MarketView for October 15

 

 

Summary

 

After being down for the morning, share prices began to move sharply higher in the afternoon, sending all three major equity indexes well into positive territory as Citigroup's earnings and retail sales sharply exceeded expectations.

 

Citigroup ended the day up 5.5 percent to close at $36.66 and gave the greatest lift to the S&P 500 after the third-largest U.S. bank reported quarterly adjusted earnings that surged from the year-ago quarter and beat expectations. The growth came as mortgage lending increased and capital markets results rebounded.

 

Concerns over third-quarter earnings have put a damper on share prices in recent weeks, with the S&P 500 falling 2.2 percent last week - its worst weekly performance in four months. Nonetheless the S&P 500 is still up 14.5 percent for the year.

 

The three major U.S. stock indexes also drew support from optimism about retail data, which showed September retail sales rose 1.1 percent - above the 0.8 percent growth that had been anticipated. However, the Street still felt that caution was the name of the game where Europe was concerned as it awaited some indication that Spain was ready to formally request a bailout, which is seen as necessary to deal with its debt crisis.

 

Meanwhile, both the Dow and the S&P 500 kept above technical support levels at their 50-day moving averages. Last week's declines had left each index on the precipice of breaking below those levels.

 

Shares of Intel rose1.2 percent to end the day at $21.73 a day ahead of its earnings report. Analysts are expected to watch Intel's gross margin figures, which have been declining in the past couple of years. Intel's advance on Monday helped drive the PHLX semiconductor index up 1.5 percent.

 

Pharmaceutical shares advanced, led by Eli Lilly, up 4.1 percent close at $52.53, and Abbott Laboratories, up 4 percent at $72.05. Eli Lilly shares rose after the company indicated that a late-stage study of its experimental gastric cancer drug met its main goal of improving overall survival. Abbott's stock gained after results from a mid-stage study of hepatitis C medicines.

 

Lending further support was a rebound in energy shares as domestic crude curbed an earlier slide that had pushed the price down below $90 a barrelBrent crude rose $1.18, or 1.03 percent, to settle at $115.80 a barrel.

 

Profits of S&P 500 companies are seen dropping 2.3 percent this quarter from a year ago, according to Thomson Reuters data. With about 8 percent of S&P 500 companies having reported, 58 percent of companies have topped profit expectations - less than the average beat rate of 67 percent for the past four quarters, Thomson Reuters data showed.

 

In other economic data, a survey showed that an index of manufacturing activity in New York State fell again for the third month in a row in October.

 

Volume on the three major equity exchanges was roughly 5.9 billion shares, as compared with the year-to-date average daily closing volume of 6.52 billion shares.

 

Retail Sales Up Sharply

 

Retail sales rose sharply during the month of September as consumers bought more of everything from cars to gasoline and electronics, resulting in the possibility of our seeing stronger-than-expected economic growth in the third quarter. However, other data on Monday showed manufacturing activity in New York state shrank for the third month in a row in October, though the pace of contraction eased.

 

Retail sales increased 1.1 percent last month, the Commerce Department said, beating expectations after an upwardly revised 1.2 percent rise in August. Retail sales outside of autos, gasoline and building materials -- a barometer of consumer spending known as core retail sales -- rose 0.9 percent last month.

 

That was well above the 0.3 percent gain expected by the Street and suggests consumers did more to drive economic growth in the July-September period than economists had expected. Consumer spending drives about two-thirds of the U.S. economy, and the data points to an economy that is growing modestly but still below its potential.

 

The Fed last month launched a new open-ended plan to buy mortgage-backed securities until the labor market improves substantially -- an unprecedented step in the history of American monetary policy. The Fed has also pledged to keep interest rates low until even after the economy strengthens.

 

Sluggish demand and a punishing drought restricted the economy to a 1.3 percent annual growth pace in the April-June period. Before the retail sales report was released, economists were expecting growth to accelerate to a 1.6 percent pace in the third quarter, according to a Reuters poll.

 

The details of the report showed broad strength across retailers, with sales of motor vehicles and parts up 1.3 percent. Receipts at gas stations rose 2.5 percent, reflecting an increase in prices paid at the pump.

 

Other categories were also strong, with sales at electronics retailers up 4.5 percent. Some analysts said that might reflect sales of Apple's newest iPhone model. Sales at food and beverage stores also posted solid growth, climbing 1.2 percent.

 

Separately, the New York Fed's "Empire State" general business conditions index rose to minus 6.16, from minus 10.41 in September. New orders improved to minus 8.97 from minus 14.03, while the index of the number of employees slipped to minus 1.08 from 4.26. The survey of manufacturing plants in the state is one of the earliest monthly guideposts to U.S. factory conditions.

 

Fed Not Anxious To Change on First Good News

 

The Federal Reserve is not anxious to remove policy accommodation at the first sign of positive news on U.S. economic growth, New York Fed President William Dudley said on Monday. Doubling down on the central bank's big monetary easing move last month, Dudley said the policy stance would "evolve" only once "we became confident that the recovery was securely established."

 

"If we were to see some good news on growth I would not expect us to respond in a hasty manner," said Dudley, a permanent voter on the Fed's policy-setting committee and a close ally of Fed Chairman Ben Bernanke.

 

Further, fears that the Fed's extraordinary stimulus steps will cause financial asset bubbles or inflation are misplaced, Dudley said.

 

Having kept interest rates near zero for almost four years, the Fed last month launched a third, massive bond-buying program to help boost tepid U.S. growth and to help Americans get back to work. Policymakers also said the Fed would keep policy easy for a "considerable time after the economic recovery strengthens," and forecast low rates through mid-2015.

 

Since then, a debate has grown over what would prompt the Fed to finally tighten policy, and the risks the Fed runs in driving deeper into uncharted policy territory.

 

While some of Dudley's colleagues, such as Chicago Fed President Charles Evans, want to set specific markers based on unemployment or inflation that would prompt the Fed to adjust its policy, others like the Philadelphia Fed's Charles Plosser warn that is no easy task and has its risks.

 

Weighing in on this, Dudley argued it is "hard to summarize the economy" in such a way that would provide more transparency, though he indicated he would like the central bank to move in that direction.

 

On the question of inflation concerns, Dudley said the Fed's ability to adjust the interest it pays banks to park funds there - called interest on excess reserves, or IOER - "means we can keep inflation in check regardless the size of our balance sheet."

 

The Fed could in theory raise this rate if it wanted to curb a surge in credit demand. However, that is not the problem the Fed has now. U.S. growth cooled in the second quarter to 1.3 percent, and forecasters do not think the economy is expanding much faster. Unemployment, having remained above 8.0 percent for three-and-a-half years, fell sharply to 7.8 percent in September, but analysts say growth is not strong enough for that to be sustained.

 

"In my view, while the costs (of stimulus) are real and need to be carefully evaluated, they pale relative to the costs of not achieving a sustainable economic recovery," Dudley said at a hotel in downtown Manhattan. "A failure in that regard would lead to widespread chronic unemployment."

 

The U.S. economic recovery has been consistently weaker than anticipated since the sharp financial crisis and recession of 2007-2009. Citing this, Dudley went so far as to say that, with hindsight, monetary policy "needed to be still more aggressive."

 

The policymaker avoided specific forecasts, but gave a nuanced view of the months and years ahead.

 

"If the economy were to continue to underperform, and experienced a severe shock, there would be some risk of getting stuck in a deflationary situation in which monetary policy would be even less effective," he said.

 

"Although the outlook for the U.S. economy remains somewhat cloudy as we look into 2013, I remain a long-run optimist about where we are headed," Dudley added. "The long term prospects for the economy are excellent."

 

What the Future Holds

                                                                                                                            

While nobody can reliably forecast the economy in the short-term, there is a consensus building that economic growth will increase in 2013, with a large caveat that Congress will modify the fiscal cliff of sharp tax hikes and spending cuts. That aside, the economy is expected to expand 2.4 percent next year, up from projected growth of 1.9 percent in 2012, according to the survey of 44 forecasters made by the National Association for Business Economics.

 

Some businesses worry the U.S. government could trigger a recession by pushing the economy over what Washington is calling a "fiscal cliff" -- about $500 billion worth of tax increases and over $100 billion in government spending cuts due to start on January 2. However, the forecasters surveyed by the NABE - who included economists at Ford, Dupont, and JPMorgan - think most of the fiscal cliff dangers will be avoided, sparing the economy from much of the potential damage.

 

Some 55 percent of respondents think tax cuts enacted under former President George W. Bush will be extended for all taxpayers in 2013, rather than expiring at the end of this year. Another 36 percent expect those lower tax rates will be extended for lower-income individuals but not for those with higher incomes. And about four-fifths of the economists polled predict that planned spending cuts will be greatly watered down.

 

The NABE survey was carried out between September 14 and September 26. The predictions gathered by the NABE stand in contrast to a scenario outlined by congressional analysts who have tried to project what running off the fiscal cliff would do to the economy.