MarketView for October 22

Summary 

Wall Street managed some small gains on Friday, thereby chalking up the third consecutive week of positive numbers. For the week the Dow and the S&P 500 each rose 0.6 percent, while the Nasdaq climbed 0.4 percent. However, the volume was anemic, with only 5.76 billion shares trading on the three major exchanges combined, when you consider that the daily average this year has been 8.8 billion. Of greater interest is the fact that the markets have resisted a pullback following a strong rally just prior to the earnings season. Many on the Street were looking for or fully expecting a broad profit-taking.

Earnings in the technology sector, the S&P's largest, have been particularly strong. Profit at Baidu, the Chinese Web search engine, beat Wall Street estimates and the company’s guidance is for continuing strong demand. Baidu ended the day up 4.6 percent at $107.28.

The Dow Jones industrial average could not pull itself into positive territory, weighed down by American Express whose shares slipped as regulatory issues overshadowed higher earnings. American Express ended the day down 3 percent to $39.03. Verizon was also in negative territory after it said additions of new wireless customers may lag. Verizon’s shares ended the day down 1.3 percent to close at $32.09.

Technology has led gains in the recent rally. The Nasdaq is up more than 17 percent since the end of August compared with the S&P 500, which is up 12.7 percent. The Nasdaq closed just shy of its highest level since May on Friday.

Early reports from technology companies have given a mostly rosy picture of the sector's future, including Google's stronger-than-expected earnings numbers that were released a week ago.

Also adding to the Nasdaq good fortune was Amazon.com, which gained 2.5 percent to $169.13 after analysts raised their price targets on the company. The higher expectations flew in the face of a disappointing guidance released on Thursday.

Leggett & Platt posted a lower-than-expected quarterly profit, hurt by weakness in its residential furnishings market. The company also forecast 2010 earnings below market expectations. The shares lost 8.6 percent to end the day at $21.01.

The S&P 500 sent a bullish signal as the index's 50-day moving average crossed above its 200-day moving average, known as a golden cross. That upward momentum indicator last occurred in June 2009, and the benchmark index rose more than 35 percent in the following 10 months.

Two top Federal Reserve officials gave contrasting views on the need for more economic stimuli. There has been ever increasing speculation during the past week that the Fed will extend the quantitative easing measures at its next meeting in November. The rumors have pressured the dollar while sending equity prices higher. Equities have recently traded in tandem with the euro, with S&P futures rising along with Europe's single currency.

New Market Regulations by SEC on Hold

New market regulations resulting from the “Flash Crash” of May 6, are on hold until the end of the year. The reason supposedly is that the Wall Street reform bill is preoccupying regulators. Rules to make anonymous trading venues known as dark pools more transparent and to ban flash orders that exchanges show to some traders before routing them to the wider marketplace will not be adopted before the end of the year, said two sources familiar with the matter.

The SEC is swamped with writing more than 100 new rules included in the Dodd-Frank bill enacted in July to prevent a repeat of the financial crisis. However, the May 6 flash crash has spurred some reforms, such as trading pauses known as circuit breakers. But several others, such as the dark pool changes, will not receive the SEC's stamp of approval this year, the sources said.

Despite assistance from the major exchanges, the SEC is taking longer than expected to react to the unprecedented market crash. It took nearly five months for the SEC and the Commodity Futures Trading Commission to produce a comprehensive report on what caused the crash.

Any further changes could revamp the way tens of trillions of dollars circulate through cash equity markets and change the trading strategies of banks, hedge funds and big proprietary trading firms.

An SEC plan to crack down on sponsored access -- in which high-speed traders borrow a broker's license to get fast and direct access to exchanges -- will likely be adopted first because it is least controversial, said the sources, who were not authorized to speak to the press.

One month after the market crash, the SEC acted with uncharacteristic speed and rolled out a pilot program to give a single stock a five-minute reprieve if that stock fell more than 10 percent in five minutes. However, that program is due to end December 10 and the SEC is pressuring the exchanges to develop a "limit up/limit down" proposal by early December, the sources said.

This would set temporary price ceilings and floors for individual stocks that would refresh regularly through the day, slowing any big price changes without halting trading altogether.

Limit up/limit down could replace or work in tandem with the market-wide circuit breakers that the SEC adopted shortly after the flash crash, which briefly wiped $1 trillion in paper value off U.S. stocks in a matter of minutes.

The crash spawned a proposed ban on so-called stub quotes, which are bids and offers well off the public price of stocks, as well as new obligations for high-frequency algorithmic traders who act as effective market makers to provide liquidity when markets are distressed.

Look For Zero Interest Rates Until Inflation Picks Up

If the analysts at Citigroup have it right, the Fed will keep its interest rate target near zero until core inflation rises to at least 2 percent. The core rate on personal consumption expenditures, the Fed's preferred inflation gauge, is running at 1 percent, far below the desired level among some Fed policy-makers. They deem this slow pace of price growth as a risk to the recovery, with the potential outcome a damaging spiral of falling prices, a phenomenon known as deflation.

Fed Chairman Ben Bernanke has said that the Fed would like to see inflation at about 2 percent, rather than 1 percent or so right now. Bernanke and other Fed policy-makers have expressed support for a second bout of Treasuries purchases, dubbed "QE2.”

It is likely that the Fed will announce an initial commitment to buy $500 billion to $700 billion in bonds after its Nov 2-3 policy meeting -- at a monthly clip of $100 billion. St. Louis Fed President James Bullard said on Thursday he would back Fed purchases of Treasuries in $100 billion increments meeting-by-meeting if the Fed decides monetary easing is necessary, but stressed no decision has been made.

When the core PCE crosses the 2 percent mark, it is likely the Fed might begin raising its target on the federal funds rate to 3.5 percent over a two-year period. A 3.5 percent fed funds rate would be consistent with full employment and price stability at 2 percent. In December 2008, the Fed adopted a zero to 0.25 percentage point target on the fed funds rate, which is the overnight rate that banks charge each other to borrow excess reserves.