Monday, December 27, 2010

U.S. markets little changed after China raises interest rates

U.S. markets were little changed today, seemingly unaffected by China's interest rate hike on Saturday. The Dow fell 20.73 points or 0.18% to 11,552.76, while the S&P 500 rose 0.74 points or 0.06% to 1,257.51.


Last week, US markets were up on positive US economic data. For the week, the S&P 500 gained 1%, while the Dow was up 0.7%. It was the 4th straight week of gains for the S&P 500 and the Dow. As of Friday, the S&P 500 had been up 6.5% so far in December, with gains of 12.7% for 2010.

Positive economic data last week included initial jobless claims, which fell slightly by 3,000 people to 420,000. GDP for the July to September quarter was also revised upwards from 2.5% to 2.6%. A report Thursday also showed Americans increased purchases for a 5th consecutive month in November, while capital goods orders by companies increased. 

China raises rates and buys Portuguese bonds

On Saturday, China raised its interest rate by 0.25%. It was the second rate hike in two months, and the 6th time that the Chinese Central Bank has intervened in the past 3 months. The benchmark lending rate was increased by 0.25% to 5.81%, while the deposit rate rose 0.25% to 2.75%. Most analysts were surprised, since they were not expecting a rate hike for the remainder of 2010.

China also reached a helping hand to the euro zone. A Portuguese newspaper reported last week that China was preparing to buy $4 to $5 billion euros of Portuguese government bonds. Portugal, along with other PIIGS nations, have been seeing the yields on their government bonds reach record highs in recent months, as investors perceive an increasing chance of default.

Unrest continues in the euro zone

As austerity budgets are pushed through across the euro zone, and citizens begin to feel the impact, unrest continues to remain in the region. Last week, Greece passed an austerity budget for 2011. Metropolitan transport workers conducted a 24-hour strike, causing traffic jams. National railway workers also went on strike, paralyzing train services.

Lookahead for this week

As 2010 draws to a close, investors have become very bullish in recent weeks. A year that has started relatively rough for the markets has now seen US markets up over 12%. Last Friday, the volatility index fell 10% to 16, its lowest level since April. Not surprisingly, early April was a high point for markets, after which they fell on the Greek crisis.

On December 23rd, the American Association of Individual Investors' survey found bullish sentiment increased 13.1% to 63.3, which was a 6-year high. According to Bespoke, bullish sentiment reached a historical extreme last Thursday. As a result, investors should not be surprised to see most analysts at the major banks predicting 10% plus gains for markets in the upcoming year. However, it is precisely these overly bullish sentiment that point to a near-term correction. 

 
In fact, after the Santa Clause rally ends and 2010 draws to a close, investors will be faced with an increasingly tense debt crisis in the euro zone, as citizens react to austerity budgets. Billions of euros of government bonds will also need to be auctioned in early 2011. In addition, with China experiencing 5% plus inflation, investors can expect further tightening measures in 2011, with 3 to 4 interest rates hike for the year.

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