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Dow looks set to scale new highs this week
LAST week, US stocks set new records after the Federal Reserve executed a shift away from extraordinary stimulus to a rate-hiking policy with finesse, and the gains should continue if economic data this week justify the central bank's confidence.
The sector leading the latest advance is the sector that the Fed had stepped in to save with its extraordinary measures in the first place: the banks. In 2008 and 2009, most of the biggest banks in the US came within days or hours away from failure, according to the memoirs of former Treasury Secretary Timothy Geithner. During the recovery, the banks have operated in, if not a chastened mode, a straitened one.
The billions are no longer rolling in from massive bets on copper prices or mortgage derivatives. The harpooning of JP Morgan's "London Whale" signalled the end of the era when trading desks ruled the world. Some global banks have quit markets like electricity and commodity derivatives that were once thought to be the future. The profits on loans shrank at the same time as the trading desks.
Last week, Fed chairwoman Janet Yellen stated in the most unequivocal terms to date that the central bank is preparing to push the benchmark rate up. For the banks, that's a licence to charge their customers more for borrowing money. While most economists don't anticipate a rate hike appearing until mid-2015, the market rates for mortgages and other loans are already picking up. Besides, another of Wall Street's geese has started laying golden eggs in the last year or so: the deal market.
The most glaring example is Alibaba Group's frenzied initial public offering last week, which saw shares priced at US$68 apiece debut at nearly US$100. That gave Alibaba a market value of US$230 billion, which eclipses that of Facebook, whose own IPO was thought to be surprisingly large.
By some measures, the Chinese online bazaar is the world's busiest marketplace. Nevertheless, such stock performance can only be justified by prolonged exponential growth.
While there's unlikely to be another IPO on the scale of Alibaba or Facebook any time soon, investment bankers are equally busy in the equally profitable business of mergers and acquisitions. This is a classic corporate strategy in a time of relatively slow economic growth, when competitors can be bought at a discount.
"In a business environment that we believe is defined by slow top-line growth, companies have looked externally to create value," said strategists at brokerage Barclays in a research note. "This has contributed to a surge in mergers and acquisitions."
The last time around, "Merger Mondays" turned out to be a sign of a market peak, as companies rushed to take advantage of endangered exotic debt structures to buy competitors no matter what the price in 2007 and 2008.
The current round of deals have a simpler recipe and less inflated price tags: whether its fast food chain Burger King's acquisition of Canada's Tim Horton or drug maker AbbVie merging with Shire, US corporations are shopping for tax savings.
"We believe the current M&A cycle will last. Debt financing costs are low, cash is elevated and should be put to better use, and there are potential tax savings available," the Barclays analysts said.
US corporations can also afford to go shopping in Europe and Asia because the US dollar has started to go a lot further there, recently hitting its highest level against the yen in six years.
"You're in a pretty strong dollar bull market right now and the long-term direction of the US economy and US rate policy is counter directional to what Europe and probably the rest of the world is doing," said Oliver Pursche, president of money manager Gary Goldberg Financial Services.
Speaking in Dallas on Thursday, former Bank of England official Charles Bean said the spillover effect of the Fed's quantitative easing programmes was mostly positive for its trading partners. By putting more money in the hands of US consumers, it helped export economies in Europe and Asia, Mr Bean said. Low rates in the US also proved contagious, he said.
The corollary to these findings is that the Fed's rate hike plans could have negative spillover effects for trading partners. A recent poll showing that household wealth - a measure of savings and home values - surpassed the pre-recession high suggests the Fed was right in thinking the US is ready for a slightly more constrained consumer.
This week, data on durable goods orders, used home sales and the behaviour of bank stocks will test the Fed's theory that the US economy is finally on an even keel.