Inflation fears diminished as energy and other commodity prices dropped, but trading was quiet ahead of Tuesday's Fed announcement
Major U.S. stock indexes finished lower Monday after a recovery attempt late in the day sparked by falling oil prices evaporated. But the plunge in oil prices on abating hurricane concerns and general weakness across the commodities complex did help diffuse some of the market pessimism caused by a rise in inflation.
Natural gas, platinum and copper prices all fell to six-month lows, while corn traded at its lowest levels in four months.
On Monday, the Dow Jones industrial average closed 42.17 points, or 0.37%, lower at 11,284.15. The broader S&P 500 ended down 11.30 points, or 0.90%, at 1,249.01. The tech-heavy Nasdaq composite index gave back 25.40 points, or 1.10%, to finish at 2,285.56.
On the New York Stock Exchange, 21 stocks were trading lower for every 10 that were gaining, while on the Nasdaq the ratio was 19-9 negative amid slow trading pre-Fed announcement. Energy and basic materials stocks were down, as were financials, but consumer staples and discretionary names were trading higher, S&P MarketScope said.
The market was initially spooked by a jump in an inflation gauge contained in the government’s personal income report for June, though those fears eased somewhat with the drop in commodity prices. The personal consumption expenditure (PCE) deflator surged 0.8% on the month and is up a hefty 4.1% over last year, well above the upwardly revised 3.5% year-over-year gain in May (from a 3.1% rise before). The core PCE deflator rose 0.3% in June and is up 2.3% from last June -- and above the 2.2% y/y pace seen since March.
The headline figure on the personal income report came in at a better than expected rise of 0.1% in June, beating expectations of a 0.3% decline due to adjustments in tax rebate assumptions in the revised data, Action Economics said. Income would have increased 0.3% in June and an estimated 0.3% in July, were it not for rebate distortions. Disposable income dropped 1.9% in June following a hefty 5.7% spike in May.
While the income and spending readings were a bit better than expected, thanks to the tax rebate checks, the big jump in inflation have worried markets ahead of the FOMC meeting, says S&P senior economist Beth Ann Bovino.
All eyes are on what the Federal Reserve policy committee's next move will be in steering the economy. The committee heads into its Aug. 5 meeting sharply divided over the appropriate direction of policy, with three of its 10 voting members having expressed their concern in recent weeks over future inflation. Economists are betting the majority, led by Chairman Ben Bernanke, will prevail in holding the Fed’s target rate steady at 2%.
Despite the higher inflation deflator figure, recent events auguring more tough times for the economy have diminished the inflation hawks' argument for a rate hike and might even put the possibility of a rate cut back on the table at some point during the second half of 2008. The troubles at the mortgage giants Fannie Mae (FNM) and Freddie Mac (FRE) have pushed up mortgage rates and created tighter credit conditions generally, whiles slower growth abroad, especially in Europe, will slow U.S. exports. Cheaper oil, if sustained, will also weaken concerns about a broader rise in inflation.
"The economy is too unstable for them to raise rates any time soon," says Doug Roberts, chief investment strategist for ChannelCapitalResearch.com, based in Shrewsbury, N.J. "We have the credit crisis, the housing crisis shows no signs of a bottom, and demand for oil, which is source of inflation, is a global thing [based on] demand driven by emerging markets."
Raising interest rates would hurt the U.S. economy more than it would the world economy, which is where a more pronounced slowdown is needed to rein in long-term trends in oil consumption, he says. Lately, oil prices have been cooperating, giving the Fed cover to hark back to its prior position on core inflation moderating over time, he adds.
"If they have a divided committee and as long as there are enough dissenters who are more hawkish, they can maintain credibility on inflation and it buys them more time to not do anything," he says.
HSBC Holdings (HBC) shares fell after the bank reported a pretax profit of $10.25 billion, down 28% from a year ago. HSBC's Tier 1 capital ratio was 8.8%. The latest results include loan impairment charges and credit risk provisions of $10.06 billion.
Citigroup (C) confirmed plans to close a $400 million convertible arbitrage fund that is the final piece of its TriBeCa hedge fund.
In other economic news Monday, U.S. factory orders surged 1.7% in June, well above the median estimate of a 0.9% gain, after rising a revised 0.9% in May. Excluding transports, orders were up 2.3% in June.
Oil prices dropped sharply as weather-related concerns faded after Tropical Storm Edouard wasn't upgraded to a hurricane. A report that Iran's chief nuclear negotiator Saeed Jalili and the European Union's foreign policy chief, Javier Solana, had called on Monday for a "positive air" over Iran's nuclear issue and would continue to keep communication open was also weighing on oil prices.
September WTI crude oil futures fell more than $4 a barrel before bouncing from the lows to settle $3.69 lower at $121.41 a barrel on Monday.
David Joy, chief market strategist at RiverSource Investments in Boston, sees the drop in oil prices as only a correction, "not a fundamental breakdown in the overall uptrend" since demand will be sustained by the industrialization efforts in emerging economies, especially in Asia.
But he thinks the price could drop as far as $90 to $100 a barrel, which is where supply-and-demand analyses suggest it should be trading now, he says.
The Reuters/CRB index, the most widely followed commodity index, fell below 402.0 on Monday, within striking distance of the 400.0 psychological area, the lowest point since the index broke that level back on May 1. That's a big drop from session highs above 416 and keeps the downtrend intact from record highs near 474 set back on July 3, Action Economics said. Energy prices came down as on reduced fears about the likely path Tropical Storm Edouard will cut on the Gulf Coast and on Barack Obama's comments about releasing oil from the U.S. Strategic Petroleum Reserve, but natural gas prices were down even more sharply.
Agricultural prices are all substantially lower, too, as are copper prices after an inventory build. Precious metals have taken a cue from energy as well, with gold probing below $900 per ounce for the second time in a week. A decisive technical break and close below $117 per barrel on NYMEX crude would prompt a re-test of the low of 377.45 on the CRB reached on Mar. 20, Action Economics said.
The drop across the commodities complex, while showing that the runup in prices was probably overdone in part by the speculation element, factor, suggests widening anticipation of weaker economic conditions worldwide ahead, says Joy.
Among other stocks in the news on Monday, shares of Charlotte Russe Holding (CHIC) tumbled after the mail-based specialty fashion retailer said that Patti Johnson had resigned as chief financial officer. Len Mogil, currently interim CEO, will assume the additional position of interim CFO. Roth Capital downgraded the stock to sell from hold.
InterContinentalExchange (ICE) shares fell after the company posted a second-quarter profit of $1.19 a share, vs. 75 cents a share a year ago, on a 44% gain in revenue. Quarterly trading volume exceeded 126 million futures and over-the-counter contracts were up 44%. The exchange set a $500 million stock buyback. S&P maintained its buy rating.
Nicor Inc. (GAS) shares rose after the company posted 64 cents a share in second-quarter earnings vs. a 40-cent preliminary forecast on a 26% rise in revenue. The company affirmed its 2008 earnings outlook of $2.20 to $2.40 a share. Standard & Poor's maintained its buy rating on the stock.
Freightcar America (RAIL) shares plunged after the company reported a second-quarter loss of eight cents a share, vs. earnings of 93 cents a year ago, on a 28% drop in sales. The manufacturer, repairer and leaser of freight cars noted that a combination of a sharp increase in input costs, specifically steel and aluminum, and pricing pressures had reduced margins. Due to increases in raw material costs on certain fixed price railcar contracts in backlog, the company's current estimated cost to complete some contracts is expected to exceed contractual sales price.
Major European indexes were trading lower Monday. In London, the FTSE 100 index slid 0.64% to 5,320.20. In Paris, the CAC 40 fell 0.78% to 4,280.63, while Germany's DAX index dropped 0.73% to 6,349.81.
In Asia, Japan's Nikkei 225 shed 1.23% to close at 12,933.18, while Hong Kong's Hang Seng index fell 1.52% to 22,514.92.
Treasuries reversed course to trade lower as commodity prices came off, undercutting inflation fears. The 10-year note moved down to 99-08/32 for a yield of 3.96% and the 30-year bond was down 14/32 at 96-17/32 for a yield of 4.59%.