MarketView for February 4

Summary

The S&P 500 index had its worst day since November, as renewed worries about the euro zone crisis caused the market to pull back from recent gains.

Shares of McGraw-Hill ended the day down 13.8 percent to $50.30, their worst daily percentage decline since the October 1987 market crash, after news the U.S. Justice Department plans to sue Standard & Poor's, a unit of McGraw-Hill, over its mortgage bond ratings. It would be the first such federal action against a credit rating agency related to the recent financial crisis. With 18.7 billion shares traded, it was the busiest day on record for McGraw-Hill shares. Shares of Moody's fell 10.7 percent to $49.45, its worst one-day drop since August 2011.

Chevron and Wal-Mart were among the biggest losers on the Dow Jones Industrial Average after analyst downgrades, and all 10 S&P 500 sectors were lower. The losses follow Friday's market climb that left the S&P 500 at a five-year high and the Dow above 14,000.

Spanish and Italian bond yields rose, renewing worries about the euro zone's sovereign debt crisis. Spain's prime minister faced calls to resign over a corruption scandal, while a probe of alleged misconduct involving an Italian bank was expected to widen three weeks before a national election.

Adding to market pressure, data from the Commerce Department showed overall factory orders for December were below expectations. Nonetheless, the S&P index remains up about 5 percent for the year, with nearly half of the gains coming after Congress temporarily sidestepped the "fiscal cliff" of automatic tax increases and spending cuts.

The CBOE Volatility index, Wall Street's so-called fear gauge, rose 13.7 percent.

Chevron fell 1.1 percent to $115.20 after UBS cut its rating to neutral, while Wal-Mart was down 1.2 percent to $69.63 after JP Morgan lowered its rating on the world's largest retailer and reduced its price target.

Shares of Clorox rose 0.7 percent to $79.72 after quarterly profit exceed expectations as a severe flu season boosted sales of disinfecting wipes.

According to Thomson Reuters data, of the 256 companies in the S&P 500 that have reported earnings through Monday morning, 68.4 percent have reported earnings above analyst expectations, compared with the 62 percent average since 1994 and the 65 percent average over the past four quarters.

S&P 500 fourth-quarter earnings are expected to rise 4.4 percent, according to the data. That estimate is above the 1.9 percent forecast at the start of earnings season, but well below the 9.9 percent forecast on October 1.

In deal news, Oracle has agreed to acquire network equipment company Acme Packet for $1.7 billion net of cash. Shares of Oracle were down 3 percent at $35.13 while Acme Packet ended the day up 23.7 percent at $29.59.

Shares of Herbalife closed up 1.3 percent at $35.54, recovering its losses ahead of the close. The New York Post reported the seller of weight loss products is facing a probe by the Federal Trade Commission.

Approximately 6.3 billion shares changed hands on the three major equity exchanges, compared with the 2012 average daily closing volume of about 6.45 billion shares.

Standard & Poor’s Facing Possible Action by Justice Department

They say good things come to those who wait. Well, if you were ripped off by the ebullient ratings on junk mortgage backed securities then you might finally see some form of justice done. However, if you are Standard & Poor's, your view might be a bit different because it appears that a civil lawsuit by the Justice Department could be in the offing. An announcement of a lawsuit is expected on Tuesday.

Standard & Poor's said it expects to be the target of a Department of Justice civil lawsuit over its mortgage bond ratings, the first federal enforcement action against a credit rating agency over alleged illegal behavior tied to the recent financial crisis.

Shares of McGraw-Hill, of which S&P is a division, fell 13.8 percent on Monday after news of the pending lawsuit surfaced, the largest one-day percentage decline for those shares since the 1987 stock market crash, according to Reuters data.

The news also caused shares of Moody's, whose Moody's Investors Service unit is S&P's main rival, ended the day down 10.7 percent. McGraw-Hill ended the day down $8.04 at $50.30, while Moody's shares closed down $5.90 at $49.45.

It is unclear why regulators may be now focusing on S&P rather than Moody's or Fimalac SA's Fitch Ratings. S&P, Moody's and Fitch have long faced criticism from investors, politicians and regulators for assigning high ratings to thousands of subprime and other mortgage securities that quickly turned sour.

A civil case involves a lower burden of proof than a criminal case would, and could make it easier for investigators to uncover potential "smoking guns." The New York Times reported that talks between the Justice Department and S&P broke down last week after the government sought a settlement of more than $1 billion.

S&P said the expected Justice Department lawsuit focuses on its ratings in 2007 of various U.S. collateralized debt obligations. The agency had previously disclosed a probe by the U.S. Securities and Exchange Commission into its ratings for a $1.6 billion CDO known as Delphinus CDO 2007-1. It was not immediately clear whether that CDO is a focus of the case.

"A DOJ lawsuit would be entirely without factual or legal merit," S&P said in a statement. "The DOJ would be wrong in contending that S&P ratings were motivated by commercial considerations and not issued in good faith."

In a variety of lawsuits brought by investors, S&P has maintained that its ratings constitute opinions protected by the free speech clause of the U.S. Constitution.

Several state attorneys general, led by Connecticut's George Jepsen, are expected to join the case. Previous lawsuits from Connecticut and Illinois accused S&P of violating consumer fraud laws by stating its ratings were objective, even though it ignored increasing risks of the securities in order to cater to the investment banks that provided the firm with revenue.

One potential winner in the news of the pending lawsuit is David Einhorn, who runs the $8 billion hedge fund Greenlight Capital. Einhorn told Reuters in 2010 that he began shorting McGraw-Hill and Moody's in 2007, and had no aversion maintaining those bearish positions in the years to come.

The ratings agencies have long been scrutinized, in part because they are paid by issuers for ratings, a standard industry practice that has nonetheless raised concern about potential conflicts of interest. In January 2011, the Financial Crisis Inquiry Commission called the agencies "essential cogs in the wheel of financial destruction" and "key enablers of the financial meltdown."

McGraw-Hill had acknowledged last July that the Justice Department and SEC were probing potential violations by S&P tied to its ratings of structured products, and that it was in talks to try to avert a lawsuit.

Last July, Mizuho Financial Group Inc agreed to a $127.5 million settlement to resolve SEC allegations that a U.S. unit obtained false credit ratings for the Delphinus CDO. The following month, a Manhattan federal judge refused to dismiss a lawsuit brought by Abu Dhabi Commercial Bank, King County in Washington state, and other investors against S&P, Moody's and Morgan Stanley over losses in Cheyne, a structured investment vehicle. Cheyne went bankrupt in August 2007. A trial is scheduled to begin on May 6, court records show.

In its statement, S&P said it "deeply regrets" how its CDO ratings failed to anticipate the fast-deteriorating mortgage market conditions, and that it has since spent $400 million to help bolster the quality of its ratings.

Capital Goods Orders Down

The government issued a revised estimate for capital goods orders outside of the defense and aircraft industries, showing they edged 0.3 percent lower in December. Previously, the government had estimated this closely watched proxy for investment plans had gained 0.2 percent during the month.

However, data from the Commerce Department also gave some positive signals, with a big jump in defense industry orders suggesting some of the surprise fall in economic output late last year that was partially attributable to a decline in military spending, was poised to reverse. Overall factory orders rose 1.8 percent during the month. Outside of the transportation industry, growth in factory orders rose a meager 0.2 percent in December, with new orders for consumer goods down 0.1 percent.

More volatile components helped make up for that softness, with civilian aircraft orders up 10.1 percent. Military aircraft orders surged by 56.4 percent, a sign that defense spending could rebound after declining sharply in the fourth quarter. The drop in defense spending dragged heavily on the economy in the fourth quarter, when gross domestic product posted a surprise contraction according to an advance estimate released last week. Outside of the defense industry, new factory orders rose a modest 0.3 percent.