MarketView for October 5

 

 

Summary  

 

Share prices continued to recover from a decline that briefly took the S&P 500 into bear-market territory as investors bid up materials and energy shares on rising commodity prices and poured into beaten-down tech names after days of selling. Crude futures snapped a three-day losing streak with a gain of more than 5 percent, while copper prices added 1.7 percent.

 

The Nasdaq 100 technology sector index closed up 3.7 percent. It has gained 7.3 percent in the past two sessions. Among the day’s leaders was Yahoo, up more than 10 percent on rumors that Microsoft is considering offering a bid for the company once again. Yahoo ended the day up 10.1 percent to close at $15.92. Research in Motion was up 12.4 percent at $23.60 on speculation that company could be acquired.

                                                                                                                     

Traders cited the relative strength in the S&P 500 after breaking the closely watched 1,100 level Tuesday as a catalyst for short sellers to pocket gains and as a damper on overall selling pressure.

 

Economic data indicated that growth in the services sector was steady in September and private hiring picked up, suggesting the economy was not yet slipping into recession. At the same time, a rise in the price of commodities, including crude oil and copper, pointed towards increased economic activity.

 

Wednesday's gains kept the benchmark S&P 500 near the lower end of a trading range that goes back two months as the deepening debt crisis in Europe remains unresolved. Greece is expected by many to be forced to restructure its debt.

 

The economy's services sector expanded in September, while the private sector added 91,000 jobs in September, increasing optimism about Friday's non-farm payrolls report from the Labor Department.

 

About 9.7 billion shares traded on the major exchanges, an number that was well above this year's daily average of 8 billion shares.

 

Service Sector Continues to Expand

 

The service sector grew steadily during September and private hiring picked up, suggesting a recession is still only a possibility and not a reality. The Institute for Supply Management said its services index ebbed to 53.0 last month from 53.3 in August. A reading above 50 indicates expansion in the sector. Details of the report were mixed, with orders rising but employment falling to its lowest level in nearly 1-1/2 years.

 

The drop in services employment, was however, at odds with a separate report from payrolls processor ADP showing overall private payrolls rose by 91,000, above economists' expectations for an increase of 75,000. ADP said most of the gains, which exceeded August's count of 89,000, came from the service sector.

 

The government will release its employment report for September on Friday.

 

Private sector business activity shrank in the euro zone for the first time in two years last month as new orders dried up, surveys showed on Wednesday. Markit's Eurozone Services Purchasing Managers' Index (PMI) fell to 48.8 last month from 51.5 in August, its lowest reading since July 2009 and below an earlier flash reading of 49.1.

 

The economy grew at a 1.3 percent annual pace in the second quarter and data ranging from business spending to motor vehicle sales suggest that output could top a 2 percent rate in the July-September period.

 

The economy needs to grow by at least an annual rate of 2.5 percent and payrolls expand 150,000 a month on a sustained basis just to keep the jobless rate, now 9.1 percent, from rising further. Last month, employers announced 115,730 planned job cuts, more than double August's total of 51,114, according to the report from consultants Challenger, Gray & Christmas. The figure was the highest since April 2009.

 

Crude Oil Rises

 

The price of crude oil rose more than 2 percent on Wednesday, snapping a three-day losing streak, on government data showing large declines indomestic inventories with added support from news that European authorities are moving forward to prop up that region's ailing banking sector.

 

While demand in the United States remained weak, data from the Energy Information Administration showed a steep drop in imports last week that aided the decline in inventories.

 

Oil and other commodities, as well as stocks, were supported by news that European finance ministers agreed to examine a way to beef up banks' balance sheets and prevent a full-blown financial crisis.

 

Brent traded up $2.43 to $102.22 per barrel after settling down more than 20 percent from its 2011 high on Tuesday, which traditionally signals a bear market. U.S. crude prices rose even more, gaining $3.38 to $79.05 a barrel and narrowing the premium of Brent to U.S. oil to $23.17 a barrel.

 

Brent trading volumes, which have been outpacing those on the New York Mercantile Exchange's over the past two weeks, reached 543,600 contracts in early afternoon in New York, already close to the 30-day average. U.S. crude volumes hit 371,003, about 40 percent below the 30-day average.

 

Further pressure on Brent has come as Libya, a key supplier to Europe, attempts to restart production forced offline by months of civil war. However, Italian oil major Eni said on Wednesday it fears its largest oilfield in Libya, known as Elephant, may be in ruins, which could mean that the time frame for production could be lenghthy.

 

The Yuan Should Rise but There Will Be Consequences

 

A sharp rise in China's yuan currency could reduce our trade deficit by as much as one third and create enough American jobs to put at least a modest dent in the unemployment rate. At the same time, it could result in a destabilizing spike in Chinese unemployment and spark a trade war that drags the global economy back into a deep recession.

 

These are the conflicting forces Congress must consider as they decide whether to pass a bill which would pressure Beijing into letting its currency rise more rapidly.

 

Beijing readily acknowledges that a gradual yuan appreciation is in its best interest, and it has allowed the currency to rise by about 6.5 percent since June 2010. Where the disagreement lies is how far and how fast.

 

The U.S. trade deficit was $428 billion through July, up from $367 billion over the same period in 2010, according to the Commerce Department. China accounts for about 37 percent of the 2011 total.  For China's economy, a stronger yuan would reduce economic growth and increase unemployment, although there is a a large variance as to the magnitude.

 

The yuan exchange rate is the clearest manifestation of a currency policy that is anything but simple. For Beijing, the yuan's value is not just about fiscal policy. It is critical to social stability as well. China's exports totaled $1.58 trillion in 2010, according to the International Monetary Fund, or about one-third of its gross domestic product. That's nearly three times the share that exports comprise in the United States.

 

The factories that fill those shipping containers with shoes, laptops, furniture and food employ millions of rural workers who migrate to China's cities each year. That is the primary reason why Beijing has no interest in speeding up the pace of the yuan's rise. Indeed, it pulled back on the rate of appreciation in September when fears intensified that the global economy could be heading toward a recession.

 

Yet China has a vested interest in a stronger yuan. It would help to tamp down inflation, which stood at 6.2 percent year over year in August, far above Beijing's 4 percent annual target. It would also boost households' buying power, which is vital to achieving China's goal of developing a more consumer-driven economy.

 

But when the directive comes from Washington, China's response is typically prickly. Part of the reason for that is a widely shared belief in China that the industrialized nations, threatened by China's swift rise, want to hobble its economic fortunes.

 

Many commentators point to the Plaza Accord of 1985, when the United States and other governments engineered a sharp depreciation of the dollar against the Japanese yen and German mark. China could become the next target of such a move, the thinking goes.

Beijing is well aware that Japan fared poorly after the Plaza Accord. The stronger yen discouraged investment and hurt the Japanese economy. Tokyo's attempts to reinvigorate the economy after the Plaza Accord have since been blamed for inflating an asset price bubble that eventually burst, plunging Japan into a deflationary spiral that it is still struggling to break.

 

To be sure, some of China's neighbors would stand to benefit if the yuan rose significantly. Nations such as Vietnam which emulated the Chinese export model as a way to speed up economic development might see more business swing their way. However, China itself has become a vital trading partner for other Asian countries. It is the top export destination for economies including South Korea, Taiwan and Malaysia.

 

Even for the United States, China is becoming a bigger export market. In dollar terms, the United States imports almost four times as much as it ships to China, but exports are growing more rapidly than imports. That is why some business groups have voiced strong opposition to the currency bill, echoing China's stern warning that Congress risked touching off a trade war.