MarketView for February 27

Summary

Stock prices took another beating on Friday, after the government said it will take a large stake in Citigroup's common shares, raising fears it will increase its role in other major banks. The decline closed out a grim month on Wall Street, with the Dow Jones industrial average falling to its lowest level since May 1997 in six consecutive months of declines.

Healthcare and pharmaceutical companies, such as Merck and Johnson & Johnson, fell for a second day on Friday on worries that the administration's budget proposal will reduce profits as a result of efforts to rein in healthcare costs. Johnson & Johnson fell 4.7 percent to $50 and Merck slid 7.1 percent to $24.20 on Friday. Both companies are components of the Dow.

At the same time, data indicating that the economy shrank at an annual rate of 6.2 percent last quarter also weighed on the market.

Citigroup saw its share price fall 39 percent after the government said it will convert up to $25 billion in the bank's preferred shares to common stock in a move that could dilute existing shareholders' ownership by 74 percent.

Friday's close marked the lowest level for the S&P 500 since December 1996. The S&P 500 is down 18.62 percent since the start of the year, its worst two-month start on record. Equities have lost $10 trillion since peaking in October 2007. With Friday's decline, the S&P 500 marked its fifth down month out of six and the biggest drop since October.

For the week, the Dow fell 4 percent, the S&P 500 was down 4.5 percent and the Nasdaq fell 4.4 percent. For the month, the S&P fell 11 percent and the Nasdaq shed 6.7 percent. The February decline for the S&P 500 was the second worst on record, after an 18.4 percent slide in 1933 during the height of the Great Depression.

General Electric, which operates a large financing unit, slid after it said it would slash its dividend by 68 percent to 10 cents a share in order to conserve cash. GE shares fell 6.5 percent to $8.51.

Crude Prices Fall

In the yo-yo of prices that is all too prevalent nowadays, the price of crude oil fell 1 percent on Friday, pulled lower by economic data indicating that the economy declined more than expected during the fourth quarter.

Sweet domestic crude for March delivery settled down 46 cents per barrel at $44.76 after touching a session low of $42.55, reversing a three-day rally. London Brent crude settled down 16 cents per barrel at $46.35.

The losses came after government data showed our gross domestic product shrank 6.2 percent in the fourth quarter versus a year earlier, marking the deepest slide since 1982 and outpacing analyst forecasts for a 5.4 percent contraction.

Global economic weakness has driven a slump of more than $100 in crude prices since July's peaks as the economic crisis cuts into fuel demand from businesses and consumers. Adding to the downward pressure on oil prices was Friday’s report from the Energy Information Administration pointing out that domestic energy demand fell last year to the lowest level in a decade.

The slide in crude prices has drawn a dramatic reaction from OPEC, which has agreed to cut some 4.2 million barrels per day of output and is considering deeper cuts when it meets in March.

Geneva-based consultant Petrologistics, which tracks OPEC supply, said this week OPEC was on schedule to deliver 89 percent compliance with the production cuts by the end of February.

The Department of Energy said on Friday that it hopes OPEC will consider the "global economic situation" when it reviews its output policy March 15 in Vienna.

There was word that  that an investigation of the United States Oil Fund LP for a large trade it made in early February was also playing into the market's losses. USO sold a large number of front-month crude futures contracts on February 6 and bought second-month contracts, a trade known as a roll, and several market participants said the move had a significant impact on prices.

Oil prices had rallied earlier in the week after the EIA reported a steep drawdown of 3.4 million barrels in U.S. gasoline stockpiles due to slower imports and rising demand.

Economy Hits the Skids Big Time

The economy suffered its deepest contraction since early 1982 in the fourth quarter, at a 6.2 percent annual rate due in large part to lower exports and a decline in consumers spending. A month ago, the Commerce Department had estimated the economy shrank at a 3.8 percent pace in the fourth quarter.

However, downward revisions to inventories, exports and spending led it to issue a much weaker figure on Friday, just shy of the 6.4 percent rate drop seen in the first quarter of 1982, when the economy was in a recession that lasted 16 months.

The Commerce Department also reported that consumer spending, which accounts for more than two-thirds of domestic economic activity, fell at a 4.3 percent rate in the fourth quarter, the largest rate of decline since the second quarter of 1980.

The spending decline lopped more than 3 percentage points off GDP. Last month, consumer spending was estimated down at a 3.5 percent pace. Consumer spending contracted for a second straight quarter.

Exports, until recently one of the few pillars supporting the distressed economy, tumbled at a 23.6 percent annual rate, the steepest plunge since 1971. That was revised downward from the 19.7 percent drop estimated in last month's report.

Inventories, which minimized the fall in the first snapshot of GDP when they were estimated as rising by a surprising $6.2 billion, were revised to show a $19.9 billion decline in the fourth quarter.

Further highlighting the severity of the recession, business investment fell at a 21.1 percent rate, the largest drop since 1975, from a previously estimated 19.1 percent decline. That took away nearly 2.5 percentage points from overall GDP.

Companies are aggressively scaling back to cope with a slump in demand, but those actions, including tremendous job cuts, are translating into further reductions in household incomes, exacerbating the slump. The government has intervened with a $787 billion package in spending and tax cuts to staunch the bleeding, and there is guarded optimism the economy could turn around in the second half of the year.

Federal Reserve Chairman Ben Bernanke said early this week there was a "reasonable" prospect the recession could end in 2009 if efforts to restore credit flows were effective. Meanwhile, separate reports showed business activity in the U.S. Midwest contracted in February, but not as sharply as feared, while activity in New York City declined for a 13th consecutive month.

The deteriorating economy is dampening inflation pressures. A price gauge in the GDP report dropped at a record 5 percent rate in the fourth quarter. Excluding food and energy, prices rose at a 0.8 percent pace, the smallest advance since a matching increase in the third quarter of 1997.