MarketView for February 25

 

 

Summary

 

Wall Street regressed back to its old ways, send share prices lower after President Barack Obama warned of stricter oversight for Wall Street, raising the specter of greater regulation lower profits. Obama's comments near the market close in which he stated that financial institutions that pose a serious risk to markets should be subject to serious government supervision caught the Street by surprise and was not taken well given its Wild West style of the past several years..

 

The equity markets were also buffeted by uncertainty over Washington's plan to shore up the banking system and weak housing sales. The market had turned briefly positive after the government gave details on stress tests of banks' capital levels, with the Street betting that banks would be able to withstand the latest tests with relative ease.

 

Meanwhile, the sales of previously owned homes fell more than expected in January, pulling down homebuilders and large manufacturers. For example, United Technologies and Caterpillar were down more than 3 percent.

 

After the closing bell, shares of Fluor rose 4.3 percent after the company posted a quarterly profit that exceeded Street estimates and maintained its earnings outlook for the year. Bank of America saw its share price rise 9 percent to $5.16 and JPMorgan Chase added 3.4 percent to $21.73, but both pared earlier gains after Obama warned of greater oversight.

 

On the NASDAQ, shares of First Solar fell almost 22 percent to $107.65 after it gave a bleak short-term industry outlook. Shares of Wynn Resorts fell nearly 16 percent to $21.75 after the casino operator reported a fourth-quarter loss as the recession hurt business and it recorded a tax expense.

 

Shares of insurer Lincoln National were down 14 percent after it slashed its dividend more than 95 percent.

 

Crude Up 6 Percent

 

The price of crude oil rose 6 percent to on Wednesday, after a government report showed a sharp drop in gasoline inventories. The decline in gasoline inventories came in data from the U.S. Energy Information Administration that also showed a 1.7 percent rise in demand for the fuel over the four weeks ending February 20. Gasoline inventories fell 3.4 million barrels last week, according to the EIA, while crude inventories rose by 700,000 barrels.

 

Meanwhile, domestic sweet crude for March delivery settled up $2.54 per barrel at $42.50, while London Brent crude settled up $1.79 per barrel at $44.29. The rise in oil prices came despite a drop in equities markets. Further support for oil prices came from reports this week of high compliance by members of the Organization of the Petroleum Exporting Countries with deep production cuts agreed last year to stem the slide in oil prices.

 

Venezuelan Finance Minister Ali Rodriguez, a former president of OPEC, said the OPEC nation expected to propose new output cuts when the group next meets in March.

 

Home Sales and Prices Drop

 

Sales of previously owned homes fell during the month of January, reversing the previous month's surprise jump, and prices spiraled down to a six-year low as the deep recession and rising joblessness took its toll. A drop in number of unsold homes offered some hope for the housing market, the main trigger of the worst financial crisis in the post-war period.

 

The pace of sales of existing home fell 5.3 percent to a 4.49 million-unit annual rate in January, the National Association of Realtors reported, from the 4.74 million rate reported for December.

 

The median national home price declined 14.8 percent from a year ago to $170,300, the lowest since March 2003 when the median was $169,400, the NAR said. Lawrence Yun, chief economist at the NAR said roughly two in five home sales were "distress" transactions where the mortgage company must erase some of the original loan amount in order to complete the sale.

 

"We are seeing worsening economic conditions - loss of housing wealth and in the stock market ... Very low confidence," Yun said.

 

The housing market collapse and the resulting global credit crisis pushed the domestic economy into recession in December 2007. Apparently, few buyers are willing to take advantage of the lowest home prices in several years as most households are experiencing sharp declines in wealth, compounded by rising unemployment and collapsing stock market prices.

 

A separate report showed applications for mortgages fell last week as mortgage rates edged higher. The decline followed recent robust increases in applications after the government unveiled its strongest action yet to aid struggling homeowners.

 

The Mortgage Bankers Association's seasonally adjusted index of mortgage applications, which includes both purchase and refinance loans, fell 15.1 percent to 743.5 in the week ended February 20 after surging 45.7 percent the prior week.

 

A decline in the glut of unsold homes offered a glimmer of hope that the housing market could find some stability later this year, a key ingredient for a turnaround in the economy's fortunes. The inventory of existing homes for sale fell 2.7 percent to 3.60 million from the 3.70 million overstock reported in December, the NAR said.

 

However, sales fell faster than supply of unsold homes, and the 9.6 months it would take at the current pace to clear the market was up from December's 9.4 months.

 

The NAR said it expected a recent federal stimulus package and other rescue measures to spur 900,000 home sales this year. Still, it is unlikely that Washington's encouragement or lower prices to quickly restore the confidence of prospective buyers.

 

Bernanke Not Worried About Inflation

 

Fed Chairman Ben Bernanke said on Wednesday that he had an exit strategy from the U.S. central bank's recent massive monetary expansion that will keep inflation under control as the economy recovers.

 

As he had on Tuesday, Bernanke also told lawmakers he saw no need for the United States to nationalize banks and he assured them that there was no plan for the government take over Citigroup.

 

The severe recession has brought price pressures sharply to heel and the Fed chief said that inflation would not be a problem for the next couple of years, but would be confronted when the time came and economic growth picked back up.

 

"We are quite confident that we can raise interest rates, reduce the money supply and do that all in a timely way to avoid any inflationary consequences," Bernanke told the House of Representatives Financial Services Committee in a second day of testimony on the Fed's monetary policy report.

 

The Fed has cut benchmark overnight interest rates almost to zero and has pumped over $1 trillion into credit markets to keep them functioning after the collapse of the domestic housing market sparked a global credit crisis last year.

 

Bernanke defended the Fed's aggressive actions, and said steps taken by the U.S. central bank and others last fall averted what could have been a "global financial meltdown."

 

"I do quite seriously believe we avoided in mid-October ... a collapse of the global financial system which would have led us into a truly deep and very protracted economic crisis," he said.

 

The Fed chairman acknowledged that at some point economic growth would begin to take up the economy's slack, and said that would mean reversing policy to prevent the enormous increase in the U.S. money supply from creating inflation.

 

"It is very important for us, once the economy begins to recover -- as usual, the Fed would have to begin to tighten policy -- it is very important for us to begin then to unwind our monetary expansion," he told lawmakers.

 

Bernanke acknowledged the risks, but said many of the emergency measures taken by the Fed to boost credit markets would expire with time, and he stressed there was more than one way to tighten monetary policy to curb inflation.

 

"We also have other tools, such as our ability to pay interest on reserves, which will help us raise interest rates, even if we don't get the amount of money outstanding back down as quickly as we otherwise would like."

 

The Fed has had to go around the nation's banks to support lending because massive mortgage losses have savaged their balance sheets and curbed their willingness to extend credit. In an effort to bring banks back to health, the government has invested more than $200 billion in them, which some fear is a step toward outright nationalization.

 

However, Bernanke said nationalization was not needed, and he singled out Citigroup as a prime example of a big bank that was not heading into public hands.

 

"Nationalization to my mind is when the government seizes the bank, zeros out the shareholders and begins to manage and run the bank, and we don't plan anything like that," he said.

 

"It may be the case that the government will have a substantial minority share in Citi or other banks, but again we have the tools ... (to) make sure that we get the good results we want ... without all the negative impact of going through a bankruptcy process or some kind of seizure."

 

"This debate over nationalization kind of misses the point," said Bernanke.

 

Banks To Be Subject To Stress Test

 

Banking regulators began a "stress test" program to assess the ability of the country’s largest banks to cope with the possibility of a deeper recession in which the unemployment rate climbs above 10 percent next year.

 

The stress tests, mandatory for the roughly 20 institutions with over $100 billion in assets, will be used to determine whether the banks need more capital from a new Treasury program for government preferred stock investments that can be converted into common equity.

 

The program, known as the Capital Assistance Program, will be placed alongside a previous program that has injected nearly $200 billion into banks since last October. Both will draw from remaining funds in the Treasury's $700 billion financial rescue fund.

 

The stress tests, to be conducted by end of April by the Federal Reserve, the Federal Deposit Insurance Corp, the Office of the Comptroller of the Currency and the Office of Thrift Supervision, will measure banks against two economic scenarios.

 

The first, or "baseline," scenario is based on the consensus of private economic forecasters. The second, or "more adverse," outlook anticipates a longer and deeper recession.

 

News of the test details, which were not as onerous as some had expected, sparked a brief late rally in financial shares. However, many sank back on comments by President Barack Obama calling for sweeping regulatory reform on Wall Street.

 

Under the stress test program, regulators will conduct "an assessment of all these banks to try and figure out how much capital they need to meet even that weaker scenario," Federal Reserve Chairman Ben Bernanke told the U.S. House of Representatives Financial Services Committee on Wednesday.

 

"Banks will be told how much capital they need to raise, if any. Some will not need any capital, but some will," he added.

 

Bernanke said banks will first have the opportunity to try to raise capital in the private market, but if they cannot do so, the Treasury will offer to buy convertible preferred shares in the bank.

 

If losses grow, this can be converted to common equity, giving the government a direct ownership stake and enhancing the bank's ability to absorb write-downs.

 

The Treasury does not intend to disclose the results of the stress tests, leaving that decision up to banks. It said banks found by the stress tests to need more capital will have six months to either find private funds or take money from the Treasury, which will charge a 9.0 percent annual dividend rate.

 

Officials said the extra, temporary capital cushions would most likely be around 1 percent to 2 percent of a bank's risk-weighted assets, but there was no explicit limit on the amount of capital the Treasury might provide.

 

The baseline scenario assumes real gross domestic product will fall 2.0 percent in 2009 and rise 2.1 percent for 2010. The more adverse scenario assumes a 3.3 percent fall in GDP for 2009 and a rise of just 0.5 percent in 2010.

 

For the unemployment rate, the baseline assumes 8.4 percent unemployment for 2009 and 8.8 percent for 2010, with the more adverse scenario at 8.9 percent for 2009 and 10.3 percent for 2010.

 

For home prices, the baseline assumes a 14 percent drop this year, while the more adverse scenario assumes a 22 percent drop.