed a freer hand should economic conditions brighten faster than expected. And with interest rates near zero, an increase of one or two percentage points would still keep rates in accommodative territory.

 

"The question is whether that flexibility is worth confusing the market," Barclay's Maki said.

 

In the past, the Fed has left ample room between the end of a recession and rate hikes, moving only well after unemployment had peaked.

 

When the last recession ended in November 2001, the first rate hike was not until June 2004 -- 31 months later. In the previous recession, the Fed raised rates in February 1994, 35 months after the recession ended in March 1991.