MarketView for September 9

 

 

Summary  

 

Share prices slid more than 2 percent on Friday after the top German official at the European Central Bank resigned in protest of the bank's bond-buying program, which has been a major tool in fighting the region's debt crisis. The resignation of Juergen Stark from the ECB throws into question policymakers' ability to deal with Europe's debt crisis, a problem that could engulf a world economy already teetering on the brink of recession.

 

The level of fear was further heightened by a 12 percent increase in the market's main measure of expected turbulence, the VIX volatility index. The VIX neared 40, close to its highest level this year, as it marked its largest rise in three weeks.

 

Doubts about President Barack Obama's $447 billion stimulus proposal added to the negative sentiment, with investors unconvinced his administration has the tools to revive the flagging U.S. economy.

 

The sell-off was broad and on solid volume. All 10 S&P sectors were in the red and more than 80 percent of stocks listed on the New York Stock Exchange fell. The S&P 500 ended the week 1.7 percent lower and is now down 8.2 percent this year. There were 8.7 billion shares traded on the three major equity exchanges, pushing the volume to above the exchanges' 20-day moving average. Unnerving traders further were unconfirmed terrorism threats against New York City and Washington just ahead of the 10th anniversary of the September 11 attacks.

 

The ECB has been buying up sovereign bonds to help hold down borrowing costs in some debt-strapped euro zone members, and the program has been considered critical to arresting market contagion. The resignation of Stark, who will step down by the end of the year, may deepen the gulf between the ECB and German guardians of central banking orthodoxy.

 

At a meeting of finance chiefs from the Group of Seven wealthy nations being held in France, Treasury Secretary Timothy Geithner on Friday pressed Europe's strongest economies to give "unequivocal" financial support to weaker euro zone states to overcome a debt crisis that threatens the world economy.

 

Shares of some large corporations fell after Obama's speech did not address proposals to allow large, multinational companies to repatriate an estimated $1.5 trillion of overseas profits to the United States, at a reduced tax rate. Among the companies that would benefit from such a move, Xerox fell 5.5 percent to $7.41 and Hewlett Packard fell 5.1 percent to $22.65.

 

Bank of America is considering cutting as many as 40,000 jobs during the first wave of its restructuring program, according to The Wall Street Journal., The Journal said it was citing people familiar with the plans. The shares slid 3.1 percent to $6.98.

 

McDonald's fell 4.1 percent to $84.02. The behemoth hamburger chain reported a lower-than-expected rise in worldwide August sales at established restaurants on a steep drop in Japan and a lull in new product launches in the United States.

 

Treasury Yields at 60-Year Low

 

Treasury debt prices rose on Friday, taking benchmark yields to the lowest in at least 60 years as investors looked for a safe haven on revived worries a European debt crisis could have a significant global impact.

 

Stocks fell sharply on Friday thereby increasing the demand for what is ultimately the safest investment, U.S. government debt, with few investors looking to go into the weekend short Treasuries due to the uncertainty surrounding the European debt crisis.

 

The worries over Europe were sparked by the planned resignation of European Central Bank (ECB) Executive Board Member Juergen Stark. The ECB confirmed that Stark was resigning due to a conflict over the central bank's bond buying program.

 

A debt swap meant to help Greece avoid default and win time to repair its tattered public finances hung in the balance Friday, with expectations of take-up by private creditors slipping amid fierce European pressure on Athens.

 

Benchmark 10-year notes were trading 19/32 higher in price to yield 1.91 percent, down from 1.98 percent late Thursday. Benchmark yields touched 1.896 percent, marking the lowest since at least World War II.

 

The drop in yields stirred some concerns about Treasury debt auctions next week. The Treasury will sell $32 billion of three-year notes, $21 billion of reopened 10-year notes and $13 billion of reopened 30-year bonds next Monday, Tuesday and Wednesday.

 

There are now some who feel that the Treasury may have a difficult time successfully auctioning the debt with yields at current low levels. Meanwhile, longer-dated Treasuries have found support in recent days on expectations the Fed could announce a bond purchase program, which the markets have dubbed Operation Twist, at the conclusion of its policy meeting September 20-21. Thirty-year Treasury bonds were trading 1-10/32 higher in price to yield 3.25 percent, down from 3.31 percent late Thursday.

 

Economists Rate Obama Jobs Plan

 

Economists have been looking over the $447 billion job-creation package President Obama proposed to Congress Thursday night. Predictably, the reaction was mixed, with most economists giving it thumbs up, and while conservatives turned thumbs down.

 

Here are a few of the economists' opinions:

 

UP - Mark Zandi, chief economist at Moody's Analytics and former adviser to Republican presidential candidate John McCain. He projects the Obama plan would add 2 percentage points to economic growth in 2012, add nearly 2 million jobs and reduce the unemployment rate by 1 percentage point. "There should be nothing controversial about this piece of legislation. Everything in here is the kind of proposal that's been supported by both Democrats and Republicans," Zandi said.

 

DOWN - Peter Morici, professor at the Robert H. Smith School of Business at the University of Maryland. "The president proposes a package that will do little to boost domestic demand, and that will permanently hamstring the economy with higher taxes and mindless bureaucracy. [He] proposes spending an additional $140 billion on roads, schools and other infrastructure, but wants Congress to pay for this with cuts in spending on Medicare, Medicaid and other programs. How will adding construction workers to the national payroll, while laying off health care workers, boost employment?"

 

UP - Paul Krugman, economist and New York Times columnist. "I was favorably surprised by the new Obama jobs plan, which is significantly bolder and better than I expected. It's not nearly as bold as the plan I'd want in an ideal world. But if it actually became law, it would probably make a significant dent in unemployment."

 

DOWN - James Sherk, senior policy analyst in labor economics for the Heritage Foundation, a conservative research group. In 2009, "the stimulus bill extended unemployment benefits, Congress has kept them in place several times since then, and the federal government has spent over $300 billion on unemployment benefits since Obama took office. It hasn't stimulated the economy before. It's not going to stimulate it now."

 

UP - Heidi Shierholz, labor economist with the Economic Policy Institute, a liberal research group. "President Obama's jobs plan, if implemented, would boost employment by around 4.3 million jobs (yes, 1.6 million of those jobs would come from continuing temporary policies that are already in place and supporting the economy today, but the new initiatives alone would generate 2.6 million jobs). ... This plan is a vital step in the direction of providing a solution that matches the scale of the ongoing crisis."

 

UP-ish - Gavan Nolan, director of credit research for Markit, a London-based financial information services firm. "Some of the [president's] measures - if they are implemented - should have a material impact on unemployment."

 

Economists Opinions Overall Support Jobs Plan

 

That's the assessment from economists, who have offered mainly positive reviews of President Barack Obama's $447 billion plan to stimulate job creation. Some predict it would put hundreds of thousands of people back to work next year, mainly because a Social Security tax cut for workers would be deepened and extended to small businesses.

 

"Payroll tax cuts are very powerful," says Allen Sinai, chief economist of Decision Economics. "They provide a boost to direct income and, in turn, spending, which is important to growth."

 

Mark Zandi, chief economist at Moody's Analytics, estimates that the president's plan would boost economic growth by 2 percentage points, add 2 million jobs and reduce unemployment by a full percentage point next year compared with existing law.

 

The heart of Obama's plan is an expansion of the Social Security tax cut, which took effect this year and is scheduled to expire by year's end. The tax cut now applies only to workers; it reduces their Social Security tax from 6.2 percent to 4.2 percent. Employers still pay the 6.2 percent rate.

 

Obama would renew the tax cut for a year and deepen it: He would drop workers' Social Security tax to 3.1 percent. Under his bigger tax cut, an extra $1,550 would go to taxpayers earning $50,000 a year. The Social Security tax is imposed on the first $106,800 of taxable income. That means the maximum savings would be about $3,300 for an individual and $6,600 for a couple.

 

Obama would also halve Social Security taxes for businesses on the first $5 million of their payroll. The White House says 98 percent of businesses have payrolls below that threshold.

 

Zandi calls this a "creative" way to help small companies, which have struggled more than larger ones to recover from the Great Recession of 2007-2009. During recoveries, small businesses normally drive job creation. "Something like this is much needed" for an economy grappling with 9.1 percent unemployment, Zandi says. "The economy is on the edge of recession."

 

Susan Wachter, a finance professor at the University of Pennsylvania's Wharton School, believes that the Social Security tax cuts alone would add 1 percentage point to economic growth and create 1 million jobs next year.

 

Michael Hanson, a senior economist at Bank of America Merrill Lynch and a former Federal Reserve economist, predicts similar benefits. He thinks the additional jobs would lower the unemployment rate by nearly half a percentage point in 2012. Such improvement, while just a start, could put the economy back on a "recovery path," Hanson says. "You'd see a notable reduction in the likelihood that we would slip into another recession," he says.

 

The president's plan takes a shot at long-term unemployment: Companies would get a $4,000 tax break for hiring people who have been unemployed for more than six months. As of August, the government says, 43 percent of unemployed Americans have been out of work for six months or more.

 

The plan would extend emergency unemployment benefits; ramp up spending on public works projects; and provide aid to keep state and local governments from laying off teachers. Obama would pay for his program with future budget cuts.

 

Some economists caution, though, that some factors might blunt the impact of Obama's enlarged Social Security tax cut. For one thing, the tax cut would deliver only a temporary boost. It would expire at the end of 2012. Most economists foresee unemployment remaining high well after next year.

 

The White House plan would also extend emergency unemployment benefits for another year. Economists note that unemployment checks put money in the hands of people who are most likely to spend it immediately.

 

That spending tends to boost demand for goods and services and give companies more reason to hire. The forecasting firm Macroeconomic Advisers has estimated that an additional year of emergency unemployment benefits would support 200,000 jobs in 2012.

 

Obama also wants $30 billion to modernize schools, $50 billion for road and bridge projects and a bank that would finance more public works projects. The president's plan will likely face resistance in Congress. Republicans have opposed further spending and have pushed to reduce the budget and shrink the government.

 

Still, the Wharton School's Wachter calls Obama's plan a serious proposal that should be politically acceptable "across the board."

 

Menzie Chinn, an economist at the University of Wisconsin, would favor an even bigger jobs package for an economy that grew at an annual rate of just 0.7 percent in the first six months of the year and didn't add jobs in August.  He says he fears that Obama's plan merely makes up for the expiration of the president's earlier $862 billion economic stimulus plan.

 

Even so, Chinn says, the measures Obama proposed Thursday night "might prevent the economy from dropping below stall speed" — at which point it would be vulnerable to another recession.

 

McDonald’s Reports Lower Sales

 

McDonald's reported a lower-than-expected rise in worldwide August sales at established restaurants on a steep drop in Japan and a lull in new product launches in the United States. The world's largest hamburger chain, whose shares fell 4.4 percent on Friday, said sales at restaurants open at least 13 months rose 3.5 percent globally.

 

Same-restaurant sales rose 3.9 percent in the United States, just shy of analysts' 4.0 percent expectation. In Europe -- McDonald's largest market -- the company reported an increase of 2.7 percent, missing analysts' estimate of a 4.7 percent increase.

 

To help increase sales, McDonald's has relied on new products like breakfast oatmeal and a beverage overhaul that has included the introduction of fruit smoothies and other drinks. In August 2010, demand for smoothies helped drive up U.S. same-restaurant sales by 4.6 percent. 

 

McDonald's sales and profits for months have been the envy of the global fast-food industry, which means that the company is punished when results meet or miss expectations. The company has been outpacing rivals like Wendy's, Burger King and Yum Brands KFC by attracting a broader range of diners than fast-food's typical young adult males.

 

McDonald's reported a 0.3 percent decline in Asia/Pacific, Middle East and Africa, while Wall Street had forecast a rise of 3.5 percent. Asia was dragged down by a sharp decline in comparable sales in Japan, where consumers are still adjusting to the aftermath of the March earthquake and tsunami.

 

Earlier this week, Red Lobster and Olive Garden parent Darden Restaurants Inc (DRI.N) warned that Hurricane Irene had dented its quarterly earnings by 2 cents per share. However, Irene had only minimal impact on McDonald's sales, a company spokeswoman said. McDonald's shares were down 4.4 percent at $84.71.