MarketView for October 3

 

 

Summary  

 

Wall Street hit the skids again on Monday sending the major equity indexes to an approximate 13-month low on fears that Greece's worsening financial crisis could cause a large European lender to fail. The S&P 500 broke through a previously strong technical support level near 1,120 before hitting a 13-month intraday low just below 1,100. The benchmark is also down 19.4 percent from its closing high this year, nearly entering a bear market, which is defined as a 20 percent decline from its recent high set on April 29.

 

More than 11 billion shares traded on the major equity exchanges, about 38 percent above the year's current daily average of 7.98 billion shares.

 

Investors pegged losses to the sharp fall in Franco-Belgian financial group Dexia, which fell 10 percent after a Moody's warning about its liquidity due to concerns about exposure to Greece. Dexia called an emergency board meeting after concerns about its exposure to Greece and a Moody's warning about its liquidity position raised pressure on Belgium and France to act.

 

Markets have feared European officials will be unable to prevent Greece's fiscal crisis from turning into a global banking crisis. Greece said it will miss its deficit targets this year and next, which could limit the country's ability to receive more aid.

 

Meanwhile, speculators have been targeting some of the large U.S. banks. For example, Morgan Stanley closed at its lowest since December 2008, and the cost to insure its debt has jumped as other banks hedge counterparty exposures and traders bet on the situation worsening. The recession that wiped 12 years of gains off the S&P 500 was caused in part by a credit crisis.

 

Morgan Stanley has been the most volatile bank in recent weeks, with the cost to insure its debt rising to November 2008 levels, according to Markit data. Morgan Stanley shares fell 7.6 percent, closing at $12.47. The market's focus on Morgan Stanley stems from a perception about the bank’s reliance on short-term funding.

 

A stronger-than-expected ISM manufacturing index briefly lifted the market’s indexes, but global manufacturing shrank for the first time in over two years in September, reinforcing fears of another recession.

 

The indisputable fact that Athens will likely miss its deficit targets for both this year and next despite harsh new austerity measures will be the focus of talks as euro zone finance ministers meet to discuss the next steps toward resolving the currency area's sovereign debt crisis.

 

Shares of AMR, parent of American Airlines, lost a third of their market value as analysts debated the prospects for a bankruptcy filing for the airline, which lags its industry peers.

 

30-Year Treasury Bond Yields Rise

 

Treasury 30-year bond prices advanced after biggest quarterly rally since the depths of the financial crisis in 2008 as the Federal Reserve began buying longer-term debt to support the economy by keeping borrowing costs low. The extra yield investors get for holding long bonds instead of five-year notes was the narrowest in almost two years as the Fed started the program known as Operation Twist.

 

Yields on 30-year bonds fell seven basis points, or 0.07 percentage point, to 2.84 percent. The long-bond yields dropped 146 basis points or 1.46 percent in the third quarter, the largest decrease since a plunge of 164 basis points in the last three months of 2008.

 

The spread between five-year and 30-year securities decreased to 189 basis points, the narrowest on a closing basis since October 2009.

 

The central bank listed 15 securities maturing from February 2036 to August 2041 for possible purchase between 10:15 a.m. and 11 a.m., the New York Fed said in a statement today.

 

Today's purchases are the first under a program announced Sept. 21 to buy $400 billion of bonds with maturities of six to 30 years through June while selling an equal amount of debt maturing in three years or less. It's part of the Fed's efforts to keep borrowing costs down and spur the economy.

 

Problems Worsen in Greece

 

Greece's admission that it will miss its deficit target this year despite harsh new austerity measures sent stock markets reeling on Monday and raised new doubts over a planned second international bailout.

 

The gloomy news from Athens brought the specter of a debt default closer and will weigh on talks among euro zone finance ministers in Luxembourg later on Monday on the next steps to try to resolve the currency area's sovereign debt crisis.

 

The draft budget sent to parliament on Monday showed this year's deficit would be 8.5 percent of gross domestic product, well off the 7.6 percent agreed in Greece's EU/IMF bailout program.

 

Finance Minister Evangelos Venizelos said in a statement that the 2012 fiscal targets would be met in absolute terms and Greece would have a primary surplus before debt service for the first time in many years. However, next year's deficit is projected to be 6.8 percent of GDP, rather than the 6.5 percent EU/IMF goal, because the economy is set to shrink by a further 2.5 percent after a record 5.5 percent contraction in 2011.

 

Deeper-than-forecast recession means public debt will be equivalent to 161.8 percent of GDP this year, rising to 172.7 percent next year, by far the highest ratio in Europe.

 

The 17 euro zone ministers will not take any decision on Monday on releasing the funds, needed to pay October salaries and pensions, since the troika has yet to report back. They are set to decide at a special meeting on October 13.

 

The likelihood that Greece's funding needs next year will be greater than forecast when a second 109 billion euro rescue package was agreed in principle in July reopened a fraught battle over who should pay -- taxpayers or financiers.

 

Deutsche Bank chairman Josef Ackermann, head of the International Institute of Finance (IIF), which negotiated a "voluntary" bond-swap by investors as part of the bailout plan, warned at the weekend against changing the terms now.

 

Private bondholders agreed to a 21 percent write-down on their Greek debt holdings but EU and German officials have suggested the "haircut" may have to be increased in light of a new funding shortfall and changed market conditions.

 

Political resistance to pouring more public money into euro zone bailouts is growing across northern Europe.

 

"Greece is bankrupt," said Michael Fuchs, a deputy parliamentary floor leader in German Chancellor Angela Merkel's Christian Democrat party, reflecting a growing mood in Berlin. "Probably there is no other way for us other than to accept at least a 50 percent forgiveness of its debts," Fuchs told the Rheinische Post newspaper.

 

Uncertainty over the extent of damage to the already fragile European banking sector from a possible Greek default has been driving investors to take refuge in safer assets.

 

Yields on Spanish and Italian government bonds rose and the cost of insuring their debt against default spiked on the news from Greece, while money poured into safe-haven German Bunds. The euro fell to an eight-month low in Asia.

 

The euro zone ministers were expected to discuss ways to leverage their EFSF bailout fund, without reaching a conclusion on Monday, and to put more pressure on Greece to implement agreed structural reforms and privatizations to try to get its economy growing again.

 

Ministers would review options to enhance the financial firepower of the rescue fund, some of which involved leveraging with money from the European Central Bank, he said.

 

The debt and GDP projections illustrate how Greece has fallen into a vicious spiral of recession, falling revenues, soaring unemployment and declining consumer purchasing power.

 

Officials expect the next aid tranche will be paid, because the euro zone will not be ready to cope with the fallout of a Greek default until its bailout fund, the European Financial Stability Facility (EFSF), gets its new powers of market intervention ratified in the next two weeks.

 

Even then, however, while the 440 billion euro fund will be able to buy government bonds from the market, recapitalize banks and extend precautionary credit to sovereigns, it may not have enough cash to cope with all the financing needs.

 

The leveraging idea, suggested by the United States, has opponents in north European creditor countries, who fear it could lead to bigger liabilities beyond the 780 billion euros in current EFSF guarantees, or credit rating downgrades for either the AAA-rated rescue fund or its triple-A guarantors.

 

Among the ideas under consideration is allowing the EFSF to refinance itself at the ECB's liquidity operations for banks. The EFSF could also guarantee to cover a percentage of potential losses investors could incur in case of a hypothetical sovereign default.

 

Any solution, however, should not require another round of ratification, officials said, because policymakers realized how difficult and lengthy the process was given the growing opposition to bailouts in many euro zone countries.

 

Apple Gets Ready

 

Tim Cook, the new Apple CEO, will make his official public debut on Tuesday as Apple introduces its latest generation of the iPhone -- still the smartphone industry's gold standard after four years, with deliveries most likely coming just in time for the holidays. Even given the current economy, consumers should again line up to purchase this latest upgrade.

 

The so-called iPhone 5 is widely expected to have a larger touchscreen and faster processor than the current iPhone 4, which helped the company stay a step ahead of rivals in an increasingly competitive smartphone market. Nonetheless, Apple will still have to wow its current and potential customer base in light of consistently greater competition than Apple has heretofore been facing in the past.

 

More than 550,000 of Google’s Android-based devices -- including tablets -- are activated each day globally. Nonetheless, Wall Street is of the opinion that Apple's ability to generate enthusiasm among consumers and its command of the higher-end market, however, may make it less susceptible to a broader slowdown,

 

Meanwhile, the current iPhone 4, and a new version is rumored to be announced along with the iPhone 5, is still an unqualified blockbuster: with more than 20 million sold in the third quarter that ended June 25.

 

Cook is likely to take the stage at Apple central at Cupertino's 1 Infinite Loop, where Wall Street will get a chance to see first-hand how the acknowledged operations maven fares at a major product launch. Although a highly regarded executive, his ability to “sell Apple,” is untested.

 

Apple product launches are the most closely watched events on the technology calendar. The new model is rumored to have a larger touch screen, better antenna and an 8-megapixel camera.

 

The event will take place in Silicon Valley rather than downtown San Francisco where Apple made some of its most famous announcements. The key reason is that Oracle is holding its World Conference and has booked up every possible venue.

 

One question floating around is whether Steve Jobs will make any sort of appearance or whether he will want to see how Cook’s maiden flight is without anything to detract from the new CEO’s thunder.

 

The iPhone's U.S. market share in August was 28 percent, making it No. 2. Android was No. 1 with 43 percent of the U.S. market, Nielsen data show. Yet longer-term, the Street has a greater interest in Apple’s progress in moving into international markets, particularly the Asian markets.

 

Cook has said China is a key market. The world's most valuable technology company has mostly catered to the higher end of a booming market in those countries, but is now considering a cheaper phone for that market if the rumors are to be believed.

 

Nokia dominates the lower end of the lucrative Asian market. Therefore, there is speculation that another version of the iPhone 4 will be launched along with the next-generation model.

 

The new phone is prompting Wall Street to forecast that Apple will post enormous sales in the October-to-December quarter, with shipments expected to be in the range of 29 million. Now sold by AT&T and Verizon Wireless, it is expected that Sprint will become the third U.S. operator to sell the iPhone when the next version is launched.

 

The new phone is also expected to accelerate the momentum in Apple shares, which are trading at around $381, off a record high of $422.86. The stock remains well below Street price targets that range from an average of $490 to a high of $666.

 

Level of Factory Activity Increases

 

Factories grew more quickly in September as production and hiring increased, suggesting that manufacturing would help keep the economy from slipping into a new recession. The Institute for Supply Management said its index of national factory activity rose to 51.6 last month from 50.6 in August, partially due to a rebound in production and increased factory hiring. A reading above 50 indicates expansion in manufacturing. As a result, September marked the 26th straight month of expansion in a sector that has shouldered the broader economic recovery, and the factory report implied that an outright contraction in output would probably be avoided.

 

Therefore, the indication now is that the economy will avoid a recession and remain on a slow growth track, even as weak incomes constrain consumer spending -- the main engine of growth.

 

Manufacturing accounts for about 12 percent of gross domestic product and almost 11 percent of nonfarm employment. The tenor of the ISM manufacturing report was strengthened by an increase in hiring last month, which could be a good omen for Friday's employment report. Keep in mind that the economy failed to add jobs in August, leaving the unemployment rate at a lofty 9.1 percent.

 

Other details of the factories survey showed production rebounded last month after contracting in August. However, new orders contracted for a third straight month, potentially pointing to a pullback in manufacturing in the months ahead. "The main concern going forward would be if new orders didn't pick up," said Bradley J. Holcomb, chair of the ISM manufacturing business survey committee in Dallas, Texas.

 

However, inventories are growing at a slower pace and the ISM viewed customers' supplies as too low, which should boost future orders. In addition, orders for exports rose and suppliers are taking a little bit longer to make deliveries to manufacturers, which is also a good sign.

 

Meanwhile, the growth in U.S. manufacturing is bucking a global trend. Factory activity in Europe and Asia slumped in September to levels not seen since the depths of the financial crisis as export demand dropped.

 

The Global Manufacturing PMI, compiled by JPMorgan with research and supply organizations, contracted for the first time in over two years.

 

It also appears that households were more willing to spend on motor vehicles last month. Reports so far from General Motors, Chrysler and Volkswagen suggest sales could be about 8 percent higher than August's on a seasonally adjusted annualized basis.

 

A separate report from the Commerce Department showed an unexpected rebounded in construction spending in August as outlays on state and local government building projects rose sharply.

 

Construction spending rose 1.4 percent to an annual rate of $799.15 billion, the Commerce Department said. Economists had forecast a 0.3 percent drop.

 

Spending on non-residential structures rose in the second quarter at its quickest pace since the third quarter of 2007.