5:00 PM EDT :Treasuries took losses today but they were relatively mild considering the extent of gains made by the stock indices. In late trading, the 10-Year Treasury Note was down by 5/32, raising its yield to 4.40%; the Dow was up by 134.78 points to 13,806.70; and the Nasdaq was up by 53.33 points to 2,804.19.
The catalysts for today's stock rally were a strong earnings report from Microsoft and positive guidance from Countrywide (despite a miserable third quarter). These were enough to eclipse the negatives facing the market. The economic release of the day was not stock-friendly. The final Consumer Sentiment Index for the month indicated that consumers were generally more pessimistic than they have been in almost a year-and-a-half.
And oil prices continue to climb. The price of a barrel of light, sweet crude oil for December delivery rose by $1.40 on the New York Mercantile Exchange to settle at a new record high of $91.86. Yet, the Dow rose by 0.99% on the day; the S&P 500, 1.38%; and the Nasdaq, 1.94%. All three indices made solid progress for the week as well. The Dow gained 2.11%; the S&P 500, 2.31%; and the Nasdaq, 2.90.
Despite the gains in stocks this week, Treasuries held their ground. For the week, the yield of the benchmark, 10-Year Note was up by only 1 basis point after falling last week by 29 basis points (yield moves inversely to price).
Next week's events calendar is brimming with potential market-movers but starts out slowly. There are no major economic releases slated for Monday and the only one on Tuesday is the Consumer Confidence Index for the month from the Conference Board, an independent research firm. September's index came in at 99.8, a sharp drop from August's 105.6, which in turn was a sharp drop from July's 111.9.
The situation was summarized in the news release by Lynn Franco, Director of the Board's Research Center: "The Consumer Confidence Index is now at its lowest level in nearly two years (Nov. 2005, 98.3). Weaker business conditions combined with a less favorable job market continue to cast a cloud over consumers and heighten their sense of uncertainty and concern. Looking ahead, little economic improvement is expected and with the holiday season around the corner this is not welcome news."
Little change is expected in October's reading with the consensus forecast being 100.0. Yet recent economic data has generally been bearish and another drop in the confidence indicator would not be too surprising.
The Federal Reserves monetary policy committee, the Federal Open Market Committee (FOMC), will begin a two-day meeting on Tuesday. Since the results of the meeting will undoubtedly catch some market participants in the wrong position, many traders take defensive actions prior to the publication of the meeting statement. This includes reeling in long positions and covering shorts. Some traders take to the sidelines. But others will attempt to get ahead of the market by taking positions based on their opinion of what the Fed will do.
On Wednesday morning, key economic data will be released which might affect expectations for the outcome of the Fed meeting. The Commerce Department will be releasing its first estimate of gross domestic product (GDP) for the third quarter. GDP is the market value of all final goods and services produced by labor or property in the country in a year’s time. Quarterly data is adjusted and annualized and changes from quarter to quarter indicate the strength and direction of the economy. The first, or advance, report for last quarter will be followed next month by a preliminary report, and a final report will be issued in December.
The final report on the second quarter showed that the economy grew in the April through June period by 3.8%. This was an improvement from the first quarter increase of 0.6%. In fact, it was the strongest reading in five quarters.
For the third quarter (July through September), analysts predict that GDP rose by about 3.1%. If the reading is notably weaker, many observers will assume that another Fed rate cut is assured.
Also out on Wednesday morning is the Employment Cost Index (ECI) for the third quarter. The ECI, a measure of the seasonally adjusted level of compensation costs for all civilian workers, rose in the second quarter by 0.9% following a 0.8% increase in the first quarter. The index is a more comprehensive gauge of labor costs than the wage data contained in the monthly employment reports because it also incorporates salaries and employer costs for non-cash employee benefits. For the third quarter, another 0.9% increase is anticipated.
The report on construction spending for September will be released a little later on Wednesday morning. In the last report, the Commerce Department said that the seasonally adjusted, annualized pace of spending rose in August by 0.2%. Although this was stronger than the decline of 0.1% that had been predicted, revisions pushed July's originally reported decline of 0.4% down to 0.5% and June's previously reported gain of 0.1% was revised to a decline of 0.1%.
As expected, the residential category continued to deteriorate. The spending rate there was down by 1.4% in August following a 1.7% decline in July and a 1.0% decline in June. August's decline was an eighteenth consecutive monthly contraction and the spending rate was the lowest since December of 2003. Another decline is expected for September, pulling the overall spending level down by a predicted 0.1%.
And the Chicago Purchasing Managers Index, a gauge of manufacturing activity for the heavily-industrialized region, will be released Wednesday morning. Last month, the index came in at 54.2, up from 53.8 in August. Any reading over 50.0 indicates a general expansion of activity relative to the preceding month and September's represented a seventh consecutive month of growth following modest contractions in January and February.
But, of course, the main event of the day will be the conclusion of the Fed's policy meeting. Between January of 2001 and June of 2003, the Fed reduced the short-term lending rate between banks (fed funds rate) from 6.50% to a decades-low 1.00% in order to reduce general borrowing costs and stimulate the economy. Then, between June of 2004 and June of last year, the FOMC raised rates fourteen times to 5.25% in order to prevent the economy from overheating and thereby fueling inflation.
Between June of last year through early August of this year, the Fed took no rate action but maintained a slightly hawkish (that is, tightening) bias, citing elevated core inflation and concerns that it might not abate as expected. But the troubled housing and mortgage industries began to obstruct credit flows since investors backed away from risky mortgage debt, thereby eroding its value. Consequently, lenders in general tightened loan standards, making it harder to borrow money. In the meantime, holders of mortgage loan products have suffered losses since buyers are scarce. This bottleneck reduces the amount of money flowing through the monetary system and drives up the cost of borrowing.
With the complex network of risk-sharing in the world markets, the credit troubles spread. In August, France's largest bank froze three of its hedge funds because of mortgage-related losses. The incident prompted central banks in numerous countries to make short-term loans to banks in order to keep money flowing and ease investor anxiety.
The Federal Reserve was one of the central banks pumping additional reserves into the monetary system. It even made a temporary 0.50% cut to the discount rate, the rate banks must pay for loans directly from the Fed. This brought the rate down from 6.25% to 5.75%. In addition, the committee extended the length of time reserves could be borrowed and it made a public relations push to diminish the negative connotations attached to such borrowing (loans from the Fed were typically considered last resort measures).
Nevertheless, short-term commercial debt offerings dried up and investors flocked to the safety of government backed securities. In order to ease the credit situation, the Fed decided in its September meeting to cut the fed funds rate by 0.50%, from 5.25% to 4.75%. This was the first rate cut since June of 2003 and the largest since November of 2002. The policy committee also cut the discount rate again by 0.50% from 5.75% to 5.25%.
Late last month, many Fed watchers felt that another cut would be made this month, but doubts were raised when the employment report for September revealed revisions to past data that indicated a respectable gain in nonfarm payrolls in August instead of the first decline in four years as had originally been reported. Moreover, comments by Fed officials earlier this month did not seem to signal that another cut in rates was imminently forthcoming.
Since then, however, prospects for a rate cut have picked up again. On Monday evening, October 15, Fed Chairman Ben Bernanke delivered a speech before the Economic Club of New York. In it, he gave an overview of the interrelated mortgage and credit market problems and summarized the central bank's responses to the recent market turmoil.
Of particular interest to market participants were his warnings that the economy might experience more challenges ahead. He noted that, "Since the September meeting, the incoming data have borne out the Committee's expectations of further weakening in the housing market, as sales have fallen further and new residential construction has continued to decline rapidly. The further contraction in housing is likely to be a significant drag on growth in the current quarter and through early next year."
He also said, "Conditions in financial markets have shown some improvement since the worst of the storm in mid-August, but a full recovery of market functioning is likely to take time, and we may well see some setbacks."
Moreover, economic data released in the last couple of weeks has been bearish. The report on housing starts said the pace in September was the lowest in over fourteen years. The report on existing home sales for last month revealed the lowest rate in at least eight years. The rate of new home sales rose in September but the latest data showed that this was from a revised level on August that was sharply lower than previously reported.
And concerns about the mortgage / credit situation have recently been revived by a huge earnings miss reported earlier this week by Merrill Lynch. The earnings news principally reflected deep losses associated with mortgage-backed investments.
For these reasons, many traders feel that next week's FOMC meeting will end with further rate cuts. Most predict that the committee will cut the fed funds and discount rates by 0.25%. A few are looking for another aggressive cut to the rates of 0.50%. Others think the committee will decide to make no rate changes. The policy statement will be released at about 2:15 PM Eastern Time.
Compounding the problems facing bond traders is that Wednesday is the last trading day of the month and affords portfolio managers with their last opportunity to make adjustments for the period. This is the process whereby holdings are rebalanced on the basis of such characteristics as yield, risk, and return horizon. This usually entails the purchase of Treasuries even in mixed portfolios since the securities have a fixed lifespan and carry no credit risk.
On Thursday, the markets are likely to be still reacting to the results of the Fed meeting. But they will also have to contend with more economic data. As usual, the jobless claims report will address the employment situation and it may get more attention than usual since it heralds the approach of the Friday's employment report. The data collection periods for the two reports do not coincide so the claims numbers will not have a direct relationship with the employment figures, but traders will be closely scrutinizing the claims report, nonetheless.
In yesterday's report, the Labor Department said the seasonally adjusted level of initial claims for state unemployment benefits fell by 8,000 last week to 331,000. The previous week's originally reported 337,000 figure was revised up to 339,000, which was a 30,000 increase from the week before.
The reports over the past month have generally exhibited larger than expected swings in the initial claims number and following the big increase in the week of October 13, a decline in last week's number had been anticipated. The four-week moving average, which smoothes out some of this week-to-week volatility, rose by 7,750 to 324,750. This is up slightly from the year-to-date weekly average of 318,238.
Yesterday's report indicated that the level of continuing claims for the week ending October 13 (continuing claims must be at least a week old) rose by 7,000 to 2.530 million but the previous week week's originally reported 2.534 million was revised down by 11,000 to 2.523 million. The four-week moving average slipped by 3,750 to 2.526 million. The weekly average for the year-to-date is about 2.530 million.
Because of the recent pattern of moves in the data, the initial claims level for this week is expected to have increased slightly.
The other early release on Thursday is the report on personal income and spending for last month. In August, the seasonally adjusted, annualized level of personal income, the fuel for spending, rose by 0.3%, the smallest increase since a flat reading (0.0%) in April. August's rise followed three consecutive months month's of 0.5% increases. Although income growth had decelerated, the report said personal consumption expenditures (PCE or consumer spending) rose by 0.6%, up from July's 0.4% and the biggest increase in four months.
The inflation measures in the report were tame. The PCE price index fell by 0.1%, the first decline since last October, and the price index minus the volatile categories of food and energy rose by just 0.1%.
For September, both income and spending is expected to show increases of 0.4%. Over the last twelve report months, the average change in income has been 0.5% and the average in spending has been 0.4%.
At 10:00 AM Eastern Time Thursday, the Institute for Supply Management (ISM) will release its index figures on the nation's manufacturing sector for October. In September's release, the overall index came in at 52.0, the lowest reading since March's 50.9. The index was 52.9 in August. Like the Chicago index, any reading over 50.0 reflects growth for the month.
Between June of 2003 and October of last year, the index posted forty-one straight expansion readings. But the extent of growth declined throughout last year until the index indicated slight contractions in November and then last January. The index strengthened after that, hitting a fourteen month high of 56.0 in June. But each three reading since then was weaker than the one before. For October's index, little change from
September's reading is anticipated.
Traders will also be watching the prices index since it measures inflation pressures associated with the sector. September's index came in at 59.0, down from August's 63.0. Though it still indicated an increase in prices manufacturers were paying, the index was the lowest since February.
Another economic release on Thursday is the report on pending home sales for September from the National Association of Realtors. The last report said that the seasonally adjusted index of pending sales fell by 6.5% in August to a record low following a 10.7% drop the month before. The first report was published in 2005 and the NAR has data going back to 2001.
The index is a measure of contract activity and the NAR asserts that 80% of contracts become sales within two months and a large portion of the rest, two months thereafter. The weakness in July and August's reports was reflected in September's existing home sale report.
On Friday, the employment report for October will take center stage. September's report said that the seasonally adjusted level of nonfarm payrolls rose by 110,000. The increase had been predicted but, as noted above, the report was much stronger than expected since August's originally reported decline of 4,000 was revised to a gain of 89,000 and July's previously reported gain of 68,000 was revised to 93,000.
A key category behind the revisions to July and August was government employment. July's previously reported decline of 52,000 was trimmed to 28,000 and August's originally reported decline of 28,000 was revised to an increase of 57,000. In September, government payrolls grew by 37,000.
Despite the increases in payrolls, they were not enough to prevent the unemployment rate from edging up to 4.7% from August's 4.6%. Though still considered low, the rate was the highest since August of last year. The unemployment rate is the portion of the workforce (over 16 years old and actively seeking employment) without jobs. While the number of jobs can increase, so can the workforce. September's report said that it rose by 573,000 individuals after falling by 340,000 in August.
Current predictions for October call for another gain in payrolls of about 90,000. The unemployment rate is expected to have remained at 4.7%. But traders have learned that the reports frequently fail to meet forecasters' estimates. Therefore, because of the uncertainty, the markets are usually subdued the afternoon before the report comes out.
The final release of the week is the report on factory orders for September. In August, the seasonally adjusted level of new orders reportedly fell by 3.3% after an increase in July of 3.4%.
Since September's report for durable goods items (which make up slightly more than half of factory orders) has already been released and indicated a surprising 1.7% decline in that category, recent predictions of a rise in factory orders of about 1.0% have been revised sharply lower. Nondurable goods have averaged a modest 0.2% increase so far this year and if that figure is plugged into prediction calculations, this would result in an overall decline in the orders level of 0.8%. This would be the first back-to-back decline since July and August of last year.
But the durable goods report showed that the decline was due primarily to a sharp drop in defense aircraft orders. Excluding the transportation category, orders were up slightly and they were also up if the defense sector was factored out. Moreover, the category of ex-defense capital goods minus aircraft -- seen as a proxy for core business demand -- also saw an increase in orders (0.4%). These categories will also be closely watched in the factory orders report. In any case, however, the employment news is likely to overshadow the orders data.
10:30 AM EDT :
As feared, mortgage lending giant Countrywide reported an even larger loss last quarter than analysts had predicted due to falling loan volumes, poorly performing loans, and set-asides the company made for future
loan losses.
But stock traders were encouraged by the company's estimation that it would post a profit in the current quarter. In addition, the tech sector is being buoyed by strong earnings reported by Microsoft after the bell yesterday.
In the only major economic news of the day, news sources report that the final Consumer Sentiment Index for the month from the University of Michigan came in at a seventeen month low of 80.0, down from the preliminary reading of 82.0 and from September's final reading of 83.4.
The expectations index fell to 70.1 from the preliminary 71.6 and September's 74.1. The index of current conditions fell to 97.6 from the preliminary 98.2 and September's 97.9. The expectations index was the lowest in fourteen months and the current conditions index was the lowest in thirteen.
Though the sentiment data was weaker than analysts had predicted, the erosion of optimism is not too surprising in light of generally bearish economic reports released recently (housing starts, existing home sales, industrial production, durable goods orders).
Rising oil prices are also a growing concern for consumers and oil futures continue to break new ground. In overnight trading, the price of a barrel of crude oil for December delivery topped $92.00. The price has since backed down but in recent trading it was still higher than the record close of yesterday's regular NYMEX session.
In the bond market this morning, traders are still in the process of absorbing this week's new supply ($6 billion 5-Year TIPS, $20 billion 2-Year Notes, and $13 billion 5-Year Notes). And with the major events of the week over, traders in both markets are now looking ahead to next week's heavy set of influences.
These include the first official look at gross domestic product for the third quarter, the Federal Reserve's latest meeting on monetary policy, the release of a key manufacturing indicator, and the employment report for October. In addition to positioning for these market-movers, traders are also considering how best to close out their books for the month.
Given the nature of these variables, stock and bond price movements may be erratic for a while.
