MarketView for August 25

Summary

Stock prices fell sharply on Monday as credit concerns were certainly a negative influence on financial stocks while global growth worries hurt the large technology and industrial stocks. The result was that you could kiss goodbye the gains from Friday, although light trading ahead of the upcoming Labor Day weekend may have exaggerated the moves.

Stocks started the day under selling pressure, led by financials, after regulators late on Friday closed Columbian Bank and Trust, the ninth bank to fail amid a weakening economy and falling home prices.

American International Group, the world's biggest insurer, was among the most down trodden of the stocks making up the Dow Jones industrial average, as its shares fell to a 13-year low. Credit Suisse cut the company's share price target and forecast a huge loss for the insurer. AIG's shares fell 5.5 percent to $18.77, after falling as low as $18.64. Late on Friday, Fitch Ratings said it may cut AIG's credit ratings.

Lehman Brothers saw its share price drop about 6.3 percent after a top South Korean regulator voiced concern about state-run Korea Development Bank's interest in acquiring a global bank. Lehman’s shares rose sharply on Friday after KDB said it was considering the investment bank.

Adding to the gloom, the International Monetary Fund trimmed its global growth forecasts for 2008 and 2009 in a note prepared for a meeting of the Group of 20 nations, while Britain reported that its economy ground to a halt in the second quarter, the lowest reading since 1992.

Industrial conglomerates were among the biggest decliners on the S&P 500. Caterpillar which has a large overseas exposure, fell 2.4 percent to $68.56.

Technology shares also fell amid concerns about the global economy. Apple, whose shares fell 2.4 percent to $172.55, was the largest loser on the Nasdaq. Ninety-seven of the Nasdaq 100's stocks were in the red for the day.

The price of domestic sweet Texas crude futures for October delivery settled up 52 cents per barrel at $115.11, adding to concerns about consumer spending and business profits.

A report by the National Association of Realtors indicated that the inventory of homes for sale rose to a record 4.67 million units in July while prices dipped also bruised sentiment.

Among the few gainers on the day Fannie Mae and Freddie Mac, which reversed large losses suffered last week on speculation a possible government bailout could wipe out shareholders. Freddie shares rose 17.1 percent to $3.29, helped by solid demand for its $2 billion bill sale, while shares of Fannie rose 3.8 percent to $5.19.

Crude Up Over Storm Worries

Oil prices ended a choppy session slightly higher Monday after Tropical Storm Gustav formed in the Caribbean. Light, sweet crude for October delivery settled up 52 cents per barrel at $115 after earlier falling as low as $113.68. Trading was light heading into the Labor Day holiday now a week away, adding to the volatility that has characterized the market in recent days. In London, Brent crude futures for October delivery settled up 41 cents per barrel at $114.33 on the ICE Futures exchange.

At the pump, a gallon of regular gasoline shed almost a penny overnight to a national average of $3.681, according to auto club AAA. Gas prices have dropped 15 cents per gallon in the last two weeks, according to the Lundberg Survey of 7,000 gas stations nationwide.

Crude traded erratically most of the day in lockstep with a wavering dollar, which has become the focal point for investors trying to figure out whether crude is going higher or lower. It gained ground against the euro earlier Monday, fell back, then gained again in a span of a few hours.

A stronger dollar typically makes oil less attractive to investors who buy commodities as a hedge against inflation and weakness in the U.S. currency. However, prices were supported by fears that Gustav could threaten oil and natural gas production in the Gulf of Mexico.

Still, unresolved tensions between the U.S. and Russia over the conflict in Georgia could rekindle supply worries and send prices higher. A Monday vote by Russian lawmakers unanimously asking President Dmitry Medvedev to recognize the independence of Georgia's two rebel provinces added to the concerns of energy markets. In analyzing the available commentary, it appears that despite the conflict, energy flows from Russia to the West are relatively safe.

In other Nymex trading, heating oil futures rose 2.03 cents to settle at $3.1514 a gallon, while gasoline prices rose 1.37 cents to settle at $2.8823 a gallon. Natural gas futures fell 1.8 cents to settle at $7.825 per 1,000 cubic feet.

Home Sales and Inventory Both Rise

Sales of previously owned homes increased slightly in July thanks to lower prices, but record inventory numbers imply strongly that the housing market is unlikely to recover soon. Home resales rose 3.1 percent to a 5 million-unit annual rate, according to the National Association of Realtors. It was the largest increase in 17 months.

Meanwhile, the median national home price declined 7.1 percent from a year ago to $212,400 and the inventory of homes for sale rose to 4.67 million which would take 11.2 months to clear at the current sales pace. That matched a record set in April.

Sales have rebounded in many markets in the U.S. West and Florida recently where prices have tumbled, but it is too soon to call a bottom for those regions, Realtors' chief economist Lawrence Yun said. "There is still too much uncertainty," he said.

Although the July data was a relief after months of grim news for housing, which enjoyed five boom years before prices begin to slide in 2006, compared to a year ago, the median existing home price was off 7.1 percent.

IMF Cuts Outlook

The International Monetary Fund has trimmed its forecasts for 2008 and 2009 world economic growth, largely due to a marked worsening in the outlook for the euro zone. With a sharp U.S. economic slowdown starting to spill out into other regions, the IMF has apparently downgraded its world growth forecast for this year to 3.9 percent, down from 4.1 percent in its World Economic Outlook last month.

It projects 2009 growth of 3.7 percent, down from 3.9 percent, in a note prepared for a meeting of deputy finance ministers of the Group of 20 emerging and industrialized economies to be held in Rio de Janeiro on August 30.

The Fund left unchanged its forecast for 2008 U.S. growth at 1.3 percent and shaved its outlook for 2009 growth to 0.7 percent from 0.8 percent but was more downbeat in its new forecasts about the prospects for the euro zone economy.

It cut its forecast for euro zone growth this year to 1.4 percent from the 1.7 percent it had predicted in July and estimated 2009 growth at 0.9 percent, down from 1.2 percent. The latest forecasts mark the start of the IMF's latest assessment of the world economy, which will be finalized when it issues its autumn WEO in Washington in October.

Debt Sales by Freddie Mac Brings Sigh of Relief

Freddie Mac sold $2 billion of short-term debt on Monday, helping to reassure Wall Street that both Freddie Mac and Fannie Mae can fund operations without a government bailout.

The two government sponsored enterprises (GSEs), that own or guarantee nearly half of all domestic mortgages, have lost money for the past four quarters as mortgage delinquencies rise. Nonetheless, both companies currently meet regulatory capital requirements and are rolling over their debt on schedule, at higher yields.

As house prices continue to fall the administration is relying on the two GSEs to fund mortgages through the issuance of debt to support the housing market. To that end, Freddie Mac on Monday sold $1 billion each in three- and six-month bills, with bids stronger than its sale earlier this month. Freddie Mac and Fannie Mae must routinely issue debt to refinance maturing issues that fund their combined $1.5 trillion in mortgage investments. Fannie Mae will test the waters with a sale of $2 billion in bills on Wednesday this week.

Wall Street is concerned that as mortgage defaults rise and erode the two companies' capital, the U.S. Treasury will be forced to intervene, as mandated by Congress in July, by either buying stock or debt in the two companies, diluting the value of existing stock.

Citing an unnamed source, Barron's last week reported a government recapitalization of Fannie Mae and Freddie Mac was increasingly likely and that losses could go beyond common stock to preferred shares and subordinated debt.

Citigroup increased their "risk" rating on the two companies to "speculative" from "high," while keeping a "buy" on the shares. Citigroup also slashed its target prices on Fannie Mae and Freddie Mac by more than half to $9 and $6, respectively.

The fall in Freddie Mac's stock over the past few months has made it difficult for Freddie to raise $5.5 billion in capital as planned, since investors would see their holdings severely diluted, and could risk their entire investments based on some scenarios of government takeover.