MarketView for March 13

 

 

Summary 

 

Will wonders never cease, it was another up day on Wall Street with the result that the Street managed to score its best week since last November. Friday’s upturn was due in large part to an upgrade of Merck by Sanford Bernstein and a statement by Citigroup that it did not need any more government aid. Bernstein raised its rating on Merck’s shares to an "outperform," stating that the agreement to acquire Schering Plough would add value to Merck at a decent price. The rally in drug stocks came after sharp declines in the sector in the wake of U.S. President Barack Obama's budget, as investors bet it would choke profits.

 

Meanwhile, the S&P 500 index marked its third best week since World War II and an index of bank stocks rose 37 percent this week after several top bank executives suggested the industry is stabilizing. The comments were a major turnaround from the past several months of serious pessimism regarding the industry's fate. The final result was that each of the major equity indexes turned in their best week since the end of November.

 

The upturn in the Dow Jones industrial average marked its highest close since February 25. However, for the year the Dow is still down nearly 18 percent. For the week, the Dow rose 9 percent, the S&P 500 climbed 10.7 percent and the Nasdaq advanced 10.6 percent. The gains for the blue-chip Dow average marked only its fourth weekly advance since the end of October 2008.

 

Price of Crude Falls

 

The price of crude oil fell again on Friday, as bearish demand forecasts outweighed the potential for OPEC agreeing to further production cuts at its weekend meeting. An OPEC report released Friday showed world oil demand contracting faster than expected, and the International Energy Agency lowered its oil demand forecast for 2009.

 

Sweet domestic light crude futures for April delivery settled down 78 cents per barrel at $46.25. London Brent crude settled down 16 cents per barrel at $44.93.

 

OPEC meets on Sunday in Vienna to discuss moves to deal with falling oil prices. U.S. President Barack Obama telephoned King Abdullah of Saudi Arabia, the OPEC kingpin, on Friday ahead of the meeting. U.S. Energy Secretary Steven Chu said on Wednesday that he planned to tell OPEC ministers that higher oil prices will slow the recovery of the world economy. Saudi Arabia, has not commented publicly about Sunday's meeting.

 

OPEC has already cut supplies by 4.2 million barrels per day since September and will decide whether to cut further or agree to stricter compliance with already-announced cuts. It is estimated that OPEC is currently adhering to about 80 percent of agreed cuts.

 

OPEC's report on Friday said global demand would fall by 1.01 million bpd in 2009, revising its earlier forecast of a fall by 580,000 bpd. However, the feeble world economy and a firmer oil price could persuade OPEC ministers to stick to existing supply cuts. On arrival ahead of the meeting, ministers said they were worried about bulging inventories and the impact of the economic slowdown on fuel use, but were cautious about demanding action.

 

"We need to discuss how to drain inventories. We need to evaluate demand and see if it is necessary to take additional measures," Venezuela's Minister of Energy and Petroleum Rafael Ramirez told reporters.

 

The International Energy Agency said Friday that strict adherence to OPEC cuts already in place would be enough to shrink oil stocks in developed nations, even though demand is expected to contract further.

 

OPEC seaborne oil exports, excluding Angola and Ecuador, will fall to a five-year low in the four weeks to March 28, to 22.76 bpd, down 350,000 bpd, UK consultancy Oil Movements said in its latest weekly estimate on Thursday.

 

Citigroup Says It Does Not Need More Help

 

Citigroup Inc Chairman Richard Parsons said on Thursday that the bank does not need any more capital injections from the government and expressed confidence that Citi would remain in private hands. The Citigroup leader also brushed aside any prospect of the government nationalizing the bank.

 

"I don't think the administration is heading in that direction," Parsons said. "But I have a lot of confidence in the future viability and strength of a privately held Citi." The Obama administration and regulators including Federal Reserve Chairman Ben Bernanke have said they do not want the government to take full control of the nation's banks.

 

Citigroup has received $45 billion of taxpayer-funded capital since October. Earlier this week Citi said it was profitable in the first two months of 2009 and is confident about its capital strength, easing concerns about the bank's survival prospects.

 

As a precautionary measure, regulators began work on a contingency plan to stabilize Citigroup if problems mounted, but no imminent rescue was planned. Citigroup and other banks are waiting for the government to announce a plan to absorb soured assets banks are holding on their balance sheet.

 

There is Dissent at the Fed

 

Some Federal Reserve insiders are breaking ranks in alarm over action by Fed to tackle the credit crisis, but this unusually blunt display of dissent will not force a reversal in policy. Fed Chairman Ben Bernanke has made plain that he will not allow orthodox central banking concerns about inflation or market intervention prevent the central bank from doing what it has to do to confront a savage economic downturn.

 

As a student of history, Bernanke also knows that it was supposedly sound, healthy monetary principles that led the Fed to cut the money supply in the 1930s, putting the "great" in "Great Depression" -- a mistake he has vowed not to repeat.

 

"I made my own mistakes, but I don't want to make somebody else's mistakes," Bernanke told the Greater Austin Chamber of Commerce on December 1. Fed watchers say this translates into an absolute determination to overcome opposition within the central bank.

 

"Bernanke is so committed to using all the resources at the Fed's disposal to deal with these credit problems that in the final analysis he will go ahead with what he thinks needs to be done. And he'll have enough support on the committee to do that," said former Fed Governor Lyle Gramley.

 

Three regional Fed Bank presidents have sharply criticized the Fed leadership in recent weeks, including one who is a voter this year on the Federal Open Market Committee (FOMC), and who dissented at the last meeting on January 27-28. Indeed, the chances that Richmond Federal Reserve President Jeffrey Lacker will dissent again at the upcoming policy gathering next week sounded high after he slammed Fed colleagues for measures that he fears risk its independence.

 

Lacker wants the Fed to boost the economy by buying longer-term Treasuries instead of private-sector debt. This concern was echoed by Philadelphia Fed President Charles Plosser, who wants to get private assets off the Fed balance sheet in order to improve its flexibility to shrink the monetary base when it is time to worry about inflation.

 

The Board of Governors in Washington, headed by Bernanke, wields emergency powers to respond to "unusual and exigent" circumstances that it invoked last year to rescue investment bank Bear Stearns and bail out American International Group to the tune of $180 billion.

 

The FOMC, whose members include the Board as well as the 12 regional Fed bank presidents, sets monetary policy. However, with Fed interest rates already almost zero, the focus has shifted to stimulating the economy by increasing the U.S. monetary base by expanding the Fed's balance sheet. That balance sheet has more than doubled in size to around $1.9 trillion.

 

The bailouts have caused particular concern. Kansas City Federal Reserve Bank President Thomas Hoenig, one of the longest serving members of the FOMC and a seasoned bank regulator, was scathing in his criticism of the Fed's role in propping up troubled banks.

 

In a strikingly outspoken March 6 speech, Hoenig warned ad hoc policy intervention aimed at avoiding the nationalization of U.S. banks had failed to quell the banking crisis and would not prevent them being taken over in the end. But his complaint is not expected to force the Fed to shift course.

 

Berkshire Hathaway’s Credit Cost More to Insure

 

Credit protection costs for Warren Buffett's Berkshire Hathaway on Friday traded at a level more appropriate for a borderline "junk"-rated company after Berkshire lost its "AAA" credit rating. Fitch Ratings late Thursday downgraded Berkshire's rating to "AA-plus" from "AAA," and its senior unsecured debt rating to "AA" from "AAA." Its outlook is "negative," meaning another cut is possible within a couple of years.

 

The rating agency said Berkshire's equity and derivatives holdings leave the Omaha, Nebraska-based company's earnings stream and capital volatility "inconsistent with the stability required at the 'AAA' level."

 

Fitch also said its downgrade reflects so-called "key man" risk, in that Berkshire's track record and ability to find companies to buy is "intimately tied" to Buffett. It said this risk factor has grown larger in the "current stressful economic environment" and is unrelated to Buffett's age, 78.

 

Standard & Poor's would have cause to give Berkshire a negative outlook if the company's capital position continued weakening this year and if S&P thought Buffett's firm would be unable to rebuild its capital through earnings, an analyst for the rating agency said. "Warren Buffett has been there for a long time, so the concentration of risk from that is not a new issue for us," said S&P analyst Damien Magarelli, addressing the "key man" issue.

 

Five-year credit default swaps for Berkshire fell on Friday to 417 basis points, or $417,000 a year to protect $10 million of debt, from 438 basis points at Thursday's close. The lower cost reflected market optimism that the rating cut did not go beyond one notch. It nevertheless suggests that Berkshire's credit risk is close to that of emerging market nations.

 

Berkshire lost its "AAA" rating from Fitch the same day that S&P took away GE's equivalent rating. Berkshire is a major GE investor.