MarketView for September 6

 

 

Summary

 

Stocks closed at multi-year highs on Thursday, with the S&P 500 ending at its highest level since before the collapse of Lehman Brothers the result of an announced new European bond-buying program aimed at stemming the region's debt crisis. Sentiment also increased as a result of stronger-than-expected data on the services sector and labor market, which was especially notable ahead of Friday's non-farm August payrolls report.

 

The rally was broad, the Dow Jones Industrial Average chalking up its largestg daily gain in two months, while the Nasdaq advanced to its highest point since 2000.

 

Tech shares helped lift the Nasdaq in its best daily performance since July 27. SanDisk rose 8.4 percent to close at $44.01, while Micron Technology added 7.8 percent to close at $6.68. Aiding the Dow was Walt Disney, up 2.1 percent to an all-time closing high of $51.86.

 

ECB President Mario Draghi, backing up his July pledge to do whatever it takes to preserve the euro, said the central bank's plan for potentially unlimited bond-buying would address bond market distortions and "unfounded" fears of investors about the survival of the euro.

 

Companies added workers in August at the fastest rate in five months, according to the better-than-expected ADP report, while a gauge of employment in the service sector also improved more than had been anticipated. New weekly claims for jobless benefits fell to the lowest level in a month.

 

Even with Thursday's encouraging numbers, it is expected that the payroll report will show only modest hiring, at 125,000 new jobs, and the unemployment rate holding steady at 8.3 percent. Equities have rallied in recent months on growing expectations for ECB action. The S&P is up about 8 percent since the start of July.

 

The ECB's program, which Germany's Bundesbank is known to have opposed, would focus on bonds maturing within three years and was strictly within the ECB's mandate. Draghi said only one member of the ECB Governing Council had dissented.

 

The ECB also announced that it will keep its main interest rate at a record low 0.75 percent, holding fire after a pick-up in inflation last month offset pressure to breathe life into the flagging euro zone economy by easing borrowing costs.

 

In corporate news, Supervalu indicated it would close about five dozen stores as it works to turn around its grocery business, which lag Kroger and Wal-Mart. Supervalu shares rose 3.5 percent to end the day at $2.36.

 

Realty Income plans to acquire American Realty Capital Trust for about $1.93 billion as it looks to diversify its portfolio outside the retail industry. Shares of Realty Income fell 0.6 percent to $42.21 and Capital Trust rose 2 percent to $12.20.

 

Volume was stronger than in recent sessions, with about 6.98 billion shares changing hands on the three major equity exchanges. However, the number remained below last year's daily average of 7.84 billion shares.

 

Economic Data Perks Up

 

Companies added personnel in August at the fastest clip in five months and a gauge of employment in the service sector also improved, upbeat signals for a struggling labor market. Another report on Thursday showed new claims for jobless benefits fell last week to the lowest level in a month.

 

The data is the latest to hint the U.S. economy is gaining a bit of steam, and it raised chances the government's more comprehensive jobs report on Friday could be stronger than economists expect. However, the data did not alter the view that economic growth is too weak to make a big dent in the still-high unemployment rate, keeping alive chances the Federal Reserve could launch a new bond buying program as soon as next week.

 

In a sign that report might bring relatively good news, payrolls processor ADP said firms expanded by 201,000 workers last month, the most since March and well above economists' expectations. Nonetheless, the word on the Street is that the government's report will show only modest hiring, with nonfarm payrolls expected to rise 125,000. The unemployment rate is seen holding at 8.3 percent.

 

Housing and retail sales data also have suggested economic growth picked up early in the third quarter after clocking a 1.7 percent annual growth rate between April and June. However, business spending is weakening and inflation is slowing.

 

While the ADP data is often used to fine-tune forecasts for the government's payrolls report, the ADP figures are not always accurate in predicting the outcome. Over the last three months, the report has overstated gains in private payrolls by about 45,000 per month, according to analysts at Credit Suisse. Still, JPMorgan economist Daniel Silver said the ADP figures for August increase the chances the payroll report could be stronger than expected.

 

In a separate report, the Labor Department said initial claims for state unemployment benefits dropped 12,000 last week to a seasonally adjusted 365,000. It was the first decrease and the lowest level since the week ended August 4.

 

The state of the labor market, particularly the unemployment rate, could determine whether the Fed offers additional monetary stimulus at its September 12-13 policy meeting. Fed officials will also weigh another report released on Thursday that showed the pace of growth in the massive U.S. services sector rose in August on a rebound in employment and exports, though a measure of new orders declined.

 

The Institute for Supply Management said its services index jumped to 53.7 last month from 52.6 in July, as service sector employment hit its highest level since April. A reading above 50 indicates expansion in the sector. A separate ISM gauge of business in the manufacturing sector earlier this week showed contraction in August for the third straight month.

 

In another positive sign for the labor market, the number of planned layoffs fell for a third straight month in August, hitting a 20-month low, according to a report from consultants Challenger, Gray & Christmas, Inc.

 

Draghi Backs Up His Pledge

 

The European Central Bank agreed on Thursday to launch a new and potentially unlimited bond-buying program to lower struggling euro zone countries' borrowing costs and draw a line under the debt crisis. Seeking to back up his July pledge to do whatever it takes to preserve the euro, ECB President Mario Draghi said the new plan, aimed at the secondary market, would address bond market distortions and "unfounded" fears of investors about the survival of the euro.

 

The scheme, to which Germany's Bundesbank reiterated its opposition, would focus on bonds maturing within three years and was strictly within the ECB's mandate, Draghi said. Only one member of the ECB Governing Council had dissented, he said.

 

"Under appropriate conditions, we will have a fully effective backstop to prevent potentially destructive scenarios," Draghi told a news conference after the central bank's monthly meeting on Thursday.

 

"No ex-ante quantitative limits are set on the size of outright monetary transactions," he said, using the formal term for ECB bond-buying programs.

 

Wall Street waited anxiously to hear how decisively the ECB would act to help bring down the borrowing costs of Spain and Italy, after disagreements among policymakers on the plan were played out in public last week.

 

Draghi's statement at least met expectations. With the bond-buying plan the focus of Thursday's meeting, the ECB kept interest rates on hold, leaving its main rate unchanged at 0.75 percent.

 

Pressure on Draghi intensified after an unsubstantiated German newspaper report last week that Bundesbank chief Jens Weidmann had considered resigning over his opposition to bond-buying, although several sources say he has made no such threat and believes in staying at the table to argue his case. Draghi succeeded in securing overwhelming support on the Governing Council for the plan despite Weidmann's opposition.

 

"In the most recent discussions, as before, Bundesbank President Jens Weidmann reiterated his frequently substantiated critical stance towards the purchase of government bonds," the German central bank said in a statement. "He regards such purchases as being tantamount to financing governments by printing banknotes," it added.

 

Other ECB policymakers saw a greater urgency to help Spain and Italy and prevent the euro zone crisis from deepening. Draghi said the ECB would only help countries that signed up to and implemented strict policy conditions, with the euro zone's rescue fund also buying their bonds, and preferably with the IMF involved in designing and monitoring the conditions.

 

Renewed ECB intervention in the euro zone's bond markets is crucial to give various sovereign governments time to come up with a longer-term response to the bloc's debt crisis, which began in early 2010.

 

Spanish and Italian government bond yields have fallen significantly since Draghi said on August 2 that the ECB would buy bonds issued by Madrid and Rome. They fell further after he fleshed out his plan to intervene on Thursday. The ECB would not target specific bond yields, Draghi said.

 

ECB debt purchases - which would succeed the bank's Securities Markets Program that has been dormant since March - would be suspended if countries did not comply with the terms. And with Germany's constitutional court not due to rule on the new ESM rescue fund until next week, there was no prospect of the ECB intervening immediately.

 

Highlighting the euro zone's economic predicament, Draghi said growth in the region would recover only gradually. Fresh ECB staff projections pointed to the economy contracting this year by between 0.2 and 0.6 percentage points.

 

One downside for policymakers may be an increase in commodity prices, which were buoyed by the ECB announcement. Brent crude added $1.50 on Thursday raising the price to $114.59 a barrel and wheat rose 8 cents a bushel to $8.54.

 

Draghi also said the ECB was prepared to waive its senior creditor status on bonds it purchased - meaning it would be treated equally with private creditors in case of default. The central bank hopes that by removing private investors' concern about being paid back last in the event of a sovereign default, they will not head for the exits if the ECB intervenes and buys bonds.

 

The ECB assumed preferred creditor status in Greece's debt restructuring earlier this year, leaving private investors to suffer a write down in the value of their Greek sovereign bond holdings while the paper it held was untouched.

 

Draghi also said all bond purchases would be "sterilized" by taking in an equivalent amount in deposits from banks to avoid any risk of inflation. The ECB's insistence on countries agreeing to strict conditions before it buys their bonds fed doubts about whether Spain would seek help, and led to disappointment with the new ECB bond-buying program among some investors.

 

Draghi said bond buys would be tied to "strict and effective conditionality" and focused on debt maturities up to 3 years.

 

"The involvement of the IMF shall be sought also for the design of country-specific conditionality and the monitoring of such programs," he said, adding that now it was up to the governments of the euro zone to act.

 

International Monetary Fund chief Christine Lagarde welcomed the new ECB bond-buying program and said the global lender was ready to cooperate "within our frameworks".

 

Spanish Prime Minister Mariano Rajoy and German Chancellor Angela Merkel said they did not discuss conditions for aid for Spain, despite expectations Rajoy would seek Germany's support for a bailout in a bilateral meeting in Madrid on Thursday.