MarketView for February 4

 

 

 

Summary

 

The major equity indexes were lower on Wednesday as a warning from Kraft Foods indicated that consumers are skimping even on the basics, combined with worries that government efforts to rescue banks could wipe out their shareholders. Kraft, the top North American food manufacturer, fell more than 9 percent and was the top drag on the Dow, followed by Disney, which fell nearly 8 percent after reporting a slide in quarterly earnings. Kraft fell 9.2 percent to $26.11, while Disney was down 7.9 percent to $19.00.

 

Nonetheless, a report indicating that the service sector of the economy shrank less than expected in January helped push the techs higher sending the NASDAQ to a near break-even finish. However, all that happened during regular trading. In after-hours trading, Cisco forecast a drop of as much as 20 percent in revenue this quarter, hitting other tech shares after the bell.

 

Costco Wholesale fell nearly 7 percent after the largest warehouse club operator warned quarterly earnings would fall short of Street's expectations. Costco ended the day down 6.8 percent to $42.98.

 

Unease about the deteriorating earnings picture and uncertainty about the banking sector are major hurdles in the market's attempt to recover from an 11-year low hit on November 21. The S&P 500 is up 4 percent since then, but is down about 8 percent since the start of 2009.

 

Shares of Bank of America fell 11.3 percent to $4.70, capping a fifth straight day of declines and touching a 19-year low during the session, due to concerns over the uncertainty of how a government plan to relieve banks of money-losing assets would work. Of particular concern is that the plan could wipe out current stockholders, traders said. The Obama administration is due to make an announcement on its bank rescue plan next week.

 

On the bright side, data from the Institute for Supply Management showed the service sector, which represents about 80 percent of all economic activity, shrank less than expected in January, welcome news for investors. The data sent large cap technology companies, including Microsoft, which posted a third straight day of gains, rising nearly 1 percent to $18.63. Intel was up 2.1 percent to $13.88.

 

However, Cisco gave investors a more sober view, with a forecast for a drop of 15 to 20 percent in its current quarter revenue as the recession deepens. Cisco’s shares were down 4 percent to $15.20 in after hours trading after closing at $15.84.

 

Price of Crude Down

 

The price of domestic sweet crude oil for March delivery settled down 46 cents per barrel at $40.32, after falling to a session low of $39.74. London Brent settled up 7 cents. at $44.15. The Energy Information Administration, reported crude inventories rose 7.2 million barrels last week to an 18-month high of to 346.1 million barrels, extending a stretch of builds as demand wanes under the weight of an economic slowdown.  Crude supplies at the Cushing, Oklahoma delivery point increased by 800,000 barrels to a record high of 34.3 million barrels.

 

The EIA data was similar to a report by the American Petroleum Institute (API) on Tuesday indicating that crude oil stocks increased by 8.1 million barrels last week. Oil traders and analysts generally consider the API report to be less credible than the EIA data.

 

Oil's losses were limited by signals from OPEC that it may cut oil production further in an attempt to bolster the market. OPEC is concerned that the global economic downturn is reducing oil demand and in turn putting down pressure on prices. It has therefore promised to reduce oil production by a total of 4.2 million barrels per day (bpd) from levels seen in September.

 

OPEC's president said on Tuesday the 12-member group could remove more oil from the market if needed to boost prices.

 

SEC Visibly Shaken

 

"You couldn't find your backside with two hands if the lights were on... You have totally and thoroughly failed in your mission," said New York Democratic Rep. Gary Ackerman said of the SEC on Wednesday.

 

Harry Markopolos, a former investment manager who tried to warn U.S. regulators about Bernard Madoff, joined lawmakers in blasting the Securities and Exchange Commission but said he was forwarding more tips to the agency.

 

Markopolos told a congressional hearing on Wednesday that SEC staff were neither willing nor able to uncover what Madoff, arrested in December and charged with a record-shattering $50-billion fraud, was really doing.

 

Calling SEC staff "too slow, too young and too undereducated," Markopolos said the regulator was hindered by lawyers, did not understand red flags, could not do the math and was captive to the financial industry.

 

"They looked at the size of Madoff and said he's a big firm and we don't attack big firms," said Markopolos, who became aware of Madoff when the firm he worked for tried to pursue the same kind of strategy Madoff did but never got the same steady, strong returns.

 

Members of the House Financial Services subcommittee hailed Markopolos but excoriated five SEC officials who declined to answer specific questions about the Madoff case, citing ongoing investigations.

 

For the SEC, Wednesday's testimony marked what some insiders called the worst day in the agency's history, further tarnishing its reputation and sending morale to a new low.

 

Lawmakers angrily questioned the SEC's head of enforcement, Linda Chatman Thomsen; the agency's top examiner Lori Richards; Erik Sirri, the SEC's trading and markets chief; Andrew Donohue, who is in charge of investment management and the SEC's acting general counsel, Andrew Vollmer.

 

Capital markets subcommittee chairman, Paul Kanjorski, a Democrat from Pennsylvania, threatened to reform the SEC out of existence.

 

And Ackerman, who personally escorted Markopolos out of the hearing room, told the SEC officials: "We thought the enemy was Mr. Madoff, I think it was you. You were the shield."

 

Harsh words were lobbed at former SEC employees including Meaghan Cheung, the agency's New York branch chief whom Markopolos contacted in 2005. Cheung, Markopolos said, was arrogant, never grasped the concepts in his report or asked him any questions. Cheung left the SEC in fall of 2008.

 

The SEC division heads told the panel that the agency was considering a number of changes in light of the Madoff case, including how frequently investment advisers are examined.

 

Thomsen, who appeared visibly shaken during the hearing, responded to charges that her enforcement division had too many lawyers. "Within enforcement we have lots of accountants, lots of market specialists and investigators."

 

Economic Data Remains Grim

 

The economy is hemorrhaging jobs and may recover for at least another year, even if the government acts quickly to stimulate the economy, according to reports released on Wednesday. The private sector cut more than half a million jobs in January, ADP Employer Services said, and other data showed planned layoffs reached their highest monthly level in seven years during the month. The reports were released ahead of the government's more comprehensive non-farm payrolls data, which is due on Friday and expected to paint a similarly bleak picture.

 

The service sector, which represents about 80 percent of U.S. economic activity, contracted at a less severe rate in January than the previous month, but the job outlook in this key area of the economy remained grim, according to the Institute for Supply Management. The ISM said its non-manufacturing index came in at 42.9 in January compared with 40.1 in December. That was below the level of 50 that separates expansion from contraction.

 

While the reports were slightly stronger than expected, the point they made was the same, even the $900 billion economic stimulus bill being debated by lawmakers will only soften the pain of the downturn.

 

Government bonds, which generally benefit from weak economic data, fell to session lows after the ISM report. As workers' fate appeared to grow less secure amid mounting job losses, President Barack Obama imposed tough new rules to rein in corporate pay. He capped executive compensation at $500,000 a year for companies receiving taxpayer funds and limited lavish severance packages paid to top officials.

 

Though the headline figure was not as bad as expected, the ISM's employment gauge reflected the job cuts throughout the economy, slipping to 34.4 from 34.5 in December.

 

The impact of an economic slump that is likely to be the most protracted since the 1930s Great Depression is broadening across a wide range of industries, outplacement company Challenger, Gray & Christmas said in its monthly report on U.S. job cuts.

 

Job cuts announced in January totaled 241,749, up 45 percent from December's 166,348. Layoffs were up from 74,986 in the year-ago period.

 

Record downsizing in the retail sector, with 53,968 layoffs planned, was the biggest area for job cuts and contributed to the overall rise in January's total, Challenger said.

 

There was some good news for the housing market, the original source of the current U.S. economic troubles.

 

Mortgage applications rose in the last week of January, reflecting a jump in demand for home refinancing loans even as interest rates rose to their highest levels since early December, data from the Mortgage Bankers Association showed.

 

Cisco Down on Missed Expectations

 

Cisco CEO John Chambers forecast a far sharper drop in current-quarter revenue than Wall Street had expected, and said the network equipment maker may cut up to 2,000 jobs as economic weakness spreads. Chambers told analysts on a conference call that he expects revenue in the current, fiscal third quarter to fall 15 percent to 20 percent from a year ago.

 

He said economic weakness had spread beyond the United States and Europe, with revenue from emerging markets falling 11 percent in the fiscal second quarter ended January 24. Low visibility in the current economic environment meant it was one of the most difficult periods in his career for making financial forecasts, Chambers said. He said the company, which ended the quarter with more than 67,318 employees, would continue a cost-cutting process that could result in a loss of 1,500 to 2,000 jobs.

 

Chambers said Cisco was not considering mass layoffs at this time, but he warned that it may become necessary depending on the economy. The CEO said he considered job cuts of 10 percent of workers as a mass layoff. Cisco's results and outlook are closely watched as an early indicator of changes in technology spending. The company is one of the first in the tech sector to report results that include most of January.

 

Tighter credit and a hazy economic outlook have made it harder for companies to invest in big-ticket technology items such as Cisco's routers. A Cisco CRS-1, for example, costs around $500,000 to $1 million. Cisco has said until recently that growing use of the Internet, particularly online video, would help shelter them from the recession. However, sluggish consumer spending has hit phone and cable service providers much harder than many had expected. AT&T Inc and Verizon have said they are trimming capital spending in 2009.

 

Net profit in Cisco's fiscal second quarter fell to $1.5 billion, or 26 cents per share, from $2.1 billion, or 33 cents a share. Profit excluding items fell to 32 cents a share from 38 cents a share. Revenue fell 7.5 percent to $9.1 billion, the first year-on-year decline since 2003, as the economic downturn forced companies to cut back on technology spending.

 

Chambers said that assuming the economy returned to a normal growth rate, Cisco was keeping its long-term target for annual revenue growth of 12 percent to 17 percent.

 

Nationalization Worries Trip Up Bank of America

 

Bank of America saw its share price fall below $5 for the first time since 1990 on speculation that spiraling losses at newly acquired Merrill Lynch might lead to government control of the largest bank, wiping out shareholders.

 

Shares fell more than 11 percent, marking the fifth straight decline, as rumors persisted that mounting losses on mortgages and corporate loans might lead to the nationalization of the bank and possibly the ouster of CEO Ken Lewis. Bank of America and Merrill Lynch ended 2008 with $2.49 trillion of assets.

 

Bank of America shares fell 60 cents to $4.70 and slipped as low as $4.62 during trading. The cost of protecting the bank's debt against default with credit default swaps rose 0.3 of a percentage point.

 

Lewis has come under fire from shareholders as the once-lauded Merrill Lynch acquisition has unraveled, leaving Bank of America dependent on government support to battle mounting losses and evaporating shareholder value.

 

Bank of America last month posted its first quarterly loss in 17 years, and said Merrill's $15.31 billion quarterly loss was so much worse than expected that Lewis needed help from the government to complete the acquisition.

 

The government, which had already given Bank of America $25 billion in October under the Troubled Asset Relief Program (TARP), agreed to inject $20 billion more, and to share in losses on $118 billion of residential and commercial mortgages, derivatives and corporate debt.

 

Lewis had coveted Merrill for its brokerage force, often known as the "thundering herd," which he called the "crown jewel" of the roughly $19.4 billion takeover.