MarketView for September 16

 

 

Summary  

 

It was another strong day for stocks on Wednesday, as the major equity indexes reached new 2009 highs in a broad-based rally following economic data that suggested a stronger-than-anticipated global recovery. Energy and manufacturing companies were among the companies benefitting the most from data indicating improved industrial demand and a falling dollar. The dollar fell to near its one-year lows against a basket of currencies. Declines in the dollar have the benefit that American exports become more competitively priced in world markets. The winners included General Electric, up 6.3 percent at $17, and Exxon Mobil, up 1.2 percent at $70.34.

 

The economic data added to optimism about a recovery, a day after Federal Reserve Chairman Ben Bernanke said the recession was "very likely" over. Specifically, industrial output advanced for a second consecutive month in August, while a government report showed a bigger-than-expected drop in crude inventories last week, indicating higher demand.

 

The S&P 500 index is now up 58 percent since hitting 12-year lows in early March and is up 18 percent since the start of the year.

 

Adding to the day’s positive tone was the latest sign that merger and acquisition activity was picking up. Adobe Systems said it plans to pay $1.8 billion for Omniture), whose software analyzes Web traffic. Adobe, the maker of Photoshop and Acrobat software, is looking to turn around declining sales. Adobe was down 6.4 percent at $33.35, while Omniture advanced 26.3 percent to $21.88.

 

Shares of healthcare companies advanced after Democrat Senator Max Baucus said his healthcare overhaul plan can pass the Senate.

 

Oil futures rose 2.2 percent to $72.51 a barrel. December gold in New York hit 18-month highs, finishing at $1,020.20 an ounce on the COMEX division of the New York Mercantile Exchange. Freeport-McMoran Copper & Gold gained 1.2 percent to $72.15.

 

Consumer Price Index Rises Slightly

 

The government’s consumer price index rose in August, but sank significantly over the past 12 months according to a Labor Department report released on Wednesday.  The CPI, the Labor Department's key measure of inflation, rose 0.4% in August on a monthly basis. The closely watched core number, which excludes volatile food and energy prices, rose 0.1% after falling 0.3% in July. Overall CPI has declined 1.5% over the past 12 months.

 

The government report attributed the month-to-month increase to the gasoline index, which rose 9.1% in August. That jump accounted for more than 80% of the overall CPI increase. However, despite the August increase, the gasoline index has fallen 30% over the past year. That's due to record-high gas prices in summer 2008, which reached a peak of $4.114 per gallon on July 17.

 

The core CPI increased 1.4% on an annual basis, marking the smallest year-over-year jump since February 2004.

 

On a sector-by-sector basis, prices in most sectors increased by less than 1% in August. But the energy index posted a 4.6% jump, and the used cars index rose 1.9%. The new vehicles index saw the biggest loss, at a 1.3% decline. Commodities excluding food and energy inched down by 0.3%.

 

Industrial Output Up

 

Industrial production rose for a second straight month in August, reinforcing views the recession had ended, while a spike in gasoline costs pushed up inflation. A report by the Federal Reserve indicated that industrial production increased 0.8 percent after gaining 1 percent in July. The data came a day after Fed Chairman Ben Bernanke said the economic slump that started in December 2007 was "very" likely over.

 

The economy's nascent recovery is being driven by factories rebuilding stocks that were drawn down to cope with weak demand. The increase in industrial activity last month was also due in part to the increase in automobile manufacturing as the "cash for clunkers" government program, which provided incentives to buy new cars, spurred a jump in sales and prompted many automakers to ramp up output.

 

There were gains in output in other segments. Look for industrial output to maintain its upward trajectory for the remainder of this year, which could translate to companies lengthening workweek and raising wages.

 

Weak consumer spending as high unemployment erodes incomes is seen a major headwind to the economy's recovery. There are concerns that growth could falter early next year in the absence of a major impetus from household consumption.

 

The Fed report on industrial production showed there was still a great deal of slack in the economy, allowing the U.S. central bank to keep its benchmark interest rate near zero for a while. The Fed's policymaking committee meets next week.

 

The capacity utilization rate, a measure of slack in the economy, inched up to 69.6 percent but remained well below the 1972-to-2008 average of 80.9 percent, the report showed.

 

Bank Bond Exit Unlikely To Be Disruptive

 

The elimination of the bank welfare program is about to reach a peaceful end without disrupting the credit markets. The Temporary Liquidity Guarantee Program for bank bonds, one of the many emergency measures implemented to save the financial system from implosion last year, is scheduled to begin winding down in October.

 

With investors appearing more comfortable with bank debt amid signs of an economic recovery, the withdrawal of the program -- under which the Federal Deposit Insurance Corp. (FDIC) pledged to guarantee up to $1.4 trillion in debt issued by banks -- is expected to go well.

 

While it is still more expensive for large banks to issue stand-alone debt, the decline in the spread of yields of bank bonds over their bonds guaranteed by the government since the darkest days of the banking crisis provides a strong signal of improved confidence in the banking system.

 

Yield spreads of stand-alone bank bonds over government-guaranteed bank bonds, which indicate the perceived level of risk of an investment, have halved from a spread of roughly 10 percent in March when investor confidence in banks hit an all-time low.

 

The Temporary Liquidity Guarantee Program, or TLGP, has served its purpose and banks and credit markets are weaning themselves off government support.

 

TLGP was launched nearly a year ago, after Lehman Brothers' collapse deepened the global credit crisis, in an effort to get credit flowing again after last year's crunch. So far, banks have sold just over $300 billion of government-backed bonds. The program offered banks a guarantee from banking regulator the FDIC for issues with a maturity of up to three years.

 

One sign that credit markets will be able to survive without government support is the resilience of the U.S. government bond market since the Federal Reserve's announcement in August that it plans to stop its purchases of Treasuries by the end of October. Bank bonds have also performed strongly, reflecting growing confidence in the sector.

 

 In fact, even bonds issued by Citigroup are faring better. Spreads on Citigroup's 8.5 percent notes due in 2019 have tightened to about 301 basis points over Treasuries from 496 basis points in late May. Spreads tightened further on Tuesday after word reached the Street that the Treasury Department is talking to the bank about how to sell the roughly one-third stake the government acquired as part of its bailout of Citigroup.

 

The corporate bond market has shrugged off the expiration because massive financial support from the Fed's near-zero interest rates and many other government lifelines still leave banks awash with cheap money.

 

Crude Above $72 Per Barrel

 

Domestic sweet crude oil futures for October delivery closed above $72 per barrel on Wednesday after a government report indicated a larger-than-expected decline in crude inventories, settling up $1.58 per barrel at $72.51, while ICE Brent settled up $1.81 per barrel at $71.67. The gain came after the Energy Information Administration reported that commercial crude oil inventories dipped last week by 4.7 million barrels, against expectations of a 2.4-million-barrel drop.

 

The decline, pegged to a slowdown in imports, came alongside builds in gasoline and distillate stocks, a combination that could hurt the refiner profitability.

 

Oil also got a boost from weakness in the dollar. A weaker dollar can also fuel purchases of oil and other dollar-denominated commodities, as they become relatively less expensive to non-dollar holding investors.

 

An OPEC delegate wrote in a Kuwaiti newspaper on Wednesday that OPEC might need to cut its oil supply next year to match an expected fall in demand for the group's crude.

 

Home Builder Sentiment Highest Since May 2008

 

Homebuilder sentiment rose in September to its highest level since May 2008, the National Association of Home Builders said on Wednesday, bolstering the view that the battered housing market is stabilizing.

 

The NAHB/Wells Fargo Housing Market index climbed to 19 from 18 in August. Government programs that have pushed down U.S. mortgage rates and instituted an $8,000 tax credit for first-time home buyers have stimulated demand, the industry group noted in a statement.

 

Restoring and maintaining stability in the housing market is critical for economic growth.

 

The sentiment index plunged to a record low of 8 in January and has since steadily climbed. Readings below 50, however, mean more builders view market conditions as poor than favorable.

 

"Today's report indicates that builders are starting to see some glimmers of light at the end of the tunnel in terms of improving sales activity," NAHB Chief Economist David Crowe said in a statement.

 

Two of the three sub indexes of the Housing Market Index rose in September. The current sales condition gauge rose 2 points to 18 and the index measuring prospective buyer traffic climbed 1 point to 17 this month. However, the index of sales expectations for the next six months declined 1 point to 29, raising concerns about the sustainability of housing market momentum as some federal rescue programs are poised to end.

 

"Those hurdles include the impending expiration of the $8,000 tax credit as well as the critical lack of credit for housing production loans and continuing problems with low appraisals that are sinking one quarter of all new-home sales," Crowe said.

 

Eligible first-time home buyers must close on their loans by November 30, when the tax credit incentive is set to end. The real estate industry is pushing for Congress to extend the tax credit beyond that deadline, to increase it to $15,000 and broaden it to all buyers.

 

In September, all four regions saw improvement in sentiment. The Midwest had the biggest increase of 3 points to 19, its highest reading since July 2007. The Northeast rose 2 points to 24, the South increased 2 points to 19 and the West rose 1 point to 18.

 

Fund Advisor Says Fed Closer To Raising Rates

 

Medley Global Advisors, a hedge fund advisory group, issued a report on Wednesday stating that there is a growing divide among Federal Reserve policy makers on how quickly they should begin raising interest rates, causing Treasury bonds to briefly sell off.

 

The report, titled "Fed: The Journey Begins", comes one week before the Federal Open Market Committee is to meet in Washington to discuss where benchmark interest rates should be set.

 

According to the report, at issue is how quickly policy-makers should begin raising interest rates to head off inflation once the economy shows sustainable signs of growth.

 

"While there are at least two senior officials who would support raising rates next week they will instead lean on communications to safeguard long-term inflation expectations," the report said, according to the source. The two FOMC members were not identified.

 

The report sparked selling of Treasurys on the notion that the Fed might be closer to raising interest rates earlier than previously thought. The central bank has said it would keep rates low for an extended period in order to foster economic growth.

 

"The majority needs to see solid evidence a sustainable recovery is under way before seriously discussing a policy tightening in any context other than the ongoing strategic debate over an exit." the report supposedly said.  "A minority nonetheless will soon launch a campaign in favor of ending the emergency policy stance."

 

The report exacerbated an already weak market, sending the benchmark 10-year U.S. Treasury yield toward session highs. The peak on Wednesday was almost 3.50 percent, but last traded down to 3.44 percent.

 

What scared the markets the most was a reference to two members of the FOMC.

 

Apparently the report indicated that there is some agreement a sustainable recovery scenario implies fed funds somewhere around 2 percent; that is still accommodative but closer to neutral.

 

"For now, at least, the idea of kicking off the cycle with 25 basis point increments seems to be in the comfort zone of most members although they will be at pains to convey that subsequent moves of the same size will not be automatic," the report is rumored to have said.

 

New York AG Subpoenas BofA

 

The New York Attorney General's office subpoenaed five members of Bank of America’s board of directors Wednesday as part of an investigation into the bank's acquisition of Merrill Lynch. The board members are expected to be questioned about what they knew regarding the mounting losses and bonus payments at Merrill ahead of the deal's completion on Jan. 1.

 

New York Attorney General Andrew Cuomo's office is also likely to ask the board members about any threats made by federal regulators to remove the board if the deal wasn't completed, as BofA executives have said.

 

The subpoenas come as Cuomo's office is preparing to file fraud charges in the coming weeks against several high-ranking executives at the Charlotte, N.C.-based bank over its acquisition of the troubled investment bank.

 

Bank of America agreed to acquire Merrill Lynch in a hurried deal almost exactly one year ago at the height of the financial crisis, just as Lehman Brothers  was about to file for bankruptcy. It was later revealed that Merrill, with the knowledge of Bank of America executives, paid Merrill employees $3.6 billion in bonuses just before the deal closed at the beginning of this year.

 

BofA had settled a separate investigation last month into disclosures about the Merrill bonuses with the Securities and Exchange Commission, but on Monday a federal judge threw out that $33 million settlement saying it "cannot remotely be called fair" and needlessly penalized BofA shareholders. The judge ordered the case to go to trial Feb. 1.

 

Merrill wound up paying the bonuses for 2008 despite losing $27.6 billion that year, a record for the firm. Those losses affected the bottom line at Bank of America, one of the largest recipients of U.S. government bailout funds.