MarketView for October 28

 

 

Summary

 

The major equity indexes end a fourth week of gains in quiet fashion on Friday, edging higher as the market took a breather after rallying 3 percent on Europe's deal to stem its debt crisis. While there are still a lot of unknowns with regard to how the deal will be implemented, for now the Street appears temporarily satiated. The result was some fairly nice returns among equity shares.

 

The S&P 500 rose 3.7 percent for the week. The benchmark index had a seven-week rally that ended in January, but only two of the weeks were in 2011. October also was on track to be the best month for stocks since 1974, supported by strong earnings. Merck and Chevron both clocked expectations on Friday. Merck rose 2.3 percent to $35.11 after its profit and sales beat expectations, and Chevron's profit more than doubled sending its shares up 0.6 percent to close at $109.64.

 

Concerns that the euro zone debt crisis would spread and stifle domestic bank profits had been a huge overhang for equities, with the S&P down almost 20 percent -- defined as a bear market -- early this month. However, as optimism grew the bulls began to gain momentum and the S&P 500 is now up more than 13 percent this month, on pace for its largest monthly gain since October 1974.

 

Nonetheless, the head of Europe's bailout fund played down hopes of a quick deal with China for that country to throw its support behind efforts to resolve the crisis but said he expects Beijing to continue to buy bonds issued by the rescue fund.

 

According to Thomson Reuters data, of the 315 companies in the S&P 500 that have reported quarterly results, 71 percent have posted earnings above analyst expectations.

 

Hewlett-Packard gained 3.5 percent to $27.94 a day after it said it was ditching a plan to spin off its personal computers unit, a plan that was expected to have cost billions of dollars in expenses and lost business.

 

Economic data on Friday showed consumer sentiment improved in October for the second month in a row as consumers felt more upbeat about the economy's prospects. Volume on the three major equity exchanges was about 7.71 billion shares, still well below the daily average of 8.03 billion shares.

 

Income Gains Woeful

 

Woeful income growth meant that consumers were forced to cut back on saving in September to raise their spending, indicating that the economy's recovery remains insubstantial. Consumer spending increased 0.6 percent, the Commerce Department said on Friday, after a 0.2 percent gain in August. However, incomes edged up only 0.1 percent after a 0.1 percent decline in August. The report showed saving slowed to an annual rate of $419.8 billion, the lowest level since August 2009, from $479.1 billion in August. The saving rate, the percentage of disposable income socked away, fell to 3.6 percent, the slowest since December 2007, from 4.1 percent in August.

 

After accounting for taxes and inflation, income slipped 0.1 percent, a third straight monthly drop. For the third quarter as a whole, it fell at an annual rate of 1.7 percent -- the first quarterly decline since the fourth quarter of 2009. The weak income growth reflects the anemic labor market, characterized by a jobless rate that has been stuck above 9 percent for five consecutive months.

 

The solid increase in consumer spending -- which accounts for about 70 percent of U.S. economic activity -- lends momentum to fourth-quarter output, but the real question for those with a bit of a longer horizon is what will the first and second quarters of 2012 bring. With household budgets stretched, expansion will be fleeting if job growth does not accelerate.

 

A separate report underscored the troubling signals on income. The Labor Department said wages and salaries rose 0.3 percent in the third quarter -- the smallest gain in a year -- after increase 0.4 percent in the prior quarter. The report showed benefit costs borne by employers, which make up about 30 percent of overall compensation, grew just 0.1 percent in the quarter, the weakest since the first quarter of 1999.

 

Some companies, like Wells Fargo, which are looking to cut costs, are rolling out insurance plans with employees paying higher premiums if they get sick.

 

Weak incomes are likely to draw the attention of policymakers at the Federal Reserve when they meet next week to debate additional ways to aid growth and cut the jobless rate. Officials who want to take further action to aid the economy may be emboldened by a slowing in inflation shown by the report on spending, although slower inflation also eases the burden on consumers.

 

A price index for personal spending rose at a 0.2 percent rate last month, slowing from August's 0.3 percent pace. In the 12 months through September, the PCE index was up 2.9 percent, the same margin as in August.

 

A core inflation measure, which strips out food and energy costs, was flat last month after increasing 0.2 percent in August. In the 12 months through September, this gauge rose 1.6 percent after increasing 1.7 percent in August. The Fed would like this measure to be closer to 2 percent.

 

JPMorgan raised its forecast for fourth-quarter growth to a 2.5 percent annual rate from 1 percent to take into account a stronger run of recent data, including the figures on spending, and rebound in stock markets.

 

Consumer confidence was a bit higher during October, with the Thomson Reuters/University of Michigan's sentiment index rising to 60.9 from 59.4 in September.

 

Earnings Distorted by Stock Repurchases

 

Stock buybacks are poised to reach their highest level since the recession once third-quarter results are posted, as companies step up repurchases to take advantage of lower stock prices.

 

The increase, however, raises several questions for investors because buybacks can make earnings look more robust than they really are, and because more money spent on shares means less invested in the business.

 

Buybacks among S&P 500 companies fellfrom 2007 to 2008, when the United States entered a recession, and bottomed in the second quarter of 2009. They have risen steadily since then, notching up eight consecutive quarters of sequential gains, according to S&P, which says the third-quarter total may top the second-quarter's $109 billion.

 

In the second quarter, the most recent for which S&P provided data, buybacks accounted for less than one percent of the S&P 500's total market capitalization. At their decade peak, in third quarter 2007, buybacks accounted for 1.3 percent of the S&P 500's market cap.

 

The majority of U.S. companies that have reported third-quarter results so far have exceeded Wall Street forecasts, many by just a penny or two per share. The scale of recent buybacks raises questions about the quality of earnings being reported. Buying stock may foster shorter-term thinking in the management suite as executives use cash, or raise debt, to buy equity when the business may need additional investment.

 

Through the third quarter, U.S. companies authorized more than $400 billion in stock repurchases, up by nearly half over 2010's year-to-date total, according to Birinyi Associates. They include Lowe's, Berkshire Hathaway, Coca-Cola, Goldman Sachs, DuPont and Navistar. IBM and Intel and 3M, which are all are committing billions to their various programs.

 

Buybacks rose steadily in August then flattened, but last week reached a 13-week high of $16.4 billion, averaging $3.3 billion a day. Some jumped too soon as weekly buybacks peaked in late April, when the S&P 500 index was near highs for the year. Some buybacks are more effective than others. Netflix bought back shares at an average price above $200 in the third quarter. Its stock fell below $80 this week.

 

Buybacks can substantially lift reported results. Airgas net income rose 17 percent, but EPS jumped 29 percent. At least one analyst cited the buyback as a reason for Airgas's 1-cent earnings beat.

 

Motorola Solutions bought back $744 million in the quarter. Asked whether that was to boost EPS, Chief Executive Greg Brown said, "Smart investors see right through that."

 

When Dr Pepper Snapple Group reported results on Wednesday, it had 218 million shares outstanding, down 22 million from a year ago, which helped the company beat expectations by 1 cent. Illinois Tool Works, whose profit beat by 2 cents, spent $1 billion this year buying back shares that at one point were down by a third from their 52-week peak.

 

It’s Not Over Till It’s Over

 

European Central Bank President Jean-Claude Trichet said in an interview in a German newspaper to be published on Sunday that the euro zone sovereign debt crisis was not yet over and that it was too early for the all-clear signal.

 

In an interview to appear in Sunday's Bild am Sonntag newspaper, Trichet said that he was, however, confident that euro zone governments would be able to restore financial stability provided the bloc's Stability Pact rules are comprehensively and more aggressively enforced.

 

Trichet said the agreements reached by European Union leaders this week need to be enacted in a very precise and quick manner. He called it "absolutely decisive" that those decisions are quickly and completely enacted.

 

He said the ECB will carefully track the progress of governments' reform measures and said the time had now come to "see some action."

 

"The crisis isn't over," Trichet told the German newspaper, according to an advance text released early on Saturday. "But after the decisions made this week, I'm nevertheless confident that the governments will succeed in restoring financial stability," richet said.

 

He said the precondition for that was "that the rules of the Stability and Growth Pact are more thoroughly and more aggressively implemented."

 

Trichet said: "The decisions reached at the summit need a very precise and timely implementation. The euro zone's government leaders have a program, now hard work awaits the governments and European Commission.

 

"The quick and complete implementation of the decisions is now absolutely decisive," Trichet said. "The quick and complete enaction of the decisions is now absolutely decisive," he added.

 

Trichet said that the ECB would track the process closely. "We now need to see some action," he said.