MarketView for July 21

 

 

Summary 

 

Stocks pretty much kept to their ongoing upward trend on Tuesday as a solid profit from Caterpillar overcame some of the concerns regarding the company’s outlook going forward. Nonetheless, trading was mixed with the broader market initially charging higher after the open and the benchmark S&P 500 reaching a fresh 2009 intraday high as it extended its rebound from the 12-year closing low of early March.

 

Shares of Caterpillar, up 7.8 percent at $39.46, provided the Dow's top boost, but finished below the day's high after the company said it expected the third quarter to be the year's weakest and "extremely challenging.

 

Merck, a Dow component, was among bellwethers with encouraging profit reports on Tuesday. A late rally also helped the Nasdaq chalk up a small gain for its 10th straight winning session, the longest in 12 years. With Apple posting a stronger-than-expected profit after the bell and its stock rising 3.4 percent in after hours trading, Wednesday could be another banner day for the Nasdaq.

 

Merck reported that second-quarter earnings fell, hurt by lower sales of its cholesterol drugs, but income from partnerships and a rebound in sales of asthma drug Singulair helped the company exceed profit forecasts. The stock, up 6.1 percent at $29.65, ranked as the Dow's second-largest advancer.

 

In addition, Fed Chairman Ben Bernanke said in testimony before a congressional panel that mounting joblessness, slumping home values and tight credit were likely to curb consumer spending, a major driver of economic growth and corporate profits.

 

Troubled lender CIT warned on Tuesday it could still file for bankruptcy if debt swap failed, one day after securing $3 billion in emergency financing from its bondholders. Its stock sank 21.6 percent to end at 98 cents.

 

Also on the defensive were shares of Regions Financial and Comerica, two large regional banking companies. Both posted second-quarter losses as a deteriorating commercial property market caused loans to go south. Regions' stock slid 15.4 percent to close at $3.42. Comerica's stock were down 10.1 percent to close at $20.51.

 

In regulatory news, the Treasury Department sent to Congress a draft bill that would curb the power of credit ratings agencies. Moody's shares fell 6.3 percent to $26.80, and shares of McGraw-Hill, which owns Standard & Poor's, were down 1.5 percent to close at $32.55.

 

New Rules for Credit Rating Agencies

 

The Treasury Department said on Tuesday it hopes new disclosure and conflict of interest rules will curb the power of credit rating agencies that have been blamed for fueling the recent financial crisis. To that end, the Department sent an 18-page draft bill to Congress that would prevent credit rating agencies from consulting for the companies they are responsible for evaluating.

 

The Securities and Exchange Commission would have new powers to regulate the industry and companies would have to disclose when they go "ratings shopping" in two other provisions of the plan.

 

"In recent years, investors were overly reliant on credit rating agencies that often failed to accurately describe the risk of rated products," the Treasury said in a statement.

 

The reform is meant to help reduce reliance on credit rating companies, the government said. Still, the plan does not tinker with the basic business model that has ratings agencies relying on fees from the companies that they evaluate.

 

Officials concluded that there was no way to eliminate conflicts and the best approach was to identify and regulate problem areas, said Michael Barr, Treasury assistant secretary for financial institutions.

 

"Look at the investor-pay models -- investors would still have a conflict because they own these securities being rated," Barr said. "Our basic approach is to say we understand the potential for conflict in this area and we need tough rules to regulate conflict of interest."

 

Tuesday's plan was the latest in a series of proposals from President Barack Obama's administration to modernize financial services regulation in light of a costly credit crisis that began two years ago.

 

Sliding home values and record foreclosures exposed deep flaws in how lenders pushed mortgage loans, Wall Street bundled securities for investors and ratings agencies weighed risk.

 

While lawmakers and regulators agree that the current system is flawed, the administration has not been able to quickly move a reform package through Congress and many issues will remain unresolved until lawmakers return from a summer break that begins in early August.

 

While officials have said credit rating agencies share some blame for allowing the current crisis, the Treasury plan does not clear hurdles that would make it easier for investors to file class action lawsuits.

 

"Including such a provision in the statute would overly inflate the role of credit rating agencies and induce more blind-faith reliance on credit rating," Barr said. "We think the system needs to fundamentally move away from that approach with better investor due diligence."

 

The SEC, which is tasked with protecting investors, is gathering fresh powers to regulate the credit rating agencies. Last week, SEC Chairman Mary Schapiro said her agency would work harder to keep ratings agencies from looking for the most lax rating companies and otherwise better scrutinize the sector.

 

Bernanke Updates Congress

 

Federal Reserve Chairman Ben Bernanke told Congress on Tuesday that the outlook for the economy was improving, but supportive policies would be needed for some time to prevent rising unemployment from undercutting recovery.

 

Delivering the Fed's semiannual report on the economy to Congress, Bernanke also sought to dispel concerns the central bank's aggressive monetary easing could end up fueling inflation, saying he was confident the Fed could pull back its extraordinary stimulus when the time was right.

 

"Better conditions in financial markets have been accompanied by some improvement in economic prospects," Bernanke told the House of Representatives Financial Services Committee. "Despite these positive signs, the rate of job loss remains high."

 

While housing and household spending appear to be stabilizing, unemployment is likely to remain uncomfortably high into 2011 and could sap fragile consumer confidence, he warned.

 

Bernanke said that a highly accommodative stance of monetary policy will be appropriate for an extended period.

 

Some economists have worried that this dramatic expansion of Fed liquidity and lending may have sown the seeds for inflation as the recovery gains traction. Bernanke, however, said the central bank had an array of weapons at its disposal to withdraw monetary stimulus when the time was right.

 

"The Fed has been devoting considerable attention to issues relating to its exit strategy, and we are confident that we have the necessary tools to implement that strategy when appropriate," he said, echoing comments he made in an article published late Monday on the Wall Street Journal's website.

 

"We will not allow the broad measures of money circulating in the economy to rise at a rate rapid enough that would cause inflation eventually."

 

Lawmakers pressed Bernanke on a wide range of issues, from the economy to regulatory reform to health care, but in general treated him with far more deference than the last time he testified on Capitol Hill at a hearing on the Fed's role in Bank of America's purchase of Merrill Lynch.

 

Bernanke said that paying interest on the reserves banks hold at the Fed would play a key role in helping the central bank tighten monetary conditions when the time comes. By increasing the amount of interest it pays, the Fed can encourage banks to park excess cash at the central bank.

 

The Fed's monetary policy report detailed a number of other measures that Bernanke also outlined in his newspaper piece. The report said the Fed could arrange so-called reverse repurchase agreements with financial firms. The Fed would sell securities from its portfolio, taking cash out of the system, with an agreement to buy them back later at a higher price.

 

It could also offer "term deposits" similar to certificates of deposit to banks. Bank funds held at the Fed in such instruments would not be available for lending. In addition, the Treasury Department could issue securities and leave the funds on deposit with the Fed, or the Fed could sell some of the securities it has accumulated.

 

CIT Could Go either Way

 

CIT said it may post a loss exceeding $1.5 billion for the second quarter and could file for bankruptcy protection if bondholders reject a debt restructuring, raising new fears that the lender to some 1 million businesses might fail.

 

A day after winning $3 billion in emergency financing, CIT said it might still be headed for bankruptcy court if it is unable to get enough support for a tender offer for notes that mature next month.

 

Problems at CIT stemmed in part from Chief Executive Jeffrey Peek's decision earlier in the decade to expand into subprime mortgages and student loans. The company has lost close to $3.3 billion since the end of 2007.

 

The U.S. government declined help to CIT, forcing the company to turn to private investors for critical cash.

 

CIT's problems came even after the company in December received $2.33 billion from the government's Troubled Asset Relief Program.

 

The company has been denied access to a Federal Deposit Insurance Corp program to sell government-backed debt, and said the debt tender offer announced Monday is only a first step to building necessary liquidity for the long term, a process it said could include asset sales.

 

"Disruptions in the credit markets that began in 2007 ... have materially worsened in the first and second quarters of 2009," CIT said in a regulatory filing.

 

CIT is tendering for nearly $1 billion of floating-rate senior notes due August 17, offering 82.5 cents on the dollar for bondholders who tender before July 31. CIT said that if it filed for bankruptcy, the FDIC could place its banking unit into receivership or conservatorship, shielding its assets from creditors.

 

The cost of insuring $10 million of CIT debt against default for five years rose to $4.7 million upfront plus annual payments of $500,000. Late on Monday the upfront payment was $3.914 million.

 

The company said estimated funding needs for the year ending June 30, 2010 include $7 billion of unsecured debt.

 

"Existing liquidity for the same period is not sufficient to make the upcoming August 17, 2009, maturity payment ... or otherwise meet the company's twelve-month funding requirements," CIT said. It also said the FDIC and the Utah State Department of Financial Institutions had barred its banking unit from lending or paying dividends to CIT without regulators' approval.

 

CIT has been trying to get regulators' approval to transfer some assets from the holding company to its bank, an action that could shore up its balance sheet. A bankruptcy would make CIT, with $75.7 billion of reported assets, the largest financial company to go bankrupt since Lehman Brothers Holdings Inc last September.

 

Apple Posts Higher Earnings

 

After the close of regular trading, Apple posted  quarterly earnings that far exceeded Wall Street forecasts as a result of higher sales of both Macs and iPhones that turned in higher-than-expected gross margins, sending Apple’s shares up more than 3 percent on Tuesday.

 

The company defied the global economic recession and reported a net profit of $1.23 billion, or $1.35 a share, for its fiscal third quarter ended June 27, up from $1.07 billion, or $1.19 a share, in the year-ago period. Revenues increased 12 percent to $8.3 billion for the June quarter.

 

Sales of Macs and iPhones both exceeded Street expectations, helped by product refreshes and lower prices, while iPod shipments were toward the low end of forecasts. Apple said it sold 2.6 million Macs, up 4 percent from a year ago, and 5.2 million iPhones in the June quarter, during which the company had launched its third-generation iPhone 3GS and cut the price on the second-generation model to $99.

 

The company said almost 20 percent of Fortune 500 companies have bought at least 10,000 iPhones, and it is currently unable to make enough iPhone 3GSs to meet a demand, a problem Apple is working to address.

 

There had been some concern about margin pressure heading into the results, given the product price cuts and the trend of higher component costs.

 

However, Apple posted a gross margin of 36.3 percent, above the 34 percent that some analysts had predicted. That compared with 36.4 percent in the last quarter and 34.8 percent a year ago. Cook forecast margins at 34 percent in the September quarter.

 

Apple issued a typically conservative outlook for the current quarter, forecasting earnings of $1.18 to $1.23 a share on revenue of $8.7 billion to $8.9 billion. Nonetheless, the results demonstrated the consumer appeal of Apple's products despite a troubled economy that has dented sales at competitors selling less expensive products.

 

According to published reports, Apple CEO, Peter Oppenheimer, said back-to-school-sales are in their early stages but started off well. "We hit the ball out of the park with Mac sales," he said. "In a better economy we'd be selling more."

 

Apple shipped 10.2 million iPods in the quarter, down 7 percent year on year. The CFO said he expects sales of traditional iPods to decline over time, cannibalized by the iPhone and iPod Touch.

 

Apple’s shares closed at $151.60 and subsequently rose to $157.02 in extended after hours trading.