Daily State of Market 2/16: Tapping the Brakes

Good morning. While the stock market has a mind of its own, one thing is for certain; traders don’t like surprises. And a surprise is exactly what the markets got on Friday morning as Chinese officials increased the reserve requirement banks must maintain for the second time in a month. When coupled with a lack of details out of Europe on a bailout for Greece and renewed concerns over Dubai, it wasn’t exactly surprising to see stocks take a dive in front of a long holiday weekend on Friday.

With most of the attention focused on Greece and the EU, China’s decision to tap the brakes again stole the show in the early going. The Chinese announced they were bumping up the amount of cash banks must keep in reserve at the central bank by 0.50% in order to slow bank lending. Analysts estimate that each 50 basis points increase in the reserve requirement drains 300 billion yuan (about $44 billion) from the banking system. As a result of the move, China’s banks will now be required to keep 16.5% of their deposits at the central bank.

The goal in China is simple. Officials are attempting to tap the brakes now in order to slow the pace of monetary and economic expansion. There are reports of bubbles forming in residential real estate as well as other asset classes and the Chinese do not want a repeat of the western credit crisis on their hands.

The fear though is that China will hit the brakes too hard in terms of their monetary tightening and wind up sending both the Chinese and global economies smashing through the windshield in the process. Economists estimate that increasing the reserve requirement is only the first step in what is likely to be a fairly substantial tightening campaign. Thus, word of a second hike in the reserve requirement within a month put a crimp in the global recovery trade.

But China wasn’t the only story traders had to deal with on Friday. In addition to the surprise monetary move, weaker-than expected economic data in Europe kept the focus on the issues of sovereign debt. On the data front across the pond, we learned that the EuroZone Q4 GDP came in at +0.1% vs. +0.3% and Q3’s +0.4%, Germany’s GDP was reported at +0.2% vs. +0.7%, and Greece’s GDP fell -0.8% (in addition, the last three quarters were revised lower). This, when combined with a lack of clarity on what the EU rescue package might look like, caused trades to fret about the prospects for the global recovery.

So, with macro worries front and center and the dollar spiking higher at the open against the Euro, traders took stocks down hard in the early going on Friday. But a funny thing happened on the way to the wipeout that the bears have been calling for; it just didn’t happen. Instead, stocks rebounded in impressive fashion to close only modestly lower.

Part of the story behind the big intraday rebound had to do with what could be a rotation into technology. Word is that the fast money crowd is exiting the commodity-demand theme and putting money into the technology sector due to the likelihood of dependable earnings going forward. Another part of the Friday recovery may have been short-covering in front of the long holiday weekend. And finally, the bulls also suggest that there is a chance the correction has run its course. As such, the thinking is that some fund buying and bargain hunting may have begun. We shall see.

Turning to this morning, although the details out of Europe on a plan for Greece are few and far between, the mood is definitely improved in the pre-market.

February’s Empire Manufacturing Index (designed to indicate the state of the manufacturing sector in the New York region) was reported at 24.91, which was above consensus expectations for 18.00. The January reading was 15.92.

Running through the rest of the pre-game indicators, the overseas markets are mixed. Crude futures are up $1.31 to $75.44. On the interest rate front, we’ve got the yield on the 10-yr trading higher at 3.72%. Next, gold is moving up by $26.10 and the dollar is higher against the Yen and lower against the Euro and the Pound. Finally, with about 45 minutes before the bell, stock futures in the U.S. are pointing to a higher open. The Dow futures are currently ahead about 80 points; the S&P’s are up about 10 points, while the NASDAQ looks to be about 12 points above fair value at the moment.

* Report includes items that make comparisons to the consensus estimate questionable

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