MarketView for February 26

 

 

Summary

 

Stock prices were lower in volatile trading, sending all three major indexes well into negative territory once again as a backlash against healthcare companies such as Merck resulted from staggering concerns over the possibility, at least from Wall Street’s perspective, that President Obama's budget proposal will strangle profits. Merck was the Dow's largest drag, closing down, 6.7 percent at $26.04. Health insurers also fell, including Humana down 19.5 percent at $23.64.

Add in another round of dismal economic data even blue chips, such as McDonald’s and Coca-Cola took a hit.

 

The plan to expand healthcare coverage and curb costs calls for cutting Medicare payments to private insurers, letting consumers buy cheaper medicines and preventing drug companies from making deals that block generic competition.

 

Adding to the pressure were financial stocks that lost some ground after a report showed the number of troubled banks increased during the fourth quarter. Citigroup ended the day down 2.4 percent at $2.46.

 

On Nasdaq, biotech companies such as Gilead Sciences and Amgen were among the primary laggards, falling 5 and 9.4 percent, respectively.

 

After the closing bell, Dell reported fourth-quarter earnings of 29 cents a share, excluding items, above the Street’s estimate of 28 cents. However, revenue of $13.4 billion was lower than expected.

 

The government released more bleak news on the economy on Thursday as one report showed the number of workers continuing to claim jobless benefits hit a new record during the second week of February, while another report indicated that durable goods orders fell for a sixth straight month in January to a six-year low. A separate report showed new homes sales hitting their lowest level since 1963.

 

IBM was the top performer on the blue-chip index, as its share price rose 3.6 percent to $88.97 after it affirmed its full-year earnings outlook, making it the top gainer in the Dow. In contrast, shares of General Motors fell 6.7 percent to $2.38 after the auto-maker posted a quarterly loss and said its auditors were likely to cast doubt on its viability.

 

Shares of Sallie Mae, the largest domestic student loan group, saw its share price fall nearly 31 percent to $5.80 on a proposal in Obama's 2010 budget that would axe the federally guaranteed student loan program.

 

Crude Futures Continue to Advance

 

Oil prices rose more than 6 percent on Thursday on expectations OPEC will cut output again and on signs of a rebound in gasoline demand in top consumer the United States. OPEC member United Arab Emirates announced it was cutting back supplies to Asia for April, adding to expectations the producer group will throttle back production further when it meets in March.

 

Sweet domestic crude for April delivery settled up $2.72 per barrel at $45.22. London Brent settled up $2.22 per barrel at $46.51. Support for the increases also came from government data released on Wednesday indicating that gasoline demand rose over the four weeks ending February 20.

 

The new Administration’s budget outline calls for eliminating substantial tax breaks and increasing fees for the oil and natural gas industry. Since September, OPEC has pledged to cut output by 4.3 million barrels per day as part of efforts to stem the steep drop in prices as demand shrinks.

 

Abu Dhabi's move to cut allocations may pre-empt a decision by OPEC to cut more when the group meets in Vienna next month. Venezuela wants OPEC to agree to a new oil output cut, the nation's oil minister said, adding that significant oversupply in the market is weighing on crude prices. However, Ecuador's oil minister said there was no need for OPEC to cut output again during its next meeting as world oil prices stabilize.

 

Unemployment Insurance Claims Set Record

 

The number of claims for unemployment insurance rose to a record high in mid-February, while the recession undercut demand for manufactured goods last month and sent new homes sales to their lowest since 1963.

 

Companies are cutting staff to lower costs as demand slumps and banks limit access to credit. However, rising unemployment is sapping consumer spending and piling pressure on an economy wallowing in a 14-month recession. As result, the government has stepped in with a $787 billion package of spending and tax cuts to break the downward spiral.

 

The number of people remaining on the benefits roll after drawing an initial week of assistance increased by 114,000 to a record 5.11 million in the week ended February 14, the most recent week for which data is available, the Labor Department said.

 

Initial claims for state unemployment insurance benefits increased to a seasonally adjusted 667,000 last week from 631,000 the prior week, the department said. It was the highest reading since October 1982.

 

The surge in weekly applications for unemployment benefits implied February's jobs report could show a decline in payrolls in excess of 700,000, according to some economists.

 

Durable Orders Decline

 

A separate report from the Commerce Department indicated that durable goods orders fell 5.2 percent to $163.8 billion in January, the lowest level since December 2002. Orders fell 4.6 percent in November. Non-defense capital goods orders excluding aircraft, a closely watched proxy for business spending, declined 5.4 percent in January from a 5.8 percent drop in December.

 

Data on Friday is expected to show that the economy contracted at a faster pace in the fourth quarter than the 3.8 percent decline the government estimated last month.

 

New Home Sales Are Down Sharply

 

The Commerce Department reported on Thursday that new home sales fell 10.2 percent to a 309,000 annual pace, the lowest on records dating back to 1963, from 344,000 in December. The median sales price in January tumbled 13.5 percent to $201,100 from a year earlier, the lowest level since December 2003, the department said. The percentage decrease was the largest since July 1970.

 

The inventory of homes available for sale in January was 342,000, the lowest in more than five years. However, because of the weak January sales pace, the supply of homes available for sale now equals 13.3 months, a record high.

 

Deficits Will Rise

 

President Obama forecast the largest deficit since World War II in a budget sent to Congress on Thursday that urges a costly overhaul of the healthcare system and would spend billions to arrest the economy's freefall.

 

The $1.75 trillion deficit for the 2009 fiscal year underlined the heavy blow the deep recession has dealt to the country's finances as Obama unveiled his first budget. That is the highest ever in dollar terms, and amounts to a 12.3 percent share of the economy -- the largest since 1945. In 2010, the deficit would dip to a still-huge $1.17 trillion, Obama predicted.

 

With that backdrop, his budget represents a gamble that Americans are ready for the sort of change they embraced by electing him in November, a shift of wealth through higher taxes on the rich to pay for more government attention to healthcare, education, climate change and social programs.

 

The coming fight with Congress, where the Republican opposition quickly opened fire on the plan will show whether Americans weary of paying for a raft of expensive bailouts for banks and the car industry can get on board with more hefty doses of big government.

 

Obama promised to get the red ink under control even as he planned new spending priorities that veered sharply away from the policies of his Republican predecessor President George W. Bush.

 

"I don't think that we can continue on our current course. I work for the American people, and I'm determined to bring the change that the people voted for last November," said Obama, who took office on January 20.

 

The cost of extra borrowing to pay for the record budget deficit pushed U.S. stocks and government debt prices down on Thursday. The budget's healthcare plans delivered a hit to shares in health insurers and pharmaceutical companies.

 

Obama also sought to push ahead with a campaign promise of expanding healthcare to the 46 million people who are uninsured in the United States. His budget includes a 10-year, $634 billion reserve fund to help pay for the president's proposed healthcare reforms, much of it paid for by raising taxes on those earning more than $250,000 a year.

 

The budget also raises the possibility of more than doubling the government's aid to the battered financial sector.

 

The administration put in a "placeholder" to buy as much as $750 billion of assets from financial firms, which have been nearly crippled by an overhang of bad mortgage debt. Assuming one-third is lost, the ultimate cost to taxpayers would be $250 billion, the budget said.

 

Obama has not decided whether to seek that money, but if he does, it would come on top of an existing $700 billion financial bailout program, which has been unpopular with many Americans who see it as rewarding Wall Street bankers who made risky bets on mortgages securities.

 

The proposed $3.55 trillion spending blueprint for the 2010 fiscal year that begins October 1 provides the broad outlines of a more detailed one to be released in April.

 

The deficit figure reinforced concerns the government will need to sell record amounts of debt to pay for programs aimed at pulling the economy out of a deep recession.

 

Obama set a goal of slashing the deficit to $533 billion, or 3 percent of GDP by 2013. A rollback of the Bush tax cuts for wealthy Americans and a planned drawdown of U.S. troops from Iraq are expected to help rein in the shortfall.

 

Obama is seeking an additional $75.5 billion for wars in Iraq and Afghanistan for the rest of the current fiscal year. He is requesting $130 billion for military operations in the two wars for 2010, which would be down from the roughly $140 billion he expects will be needed this year.

 

Washington spent about $190 billion on the wars in 2008. Obama looks likely to order U.S. combat troops to withdraw from Iraq over about 18 months, according to U.S. officials. At the same time, he is ramping up the military effort in Afghanistan.

 

Obama's budget proposal lays out spending cuts in farm subsidies and other areas to meet the deficit-reduction goal. The budget also includes billions in revenues, starting in 2012, from a greenhouse gas emissions trading system. That is central to Obama's proposals to fight global warming, which are a major departure from the policies of Bush, who was widely criticized by environmentalists for resisting action.

 

The $85-billion U.S. college student loan business reeled from a budget proposal to axe the giant federally guaranteed student loan program. In a major shift that severely undercut shares in top student lender Sallie Mae, the budget called for moving most student lending into the direct-loan program run by the U.S. Education Department.

 

The $1.75 trillion budget deficit forecast for this year reflects shortfalls accumulated under Bush as well as new spending proposals under the $787 billion economic stimulus package Obama signed earlier this month.

 

While Obama is still basking in high approval ratings from the U.S. public, his stimulus package and other efforts to revitalize the economy have done little to win over Wall Street. U.S. stocks prices hit 12-year lows this week.

 

The Abyss for AIG Gets Deeper and Wider

 

The government may agree to finance the purchase of some American International Group Inc businesses, take stakes in assets and ease terms of its aid package to the insurer. These are some of a wide range of options under discussion between the government, the insurer and credit rating agencies, as AIG looks to avoid a credit downgrade that would trigger a host of liquidity issues and hurt its business.

 

Other options that are being discussed include changing the terms of a $40 billion preferred stock investment that has a 10 percent coupon, the source said. New terms could include reducing or even eliminating the dividend on that. Both sides are also looking at the possibility of lowering the interest rate on the government's credit line to AIG, and swapping debt for equity for some businesses, the source added.

 

AIG may also get an additional equity commitment of several billion dollars from the government, which could come as an expanded credit line, the source said.

 

One idea also being discussed with the government is that AIG is too big and unwieldy, and some businesses may be more valuable outside of the company than inside.

 

Talks include possibly breaking out certain units, including American Life Insurance, American International Assurance and the auto insurance business. Under one scenario, there could be a debt-to-equity swap, where the government would take a stake in these businesses and reduce AIG's debt. However, the valuation of the businesses was unclear. The talks come as AIG expects to post a record $60 billion quarterly loss, or about $460,000 per minute.

 

A ratings downgrade could have serious ramifications on the insurer's liquidity and hurt businesses. Customers could cancel their insurance policies if a minimum rating is no longer satisfied.

 

AIG was first rescued in September after bad mortgage bets left it on the verge of collapse. The government stepped in with $85 billion in bailout financing, as the credit crisis peaked with Lehman Brothers Holdings Inc filing for bankruptcy and Merrill Lynch agreeing to be bought by Bank of America. The government subsequently offered additional financing, bringing the support up to $123 billion. Last November, the government had to revise its bailout package, raising its aid further, to about $150 billion.

 

Last year, AIG said it would sell all assets except its property and casualty business, foreign general insurance and an ownership interest in some foreign life operations, to pay back the government. While the company has announced some sales, it has been difficult to find buyers and get a good price for assets amid the financial crisis. Credit for deals remains difficult to arrange due to the crisis and as many would-be buyers struggle with their own problems.

 

AIG was in talks to sell its U.S. auto insurance unit to Swiss insurer Zurich Financial Services AG in a deal that was expected to be worth around $2 billion. However, the transaction has run into difficulties. Some buyers, especially for the large businesses such as its aircraft leasing unit, International Lease Finance Corp, have been looking for government help with financing. Deadlines for bids for the Asian assets are due Friday, according to sources. The sales could raise tens of billions of dollars for AIG. However, there is a sense that prices for the businesses in the current environment will not reflect their true value.