MarketView for October 27

 

 

Summary

 

Share prices were on a tear on Thursday, in a broad rally brought on by a long-awaited agreement by European leaders to increase the region's bailout fund. That agreement should now remove a major headwind for the markets. The agreement also strikes a deal for write-downs on Greek bonds, a source of global equity weakness over the past several months. After more than eight hours of talks, European heads of state, the International Monetary Fund and bankers sealed a deal that also foresees a recapitalization of hard-hit European lenders and a leveraging of the bloc's rescue fund to give it firepower of $1.4 trillion.

 

Analysts see the European developments removing risk to the U.S. economy and tamping down fears of it spilling over into the global financial system.

 

The S&P 500 is up more than 13 percent this month, on pace for its largest monthly gain since October 1974. The gain follows five negative months on the index. It was also the strongest day for volume since October 4. The gain by the S&P 500 broke the benchmark index out of a trading range of between 1,230 and 1,250 and was just above the 200-day moving average of 1,274, viewed as the next significant technical resistance level. Furthermore, the rise above the 200-day moving average may pull more long-term buyers into the market in coming days.

 

 About 11.95 billion shares traded on major equity exchanges, well over last year's daily average of 8.47 billion. Financials were the best performers, with JPMorgan Chase up 7.2 percent to close at $36.63, while Citigroup rose 8.6 percent to $33.85.

 

All 10 S&P sectors rose by more than 1 percent. Materials and energy shares were among the top gainers as the resolution in Europe allayed fears about how weak growth might impact demand.

 

Third Quarter Growth Up 2.5 Percent

 

The economy grew at its fastest pace in a year in the third quarter as consumers and businesses stepped up spending, creating momentum that could carry into the final three months of the year.

 

The expansion was a welcome relief for an economy that looked on the brink of recession just weeks ago, although part of the pick-up came from a reversal of factors that held back growth earlier in the year, and analysts worry about 2012.

 

According to a report by the Commerce Department Thursday morning, Gross domestic product (GDP) grew at a 2.5 percent annual rate in the third quarter, up from a 1.3 percent pace in the prior three months. That took output back to pre-recession level. While the growth pace matched economists' forecasts, domestic demand showed a bit more vigor than most had expected.

 

The GDP report could give some breathing space for Federal Reserve policymakers who meet next week to debate additional ways to help the economy and lower an unemployment rate that has been stubbornly stuck above 9 percent for five months. The economy needs to grow at a rate of more than 2.5 percent over a sustained period to reduce the jobless rate.

 

The largest problem is the weakness of the labor market. Inflation-adjusted disposable income fell at a rate of 1.7 percent in the third quarter -- the first decline since the fourth quarter of 2009 -- and consumers had to dip into savings to lift their spending.

 

A rise in gasoline prices had weighed on consumer spending earlier in the year, and supply disruptions from Japan's big earthquake and tsunami in March had curbed auto production. As those factors faded, the economy picked up speed.

 

Consumer spending grew at a 2.4 percent rate in the third quarter, the strongest since the fourth quarter of 2010, while business investment spending shot up at a 16.3 percent pace, the most in more than a year. Failing to anticipate the fairly strong demand, businesses were slow to restock warehouses. Inventories posted their smallest gain since the fourth quarter of 2009, a slowdown that subtracted more than 1 percentage point from GDP growth.

 

Excluding the drag from inventories, the economy grew at a brisk 3.6 percent pace. The peppier spending and sluggish pace of inventory growth lays the base for a solid fourth quarter but the possibility of another recession in Europe and the exhaustion of pent-up U.S. demand could leave a weak spot early in 2012.

 

The jobs market is showing little improvement. Data from the Labor Department on Thursday showed new claims for state unemployment benefits fell 2,000 last week to 402,000, a level that suggests little headway.

 

Households, however, should see some relief as price pressures abate. A price index for personal spending rose at a 2.4 percent rate in the third quarter, slowing from the April-June quarter's 3.3 percent pace.

 

A core inflation measure, which strips out food and energy costs, rose at a 2.1 percent rate after increasing 2.3 percent in the prior three months.

 

Apart from consumer and business spending, growth in the third quarter was also supported by a smaller trade deficit. Spending on residential construction also rose modestly.

 

Still, there are no signs of a real housing recovery. A report from the National Association on Realtors on Thursday showed pending sales of previously owned homes fell for a third successive month in September.

 

Government spending was flat in the third quarter, reflecting continued budget cuts by state and local governments.

 

While the pace of decline in state and local government spending is now moderating, economists worry fiscal policy will tighten next year if Congress fails to extend expiring payroll tax cuts and emergency jobless benefits.

 

Avon Plummets

 

Regulators are formally investigating whether Avon broke bribery laws overseas, and the cosmetics company said it was again reassessing its strategy after quarterly profit fell far short of expectations. As a result, Avon fell 18.25 percent to close at $18.81as analysts questioned whether the company can come up with a turnaround plan as quickly as it expects to.

 

Regulators also subpoenaed Avon over its contact with analysts and others as part of an investigation related to fair disclosure under Regulation FD.

 

Under Jung, Avon has turned in poor performances in key markets such as Brazil and Russia, poured tens of millions of dollars into its international bribery investigation and struggled to stem declines in a sluggish U.S. market.

 

The world's largest direct seller of cosmetics, which has been celebrating its 125th anniversary with celebrity-studded events this year, now plans to assess long-range business plans and give an update during the first quarter of 2012.

 

Consumer industry bankers implied that Avon could be a target for a private equity firm in the future, but that for now, the investigation is too risky for any buyer to take a look at it.

 

Another potential red flag is that Avon cannot fully fund its dividend with free cash flow. The payout was raised to a quarterly rate of 23 cents per share earlier this year. Avon has had "disappointing" cash management as well as one-time cash outlays, said Cramb, who will end his six years as Avon's CFO at the end of November.

 

Avon's incoming CFO, Kimberly Ross of Royal Ahold, will be involved in the review, Jung said. Avon changed its corporate structure and shook up management in February. It overhauled operations and cut thousands of jobs under a restructuring laid out in November 2005 and updated in February 2009, and eliminated the dual role of president and chief operating officer in 2006, leaving business units to report directly to Jung.

 

Avon said on Thursday that it received the subpoena from the U.S. Securities and Exchange Commission on Wednesday. The SEC is investigating the company's contact during 2010 and 2011 with certain analysts and other representatives of the financial community, Avon said in its quarterly filing.

 

The SEC adopted Regulation FD, short for "fair disclosure," in 2000 to prevent companies from tipping off analysts and investors about material information.

 

The SEC issued a formal order of investigation of both Regulation FD matters and the Foreign Corrupt Practices Act matter that Avon itself has been looking at since June 2008.

 

Meanwhile, Avon blamed disappointing results in Brazil on poor implementation of an "unforgiving" new computer system and said tough economic conditions in several areas crimped sales.

 

The company -- which does not issue quarterly earnings forecasts – said it no longer expects to meet its 2011 goals of mid-single digit revenue growth or a 0.5 percentage point to 0.7 percentage point improvement in operating margin. 

 

Jung, a magna cum laude graduate of Princeton University, is one of the leading female executives in the world. She ranked sixth on Fortune magazine's list of powerful women in U.S. business in September.

 

She co-leads the seven-member board at Apple Inc and chairs its compensation committee. When announcing her nomination to Apple's board in 2008, Steve Jobs referred to Jung as a "strong CEO and marketer."

 

She has also served on General Electric Co's board since 1998 and serves on two of its committees: nominating and corporate governance and management development and compensation. A GE spokesman said the company is not reviewing her position as a director, while an Apple spokesman did not immediately return a call for comment.

 

Avon's third-quarter profit fell to $164.2 million, or 38 cents per share, from $166.7 million, or 38 cents a share, a year earlier. Revenue rose 5.7 percent to $2.76 billion.

 

Avon also sold 5 percent fewer products in the quarter. In North America, sales continued to slide as more sales representatives left, and operating profit fell 85 percent.

 

Exxon and Shell

 

Oil giants Exxon Mobil and Royal Dutch Shell said their profits jumped more than 40 percent in the third quarter as higher energy prices offset declines in their output.

 

Oil prices have sagged from their May peaks, but still remain well above the 2010 levels. Recent optimism that the global economy may be recovering has sent crude prices climbing 20 percent this month.

 

Still, the world's two biggest publicly traded oil companies have struggled to stem a drop in their output, and record spending by Exxon of $26.7 billion for the first nine months of 2011 has not yet turned that trend around.

 

Exxon's oil and gas output fell 4 percent to 4.28 million barrels of oil equivalent per day, lagging Wall Street expectations. Shell's output slid 2 percent.

 

The dip in crude oil prices during the third quarter helped both Exxon and Shell lift their profit margins at their refineries and chemicals businesses, particularly in the United States.

Shell posted a 25 percent profit increase over year-ago levels at its refineries and chemicals businesses, and Exxon saw its refineries' profits climb 36 percent.

 

Those gains, however, lagged the nearly 54 percent increase Exxon posted from its oil and gas producing arm and the 58 percent jump in Shell's earnings from that segment.

Exxon has projects in the works that promise growth. On a conference call with analysts, the company said drilling has shown that its big Hadrian prospect in the Gulf of Mexico is exceeding expectations. The company is also adding wells in the oil-rich Bakken shale in North Dakota.

 

Shell, Europe's largest oil company by market capitalization, said its underlying current cost of supply (CCS) net income, which excludes one-offs and non-cash accounting charges, soared 42 percent in the third quarter to $7.0 billion, while Exxon reported a 41 percent increase to $10.3 billion.

 

Occidental Petroleum Corp, the fourth-largest U.S. oil company said its third-quarter profit rose 49 percent while daily oil and gas production soared to a record. Italy's Eni's production fell 13.6 percent due to the conflict in Libya, while underlying, or "adjusted" net profit, in dollar terms rose 19 percent.

 

Norway's Statoil said its adjusted net income rose 50 percent to $2.07 billion in the third quarter and its production climbed 14 percent. Still, the company cautioned that its output would fall slightly this year.

 

Exxon shares were up 0.3 percent at $81.34, while shares of Occidental Petroleum soared 9 percent to $95.13.