MarketView for August 26

Summary

 

Two key indexes, the Dow Jones industrial average and the S&P 500 index, were higher on Tuesday as hurricane fears sent the price of crude oil higher, which in turn sent energy stocks higher. On the down side, a report from the FDIC that there is a growing number of problem banks. The report indicated that 117 banks were on its troubled banks list at the end of the second quarter, up from 90 after the first three months of the year.

 

The FDIC said the assets of the banks on the problem list totaled $78.3 billion through June, up from $26.3 billion at the end of the first quarter. While the FDIC list unnerved the broader market, one analyst said it may be good news for the largest U.S. banks in that the weak are going to get weaker and the strong will be able to take advantage of the weak. Most of the banks on the FDIC's list are small banks.

 

Market gains were also limited by minutes from the Federal Reserve's last policy meeting, where officials said high energy prices, a weak labor market and the housing slump would continue to drag on the troubled U.S. economy.

 

Crude, which at one point rose above $117 per barrel, ended up 1 percent on fear that Hurricane Gustav could disrupt output in the Gulf of Mexico. Exxon Mobil benefited from the rise in oil prices as its shares ended the day up 1.6 percent to close at $79.95, while at the same time adding considerable momentum to both the Dow and the S&P 500. The gain in the price of oil weighed on companies that are sensitive to higher fuel costs, such as airlines. An index of airline stocks was down 4.1 percent.

 

On the NASDAQ, Marvell Technology fell 6.6 percent after Jefferies & Co. downgraded the microchip design company's stock on concerns about its hard disk drive inventory and weak cellular positioning.

 

For now, consumer confidence appears to be holding up. A Conference Board report on Tuesday showing consumers were feeling more optimistic in August gave stocks an early boost and helped offset a mixed bag of housing data.

 

The Standard & Poor's/Case-Shiller showed prices of single-family homes fell at a record pace in June, though nine of the 20 cities tracked showed price increases, up from seven in May.

 

Fannie Mae and Freddie Mac rallied on hopes that a possible government rescue would not necessarily wipe out shareholder value. Fannie's shares rose 8.3 percent to $5.62 and Freddie's shares jumped 20.7 percent to $3.97.

 

Consumer Confidence Rises

 

The Conference Board reported on Tuesday that Consumer confidence recovered more than expected in August as fears over inflation eased, while financial markets combed through housing data for reasons to hope the worst is over for the moribund sector. According to the  Board, its index measuring consumers' mood jumped to 56.9 this month from July's 51.9 for the highest reading since May, while a decline in inflation expectations should please Federal Reserve officials worried about an unwelcome rise in price pressures this year.

 

However, the data by no means suggests the currently stagnant economy is about to vault into recovery mode, though some analysts said it showed embryonic signs of stabilization that could herald a slow turn for the better if maintained.

 

"Consumer confidence readings suggest the economy remains stuck in neutral, but may be showing signs of improvement by early next year," Lynn Franco, director of the Conference Board Consumer Research Center, said in the report.

 

According to the Board its gauge of inflation expectations fell to 6.7 percent, its lowest since 6.1 percent in March, from July's revised 7.5 percent. It hit a record high of 7.7 percent in May and June and was originally reported at 7.6 percent for July.

 

Minutes Show Fed Is Aware Of Rising Inflation

 

The Fed saw a weakening economic outlook and financial market stress as supporting the case for steady interest rates despite persistent concerns about inflation. At their latest policy meeting on August 5, members of the rate-setting Federal Open Market Committee agreed that softening labor markets, high energy prices and a continuing housing contraction would weigh on future growth, leaving economic activity "damped" for several quarters.

 

"In addition, members saw continuing downside risks to this outlook, particularly reflecting possible further deterioration in financial conditions," the Fed said in minutes of the meeting released on Tuesday.

 

While the members agreed the next policy move would likely be an increase in rates, most of them did not see the Fed's current monetary stance as "particularly accommodative," because households and businesses were facing tighter credit and higher borrowing costs.

 

The meeting ended with the Fed keeping its benchmark federal funds rate unchanged at a low 2 percent, where it has been since April, when the U.S. central bank paused a six-month rate-cutting campaign.

 

At the same time, FOMC participants said inflation was expected to moderate in coming quarters, reflecting a "leveling-out" of energy and commodities prices.

 

"Although measures of core inflation might well edge up later this year, given the pass-through to final goods prices of earlier increases in the prices of energy and other inputs, most participants anticipated that core inflation would edge back down during 2009," the Fed said.

 

Still, FOMC members expressed concerns that persistently high headline inflation could unmoor long-run inflation expectations.

 

"A number of participants worried about the possibility that core inflation might fail to moderate next year unless the stance of monetary policy was tightened sooner than currently anticipated by financial markets," the Fed said.

 

But with banks reluctant to lend, some analysts said low interest rates were not currently fanning inflation.

 

Dallas Fed President Richard Fisher was the lone dissenter in the 10-1 vote to hold rates steady. He preferred to raise rates to combat rising inflationary pressures, which he saw as a greater risk to the economy. Fisher saw businesses as being more inclined to raise prices to pass on higher costs for imported goods and other inputs, the minutes said.

 

In a July 24 conference call during which the FOMC and the Fed Board of Governors agreed to expand Fed lending facilities, some participants raised questions about the timing of the move, according to minutes of the call.

 

Some asked whether the announcement could suggest that the Fed saw markets as more fragile than expected or whether the Fed intended to keep the facilities in place permanently. But the minutes noted there was considerable support for expanding the Term Auction Facility to allow for 84-day loans to banks.

 

Troubled Banks Increase 30 Percent

 

The number of troubled banks rose 30 percent to 117 in the second quarter, the highest level in five years, as the housing slump and worsening economy pounded profitability, a regulator said on Tuesday.

 

FDIC Chairman Sheila Bair expects more banks to join the agency's watch list of problem banks, which tallies institutions with financial, operational or managerial weaknesses that threaten their financial viability.

 

"We don't think the credit cycle has bottomed out yet," Bair told a news conference, adding that U.S. banks will not return to high levels of earnings any time soon. The news initially pulled down financial shares before markets closed higher after a boost in oil prices.

 

Bair said the FDIC will consider a plan in October to require banks that engage in high-risk behavior to contribute more to the agency's dwindling Deposit Insurance Fund, which it uses to repay insured deposits at failed banks.

 

"The higher premiums will be high enough to provide incentives to decrease their higher risk activities," Bair said.

 

The FDIC said the banking sector's earnings fell 86 percent from a year earlier to $5 billion in the second quarter due to a fourfold increase in provisions for bad loans. With the exception of the fourth quarter of 2007, the industry's earnings were the lowest since the fourth quarter of 1991.

 

The FDIC said the combined assets of the 117 problem banks increased to $78 billion from $26 billion in assets at 90 banks in the first quarter. Bair has said that historically 13 percent of banks on the watch list fail.

 

The latest figure included $32 billion of assets from IndyMac Bancorp, which became the third-largest bank failure in July. Nine banks have failed so far this year. FDIC examiners closely monitor the watch list but do not publicly release the names on it.

 

Bair said 98 percent of U.S. banks continue to be well-capitalized. She also noted that the banking sector's exposure to mortgage giants Fannie Mae and Freddie Mac's preferred securities is "not problematic" but said some smaller institutions could be under stress.

 

The housing slump, worsening economic conditions and the overall downturn in the credit cycle forced banks to set aside $50.2 billion in loan loss provisions during the second quarter, the FDIC said in its quarterly industry update. That figure is more than four times the $11.4 billion that the industry set aside in the second quarter last year.

 

The FDIC's Deposit Insurance Fund fell to $45.2 billion at the end of the second quarter from $52.8 billion at the end of the first quarter due to IndyMac and other bank failures. It is likely the FDIC will increase the insurance premium banks pay.