MarketView for July 16

The three major equity indexes rallied more than 2 percent on Wednesday, powered by the best day in two decades for some major banks as unexpectedly strong results from Wells Fargo eased somewhat the Street’s concern over the credit crisis spiraling out of control. At the same time, a $4 drop in oil prices added more fuel to the rally, offsetting a report by the Labor Department indicating that consumer prices in June rose by the most since the aftermath of Hurricane Katrina in September 2005. The three indexes had their largest single-day percentage gain since April 1.

 

Wells Fargo, the fifth-largest U.S. bank and a large mortgage lender, also raised its dividend at a time when competitors are cutting them. That allayed some concerns regarding the financial sector just days after IndyMac collapsed in one of the largest bank failures in U.S. history. At the same time, shares of Freddie Mac and Fannie Mae, which had lost over 60 percent of their value since the beginning of the month, were swept up in the broad rally.

 

Adding to the gains of the NASDAQ were shares of Altera, which were up $2.33, or 12.13 percent to close at $21.54 on news the chip maker's second-quarter revenue came in better than Wall Street had been expecting.

 

U.S. crude prices for August delivery fell $4.14 to settle at $134.60 per barrel, a slump of over $10 since Monday's close, hurting shares of energy companies such as Chevron, down 3.4 percent at $86.39, and Exxon Mobil, down 1.7 percent at $80.81.

 

Shares of retailers also gained because any reduction in energy costs would ease the strain on consumers, who have been struggling with high gasoline prices. Shares of Amazon.com climbed $4.81, or 7.18 percent, to close at $71.84.

 

In the fixed income markets, the 10-year Treasury note traded a full point lower in price for a yield of 3.95 percent from 3.83 percent late on Tuesday. Two-year notes were trading 4/32 lower in price for a yield of 2.44 percent from 2.37 percent.

 

Consumer Prices Skyward In June

 

The Labor Department reported on Wednesday that consumer prices rose sharply during the month of June at the second fastest pace in 26 years with two-thirds of the increase resulting from rising energy prices. According to the Department, its consumer price index rose 1.1 percent last month, a number that was higher than had been previously anticipated. Energy prices were up 6.6 percent, reflecting the large gains for gasoline, home heating oil and natural gas.

 

The rise in prices cut deeply into consumers' earning power with average weekly wages, after adjusting for inflation, falling by 0.9 percent in June, the largest monthly decline since 1984.

 

The 1.1 percent June price increase was the second largest monthly advance in the past 26 years, surpassed only by a 1.3 percent gain in September 2005 from a jolt to energy costs after Hurricane Katrina. The report on retail inflation followed similarly grim news on Tuesday that wholesale prices had shot up by 1.8 percent in June.

 

Over the past 12 months, consumer inflation is up by 5 percent, the largest year-over-year gain since a similar 5 percent rise in May 1991. Food prices also showed a large increase in June, rising by 0.7 percent, more than double the 0.3 percent increase of May. Vegetable prices shot up by 6.1 percent, the biggest increase in nearly three years.

 

Core inflation, which excludes energy and food, showed rising pressures too with an increase of 0.3 percent in June, up from a 0.2 percent gain in May and the biggest one-month rise since January. This increase reflected a 4.5 percent jump in airline ticket prices, the biggest one-month rise for airline fares since March 2000.

 

Crude Prices Tumble For The Second Day

 

The price of crude oil dropped sharply for a second day on Wednesday after a government report showed a surprise increase in inventories and a continuing drop in demand. The decline in prices, which marked the largest two-day loss in percentage terms since January 2007. Domestic crude futures settled down $4.14 at $134.60 per barrel, bringing oil close to $13 below last week's all-time peak. London Brent crude settled down $2.56 per barrel at $136.

 

Wednesday's decline came after the Energy Information Administration reported crude inventories rose by 3.0 million barrels last week, alongside builds in gasoline and distillate stocks. The widely watched government report also showed the demand for crude products running about two percent below year-ago levels, another sign that soaring prices are cutting into consumer demand for fuel.

 

Adding to pressure on oil prices, the United States is planning to send an envoy to talks this weekend between Iran and major powers over Tehran's nuclear program. Washington had indicated previously it would not be involved in any pre-negotiations with Iran unless it gave up nuclear enrichment.

 

Meanwhile, Saudi Arabia wants to see lower oil prices, Saudi King Abdullah said in an interview with an Italian newspaper. "When the price of oil hovered around $100 a barrel, we were already unhappy. Imagine what we feel now, when there is talk of $200," he said.

 

Oil's six-year rally has been due in part to ballooning demand from developing economies such as China and India.

 

Fed Minutes Show Great Concern Over Inflation

 

The minutes from the most recent meeting of the Federal Reserve’s Open Market Committee indicated that there was considerable concern over rising inflation. According to documents, released Wednesday, from the June 24-25 session, the Fed was increasingly concerned that rapidly rising energy and food prices could spread inflation through the economy, so they left the Fed's key rate at 2 percent.

 

"With increased upside risks to inflation and inflation expectations, members believed that the next change in the stance of policy could well be an increase," according to the documents. However, with all the economic uncertainty, the timing of any such increase was far from clear.

 

Bernanke, in his most recent economic assessment - delivered to Congress on Tuesday and Wednesday - said the deepening housing crisis, a fresh bout of problems in financial markets and rising unemployment all have added to risks that the economy could lose speed. At the same time, he told lawmakers that inflation has remained high. All of which has reinforced the belief that the Fed will leave rates alone when it meets next on Aug. 5.

 

In his Capitol Hill appearances over the last two days, Bernanke acknowledged that the situation is difficult for Fed policymakers as they try to chart a course of righting the economy and preventing inflation from getting worse. Meanwhile, inflation has consumer prices rising in June at the second fastest pace in 26 years, with two-thirds of the surge blamed on soaring energy prices,.

 

At the June meeting, one member - Richard Fisher, president of the Federal Reserve Bank of Dallas - wanted to increase rates. Fisher, who has a reputation for being extra vigilant on inflation, was the sole dissenter.

 

In the Fed minutes, most other members thought the outlook for both economic activity and for price pressures "remained very uncertain" and thus "the timing and magnitude of future policy actions was quite unclear."

 

Nonetheless, Fed policymakers recognized that "circumstances could change quickly" and that they "might need to respond promptly to incoming information about the evolution of risks."

 

Fisher, at the June meeting, wanted to boost rates because he believed the risk that inflation would fail to moderate had "increased substantially" between the Fed's meetings in April and June.

 

He was especially concerned about changes in the behavior of businesses as more raised prices of their goods to cover their higher costs and protect their profit margins. The government on Tuesday reported that wholesale prices - prices of goods before they reach store shelves - had jumped 1.8 percent in June.

 

As part of the Fed's June session, policymakers discussed the financial activities and conditions of big Wall Street firms, the minutes revealed.

 

In unprecedented action in March, the Fed agreed to temporarily open its emergency lending facility to investment firms, a privilege that commercial banks have had for years. The Fed also set up another facility where investment firms can exchange on a short-term basis certain mortgage-backed securities and bonds secured by federally guaranteed student loans for super-safe Treasury securities.

 

Fed policymakers talked about extending both programs for investment firms past year end given "continuing significant strains in financial markets," the minutes said.

 

Longer-run issues also were discussed including tightening supervision of investment firms and possible measures to strengthen the functioning of financial markets, and thus, financial stability. No details were provided.

 

Wells Fargo Increases Dividend Despite Lower Earnings

 

Wells Fargo gave reported lower earnings on Wednesday but the number was not as bad as had been anticipated by the Street. At the same time, the bank announced that it was raising  its quarterly dividend by 10 percent.

 

Wells Fargo's second-quarter profit fell 22 percent as more customers at the nation's fifth-largest bank failed to pay back their loans. But it raised its dividend to 34 cents from 31 cents, at a time when many other financial institutions are slashing theirs to preserve capital.

 

Wells Fargo & Co. earned $1.75 billion, or 53 cents per share, in the April to June period, down from $2.28 billion, or 67 cents per share, in the same timeframe last year. Wells Fargo has now chalked up three straight quarters of profit declines. But the bank has been weathering one of the nation's worst credit crises much better than most of its peers, in part because it had less exposure to the subprime mortgages whose failures have undermined the financial sector.

 

The bank took a provision for credit losses of $3 billion. That provision included total charge-offs of $1.5 billion, and an increase in reserves for future losses of $1.5 billion. Wells Fargo's total allowance for credit losses now stands at $7.52 billion, up from $6.01 billion at the end of the first quarter.

 

But revenue soared 16 percent to a record $11.5 billion, on strength in the bank's deposits, mortgage banking, credit card, and wealth management businesses.

 

"We were able to lend more to current customers where we believed it was prudent and properly priced," CEO John Stumpf said a statement. He added that the company gained more business and customers through acquisitions.

 

The mortgage lending climate remains tough, but Wells Fargo managed to keep total retail mortgage originations at $31 billion, the same as last year, despite tightening its pricing and underwriting standards. The San Francisco-based company's stock is down about 42 percent over the past year.