MarketView for September 22

 

 

Summary  

 

The financial markets skidded lower on Thursday, extending a selloff to four days, as a failure to arrest global economic stagnation sent markets spiraling downward. Wall Street's "fear gauge," the CBOE Volatility Index, was up 12 percent, giving the index its largest 2-day percentage spike in a month as investors protected against more losses to come.

 

Energy and materials shares were among the hardest hit areas on worries of slowing worldwide demand. Signs of a slowdown in China fed those fears.  The weak data from China followed an unsettling outlook regarding the economy from the Federal Reserve on Wednesday. China's once-booming manufacturing sector contracted for a third consecutive month, while the euro zone's dominant service sector shrank in September for the first time in two years.

 

The one positive was that the benchmark S&P 500 index held above 1,120 level, a number that is considered a key psychological support level which could trigger more selling if broken.

 

About 13.24 billion shares changed hands on the three major equity exchanges, a level that was well above the daily average of 7.8 billion shares and the high water since August 10.

 

Crude oil futures fell more than 6 percent, the largest one-day percentage decline in six weeks.

Schlumberger closed down 6 percent at 61.22. Freeport-McMoRan closed down 9.7 percent at $32.14.

 

Banks also lost ground with Citigroup ending the day down 6.1 percent at $23.96. The Fed's plan to lower long-term rates will compress margins for banks that borrow at short-term rates and lend at longer-term rates. The declines also came a day after Moody's cut debt ratings on three of the nation’s largest banks.

 

FedEx, considered to be an economic bellwether, fell 8.2 percent to close at $66.58 after the world's second largest package delivery company pared its outlook for the full year.

 

Near the close, traders exchanged about 1.10 million option contracts in the S&P 500 Index as 2.69 puts were in play for each call, according to Trade Alert. That put-to-call ratio was higher than the 22-day moving average of 1.77.

 

The yield on the 10-year Treasury note has fallen to a record low as buying by the Federal Reserve and spooked stock traders increases demand for lower-risk investments.

 

Money also flowed into Treasuries from global stock markets. Shares plunged in Asia and Europe early Thursday as traders digested the Fed's bleak economic outlook. U.S. stocks were down more than 3 percent by late morning.

 

Unemployment Claims Fall

 

The Labor Department reported Thursday morning that unemployment claims fell by 9,000 claims to 423,000 claims during the week ended September 17 although the decline was not enough to dispel worries the economy was dangerously close to falling into a new recession. Excluding one week in early August, first-time claims have held above 400,000 since early April, showing a still troubling pace of layoffs. A Labor Department official said there was no discernible effect from recent storms.

 

While initial claims for state unemployment benefits dipped last week, the trend has moved higher. A closely watched four-week moving average of new claims edged up to 421,000, the highest level since the ended July 16.

 

Leading Economic Indicators Up 0.3 Percent

 

The Conference Board reported on Thursday that its index of leading economic indicators rose 0.3 percent in August, the fourth consecutive increase. Still, the improvement in August wasn't broad-based and mostly stemmed from an improvement in financial conditions, such as low interest rates.

 

"There is growing risk that sustained weak confidence could put downward pressure on demand and business activity, causing the economy to potentially dip into recession," said Ken Goldstein, an economist at the Conference Board. "While the chance of that happening remains below 50-50, the odds have certainly increased in recent months."

 

Only four of the 10 measures that the Conference Board uses to compile its index showed improvement in August. Two were related to financial conditions. Building permits also rose.

 

Without the Federal Reserve's efforts to keep rates low, the index would likely have fallen last month, economists said.

 

Declining factory orders, falling consumer confidence, and rising unemployment benefit applications were among six measures that weakened in August.

 

Recent economic reports suggest the economy is barely growing. Retail sales in August were flat, indicating consumers are holding back on spending. Sharp declines on Wall Street last month, along with the higher level of political bickering over the borrowing limit, sent confidence indexes falling to their lowest levels since the recession. Many economists put the odds of another recession at about one-third.

 

Employers failed to add any jobs in August, and the unemployment rate remained high at 9.1 percent. Applications for unemployment benefits fell last week, the Labor Department said Thursday, but they have ticked up since last month. That's a sign layoffs are rising and jobs are still scarce.

 

The Fed said Wednesday that the economy will likely improve in the coming quarters, but added that there are "significant downside risks" to its outlook. That includes "strains in global financial markets," a reference to Europe's debt crisis.

 

Most economists think growth will pick up some in the second half of the year, to just below 2 percent. That would be an improvement from a pace of only 0.7 percent growth in the first six months of this year. But that's far below the 5 percent rate that most economists say is needed to bring down the unemployment rate.

 

The Fed launched its latest effort to boost growth Wednesday. The central bank said it will try to push long-term interest rates lower and make consumer and business loans cheaper by shifting $400 billion out of short-term Treasury securities and into longer-term bonds. It also said it will reinvest the proceeds from its maturing mortgage-backed securities into new mortgage-backed bonds. That should reduce mortgage rates.

 

Operation Twist May Hurt Pension Plans

 

The Federal Reserve's 'Operation Twist' to bring down bond yields and stimulate the economy is likely to cause pain for the nation's largest pension funds, already struggling with funding shortfalls from the recent stock market decline.

 

Hit both by falling stock prices and falling bond yields, the 100 largest pension plans of public companies have assets covering only 79 percent of their liabilities as of the end of August, down from 86 percent at the end of 2010. Already approaching its all-time low of 70.1 percent in August, 2010, the funding ratio could fall below 60 percent within two years if equities stagnate and rates decline further.

 

Corporate pensions were well funded back in 2007 before the financial crisis hit, but even though the stock market has recouped most of its losses, falling bond yields have prevented the funds from regaining their solid footing.

 

Most private defined benefit plans, which oversee about $2 trillion, are hurt when long-term yields decline because of the way the plans must value future payouts they will make to retirees in coming decades. Lower rates mean the future benefits have a higher present value, thereby increasing the defined benefit funds' liabilities. Pension consultants estimate a 1.0 percent drop in rates increases liabilities by 10 percent to 15 percent.

 

Well-managed pensions are supposed to match the current worth of their assets and liabilities. In essence, a present value calculation estimates how much it would cost to borrow the total future liabilities right now and deducts the cost of the interest.

 

Falling rates also increase the value of any bonds the funds may own but most pension portfolios tilt more toward equities and away from fixed income assets. And bonds they do own tend to be in shorter maturities, which appreciate less when rates fall.

 

If the funds' assets fall short, companies that sponsor the plans for their workers will have to increase their annual contributions by tens of billions of dollars over the next few years, Belt said. And if the companies ultimately fall short, the PBGC's government insurance would be on the hook.

 

On average, companies rated by S&P used a discount rate of 5.34 percent in 2010, down from 5.85 percent in 2009.