MarketView for January 16

Summary

 

Stock prices ended the day on a positive note, the result of strength in the energy sector and companies that hold up well in recessions, while reassuring comments from Britain's Barclays late in the day helped financials cut losses that had driven the market lower earlier. Barclays said it expected next month to report a pretax profit for 2008 "well ahead" of expectations. The Barclay comments came a few hours after its shares fell 25 percent in European trading.

 

Adding additional attention to the sector was an additional $20 billion government capital injection for Bank of America revived worries about the fate of the sector. In addition, Bank of America posted its first quarterly loss in 17 years, while Citigroup also reported a hefty quarterly loss and said it plans to split into two units.

 

Bank of America and JPMorgan Chase were the drags on the Dow Jones industrial average , falling 13.7 percent to $7.18 and 6.2 percent to $22.82, respectively. Although JPMorgan is viewed as being healthier than Bank of America and Citigroup, it posted a hefty decline in quarterly profit on Thursday.

 

Bank of America, which recently absorbed Merrill Lynch, and Citigroup (C.N) both reported huge losses for their fourth quarters on Friday, including billions of dollars of write-downs from exposure to debt and real estate markets.

 

Despite the maneuvers surrounding the financial sector, concerns remain over the health of the sector and whether banks will need to raise more capital as they struggle to deal with the credit crunch and global economic slowdown.

 

Energy shares rose along with a rebound in the price of oil, while McDonald's was the largest gainer on the Dow, offsetting the drag from Bank of America and JPMorgan Chase. McDonald's (MCD.N) gained 2.9 percent to $59.67 after its chief executive told CNBC television the company expected to continue paying dividends.

 

For the week the Dow was down 5.6 percent, the S&P 500 lost 5.9 percent, while NASDAQ gave up 3.02 percent. The S&P 500 is now up almost 15 percent since the bear market low on November 21, after starting 2009 up about 20 percent from that level.

 

Markets will be closed on Monday for the Martin Luther King Jr. Day holiday, a day before the inauguration of President-elect Barack Obama.

 

Friday marked an end to the stock market's run under the administration of President Bush. The S&P 500 lost more than 35 percent of its value since the day Bush took office in 2001, wiping out more than $4.6 trillion of investor wealth during his eight-year presidency. By contrast, under his predecessor, the S&P tripled, gaining more than $9 trillion. Bush is the first president since Richard M. Nixon to preside over a net fall in stocks during his term.

 

Energy shares, including Exxon Mobil, rose along with oil prices as short covering overshadowed a gloomy demand outlook. Domestic sweet crude for February delivery settled up $1.11 per barrel at $36.51. The contract, which expires on Tuesday, sank on Thursday to $33.20, the weakest price in nearly a month. Exxon gained 1.9 percent to close at $78.10.

 

There was no let up in companies announcing job cuts, as Advanced Micro Devices said it would cut 1,100 jobs, while The Wall Street Journal reported that Pfizer plans to lay off as many as 2,400 of its sales force.

 

Crude Rises on Short Covering

 

Oil prices rose 3 percent on Friday, with short covering amid choppy pre-holiday trade outweighing a gloomy demand outlook.

 

U.S. light crude for February delivery settled up $1.11 per barrel at $36.51 a barrel, while London Brent for March delivery settled down $1.11 per barrel at $46.57, maintaining an unusual premium to the U.S. benchmark due to growing U.S. stockpiles.

 

Prices had fallen earlier as the International Energy Agency's revised down its estimate for 2009 demand by 940,000 barrels per day to 85.3 million bpd, a decline of about 500,000 bpd year-on-year, as the economic slowdown erodes consumption. In its report, the IEA said Chinese oil demand would grow at its slowest rate in eight years, rising by just 90,000 bpd in 2009 as its GDP growth slows to 6.5 percent.

 

OPEC, which already has cut 4.2 million bpd in supply from the world market since September, could quickly deepen output cuts, if needed, OPEC President Botelho de Vasconcelos has said.

 

The global financial crisis has forced many economies into recession, reducing energy consumption and dragging down oil prices by more than $110 since a record peak in July.

One potential support for prices is the continuing contract dispute between Russia and Ukraine that led to a cut of gas supplies through Ukraine to Europe, affecting countries across the continent.

 

The European Commission said on Friday that Russia and Ukraine had a last chance this weekend to solve the dispute, or risk seeing their relations with the bloc suffer. The European Union normally gets a fifth of all its gas from Russia via Ukraine. The loss of this supply has forced generators to switch to oil and coal at a time when Europe is experiencing bitter winter temperatures.

 

CEO at BoA Upset

 

Bank of America executives were livid after uncovering heavy losses at Merrill Lynch as it prepared to complete its purchase Merrill, the Financial Times said Thursday, without saying where it got the information.

 

It said that in December, after learning that Merrill's fourth quarter would be worse than expected, Bank of America sent lawyers to investigate whether results were so bad that it could break off the deal, invoking a contractual provision governing a "material adverse" change in Merrill's condition.

 

Bank of America then told the U.S. government it would cancel the deal unless it received government funds, and closed on Jan. 1 after a commitment was secured, the newspaper said. The newspaper said the problems have caused strain between Bank of America Chief Executive Kenneth Lewis and former Merrill CEO John Thain.

 

Bank of America is now blaming Merrill executives for glossing over the bank's problems ahead of the sale, the newspaper said.

 

Tensions between Lewis and Thain spiked after the latter sought a bonus of more than $10 million for 2008, leaving Lewis "purple-faced" with rage, the newspaper said, citing an unnamed North Carolina executive. Bank of America is based in Charlotte, North Carolina.

 

Thain, who was named president of global banking, securities and wealth management at Bank of America, said in December he would not seek a bonus for 2008. Many on the Street are questioning how long Thain will remain subordinate to Lewis,

 

Core Inflation Flat

 

Inflation slowed to a half-century low last year and industrial output fell for the first time since 2002, data showed on Friday, as the recession deepened toward year-end, raising the specter of deflation. With consumer confidence remaining at depressed levels, the reports suggested the economy could take longer to pull out of a downturn that is on track to be the longest and possibly deepest since World War Two.

 

The Consumer Price Index fell 0.7 percent in December, a third straight monthly decline, capping a year in which prices advanced only 0.1 percent, the weakest 12-month reading since December 1954, the Labor Department said.

 

Weakening economic activity worldwide has depressed commodity prices, pulling headline inflation figures down sharply. However, core inflation, which strips out volatile food and energy costs, is also slowing, increasing the risk of deflation.

 

The inflation report, coming on the heels of data on Thursday that showed a fifth straight decline in producer prices in December, marked the shift toward technical deflation in the headline CPI number. Deflation, which is a sustained decline in price levels, is regarded as dangerous because it stifles economic growth.

 

Mounting job losses, falling household wealth and tight credit conditions have forced consumers to hold back on spending, limiting businesses' ability to raise prices and encouraging some to offer heavy discounts to lure customers.

 

With consumers retrenching, industry is cutting back sharply. The Federal Reserve said on Friday that industrial production dropped 2 percent last month, capping a dismal year for manufacturing as the recession took hold. For the fourth quarter, industrial output fell at an 11.5 percent annualized rate. Compared with December 2007, industrial production was down 7.8 percent, the biggest 12-month drop since September 1975.

 

Core prices, which exclude food and energy items, were flat for the second month in a row in December. On a year-over-year basis, core inflation rose 1.8 percent, the smallest increase since December 2003 and still within Fed officials comfort range.

 

Energy prices fell 8.3 percent in December, after declining 17 percent the prior month. Compared to the same period last year, energy prices were down a record 21.3 percent. The gasoline index slid 17.2 percent and accounted for almost 90 percent of the decrease in headline CPI, the Labor Department said.

 

Richmond Federal Reserve President Jeffrey Lacker Says Buy Bad Assets

 

Richmond Federal Reserve Bank President Jeffrey Lacker said on Friday that lifting bad assets from troubled banks would be a "compelling" way to recapitalize the financial system, hours after the Fed backed major aid for Bank of America.

 

"As long as you have some material risk that remains on the bank's books, any new equity investor is going to be subsidizing existing debt holders," Richmond Federal Reserve Bank President Jeffrey Lacker said.

 

"That is going to pose an impediment to raising new equity and recapitalizing the banking system from the private sector, which is what, ultimately, we want to do," he said.

 

The concern is that the government is putting taxpayer money at risk while officials, including those from the Federal Reserve, argue there is no other option to restore growth. Lacker has consistently voiced misgivings about Fed support for financial firms since the collapse of the country's housing market, which destroyed some of the oldest names in banking and has tipped the country into a year-long recession.

 

During the savings and loans crisis of the 1980s and 1990s, the creation of a "bad bank" to house nonperforming loans allowed U.S. authorities to cleanse financial intuitions of troubled assets that otherwise would have crippled the system.

 

The Fed on Friday joined the U.S. Treasury in providing a massive financial backstop to Bank of America to buffer it from losses, including a $20 billion capital injection. Lacker said the Fed should not be used to finance "bad bank" arrangements because this could hinder monetary policy.

 

"I think financing via monetary liability would be a mistake, and unnecessary, and could potentially constrain us going forward ... for us to take it on our balance sheet; I don't think there is any need for that," he said.

 

He also played down the risks that slowing growth could tip the country into a Japan-style period of deflation, where prolonged price declines inflicted a decade of stagnation in the 1990s.

 

Government data on Friday showed U.S. headline consumer prices fell 0.7 percent in December and grew just 0.1 percent over the previous 12 months, the weakest gains since 1954.

 

Lacker said this reflected nose-diving energy prices and noted that wages continue to grow.

 

"This looks like a temporary dip in the price level over the last half year or so, and when energy prices bottom out or stabilize, ultimately, those inflation numbers will pick up," he said.

 

Heavy News From Citi and BofA

 

Citigroup said it was going to split into two units and Bank of America took $20 billion in government aid after the two banks suffered huge quarterly losses from the worsening credit crisis.

 

After losing more than $28.5 billion in the last 15 months, including $8.29 billion in the fourth quarter, Citigroup said on Friday it will divide itself into one business focused on commercial and retail banking, and another on brokerage, retail asset management, consumer finance and troubled assets.

 

Bank of America obtained a second capital infusion from the government, which agreed to limit potential losses on $118 billion in troubled assets. The bank added picked up these assets when it bought Merrill Lynch in January. Bank of America also reported a $1.79 billion fourth-quarter loss and slashed its quarterly dividend to a penny per share from 32 cents.

 

Moody's Investors Service said it had cut Bank of America's credit ratings and separately said it was mulling a cut in Citigroup's. Moody's said it may lower Citigroup's "A2" long-term debt and "Prime-1" commercial paper ratings, after reviewing the bank's financial prospects and restructuring.

 

Bank of America and Citigroup face mounting pressure over how well they will absorb a surge in soured loans, amid a deep recession that shows few signs of easing. Bank of America's fourth-quarter loss was 48 cents per share, or 44 cents excluding merger costs. Results did not include Merrill, which Bank of America said lost $15.31 billion, or $9.62 per share, in the quarter.

 

The largest and third-largest U.S. banks by assets have now each taken $45 billion from the government's taxpayer-funded $700 billion Troubled Asset Relief Program.

 

Citigroup's quarterly loss equaled $1.72 per share, and was $2.43 per share before a gain from selling a German retail bank unit. Under the split-up, Citi will separate into Citicorp, housing its key businesses, and Citi Holdings.

 

Citicorp will be home to the company's retail banking and credit card businesses, its corporate and investment bank, Citi Private Bank and a transaction services unit.

 

Citi Holdings will house brokerage and asset management units, including the Primerica life unit, Nikko Cordial Securities and a 49 percent stake in a new brokerage venture with Morgan Stanley. It would also hold local consumer finance operations, including CitiFinancial and CitiMortgage.

 

Citi Holdings will also house $301 billion in assets that received government backing in a November rescue package. The unit would have about $850 billion in assets, or 44 percent of Citigroup's total $1.95 trillion.

 

"It is difficult to focus on what is going right at this time," a downbeat Kenneth Lewis, Bank of America's CEO, said on a conference call.

 

Bank of America's own lending also suffered in the fourth quarter as it set aside $8.54 billion for bad loans, up from $3.31 billion a year earlier. Net charge-offs nearly tripled to $5.54 billion. Lewis said he expects "no relief" in the amounts set aside for credit losses for "several quarters."