MarketView for November 7

Summary 

 

 

Stock prices turned in a surprising rally on Friday as bargain fishers scooped up shares at multiyear lows despite some rather unpleasant economic news. Nonetheless the major indexes closed lower for the week after an extremely volatile run. Specifically, the first week of November turned in not only by the largest Election Day rally ever, but followed that up by a huge reversal the next day. The week included the largest two-day dive since October 1987.

 

The 4.09 percent drop by the Dow Jones industrial average this week marks the worst presidential election week for the blue chips since Harry Truman upset Thomas Dewey in 1948. For the S&P and NASDAQ, it's only the worst since the week in 2000 when there was no decision in the George W. Bush-Al Gore election. The S&P lost 3.9 percent for the week and the Nasdaq finished the week down 4.3 percent.

 

Goldman Sachs wrote to clients that it expected up to 300,000 jobs may have been cut from non-farm payrolls in October. So when the Labor Department reported 240,000 jobs lost, that did not send the stock market into a tailspin even though the figure exceeded the median forecast of 200,000. The unemployment rate jumped in October to 6.5 percent, the highest since March 1994. For September, the nation's unemployment rate was 6.3 percent.

 

The unemployment rate is expected to rise to 8.5% by the end of next year and inch even higher in early 2010, Goldman Sachs wrote on Friday. The cumulative trough-to-peak increase of more than 4 percentage points in the jobless rate would be the most since World War II, they said.

 

Goldman analysts lowered growth forecasts for the next three quarters, and said they now expect the Federal Reserve to cut its interest rate target to 0.50% by December. "The main reason for these changes is the accumulation of evidence that U.S. domestic demand and production are dropping sharply," they wrote. "We do not see a resumption of anything close to trend growth before 2010."

 

Exxon Mobil gave the biggest lift to the Dow, benefiting from bargain hunting and oil's ability to stay above the psychologically important $60-a-barrel level. Exxon Mobil jumped 6.3 percent to $73.95, while Chevron added 4.8 percent to $73.46. U.S. front-month crude gained 27 cents to settle at $61.04 a barrel as the U.S. dollar slumped.

 

Stocks pared gains immediately after a news conference by President-Elect Barack Obama on some disappointment that he did not outline any new additional steps to shore up the ailing economy in the near term. But stocks recovered by the close.

 

Highlighting the impact of the economic downturn on the auto industry, General Motors and Ford both posted wider-than-expected quarterly losses. GM said liquidity will fall short of the minimum needed to run its business by the first half of next year without new funding or other drastic action. GM sank 9.2 percent to $4.36, while rival Ford rose 2 percent to $2.02.

 

On the NASDAQ, Qualcomm rose 7.9 percent to $35.66 following quarterly results released after Thursday's closing bell that exceeded expectations. Investors also snapped up shares of companies believed to be better positioned to weather a slowing economy, including utilities and pharmaceutical stocks. Johnson & Johnson, a Dow component, gained 4 percent to $60.22 .

 

September Pending Home Sales Index Falls

 

Pending home sales fell more than expected in September, after posting a large increase in the previous month. The National Association of Realtors said Friday that its seasonally adjusted index of pending sales for existing homes fell 4.6 percent to a reading of 89.2. That's down from an upwardly revised August reading of 93.5.

 

That latest reading from the NAR should provide a preview of October's existing home sales numbers when the Realtors group releases them on Nov. 24. Home sales are considered pending when the seller has accepted an offer, but the deal has not yet closed. Typically there is a one- to two-month lag before a sale is completed. An index reading of 100 is equal to the average level of sales activity in 2001, when the index started.

 

National Association of Realtors Chief Economist Lawrence Yun highlighted one positive sign: The pending sales index has been above year-ago levels for two straight months, though prices continue to sink.

 

Yun noted sales increases in California, Florida, Long Island, Boston, Minneapolis, Denver and Washington, D.C. Much of that gain, however, likely comes from buyers who are snapping up foreclosed properties at discounted prices.

 

The Realtors group forecasts U.S. home prices will rise slightly next year to a median of $200,800 after two consecutive years of declines. It forecasts existing home sales will pick up next year to 5.3 million after sliding to a projected 5 million this year.

 

Unemployment Rises Sharply

 

According to a report by the Labor Department on Friday, the unemployment rate hit a 14-1/2 year high last month as employers slashed jobs by an unexpectedly steep 240,000, suggesting President-elect Barack Obama will face a deep recession when he takes office. The Department said the jobless rate came in at 6.5 percent in October, the highest since March 1994, and that job losses in September and August were deeper than previously thought.

 

So far this year 1.2 million U.S. jobs have been lost, with 651,000 in the past three months alone as the slide in the national labor market picked up in intensity.

 

About 284,000 jobs were shed in September, the most since November 2001, shortly after the September 11 attacks on the United States, and 127,000 were lost in August. In all, 179,000 more jobs were cut in August and September than previously thought.

 

According to the jobs report, the construction industry shed 49,000 jobs last month, the 16th straight monthly loss. It also showed that 90,000 manufacturing jobs were cut in October, reflecting in part 27,000 striking workers at Boeing and marking the 28th consecutive month in which factory employment has fallen.

 

Earlier this year, job losses had been concentrated on the goods-producing side of the economy. But the latest data showed the pain spreading further into the vast services sector. Service industries cut 108,000 jobs last month, on top of 201,000 lost in September.

 

GM and Ford Burning Through Cash

 

General Motors and Ford reported far deeper-than-expected quarterly losses on Friday and said their rate of cash burn had accelerated, leaving many to wonder as to the future of the domestic automobile industry..

 

The two collectively burned through $14.6 billion in cash in the quarter as they ran up bills related to restructuring actions and as they face a deepening global financial crisis. Chrysler LLC is also burning through cash but it does not report financial results.

 

GM also indicated it was not considering going through with an acquisition of Chrysler stating that it was focused on cost-cutting and other steps to free up $20 billion in liquidity through 2009.

 

The financial results were posted a day after all three went hat in hand, along with the head of the United Auto Workers union to Congress in an effort to try and pick up about $50 billion of taxpayer money to help them ride out the crisis.

 

GM reported a $4.2 billion quarterly loss and said it would cut white-collar jobs and slash next year's capital spending budget by $2.5 billion to try to cope with a sharp sales slowdown. Ford posted a $2.98 billion quarterly operating loss on Friday and told investors that it would look to cut salary expenses by 10 percent, a move that follows a 15 percent cut earlier this year.

 

Now would someone please tell me what cuts are being applied to the salaries and benefits of the companies’ executive management?

 

Ford said it depleted its cash by $7.7 billion -- almost 30 percent -- as it had to pay costs related to production cuts and make payments to Ford Credit in an effort to spur consumers to buy automobiles. GM said it went through $6.9 billion in cash.

 

"That cash burn was quite a bit higher than what would be a normal cash burn," said Ford CEO Alan Mulally in an interview on CNBC, explaining that Ford ratcheted down production of its best-selling F150 pickup in the quarter to prepare for the launch of a new 2009 model.

 

Where Does It End

 

It seems that every poorly run, high risk taking company that now finds itself in trouble views Uncle Sam and the taxpayer as an endless supplier of cash to smooth over their incompetency. The latest to come hat in hand are Chrysler and General Motors, both touting Armageddon if Congress does not start shoveling money their way.

 

The lifeboat is coming. We just have to keep rowing," Chrysler Vice Chairman Jim Press said in a briefing for dealers that also discussed the automaker's lobbying for government support.

 

 Chrysler Chief Executive Bob Nardelli, GM CEO Rick Wagoner and Ford CEO Alan Mulally on Thursday met with House Speaker Nancy Pelosi and Senate Majority Leader Harry Reed in an effort to lobby the Democratic lawmakers for up to $50 billion in federal aid.

 

The push for aid has been accompanied by increasingly dire warnings from industry executives the risk of not giving them the money would be a loss of tens of thousands of manufacturing jobs. Oh and by the way, Chrysler does not release financial information to the public, but they are willing to take public money and we have to do is trust them.

 

Chrysler Vice Chairman and President Tom LaSorda, has said that the lack of disclosure was one of Chrysler’s strengths and that of its owner Cerberus, a secretive hedge fund. Of course, that now poses a slight problem when you consider that Cerberus is chaired by former Bush administration Treasury Secretary John Snow and its board includes Dan Quayle, who was vice president under former president George H.W. Bush.

 

Meanwhile, GM and Ford are expected to post deep quarterly losses on Friday and announce further urgent steps to cut costs and conserve cash in the face of a plunge in auto sales to their lowest in around a quarter of a century.

 

GM's president for North America Troy Clarke said late on Wednesday the government and industry faced a critical "100-day" window to secure financing and restructure.

 

Unfortunately, it does not and will not end there. Look at American International Group. AIG apparently is in talks with the government to restructure its credit facility, which could lead to an equity investment in the troubled insurer of several billion dollars, along with a reduction in the interest rate and an extension of the term of the existing loan, which could be for as much as five years from current two years.

 

An equity injection through preferred shares may also come with a reduction in the size of the $85 billion loan, along with some sort of a vehicle designed to reduce cash drain on AIG’s credit default swaps and securities lending.

 

AIG Looking To Ask Uncle For More

 

American International Group is in talks with the government in an effort to restructure the troubled insurer's credit facility, which could lead to the government buying AIG preferred shares worth several billion dollars.

 

The government has already extended AIG, once the world's largest insurer, $85 billion in bailout financing in September, and later raised the loan to $123 billion. The initial credit line has a two-year term, carrying a steep interest rate. AIG also had to grant the government warrants for a nearly 80 percent stake in the company. As of November 5, AIG owed $81.2 billion, $61.3 billion under the $85 billion credit facility and $19.9 billion under a subsequent $37.8 billion securities lending agreement.

 

The terms being discussed include a reduction in the interest rate and increasing the term of the existing loan, which could be extended to five years, the source said. Currently the loan carries an interest rate of 8.5 percent over the London Interbank Offered Rate, which sets the cost of borrowing between banks. An equity injection through preferred shares may also come with a reduction in the size of the $85 billion facility.

 

The talks with the government also include the possibility of setting up vehicles to reduce cash drain on AIG associated with credit default swaps and securities lending. Among the options being discussed is a plan to set up a facility where the government would buy residential mortgage-backed securities from AIG's securities lending portfolio.

 

The size of the facility is unclear and the final figure could be between $20 billion and $25 billion,. Such a facility would likely remove the one for $37.8 billion created in October.

 

Under the other vehicle, the government would buy some of the bonds underlying credit default swaps, a type of insurance contract providing the buyer with protection against risk. Such a facility would be offset by the cash collateral of about $30 billion that AIG has posted to back those CDS and that the government can expect to get back. The size of such a facility is also under discussion and could be in the range of $60 billion to $70 billion

 

Even The Best Find Tough Sledding

 

Warren Buffett's Berkshire Hathaway reported on Friday that its third-quarter profit fell 77 percent, the fourth straight quarterly decline, hurt by weaker results from insurance underwriting and a big loss on derivatives contracts. Net income declined to $1.06 billion, or $682 per Class A share, from $4.55 billion, or $2,942, a year earlier. Operating profit fell 18 percent to $2.07 billion, or $1,335 per share, from $2.56 billion, or $1,655. It fell short of analysts' average expectation for $1,429 per share.

 

Berkshire is a roughly $175 billion conglomerate that owns several dozen businesses in such areas as insurance, energy, housing, kitchen supplies, clothing and food. It also tries to invest in out-of-favor companies with strong earnings and management. Insurance typically generates half of results

 

Profit from insurance underwriting fell 83 percent to $81 million, hurt by increased price competition and about $1.05 billion of losses tied to Hurricanes Gustav and Ike. Berkshire raised insurance premiums following Hurricane Katrina in 2005, but prices and profit margins have fallen. The 2007 hurricane season was also quiet, making this year's results look comparably worse.

 

Insurance investment income declined 12 percent in the quarter to $809 million and profit from other businesses declined 8 percent to $1.08 billion. The latter included a decline of 8 percent in utilities and energy and an increase of 3 percent in manufacturing, retailing and services.

 

Berkshire also had $1.26 billion of pre-tax losses from derivatives contracts. The bulk of this related to previously disclosed contracts tied to the long-term performance of the Standard & Poor's 500 .SPX and three foreign stock indexes and to the credit quality of high-yield bonds. Accounting rules require Berkshire to regularly report unrealized gains and losses on the contracts.

 

But Berkshire can invest the cash it got up front to enter into the contracts. It would also pay on the stock index contracts only if various indexes are lower between the 2019 and 2027 than when the contracts were created. Buffett entered the contracts, although he has called derivatives "financial weapons of mass destruction."

 

Berkshire's Class A shares closed up $800 at $113,000 on Friday, while its Class B shares fell $14 to $3,686. The company released results after U.S. markets closed.

 

Buffett has committed more than $27 billion of Berkshire's money this year to make acquisitions, finance takeovers and invest in blue-chip companies such as General Electric and Goldman Sachs. The investments give Berkshire new ways to grow as the credit crisis drives asset values down and makes it harder for other companies to borrow.

 

Despite the investments, Berkshire increased its cash stake to $33.37 billion as of September 30 from $31.16 billion in June, although it was down from $44.33 billion at the end of 2007.

 

Last month, Buffett pledged to move all his personal holdings apart from Berkshire stock, which is pledged to charity, into U.S. stocks from government bonds, citing long- term optimism in corporate America.

 

Within insurance, pre-tax underwriting gains at auto insurer Geico fell 27 percent to $246 million, hurt by higher claims. Gains before taxes fell 66 percent to $54 million at General Re Corp, which rejected business where it did not believe it was getting paid enough. Berkshire Hathaway Reinsurance Group, meanwhile, had a $166 million pre-tax loss, hurt by hurricanes and lower premiums.