MarketView for August 5

Summary  

Share prices on Wall Street ran into a bit of a brick wall on Wednesday as weak data from the services sector, along with a drop in private payrolls, reversed the optimism of late, although the major equity indexes did manage to finish off their low points as funds moved into riskier shares within the financial sector. The drop in share prices came on the heels of a four-day rally that had driven the three major indexes to close on Tuesday at their highest levels in nine to 10 months.

The Institute for Supply Management's services index came in at 46.4 in July. Any reading below 50 indicates a contraction in the service sector, which accounts for about 80 percent of economic activity in the United States.

A report from ADP indicated that private employers cut 371,000 jobs in July, suggesting the labor market remained weak. The Labor Department's non-farm payrolls report, due out at the end of the week, is expected to show 320,000 jobs were lost in July. The ADP private-sector jobs report increased investors' caution ahead of Friday's government data.

Meanwhile, The Commerce Department said new factory orders unexpectedly rose in June, advancing for a third-straight month.

Procter & Gamble was the biggest drag on the Dow Jones industrial average after it reported a slide in quarterly sales. P&G's stock closed down 2.8 percent at $53.91. Meanwhile, Cisco could set a negative tone on Thursday after the company reported lower quarterly revenue after the closing bell and forecast first-quarter revenue would be down 15 to 17 percent year-over-year. In extended-hours trading, Cisco's stock fell 3.3 percent to $21.43 from its close of $22.17 in regular trading.

Companies, such as AIG, were up sharply in price, pointing to  a short squeeze as investors who were short the stock scrambled to buy back their short positions on fears that stocks would continue to rise. AIG was up 62.7 percent to $22 ahead of the company's second-quarter earnings on Friday, which are expected to stabilize for the first time in five years.

Bank of America rose 6.5 percent to $16.66. American Express rose 5.8 percent to $30.36 after it said credit card defaults fell for a second straight month in July, helped by a lower-than-expected number of bankruptcies.

Baker Hughes and Transocean also fell after they reported quarterly results that missed expectations. Baker Hughes' fell 7.8 percent to close at $38.68, while Transocean's shares were down 3.4 percent to $77.60.

The Unexpected Move Higher 

Shares of AIG and CIT rose sharply on Wednesday, as investors rushed to buy shares to cover short positions in the companies. AIG closed up 62.7 percent, ahead of its quarterly earnings report due on Friday. CIT shares hit an Intraday high of $1.56, up from a close of $1.01 on Tuesday. The lender to small and medium-sized companies has been battling losses and recently secured a $3 loan facility from bondholders. The stock closed at $1.39.

Shares in mortgage finance companies Fannie Mae and Freddie Mac were also higher on Wednesday. Fannie closed up 29.8 percent at 74 cents, while Freddie was up 31 percent at 80 cents. Shares in Ambac Financial, another company that has been hurt by losses, gained 34 percent to close at $1.22.

Shares in AIG rose as analysts forecast operating earnings could stabilize after five-straight quarterly losses. The Street has been predicting AIG would benefit from unrealized investment gains, partly reversing write-downs in earlier quarters. There is also optimism surrounding the appointment of new CEO Robert Benmosche, who next Monday will become the fourth person in the last 14 months to assume the insurer's leadership.

In all, option traders had exchanged about 380,000 contracts in AIG, five times the average daily volume, according to option analytics firm Trade Alert. The turnover was dominated by 228,000 calls, which grant investors the right to buy AIG shares at a fixed price and time.

Dire News From Deutsche Bank

The percentage of U.S. homeowners who owe more than their house is worth will nearly double to 48 percent in 2011 from 26 percent at the end of March, portending another blow to the housing market, Deutsche Bank said on Wednesday.

Home price declines will have their biggest impact on prime "conforming" loans that meet underwriting and size guidelines of Fannie Mae and Freddie Mac, the bank said in a report. Prime conforming loans make up two-thirds of mortgages, and are typically less risky because of stringent requirements.

"We project the next phase of the housing decline will have a far greater impact on prime borrowers," Deutsche analysts Karen Weaver and Ying Shen said in the report.

Of prime conforming loans, 41 percent will be "underwater" by the first quarter of 2011, up from 16 percent at the end of the first quarter 2009, it said. Forty-six percent of prime jumbo loans will be larger than their properties' value, up from 29 percent, it said.

"The impact of this is significant given that these markets have the largest share of the total mortgage market outstanding," the analysts said. Prime jumbo loans make up 13 percent of the total market.

Deutsche's dire assessment comes amid a bolt of evidence in recent months that point to stabilization in the U.S. housing market after three years of price drops. This week, the National Association of Realtors said pending home sales rose for a fifth straight month in June. A widely watched index released in July showed home prices in May rose for the first time since 2006.

Covering 100 U.S. metropolitan areas, Deutsche Bank in June forecast home prices would fall 14 percent through the first quarter of 2011, for a total drop of 41.7 percent.

The drop in home prices is fueling a vicious cycle of foreclosures as it eliminates homeowner equity and gives borrowers an incentive to walk away from their mortgages. The more severe the negative equity, the more likely are defaults, since many borrowers believe prices will not recover enough.

Homeowners with the riskiest mortgages taken out during the housing boom have seen the greatest erosion in equity, in part because they were "affordability products" originated at the housing peak, Deutsche said. They include subprime loans, of which 69 percent will be underwater in 2011, up from 50 percent in March, Deutsche said,

Of option adjustable-rate mortgages -- which cut payments by allowing principal balances to rise -- 89 percent will be underwater in 2011, up from 77 percent, the report said.

Regions suffering the worst negative equity are areas in California, Florida, Arizona, Nevada, Ohio, Michigan, Illinois, Wisconsin, Massachusetts and West Virginia. Las Vegas and parts of Florida and California will see 90 percent or more of their loans underwater by 2011, it added.