Markets are Sluggish Following Chinese Inflation Data

2/15/11: In the markets, as in life, there are no guarantees but everyone is entitled to their opinion. Here’s my opinion on the financial markets today.

U.S. stocks opened slightly lower this morning following an increase in Chinese inflation reported overnight and a just-released tepid January increase in the government’s measure of retail sales.  European stocks were slightly higher on some well-received earnings results, while Asian markets were mixed.  The Nikkei was slightly higher while Hong Kong shares fell 1% following the Chinese inflation data.  On today’s U.S. economic calendar will be reports on business inventories, import/export prices, New York Empire Manufacturing data and weekly chain store sales.

Looking back at Monday, overseas news helped provide market gains.  In the absence of domestic economic data to begin the week, U.S. market participants looked internationally for a reason to take the broad averages even higher.  In essence, they found it in strong Chinese trade data which drove Asian markets and China-sensitive commodities solidly higher.  Market participants took the 2012 budget proposal from the Obama Administration “in stride,” both in equity and fixed income.  Energy (+2.2%) and Materials (+1.0%) topped the sector rankings, while Consumer Staples, Telecom and Utilities each lost about a half percent.

Around our financial planning firm this morning, we were discussing five major items that we thought would be of particular interest to our readers:

Europeans agree to a permanent rescue fund. European finance ministers agreed to a $500 billion euro European Stability Mechanism (ESM) intended to replace the temporary euro rescue fund set up last spring to avert a wider crisis in the wake of the Greek debt situation.  This fund would not go into place until 2013, but knowing it is coming may help countries obtain financing in the meantime.  The improvement in the credit situation in Europe, solid economic reports and a stable currency have helped the Eurozone stock markets to outperform the U.S. and emerging markets year-to-date.

Corporate bonds outperformed again last week. February has so far witnessed strong corporate bond outperformance.  Investment-grade corporate bond yield spreads contracted by 7 basis points (bps) to just under 1.5%.  For investment-grade corporate bonds, the story is one of relative outperformance to Treasuries as the rise in bond yields still translates to negative total returns.  High-yield is up nearly 1% for the month as spreads contracted by 8 bps and remain under 5% to Treasuries.

Proposed Fannie Mae and Freddie Mac reform is a modest positive for bondholders. The Treasury’s “white paper” on reforming residential mortgage finance put forth three options for reducing the role of government in the mortgage market.  While it will possibly take years to “wind down” the agencies, the Treasury has suggested interim steps to encourage private company participation in the mortgage market.  Nonetheless, the gradual reduction of Fannie and Freddie’s role is a modest positive for bondholders as it shrinks debt outstanding, which leads to a contracting supply relative to demand.

Congressional hearings on municipal bonds continued yesterday. Lawmakers continue to assess developing legislation to allow states a bankruptcy option.  So far, lawmakers are “leaning against” the idea.  Congressional hearings and talk of a state bankruptcy route will likely continue and could be a source of market volatility.  Elsewhere, Congress introduced legislation that requires states, cities and municipalities to provide better pension disclosure.  This is a topic that many agree upon and certainly would be welcomed by investors.

February data on manufacturing and weekly retail sales look “okay” and continue to point to a further expansion in the economy. The Empire State manufacturing index, which provides the first look at manufacturing activity in any given month (albeit in a narrow region of the country), accelerated between January and February with the components of the report being solid, but not spectacular.  In a separate report, the International Council of Shopping Centers reported that weekly retail sales posted a week-over-week drop in the latest week, leaving sales up 2.7% year-over-year.

As always, email me here with your questions or comments.  I love to hear from you and thoroughly enjoy the “intellectual debate” with our clients and friends that these opinions generate.

Greg Powell, CIMA
Wealth Consultant

Note: The opinions voiced in this material are for general information and are not intended to be specific advice. Any indices such as the S & P 500 can’t be invested into directly.

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