MarketView for August 4

Summary

Stock prices were lower on Monday sending all three major equity indexes into negative territory for the day as shares of energy and commodity-related companies fell as a result of declining oil and metals prices. To make matters worse, the Street remained concerned that the housing slump would continue to punish the financials. In addition, the price of crude was lower again on Monday.

 

Copper futures hit a six-month low as all the industrial metals declined after rising inventories on the London Metal Exchange reinforced concerns that economic slowdown could dent demand. Gold dropped more than 1 percent. Domestic sweet crude settled down $3.69 per barrel, or 2.95 percent, at $121.41.

 

While the drop in crude prices was welcome news to consumers as they filled up at the pump, there was concern on the Street that a slowdown in global economic activity would lower demand. As a result, Exxon Mobil saw the price of its shares drop sharply. Exxon ended the day down $3.12, or 3.91 percent, to close at $76.60 and Chevron fell $1.51, or 1.79 percent, to close at $82.80.

 

Downward pressure on stocks occurred early in the trading day after HSBC, Europe's largest bank, reported a 28 percent drop in first-half profit as it took a $14 billion hit from bad debts on U.S. mortgage loans and asset write-downs. Wachovia fell almost 10 percent after a Wall Street analyst placed a sell rating on the shares.

 

Meanwhile, economic data pointing to mounting inflation pressures added to the market's concerns, as did news that WCI Communities, a major U.S. home builder, had filed for bankruptcy. The Dow Jones home construction index fell 1.7 percent to 272.40, after the WCI said it failed to obtain the financing that would keep $1.8 billion of debt out of default.

 

New York University economics professor Nouriel Roubini also fueled concerns about the slumping U.S. housing sector when he told Barron's that the United States is in the early stages of a recession that will last for at least 18 months and will help cause hundreds of banks to fail.

 

Government data that showed U.S. consumer prices increased at the sharpest rate in more than a quarter century during June. The data came a day before a Federal Reserve policy meeting at which the Fed is expected to keep rates unchanged.

 

Qualcomm was among the largest decliners among the NASDAQ 100, falling 4.7 percent to $52.87 after Motorola announced that it had hired Qualcomm's chief operating officer to head its money-losing mobile devices unit.

 

Crude Drops Sharply

 

The price of crude oil fell to a three-month low on Monday, after Tropical Storm Edouard seemed less likely to disrupt oil and natural gas output in the Gulf of Mexico. Crude's steep drop dragged down other commodities from corn to copper. The dramatic drop came after traders learned that Edouard, aiming for the coasts of Texas and Louisiana, likely would not damage offshore oil and natural gas drilling platforms that sit in the storm's path.

 

Also weighing on oil prices Monday was a report by the Commerce Department that consumer spending after adjusting for inflation fell in June as shoppers dealt with higher prices for gasoline, food and other items. That added to expectations that the economic slowdown is sharply curbing domestic demand for fossil fuels.

 

Light, sweet crude for September delivery settled down $3.69 per barrel, or 2.9 percent, at $121.41 per barrel. It was crude's lowest settlement price since May 5. Crude has now fallen in six of the last nine sessions and is down 18 percent off its trading record of $147.27 reached July 11.

 

Natural gas futures also fell sharply, dropping 66.3 cents, or 7.1 percent, to settle at $8.726 per 1,000 cubic feet. And gasoline futures fell 8.41 cents, or 2.7 percent, to settle at $3.0002 a gallon. Other commodities including gold, copper, corn and soybeans also traded lower.

 

Meanwhile, retail gas prices kept falling, reflecting the continuing price-driven drop in the demand for gasoline. Gasoline has fallen 5.6 percent since hitting an-all time high above $4 a gallon on July 17, but so far hasn't kept up with oil's steep descent, suggesting struggling filling stations are still saddled with gas bought when crude prices were higher.

 

Oil prices began the day trading mostly lower after the Commerce Department said inflation-adjusted consumer spending fell by 0.2 percent in June. That was the worst showing since February and gave energy market traders another reason to sell on beliefs that people will further cut back on their driving to cope with near $4-a-gallon gasoline.

 

The question is how the markets will react to Iran’s stubbornness. The Bush administration said Monday the five permanent members of the U.N. Security Council and Germany have agreed to seek more sanctions against Iran over its nuclear program after it failed to meet a weekend deadline to respond to an incentives package aimed at diffusing the standoff.

 

On Sunday, Iranian President Mahmoud Ahmadinejad said diplomacy was the only way out of the standoff. Those comments came a day after he asserted his oil-producing country would not give up its "nuclear rights," signaling that it would refuse demands to stop enriching uranium or at least not to expand its enrichment work.

 

In other NYMEX trading, heating oil futures fell 8.67 cents to settle at $3.3501 a gallon. In London, Brent crude for September delivery fell $3.50 cents to settle at $120.68 a barrel, after earlier falling to a contract-low of $118.80.

 

Inflation Eats Stimulus Payments

 

In June, the second largest increase in inflation in nearly three decades muted the impact of billions of dollars in government stimulus payments, the Commerce Department said on Monday. According to the Department, incomes barely rose in June and consumer spending retreated after taking into account the higher prices for food, energy and other items.

 

Consumer spending was up 0.8 percent in May and 0.6 percent in June, the Commerce Department said. Those increases were slashed to a modest 0.3 percent increase in May and a drop of 0.2 percent in June, however, when adjusted for rising prices of gasoline, food and other products. Incomes rose just 0.1 percent.

 

An inflation gauge tied to consumer spending increased 0.8 percent in June. That was the second largest monthly increase since 1981. In September 2005, the gauge rose by 1 percent after Hurricane Katrina shut down Gulf Coast oil facilities and sent energy prices soaring.

 

The increase in energy and food prices had dampened the impact of the government's economic stimulus program which was pumping out $76 billion in payments during May and June as Washington sought to keep the economy from falling into a deep recession.

 

Even with the recent declines, gasoline is selling for around $3.88 a gallon, up more than $1 from the price a year ago. Last month, gas prices hit an all-time high of $4.11, according to AAA, the Oil Price Information service and Wright Express. Given that economists estimate that every $1 increase in gasoline is like a $120 billion tax, it's understandable that consumers are feeling stretched.

 

The meager 0.1 percent rise in incomes in June followed a sizable 1.8 percent jump in May. Those results were skewed by how the government accounted for the billions of dollars in rebate checks disbursed during the two months, inflating the May figure and making the June performance look weaker.

 

The overall economy, as measured by the gross domestic product, grew at a 1.9 percent rate in the April-June quarter, more than double the 0.9 percent increase in the January-March quarter. That improvement reflected in part the stimulus payments, although the effect was softened by a surge in energy costs.

 

It is likely that the $168 billion stimulus program will continue to lift the economy in the current quarter. However, the economy could slow significantly in the final three months of this year and early next year as the impact from the one-time checks wears off.

 

The savings rate, as a percent of after-tax incomes, dropped to 2.5 percent in June after having shot up to 4.9 percent in May. Both months had a savings rate above the 0.3 percent level of March before the stimulus payments began.

 

The most extensive study done so far of the stimulus payments showed that the average family spent about 20 percent of its rebate in the first month after receipt. That's similar to the spending rate in 2001 when the government was also trying to bolster the economy with a stimulus package. Studies have shown about two-thirds of the 2001 payments were spent within the first six months.

 

Jonathan Parker, an economist at Northwestern University's Kellogg  School of Management and one of the authors of the 2008 study, said in an interview that the typical family increased its spending on food, drug products and other daily merchandise by 3.5 percent when the rebates arrived relative to a family in similar circumstances who had not yet received its rebate.

 

The Treasury Department completed the mass distribution of payments in the week ending July 11, sending out 112 million payments totaling $91.8 billion. Payments will continue in smaller batches to households who file returns in coming months.

 

In other economic news, the Commerce Department reported that orders to U.S. factories shot up by 1.7 percent in June, the fastest pace in six months, reflecting big increases in petroleum prices and heavy demand for military equipment.

 

Head of new FHFA Considers Revising Capital Requirements

 

The head of the new regulatory agency overseeing Fannie Mae and Freddie Mac is considering new capital requirements for the mortgage finance companies, and said he expects the agency to move with "deliberate speed."

 

James Lockhart, chief of the newly-formed Federal Housing Finance Agency and who also headed the predecessor regulator is concerned that protecting the country's housing finance infrastructure is his biggest priority.

 

The Federal Housing Finance Agency was conceived as part of a sweeping, housing-rescue bill meant to aid the battered homes market and buttress Fannie Mae and Freddie Mac which had been pushed to the brink of collapse.

 

The FHFA, which replaces the Office of Federal Housing Enterprise Oversight, will oversee Fannie and Freddie, the two largest U.S. home finance providers, and the 12 Federal Home Loan Banks. All 14 entities have government mandates to make investments in the housing market.

 

Mandating the capital cushions that Fannie Mae and Freddie Mac must hold against possible losses is one of the most nettlesome duties facing the new regulator. The predecessor Office of Federal Housing Enterprise Oversight needed nearly nine years to set those standards.

 

Since Lockhart became the overseer for Fannie Mae and Freddie Mac in mid-2006, he had argued for consolidation of all the federal housing regulators. When President George W. Bush signed the housing legislation on Wednesday, Lockhart became the new agency chief. He is likely to be replaced soon after a new president is elected in January but will help build many new systems before then.

Lockhart said that he has spent the last two years mulling how to set risk-based capital rules for Fannie Mae and Freddie Mac but that establishing such standards would come only after much input from mortgage industry stakeholders.

 

A year ago, shares of Fannie Mae and Freddie Mac were trading above $60 but were driven to single-digits early last month as Wall Street remains concerned over future mortgage losses. Although Lockhart is likely to see his term end early next year, he said he intends to do important work building the agency's infrastructure.