Weekly Markets Review 05-24-2010

May 24, 2010

"Washington is doing everything in their capability to destroy US manufacturers… Cap and trade, medical reform, labor rules. What do they want to do? Raise taxes. They're just going to destroy jobs… Jobs are going to be created offshore. They're going to be created in India and China, places where people want the products and where the government welcomes you. They actually do something." –David Farr, CEO, Emerson Electric, 94th largest company in Fortune 500, November 2009
Stocks jumped around like children on a trampoline last week, with the two-hundred day moving coming into question Thursday before bulls stepped in and pushed the markets back into safe territory. Then, the S&P 500 touched its 2010 low on Friday before rebounding. Still plenty to consider. And the volatility is indicative of that sentiment. 15 of the last 19 sessions have seen the Dow Jones Industrial Average move 100 points or more. A very rare occurrence, indeed.
Major market indices finished down. The DJIA lost 4.02%, the S&P 500 declined 4.23%, and the Nasdaq fell 5.02%. Value stocks outperformed growth stocks. And the small cap index dropped 6.44%. The 10-Treasury yield was down 22 basis point on the week, closing at 3.24%.
As risk aversion mounted and investors fled to safer securities, the yield on the 30-year U.S. Treasury bond dropped to its lowest level of the year. The Chicago Board Options SPX Volatility Index, considered Wall Street's fear gauge, rose to a 13-month high.
Recent market turmoil may be, ironically, a sign of increasing stability, as sectors and regions that got way out of line on the upside have come down in value as they reach toward their medians. But, now that we've seen a period of extra-low volatility followed by a period of extra-high volatility, the next period will likely bring more normal volatility.
Stocks were all world leaders on the way up in 2009, and now they are leaders on the way lower. This is a graphic example of the unwinding of the dollar carry trade. Every time the dollar ticks higher in reaction to the decline of the euro, it forces fund managers out of their cheaply funded bets on commodities and commodity-producing countries.
But there's more to it than that, because there's another reason for these declines that is fascinating, frightening and emblematic of what world markets face now: Australia plans to levy a massive 40% tax on mining companies' profits to help defray the cost of all the borrowing the country did to rescue its financial system last year. This tax is expected to severely reduce earnings forecasts for mining giants BHP Billiton (BHP) and Rio Tinto Group (RTP), which make up a large percentage of the Australian stock market's total market cap.
Now the worst part of this is fears that other countries will consider this a great idea and levy such taxes of their own. While that may sound like a good idea to populists, for investors it is beginning to look like "global financial markets suicide," in the words of Charlie Aitken, a commodities analyst at Southern Cross Equities who was interviewed by Bloomberg.
Government intervention in financial markets is having similarly troublesome effects in Europe. The German ban on naked short selling of stocks, bond and credit default swaps this week was a perfect example. It is becoming clear that Germany decided to launch this plan unilaterally without first consulting its partners. German Chancellor Angela Markel was quoted by a newspaper as stating that the action was political rather than economic in nature. She said, according to a report in the London Telegraph, "In some ways it's a battle of the politicians against the markets. I am determined to win. The speculators are our adversaries.''
The Telegraph was quick to observe that this view reflects a misunderstanding of speculation. Speculators do not attack the strong, but the weak and vulnerable. The best way that politicians can shrink the impact of speculators is to enact more credible fiscal and monetary policies.
Meanwhile, the rising tide of populism in the U.S. Congress and state governments is emboldening congressmen to insert new rules in financial reform bills that will have a very material effect on the profits of credit and debit card companies. This is one of those victories that consumers may ultimately wish they hadn't won, as fees may come down but lending will also become more restrictive. If you stop to think about it a moment, at the exact moment that government wants banks to lend, these laws will likely have the opposite effect. And that will impact consumer buying power and so retailers, and possibly employment. Stay tuned…
Equity Markets Review
* The U.S. Senate approved a sweeping overhaul of the financial services sector that would restrict the actions of banks and other financial firms. The measure must now be reconciled with the bill passed by the House of Representatives.
* The U.S. Treasury said May 17 that China increased its holdings of U.S. debt by 2 percent to $895.2 billion, the first increase in six months.
* The Treasury said yesterday it will lose $1.6B on a loan made to Chrysler in early 2009. Chrysler repaid $1.9B of a $4B government loan it received before filing for bankruptcy, and the Treasury hopes to get another $500M out of the restructured company. The government does not intend to boost its stake in Chrysler to compensate for the loss, and may lose another $1.9B on a separate loan made to the firm.
* Nearly a quarter of the 1.2M homeowners offered help through the government's mortgage-modification program have dropped out of the program so far, according to a newly released report. Those who are weeded out of the program often end up worse off than if they had never participated in the first place, having exhausted their savings and delayed taking actions that could have given them fresh starts in more affordable homes.
* Germany's securities market regulator Bafin banned "naked short sales" of certain securities, in particular the government bonds of the 16 countries that use the euro, EU Business reported May 19.
* In a bid to prevent occurrences like the May 6 "Flash Crash," U.S. regulators and stock exchanges plan a six-month pilot program for market wide, stock-specific circuit breakers. The SEC proposes a rule for a five-minute cross-market "time-out" for any stock that moves 10% in the prior five minutes. Also, the SEC and CFTC issued a joint report on the plunge that explores six hypotheses - including stop-loss orders, liquidity mismatches and "stub quotes" for just pennies on some issues - to explain what went wrong.
* The U.S consumer price index (CPI) fell a seasonally adjusted 0.1 percent month-over-month in April due largely to a 1.4 percent decline in energy prices, the Bureau of Labor Statistics reported May 19. The same measure was up 2.2 percent year-over-year. Core CPI, which excludes volatile food and energy prices, did not change month-over-month and increased 0.9 percent year-over-year. U.S. inflation sits at its lowest level in 44 years. This is the latest sign that high unemployment and excess production capacity are holding down wages and prices.
* The Japanese economy grew an annualized real 4.9 percent in the first quarter of 2010, the government said on May 20, Kyodo reported.
* Greek public debt was up in the first quarter of 2010 to about 310 billion euros (about $385 billion) from 298.5 billion euros at the end of 2009, Greek officials said May 19, Xinhua reported. As of March 31, Greece had cash reserves of 7.5 billion euros, compared to 1.1 billion euros at the end of 2009, the Greek General Accounting Office announced. Also, on May 19, Greece paid a 10-year bond due on May 19, amounting to 8.5 billion euros, the Greek Public Debt Management Agency announced in another statement. Greece's budget shortfall stood at 6.31 billion euros ($7.89 billion) at the end of April, compared to 10.79 billion euros at the end of April 2009, according to official data, Xinhua reported May 21. Officials attributed the achievement to a large cut in state spending and an increase in public revenues due to higher taxes since the beginning of 2010.
* There were no major surprises in the FOMC minutes released Wednesday. A majority of members favor postponing asset sales, most likely until after a rate hike which is still somewhere in the future. Most forecast faster growth in 2011 and 2012, with opinions beginning to diverge on the inflation outlook. Members acknowledged the possibility of spillover effect on the U.S. from Greece's debt crisis, particularly if the situation would have prompted intensified fiscal consolidation in the eurozone.
* Warren Buffett's Berkshire Hathaway sold more than 31M shares of Kraft in the first quarter, a stake worth almost a billion dollars at yesterday's closing price. The 22.8% reduction came as Buffett heavily criticized Kraft for using its stock to acquire Cadbury's. Post-sale, Buffett remains Kraft's largest shareholder with a 6.3% stake.
* Hewlett-Packard beat expectations with its second-quarter earnings per share of $1.09, on revenue more than 12% higher than the year-ago period. H-P raised its full-year profit expectation to $4.45-$4.50 a share on demand for PCs and servers as well as a resurgent printing business, as companies are widely expected to replace old equipment as a recovery continues.
* Symantec reached an agreement to buy VeriSign's authentication services unit for around $1.3B in cash.
* PepsiCo announced May 21 that it will invest $2.5 billion in its food and beverage businesses in China over the next three years. The company plans to open 10 to 12 new plants in China. The investment comes in addition to a $1 billion investment announced in 2008 to be completed this year.
* Wal-Mart reported its fourth consecutive quarter of sluggish U.S. sales but still managed to post a 10% profit increase for the quarter ended April 30 amid tighter expense controls and strong international sales.
* Home Depot's fiscal first-quarter earnings rose a more-than-expected 41% as improved profitability and strength in products tied to simple repairs and the outdoors helped results. The company boosted its current-year sales and earnings forecasts.
Weekly Sector Review
The sectors of the U.S. economy, as well as the S&P 500, have performed as follows:
Last Week’s Returns:
Information Technology… (4.59)%
Materials… (4.00)
Consumer Staples… (2.62)
Utilities… (4.47)
Consumer Discretionary… (3.95)
Financials… (3.86)
S&P 500… (4.23)
Industrials… (5.87)
Healthcare… (3.87)
Telecommunications… (2.04)
Energy… (5.38)
Falling Euro, Rising Exports
One key area of focus when considering the impact of a falling Euro is the impact on international trade. While there is some risk that a lower Euro can lead to higher import costs, thereby giving rise to inflation pressures, Euro-area inflation has remained well-contained thus far. On the positive side, a falling Euro can help make European exports more attractive, which could represent a healthy development for Europe. Exports account for as much as 41% of GDP in Europe, as compared to only 11.3% in the U.S. and 12.8% in Japan. Perhaps a falling Euro will actually help provide a welcomed boost to the region. (source: JP Morgan Asset Management)
Sports, Culture & Politics
* The United States anticipates a vote on new U.N. Security Council (UNSC) sanctions against Iran within weeks, U.S. State Department spokesman Philip Crowley said May 18, DPA reported. Crowley said Washington wants a vote "as quickly as possible," but warned that there are likely to be changes to the draft resolution as the rest of the UNSC reviews it.
* Iranian Intelligence Minister Heydar Moslehi said the American hikers who have been accused of entering Iran illegally are spies, Iranian Students News Agency reported May 19. He said the hikers' mothers were granted visas on humanitarian grounds. He asked how an Iranian abducted by the United States would be treated.
* Iran will abandon the proposed nuclear fuel swap deal with Turkey and Brazil if the United States attempts to impose new sanctions on Tehran, according to Iranian Parliament Speaker Ali Larijani, Reuters reported May 23.
* South Korea found a serial number marked on torpedo propeller fragments collected from the scene where its naval ship sank, according to officials, Yonhap reported May 19. The number was written in a font used in North Korea, and investigators concluded that the patrol ship ChonAn came under a North Korean torpedo attack near the Yellow Sea border on March 26 before breaking in half and sinking, officials said. Foreign experts from the United States, Britain and Australia working as part of an international investigation team agreed to the assessment that a torpedo attack sank the ship. South Korean President Lee Myung Bak pledged to take resolute measures against North Korea and make the regime admit it’s wrongdoings through strong international cooperation and return to the international community as a responsible member, Yonhap reported May 20. The results capped an investigation that also included forensic experts from the United States, Britain, Australia and Sweden to ensure the investigation's fairness. Pyongyang's National Defense Commission, the highest seat of power, offered to send an inspection team to the South. The U.S. and South Korean militaries plan to hold a joint military exercise as early as June to prepare themselves to cope in the event of a contingency on the Korean Peninsula, according to diplomatic sources of the two countries, AP reported May 21.
* A new American intelligence analysis of the torpedo attack on a South Korean warship concludes that North Korean leader Kim Jong Il likely authorized the torpedo assault to help secure the succession of his youngest son, The New York Times reported May 22. The senior American officials who compiled the highly classified assessment cautioned that it was based on their sense of the political dynamics there rather than hard evidence. The analysis was based on information collected by many of the country's 16 intelligence agencies.
* U.S. Director of National Intelligence Adm. Dennis Blair will resign as early as May 21, ABC News reported May 20. U.S. President Barack Obama had been considering whether to ask Blair to resign for weeks. Obama and Blair reportedly met in the Oval Office on May 20, where Blair proposed he resign and Obama agreed.
* Two American tourists, a husband and wife, and their driver and translator were kidnapped by Yemeni tribesman near Sanaa on May 24, an unnamed Yemeni security source said, Reuters reported.
* Syrian President Bashar Assad said the United States has lost its influence in the Middle East peace process, AP reported May 24. Assad said U.S. President Barack Obama raised hopes, but that Syria cannot wait anymore. He noted that China and Brazil were also refusing to wait for the United States to "hand out roles," and that Russia was trying to rebuild its own role in the region. On Syrian-Israeli relations, Assad said that if Israel returned the Golan Heights to Syria, he would not refuse a peace treaty.
* The Reds took two of three from Cleveland, having now won six of their last nine games. Still, they trail the NL East leading Cardinals by a half game.
The weekend’s top-five box office performers as reported by The New York Times were:
1) Shrek Forever After, Paramount, $71,250,000
2) Iron Man 2, Paramount, $26,600,000
3) Robin Hood, Universal, $18,699,175
4) Letters To Juliet, Summit Entertainment, $9,100,000
5) Just Wright, Fox Searchlight, $4,225,000

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