Innovation Update

Return to Article

Dow Overcomes the Negatives

Liz Rappaport

Tuesday was reversal day. And, like driving the switchbacks on a mountainous pass, every turn brought a new perspective on the markets.

Thai regulators imposed currency controls on international investors but then reversed them after watching their benchmark SET Index tank by 15%. The U.S. bond market sold off on the release of December's producer price index but then reversed course when traders took a second look and found the data flawed, only to reverse again on the hawkish words of a Fed president. The stock market opened in the red, reacting in part to the inflation data, memories of the Asian contagion of 1997-98, mixed housing data and disappointing quarterly results from Circuit City (CC Quote), Oracle (ORCL Quote) and Hovnanian (HOV Quote).

But stocks reversed course, and the Dow Jones Industrial Average ended at a record high, up 0.2% at 12471.32, while the S&P 500 finished up 0.2%, closing at 1425.55. The S&P was aided by strength in energy stocks such as Marathon Oil (MRO Quote), which rallied as oil (ta-da!) reversed early weakness to close up 94 cents at $63.15.

The Nasdaq Composite ended the day down 0.3% to close at 2429.55, under pressure after Oracle slipped 4.5% on its earnings that merely met analyst expectations. Shares of the semiconductor stocks were also down Tuesday. The Merrill Lynch Semiconductor HOLDR(SMH Quote) exchange traded fund slipped 1.5%.

Shares of Circuit City plunged 16.5% on its disappointing third-quarter results, which suffered because of intense price competition among its competitors. Shares of Best Buy(BBY Quote), which recently reported disappointing margins, slipped 1.6% Tuesday.

Sending the Dow to new highs were gains of 2% or more by shares of Honeywell(HON Quote) and ExxonMobil(XOM Quote). Pfizer's(PFE Quote) shares gained 1.4% even as the company suffered a credit-rating cut from top-rated triple-A to Aa1 by Moody's Investors Service. Investors were instead cheering Pfizer's announcement late Monday to increase its dividend by 21%, or five cents per share.

The U.S. stock market largely shrugged off the 15% decline in the Thai SET, and the drops of more than 1% in the benchmark indices in Hong Kong, Russia, Mexico, Malaysia, Indonesia, Hungary and India.

The Thai government reversed its decision to impose currency controls on stocks within 24 hours. But Tuesday's SET slump and the motives behind the currency controls are a reminder of how unpredictable the moves of emerging market governments and regulators can be. It is a lesson in how fast hot money can move out of a market, and that risk really does exist.

Thailand imposed the controls to keep out speculators and reduce the upward pressure on the baht, which had jumped 16% thus far this year. Thai exporters, like exporters in many emerging market countries where hot money has driven up currency valuations, have complained that they can't sustain themselves with such strong currencies.

"Underlying this is the message that capital is very mobile and hot money rushes into a country but rushes out even faster," says Marc Chandler, currency strategist at Brown Brothers Harriman and a RealMoney.com contributor. "It distorts prices when it rushes in [and] fuels equity bubbles and inflation. It complicates the management of the economy, because it is fueled by speculators rather than real long-term investors."

Treasury Secretary Paulson and Fed Chairman Ben Bernanke and half the U.S. Congress can go to China, but the Thai mistake Tuesday sends the biggest message to the Chinese, and a setback to hopes for revaluation of the yuan, says Chandler. Why would China, the largest exporter to the U.S., revalue the yuan and subject its economy to all that speculative hot money? (After the close, the Treasury Department released its semiannual foreign-exchange report, which declined to name China a formal currency manipulator, a development that may prompt more anti-China rhetoric -- and possibly legislation -- in Congress.)

The Thai story also may once again raise awareness about risk appetite, says Axel Merk, manager of the Mark Hard Currency Fund. "Instances like this will increase volatility in the market in general, and it could cause investors to trim down the carry trade," says Merk.

The carry trade has been wildly popular lately. It is the trade that everyone is afraid not to put on. It's just too easy. Investors borrow money in countries with low rates, like Japan, and invest it in higher-yielding currencies. Such a trade has been virtually given the green light by a Federal Reserve on pause and a Bank of Japan that seems fearful of roiling world financial markets. The Bank of Japan left its overnight benchmark rate rates steady at 0.25% Tuesday.

So while investors remember the 1997 Asian crisis when something like Tuesday's Thai baht debacle happens, they note that things are different. Still, they might also reassess the risk they have in emerging markets.

"You're playing with fire when you deal in Asian currencies," says Merk.

Doubting the Data

It seems the U.S. government is playing with data, not fire. The Bureau of Labor Statistics reported Tuesday that producer prices jumped 2% in November and core producer prices jumped 1.3%. Within the report, the data suggests that energy rose 6.1% in the month.

"The labor department, in their esteemed wisdom, provided us with a healthy set of contradictory data," says Joe Brusuelas, chief economist at IDEAglobal. He says the Treasury market reversed course as soon as economists and traders realized that last week's consumer price index shows energy prices declining in the same month. He also notes an increase in prices of autos and trucks in the PPI data.

"There is no way that factories are increasing prices of cars to distributors where distributors still have 2006 models on their lots," he says. "The market will be looking at the personal consumption expenditures report out Friday to resolve the differences."

Frustrating data aside, the Treasury market also contended with a round of hawkish commentary out of Dallas Fed President Richard Fisher. Even with the 0% CPI print for November, the Fed is sticking to its tightening bias. Fisher said inflation is still too high, the "risk of high inflation outweighs slower growth risk," and the Fed will raise rates if inflation doesn't come down.

The 30-year Treasury bond slipped 3/16 to yield 4.72% while the 10-year fell 1/16 to yield 4.59%. The two-year was unchanged, yielding 4.71%.

The one thing that didn't go topsy-turvy Tuesday was the housing market. While evidence of a bottoming process continues to accumulate, as new home starts were slightly higher than expected, building permits were weaker than expected.

"The decline in starts along with the downtrend in building permits imply that residential investment and construction employment will remain weak into the new year," writes Peter Kretzmer, economist at Banc of America Securities.

At least there's something to count on.