Monday, January 25, 2010

The Market ''Hates Uncertainty'' - Once Again

Last week, stocks declined over 5% in three days, as the market suddenly recognized that a lot of "new certainties" became suddenly uncertain: (1) First, the world got swept up in paranoia when China abruptly told banks to ''stop lending.'' (2) Then came the Massachusetts Senate seat shift and the morning-after ''blame game,'' including (3) threats of new fees on big banks. (4) And, some Senators suddenly got cold feet on Fed Chairman Bernanke's confirmation, which seemed so certain last month. Then came more worries about Greece servicing its debt, and new concerns for Portugal. Despite great earnings and economic data released last week, the market hates uncertainty, so the Dow fell 550 points in three days.

China Tells Banks to "Stop Lending"

The ''tipping'' point for last week's market freefall came after China's state-run China Securities Journal said that the China Banking Regulatory Commission had asked several commercial banks to stop issuing new loans for the last 10 days of January. Unnamed sources said that the Bank of China - the most active lender among China's large state banks - had ''switched off'' its internal electronic loan approval system.

Liu Mingkang, Chairman of the China Banking Regulatory Commission since 2003 and China's top banking regulator (''China's Bernanke''), denied these reports, but he also said that Chinese banks were expected to issue only about 7.5 trillion yuan ($1.1 trillion) in new loans in 2010, down 22% from the 9.6 trillion yuan ($1.4 trillion) in 2009 - a record-high level which was nearly double the 2008 loan totals.

The Financial Times (FT) reported last Wednesday that Chinese regulators told some banks to halt their lending due to rising fears of asset bubbles and inflation, caused by China's overheated economy. Sure enough, on Thursday, China's National Bureau of Statistics announced that its GDP grew at a 10.7% annual pace in the fourth quarter - the strongest growth since 2007, and up from 9.1% in the third quarter.

For all of 2009, China's GDP expanded at an 8.7% annual rate, well above the government's goal of 8% GDP growth. But China's consumer prices rose by 1.9% in December (vs. a year ago), triple the 0.6% annual rate in November, so inflationary fears are clearly brewing. The most dramatic inflation is in the housing market, where prices of new residential property are rising at an annualized rate of over 20%, with new construction still booming - more or less replicating the U.S. housing bubble of five years ago, as housing prices in Beijing and Shanghai have soared out of reach for most middle-income families.

Global stock markets clearly fear that China's sudden tightening of credit could cool its strong GDP growth and lower the worldwide expectations for the pace of the economic recovery. These fears may be overblown, but last week's sell-off clearly reminded investors that China is a key global economic engine.

Economic News Still Looks Encouraging

There is good economic news released last week. First, there was good news on the inflation front. Last Wednesday, the Labor Department announced that the Producer Price Index (PPI) rose only 0.2% in December, a very welcome contrast to the +1.8% rise in November. Even better, the core PPI, which excludes food and energy, was unchanged in December.

Also on Wednesday, we learned that December Housing Starts fell 4%, while new permits jumped 11% to 653,000, the highest level since October 2008. The decline in starts is healthy for the housing market, as it helps work down inventory, while the rise in new permits implies a boost to the GDP later this year.

Then, the Conference Board announced on Thursday that the Leading Economic Indicators (LEI) rose by a very healthy 1.1% in December, much stronger than economists' consensus expectation of a 0.7% rise. Eight of the 10 LEI indicators rose. This represents the ninth straight monthly rise in the LEI.

In addition, we're just beginning the earnings season, and positive earnings surprises should help lift the market. This week, more than one-fourth of the companies in the S&P 500 (and over one-third of the Dow Industrials) will release earnings. In the beleaguered retail sector, forward earnings estimates for January are up for a 10th straight month, and are now 42.2% up from last March's lows. With some good earnings reports this week, and a strong GDP report on Friday, the market should turn up by week's end.