MarketView for February 23

Summary

Wall Street hit a 12-year low on Monday as concerns ran wild over whether the government will be able to stabilize the financial system. Of course it will, but it will take time and running around crying wolf all the time is certainly not going to solve any problems. Nonetheless, the concerns that have been fanned by both the media and the so called pundits resulted in the S&P 500 and the Dow both posting their lowest close since the spring of 1997. Adding to the uneasiness were reports that the government may convert its stake in Citigroup into a big common stock holding fell short of what many see as what is supposedly necessary to fix large banks.

Dow component General Electric, whose businesses include a big financing arm, also weighed on the blue-chip index after Deutsche Bank cut its price target on GE by almost a third and said the company's dividend may be vulnerable in the second half of 2009. GE fell 5.7 percent to $8.85, after hitting a 13-year low of $8.78.

A decline of more than 13 percent in shares of U.S. Steel Corp contributed to a 6.2 percent slide in the S&P materials index. Adding to the bleak picture, CNBC reported that insurer American International Group could be forced into bankruptcy if new rescue talks with the government fail to secure it more funding.

At the same time, concerns over whether the decline in business and consumer spending on technology has been a mortal wound, or close to it, resulted in IBM and Hewlett-Packard becoming two of the biggest drags on the Dow Jones industrial average, with IBM losing 5.0 percent of its share price, to close at $84.37 and Hewlett-Packard falling 6.3 percent to $29.28 a share.

Helping to fuel the tech slide was a Morgan Stanley downgrade of its PC sales forecasts for 2009 and 2010, citing lower prices and weaker-than-expected demand for PCs given the rising sales of netbooks, which are cheaper, no-frills notebook computers. Apple closed down nearly 5 percent to $86.95. It was the primary drag on NASDAQ.

The market capitalization of the Dow fell $77.1 billion on Monday. The index is down nearly 50 percent from its record high close in October 2007, with about $10 trillion of value in wiped out since then. So far this year, the Dow has fallen 18.9 percent while the S&P 500 has shed 17.7 percent and the NASDAQ has fallen 12 percent.

Fears that some major banks could be nationalized continued to drag on sentiment on Monday, as stocks briefly came off lows after the White House reiterated that a privately held banking system regulated by the government was still the best way to operate.

The only positive news regarding the Dow came from Citigroup and Bank of America, which were up 9.7 percent and 3.2 percent, respectively, after having fallen more than 35 percent each on Friday.

After the closing bell, JP Morgan announced it will slash its quarterly dividend to 5 cents a share from 38 cents, saying that will enable it to retain an additional $5 billion in common equity per year. Shares rose 1 percent to $19.70 in extended trading.

Crude Down Again

The price of crude oil continued to decline on Tuesday, sliding toward $38 on growing economic worries after U.S. stocks slumped to a 12-year low at the previous day's close. Sweet domestic crude for April delivery settled down 35 cents per barrel at $38.12. London Brent crude settled down 6 cents per barrel at $40.93. Global energy consumption has collapsed as the financial crisis throws a raft of major economies into a recession, prompting oil prices to tumble nearly $110 since peaking in July.

Oil's decline was curbed by a report that OPEC's supply was likely to fall in February as members enforced a deal to cut output, increasing the group's scope to slow production further at a March 15 meeting, traders said. Of the 11 members with quotas, all except Iraq had reduced output by 3.8 percent to 25.3 million barrels per day in February.

Iran's local media reported that its OPEC governor had said the producer might decide to cut output again next month if crude prices fell further. Along with Iran, Venezuela and Iraq said last week that OPEC was prepared to cut production again. The Street is keeping a close watch on current oil inventory data, which is likely to show a 1.9 million barrel increase in U.S. crude stocks last week.

AIG Still in Trouble

American International Group and the government are engaged in talks, as the troubled insurer faces massive losses due to write downs on commercial real estate and other assets, according to a CNBC report on Monday. The talks with the government include the possibility of additional funds for the insurer and trading debt for equity, a source familiar with the matter told Reuters.

The situation is fluid, and other options are also being discussed, the source said, adding that it was unclear where the talks would ultimately lead. AIG's board is trying to work out an agreement with the government, CNBC said.

In case they do not reach a deal, AIG's lawyers at Weil, Gotshal & Manges LLP were preparing for the possibility of bankruptcy, CNBC said.

AIG has already gone to the government twice for help. The government rescued the company in September after bad mortgage bets left it on the verge of collapse. The bailout swelled to about $150 billion in November when the Federal Reserve and U.S. Treasury stepped in with more cash to buy mortgage assets that had left AIG deeply in the red, and to ease the terms of its loan repayment.

Concerns over Commercial Property

Commercial real estate problems could derail the country's economic recovery later this year, Federal Reserve Bank of Atlanta President Dennis Lockhart said on Monday.

"Many banks are pretty heavily exposed to commercial real estate. It is also a big part of the securitization market. So commercial real estate is one that concerns me," He said.

Lockhart, a voting member of the Fed's policy-setting committee this year, said that around $400 billion of commercial real estate refinancing was hanging over the market and he was monitoring its progress with care.

"If you think of 2007 and 2008, in a negative sense, as the year of...residential real estate issues, it is possible to think of 2009 as the year of commercial real estate. That is the one domestic factor that keeps me up at night," he said.

Lockhart said bold action by U.S. officials should restore growth in the second half of 2009, and he emphasized this meant that Fed rates would be hiked at some stage from their current near-zero levels to keep inflation at bay.

"We see very little risk of hyper-inflation, or serious inflation, in the short term. If anything, we're somewhat more concerned about the opposite," Lockhart said.

According to Lockhart, "One of the requirements of the future, conceivably, as the economy recovers, will be the return to more conventional policy and shrinking of the Fed's balance sheet (and), conceivably, rate rises. You have to time that appropriately to ensure that we don't have a long-term inflation,"

Lockhart stressed that the U.S. central bank had undertaken to use all the tools at its disposal to aid the economy, and he endorsed government action to boost bank balance sheets. "By injecting capital into banks, I believe the U.S. Treasury has strengthened and will further strengthen bank balance sheets," he said.

The Treasury has already injected more than $200 billion into banks and was joined by the Fed and other agencies on Monday in a fresh assurance that the government would provide more capital as needed to keep large financial institutions viable.

In one brighter note, Lockhart said it was very hard to gauge the start and end of recessions, and cautioned there was a tendency to be too gloomy in predicting a recovery.

"Economic forecasts will tend to be overly optimistic as the economy goes into a recession, but overly pessimistic as the economy comes out of recession and begins its expansion phase. Perhaps we should take some comfort from that," he said.

But he warned there were significant risks to his outlook from a chilled international growth climate, in addition to the weakened state of the domestic housing and bank sectors.

"I'm also playing close attention to the trajectory of Japan. Last quarter the Japanese economy contracted by 13 percent and deflationary pressures have accelerated," he said.

Asked if he was confident that China would be able to boost domestic demand speedily, Lockhart made plain that he was not holding his breath for quick results from stimulus measures announced by Beijing.

"Whether that is going to be possible in the short-term is a very debatable question. Because shifting from a high savings, low consumption society to a lower savings, higher consumption society in a short period of time can't easily be done," he said.