MarketView for March 2

 

 

Summary

 

Stock prices lost ground again on Monday, sending the major equity indexes to a low point that had not been seen in nearly 12-years as a record $61.7 billion loss for AIG, combined with another government bailout for the once high-flying insurer aggravated concerns about the extent of the damage being done to the nation’s financial system. AIG will gain access to an additional $30 billion in new capital, if needed.

 

Last fall, AIG received a commitment for $150 billion in government aid. The company, once the world's largest insurer, also reported a fourth-quarter loss on Monday that was the biggest in corporate history. The latest bailout comes on the heels of last week's plan for the government to boost its equity stake in Citigroup in order to increase the bank's capital base. Citigroup's stock lost 20 percent to end the day at $1.20. Shares of AIG ended flat at 42 cents per sahre.

 

Shares of companies that are on the wrong side of President Barack Obama's proposed budget were also lower, with pharmaceutical companies and health insurers suffering a fourth consecutive day of losses over concerns that their earnings could feel the pressure that is expected to be brought to bear.

 

Disarray at banks around the world has pounded global stocks, pushing the Dow Jones industrial average to its first close below 7,000 since May 1997. Selling of financial, energy and industrial stocks briefly drove the S&P below 700 during the session for the first time since October 1996. All 30 companies that are components of the Dow ended the day in the red, while all 10 of the S&P's sectors also were negative.

 

Wall Street's fear gauge, the Chicago Board Options Exchange Volatility Index, rose 13.6 percent to 52.65, ending the day at its highest point since Jan 20, the day of President Obama's inauguration.

 

Worries that a multitude of efforts to shore up the ailing bank sector were not taking hold dragged down companies such as Goldman Sachs, down 5.3 percent to $86.27, and Morgan Stanley, down 8.1 percent to $17.95.

 

Other stocks hit by the Obama budget include higher education lender Sallie Mae, which is down 57 percent in the last four days. Shares of Sallie Mae have been hit by a proposal in Obama's budget to axe the giant federally guaranteed student loan program. Sallie Mae's saw its share price fall 18.5 percent to close at $3.75 on the NYSE.

 

Shares of large manufacturers were also down with 3M seeing a decline of 5.8 percent, to close at $42.84, while Caterpillar saw a drop of 9.9 percent, closing at $22.17. Since the start of 2009, the Dow has lost nearly 23 percent, while the S&P 500 is off more than 22 percent after attempting a rally off November lows.

 

Underscoring the day’s negative tone were comments from billionaire investor Warren Buffett, who said "the economy will be in shambles throughout 2009", further dampening investor confidence.

 

Fresh data pointed to more damage in the economy after a report from the Institute for Supply Management showed manufacturing continued to contract in February, albeit at a slower rate than expected.

 

So-called Fear Index Moves Higher

 

The index known as Wall Street's fear gauge, the Chicago Board Options Exchange Volatility Index .VIX, rose sharply on Monday pushing above the key 50 level, reflecting the bearish tone in the stock market. The VIX was up 11.20 percent to 51.24 after notching a session high of 51.84 near midday.

 

The VIX is a 30-day forecast of S&P 500 future volatility calculated from the S&P benchmark's option prices. Typically, the VIX and the S&P 500 are inversely related, with the VIX moving up when stocks decline.

 

The VIX's performance in the past few weeks has been unusually sedate given that the S&P 500 has broken key levels of support. However, on Monday, the high levels of actual volatility, event risk and demand for portfolio protection pushed the VIX decisively above the 50 level,

 

Crude Oil Down Again

 

The price of crude oil fell once again on Monday, cutting about 10 percent off of Friday’s price as a deteriorating world economy threatened to cut further into fuel consumption, outweighing OPEC's strong compliance with supply curbs. The seemingly endless 14-month economic decline has taken a toll on many raw materials, and crude oil is no exception. Domestic sweet crude for April delivery settled down $4.61 per barrel at $40.15, while London Brent crude settled down $4.14 per barrel at $42.21.

 

The deepening recession has crimped demand for oil worldwide and sent oil prices off record peaks over $147 a barrel in July, prompting OPEC to pledge cuts totaling 4.2 million barrels per day (bpd) since September.

 

The economic crisis has prompted some members of OPEC to call for further output reductions when the group next meets on March 15.

 

Algerian Energy and Mines Minister Chakib Khelil said it was quite possible OPEC would cut again. Yet, Iran's Oil Minister Gholamhossein Nozari said he did not expect another reduction because the group's 80 percent commitment to existing curbs had helped stem price falls..

 

Small Improvement in Economic Data

 

Domestic manufacturing was lower for the month but the numbers were still better than what had been expected last month and consumer spending bounced back in January, data showed on Monday, but the improvement was likely a blip amid a rapidly deteriorating economy. Evidence that the 14-month economic downturn was deepening came from a report showing spending on construction projects slumped to the lowest level in over four years in January.

 

With household wealth falling sharply and revenue-squeezed companies aggressively laying off workers, the economic rout is set to worsen in the months ahead, analysts said. The government has stepped in with a $787 billion stimulus package.

 

The Institute for Supply Management's index of national factory activity inched up to 35.8 in February from 35.6 the prior month, but the employment gauge dived to a record low, raising the specter of an ugly nonfarm payrolls report on Friday.

 

The modest improvement in the overall index contributed to stability in global manufacturing activity in February. Domestic manufacturers said the gain was likely due to the resumption of production at some auto plants after long holiday closures.

 

Meanwhile, a report from the Commerce Department indicated that consumer spending rose 0.6 percent in January, the largest increase since May, after falling 1 percent in December. Data last week showed consumer spending, which accounts for more than two-thirds of economic activity, declined at a 4.3 percent rate in the fourth quarter, the biggest drop since the second quarter of 1980. That helped to push fourth-quarter gross domestic product to a 6.2 percent annual rate of decline.

 

Incomes advanced 0.4 percent in January, the biggest increase since May, after December's 0.2 percent decrease, the Commerce Department said. The government attributed the rise in incomes to pay increases for federal civilian and military employees, as well as cost-of-living adjustments to several government transfer payments programs. It said excluding these factors, incomes increased by 0.2 percent in January.

 

Private wages and salaries fell $25.8 billion in January, compared to a decrease of $27.0 billion the prior month, following smaller-than-usual bonus payments. In yet another sign that consumers were not ready to loosen their purse strings, savings jumped to an annual rate of $545.5 billion in January, the highest level since monthly records began in 1959, the Commerce Department data showed. The saving rate surged to 5 percent in January, the highest level since March 1995.

 

In another report that highlighted the severity of the current economic downturn, the Commerce Department said spending on construction projects dropped 3.3 percent to a seasonally adjusted annual rate of $986.2 billion, the lowest rate since June 2004, after tumbling 2.4 percent the prior month.

 

Private residential spending fell 2.9 percent in January after December's 4.4 percent drop. Compared to the same period last year, spending was down 28 percent. The level of spending, at a $291.5 billion rate, was the lowest in over 10 years.

 

Auto Sales Likely to Hit 27 year Low

 

Automobile sales in the United States will likely reach a 27-year low point when the numbers are tabulated for February, due in part to job losses and the deep recession with the resulting tight credit that has ensued for consumers of big ticket items. Major automakers are scheduled to announce February sales results on Tuesday.

 

Large dealers, auto executives and analysts have said that the sales trend last month mirrors that of January, when the industry-wide annual sales rate dropped to 9.57 million units, the lowest level since 1982.

 

Ford Motor's chief analyst, George Pipas, estimates that domestic auto sales dropped in February to a range of about 9 million units. Retail sales, or vehicles sold at showrooms, likely declined about 40 percent in February. "The environment continues to be very challenging," he said on Friday.

 

The weakness in sales to corporate and daily rental fleets has also added pressure to the already-soft retail volume, which may in turn be a strain on automakers' production plans.

 

All major automakers- including General Motors, Ford and Chrysler LLC CBS.UL -- had significantly scaled back production of vehicles during the first quarter in the face of falling demand.

 

Domestic automakers were expected to provide targeted production figures for the second quarter on Tuesday. The sales results for February are likely to show just how badly GM and smaller U.S. rival Chrysler need the additional $22.6 billion federal aid they have requested.

 

The median forecast of 34 economists surveyed for Reuters is for an annualized sales rate of 9.4 million cars and light trucks for February, significantly lower than the 15.3 million rate in the same period last year.

 

On a unit basis, last month's new vehicle sales are expected to be 685,000 units, a 41.4 percent decrease from 2008 but a 4.6 percent increase from January, according to Edmunds.com. The depressed car sales, which account for 20 percent of all U.S. retail sales, add to concerns about the economy, which is not expected to improve any time soon.

 

Some automakers, such as Ford, and large dealer AutoNation Inc (AN.N) are forecasting a slight improvement in car sales in the second half of the year as the economic stimulus package from the Obama administration takes effect. At the same time, some forecasting firms are cutting their overall sales view for the year, but say domestic  vehicle sales appear to be at or near bottom.

 

AIG to the Well Once More

 

American International Group posted a record $61.7 billion quarterly loss on Monday and got a new but not necessarily final government bailout after officials concluded again that letting the insurer fail would threaten the world financial system. As a result, AIG will receive access to up to $30 billion of new capital, after getting a commitment for $150 billion in aid last year that gave the government a stake of nearly 80%.

 

The latest bailout avoids for now any crippling credit rating downgrades that could force AIG to come up with billions of dollars it might not have.

 

The new rescue agreement increases the government’s commitment to keeping AIG on life support and was announced just three days after the government announced a new bailout for Citigroup, which like AIG has struggled to sell businesses and raise cash to pay back bailout funds. Both companies are based in New York.

 

As part of the latest bailout effort, the Fed will reduce a $60 billion credit facility in exchange for taking a preferred interest in AIG subsidiaries American Life Insurance Company and American International Assurance Company. The credit line will not fall below $25 billion.

 

All the common stock of the two AIG units will be held in a so-called special purpose vehicles that will allow AIG to keep control of them but give the Fed rights to protects its ownership interest.

 

In agreeing to a new AIG bailout, the Treasury Department and the Federal Reserve cited AIG’s operations in more than 130 countries, its role as an insurer for more than 100,000 entities including operations that employ more than 100 million Americans, and its more than 30 million U.S. policyholders.

 

The government also acknowledged that Monday’s bailout might not be AIG’s last. “Given the systemic risk AIG continues to pose and the fragility of markets today, the potential cost to the economy and the taxpayer of government inaction would be extremely high,” the government said in a statement.

 

It said fixing the insurer “will take time and possibly further government support if markets do not stabilize and improve.

 

The quarterly loss, AIG’s fifth in a row, equaled $22.95 per share, and compared with a year-earlier loss of $5.29 billion, or $2.08 per share. AIG’s latest loss, a record for a U.S. company, equaled about $465,000 a minute. For all of 2008, AIG lost $99.29 billion, wiping out profit dating back to the early 1990s.

 

AIG also announced plans to spin off part of its property-casualty business, to be renamed AIU Holdings. The company said it believes it has adequate liquidity to keep operating for the next year.

 

Losses from credit default swaps have threatened to wipe out the company. AIG built this exposure earlier this decade. Meanwhile, AIG has become “too complicated, unwieldy and opaque” to keep operating as a conglomerate, and plans over “several years” to break itself into separate businesses.

 

However, major credit rating agencies have reaffirmed AIG’s ratings, which fall in the “single-A” category, a medium investment grade. Ratings agencies reacted positively Monday to the news of American International Group’s revised bailout package, which includes an additional $30 billion of available federal assistance, an easing of earlier loan terms and a restructuring of the embattled company.

 

Standard & Poor’s Corp. affirmed is A+ financial strength and counterparty credit ratings on New York-based AIG’s insurance subsidiaries, as well as its A-/A-1 counterparty credit rating on the parent company.

 

“The affirmation primarily reflects our view that the U.S. Treasury and the Federal Reserve will continue their financial support of and ongoing commitment to AIG as the revised recapitalization the company announced today improves its capital adequacy and reduces pressure on debt holders,” S&P credit analyst Kevin Ahern said in a statement.

 

“The ratings reflect a combination of the extraordinary external support from the U.S. government in light of AIG’s status as a highly systemically important financial institution. We expect this support to be ongoing during AIG’s period of stress.”

 

S&P noted, though, that its outlook on the ratings is negative, based on continuing concerns about AIG’s ability to retain staff and win business, as well as the timeframe for planned asset sales.

 

In addition, Moody’s Investors Service affirmed the insurance financial strength rating of AIG’s core property/casualty operations, including AIG Commercial Insurance (Aa3, negative), AIG U.K. Ltd. (A1, negative) and AIG General Insurance (Taiwan) Co. Ltd. (A3 negative).

 

Fitch Ratings said that the U.S. government’s support for AIG overrides the effects of AIG’s $61.7 billion fourth-quarter loss for most of the company’s subsidiaries. AIG announced the loss and the revised bailout plan Monday.

 

The Treasury Department announced on Monday that it would supply another $30 billion in taxpayer funds on top of the $153 billion the embattled insurer has already received, after the company announced a loss of $62 billion in the quarter that ended on Dec. 31. Much of the loss reflected a decrease in the value of assets AIG insured through credit default swaps sold to U.S. and European financial institutions.

 

“Given the systemic risk AIG continues to pose and the fragility of markets today, the potential cost to the economy and the taxpayer of government inaction would be extremely high,” the government said in a statement.

 

While there is a growing call for an exchange to be set up to help reduce that risk, even if it could be put in place immediately. Instead, one move might be for the government to force AIG customers to stop demanding more collateral for the credit default swaps they hold.

 

The problem with a CDS exchange is that there’s no natural seller of swaps, unlike with commodities, so none of those sellers would have sufficient capital to back up its commitments. And so long as sellers are inadequately capitalized the exchange would have no way to protect itself, which creates an almost impossible position for the exchange.

 

AIG is a case in point, as its takeover last September by the government indicates. While the insurer sold more than $400 billion in contracts on the strength of its AAA rating, it did not have anywhere enough capital to meet the collateral calls of its counterparties once the value of the assets it sold CDS against began to fall.