MarketView for May 14

MarketView

 

Events defining the day's trading activity on Wall Street

 

Lauren Rudd

 

Wednesday, May 14, 2008

 

 

 

 

Summary

 

Wall Street appeared to take the Government’s release on Wednesday of its latest consumer price index at its face value showing of a modest rise in consumer prices for April pointed to a cooling of inflationary pressures. Before the opening bell, the Labor Department reported that the overall CPI for April rose 0.2 percent. Core CPI, which excludes the volatile food and energy sectors, gained 0.1 percent in April.

 

At the same time, Macy's and Freddie Mac posted reassuring quarterly results. Macy's stood by the profit forecast for its department stores despite expectations of an economic slowdown. Freddie Mac, seen as a housing market barometer, brightened the Street’s mood by raising its growth outlook and unveiling a plan to raise new capital to support the beleaguered home loan market. Macy's ended the day up $0.87, or 3.62 percent, to close at $24.93. Freddie Mac ended the day up $2.29, or 9.17 percent, to close at $27.25.

 

Shares of retailers and home builders, which benefit from steady to lower borrowing costs, advanced. The S&P retail index rose 1.6 percent, The Dow Jones home construction Index ended the day up 2.7 percent. D.R. Horton, the largest U.S. home builder, saw its share price end the day up $0.43, or 2.88 percent, to close at $15.36.

 

However, the market retreated somewhat late in the trading day leaving the NASDAQ just barely above water. Shares of Apple slid downward as investors took some profits off the table after two days of solid gains in the price of the stock. Apple ended the day down $3.70, or 1.95 percent, to close at $186.26. The stock of video game publisher Electronic Arts fell $1.79, or 3.28 percent, to close at $52.78. Late Tuesday, Electronic Arts issued an annual profit outlook that fell short of Wall Street forecasts.

 

Trading was extremely light on the New York Stock Exchange, with about 1.19 billion shares changing hands, well below last year's estimated daily average of roughly 1.90 billion, and the second-lowest level of volume so far this year. NYSE trading volume hit its low for the year on Monday, when 1.05 billion shares traded hands.

 

The Chicago Board Options Exchange Volatility Index, which is Wall Street's fear barometer, slid at one point to its lowest level since October 2007 as stocks rallied. The VIX was down 1.8 percent at the close.

 

Energy companies' stocks also fell after U.S. crude slid $1.58 to settle at $124.22 per barrel, a day after it approached a record just 2 cents shy of $127. The S&P energy index ended down 0.9 percent.

 

Shares of Deere & ranked among the worst performers on the S&P 500 after the farm and construction machinery company warned that higher material costs and possible shortages of components will affect results

 

Other stocks on the NASDAQ that performed poorly on Wednesday were Whole Foods Market down $4.68, or 13.91 percent, to close at $28.96 after it posted a lower quarterly net profit that missed analysts' estimates.

 

Government Reports Lower Than Expected CPI

 

Before the opening bell, the Labor Department reported that the overall consumer price index (CPI) for April rose 0.2 percent. The core CPI, which excludes volatile food and energy costs, was up a meager 0.1 percent in April. April energy prices were unchanged after a 1.9 percent rise in March, as gasoline prices dropped 2 percent, the Labor Department said on Wednesday.

 

The bottom line is that consumer prices were tamer than expected in April on a lower energy price reading, giving the inflation-wary Federal Reserve a little breathing space as it seeks to fortify an anemic economy.

 

The resulting news that price pressures might be more benign than had been previously believed helped to send stocks higher, while bonds prices fell. The dollar was higher. Nonetheless, skyrocketing prices for energy and food have sent inflation warning lights flashing, and some Fed officials have warned of the dangers of leaving price increases unheeded for too long.

 

The government said the decline was due in part to seasonal adjustments. Gas prices normally rise in the first five months of the year, with the biggest increases occurring in March and April, the Labor Department said. When not adjusted for seasonal swings, gasoline prices rose 5.6 percent in March. In the meantime, energy prices rose 15.9 percent from the same time a year ago.

 

Other reports have pointed to higher energy prices in the pipeline for U.S. consumers. Crude oil prices hit a record high this week, likely pushing gasoline prices even higher from already record levels. In fresh evidence of persistent price pressures, the Labor Department said food prices rose 0.9 percent in the month, the sharpest advance since January 1990.

 

Nonetheless, year-over-year consumer prices rose more modestly than forecast. Overall prices advanced 3.9 percent from April a year ago and core prices were up 2.3 percent. Analysts were expecting a 4.0 percent advance in overall prices and a 2.4 percent gain in core prices.

 

Fed Is Facing a Predicament

 

Pimco's Mohamed El-Erian wrote to clients on Wednesday that the Federal Reserve's monetary policy may not help the economy to escape a severe recession caused by falling home values and rapidly rising consumer prices. According to the co-head of the world's largest bond fund, policy-makers "do not have good policy tools to deal with the destabilizing combination of asset price deflation and goods inflation."

 

El-Erian added that the Fed is "particularly challenged" because of its dual mandate that calls for maintaining solid employment and low inflation. "This comes at a time when regulators are trying to play catch-up with a financial system that has morphed into something that does not fit neatly into existing frameworks and mindsets."

 

"Inflationary pressures will continue to increase over the secular horizon," El-Erian, who helps oversee $750 billion in assets, wrote. As commodity prices continue to rise because of higher demand accompanied by higher wages in emerging economies, "especially from the perspective of the U.S., look for inflation to become more sensitive to foreign factors," he wrote.

 

That is not only issue facing the U.S. economy. The 10-month-old credit crisis, which has already forced banks to write off hundreds of billions of dollars for bad investments in riskier assets and recapitalize balance sheets, will now force households and consumers to scale back and save, he expects.

 

"The world has been going through a sequential secular recapitalization process," over more than a decade, he wrote.

 

This happened during the Asian, Russian and Latin American financial market crises between 1997 and 2002, in the United States with troubles at Enron and WorldCom in 2002-2003 acting as catalysts and now with banks.

 

"The U.S. household will inevitably be the next part of this process in the period ahead," he said, characterizing consumers as being overwhelmed by "debt exhaustion."

 

The major concern El-Erian has is that consumers have yet to recapitalize their balance sheet notwithstanding mounting pressure from sluggish employment, high energy and food prices, less ample access to credit and, most importantly, a housing price correction "that is still far from complete."

 

"The longer the delay out of Washington, D.C., in implementing fiscal measures to stabilize the housing sector, the greater the risk that the higher collateral damage on Main Street will induce a politically driven regulatory over-reaction with unpredictable economic outcomes," he added.

 

El-Erian also said the Fed's move to let securities firms borrow directly through its discount window will likely evolve into a permanent facility.

 

Investment banks, forced to unwind years of huge leverage, will seek ways to secure a deposit base that can reduce their cost of funding, including through merger and acquisition, El-Erian added. "This process of deleveraging and, if done properly, de-risking will have a number of implications for investors," El-Erian said.

 

"And by creating an initial vacuum in the more highly leveraged space vacated by investment banks, it will entice new entrants, some of which will come from the current generation of private equity and hedge funds."

 

Higher Earnings at Deere

 

Deere & Co reported higher quarterly earnings on Wednesday as rising prices for agricultural commodities raised the global demand for its equipment. Unfortunately, the company's forecast for the remaining part of its fiscal year disappointed Wall Street and its shares paid the price.

 

Deere, the world's largest maker of tractors and combines, said raw material prices, particularly for steel, were "racing ahead ... well beyond what we anticipated" when the company set its own prices for the year. It said this would be a drag on results in the current quarter.

The company also said its material and freight costs would be $400 million to $500 million higher this year than in 2007, double the price inflation it originally anticipated.

 

Deere indicated that its earnings increased 22 percent to $763.5 million, or $1.74 per share, in its fiscal second quarter ended April 30, as compared to $623.6 million, or $1.36 a share, a year earlier. Revenues increased 18 percent to $8.1 billion, lifted by a 46 percent jump in equipment sales outside the United States and Canada.

 

Deere warned that "escalating raw material costs and the tight supplies of various parts and components, including tires, are expected to have an impact on operations for the balance of the year." As a result, the company said it expects net profit of $550 million to $575 million for the third quarter and $2.2 billion for the full year.

 

Deere’s shares ended the regular trading day down $8.94, or 9.91 percent, to close at $81.25.