MarketView for October 7

Summary

 

Stock prices fell for the fifth straight session on Tuesday, capping the largest five-day point loss by the Dow Jones industrial average ever; as fears rise that the rapidly spreading credit crisis would drag the economy into a deep recession.

 

Federal Reserve Chairman Ben Bernanke did little to reassure markets when he cautioned that downside risks to economic growth have worsened, though he did signal a readiness to lower interest rates. An earlier move by the Federal Reserve to unclog the commercial paper market, which companies use to fund their day-to-day operations, gave the stock market only a fleeting boost. Meanwhile, the financial sector was the largest drag on the market, with the S&P financial sub-index dropping to its lowest level in more than a decade.

 

Bank of America fell 26.2 percent to $23.77 the day after it said it would cut its dividend and raise $10 billion to help staunch rising loan losses. For the S&P 500 index, it was the first it has closed below 1,000 in more than 5 years.

 

The negative headlines continued after Wall Street's closing bell. Shares of aluminum producer Alcoa fell 4.2 percent to $16.01 in after-hours trading, after the company said third-quarter profit fell on softening demand, higher costs and sharply lower prices for aluminum. In regular trading, Alcoa had already lost 7.7 percent to close at $16.71 on the New York Stock Exchange.

 

Tuesday's stock market losses came a day after a steep global equity market sell-off and traders said there was some disappointment that central banks had not orchestrated a coordinated interest-rate cut to calm financial markets.

 

The U.S. Federal Reserve stepped forward as a commercial lender of last resort as governments around the world scrambled to stem the global financial crisis and calls arose for concerted action. The Fed created a new commercial paper facility that would buy short-term, highly rated debt, stepping into the corporate debt market in a program that falls outside the $700 billion rescue plan approved by the U.S. Congress on Friday.

 

Morgan Stanley shares fell as much as 40 percent but rebounded to close down 24.9 percent at $17.65 after a company spokesman said its deal to sell up to 24.9 percent of its voting shares to Japanese bank Mitsubishi UFJ Financial Group was on track to close "imminently".

 

The drop in financials came on the eve of the lifting of the ban on short selling in a raft of companies with financial exposure. Short sellers borrow stocks and sell them on the bet that the stocks will fall in value, so that they can buy them back at a lower price and pocket the difference.

 

The price of crude for November delivery settled up $2.25 per barrel, or 2.6 percent, at $90.06 raising concerns over consumer and business spending. An index of airline stocks fell 15.6 percent.

 

A Gloomy Outlook From Bernanke

 

Federal Reserve Chairman Ben Bernanke warned Tuesday that the financial crisis has not only darkened the country's current economic performance but also could prolong the pain.

The Fed chief's more gloomy assessment appeared to open the door wider to an interest rate cut on or before Oct. 28-29, the central bank's next meeting, to brace the wobbly economy.

 

Bernanke said the Fed will "need to consider" whether its current stance of holding rates steady "remains appropriate" given the fallout from the worst financial crisis in decades.

 

If the Fed does lower its key rate from 2 percent it would mark an about-face. The Fed in June had halted an aggressive rate-cutting campaign to revive the economy out of fear those low rates would aggravate inflation. Since then, financial and economic conditions have deteriorated, while record-high energy prices have calmed, giving the Fed more leeway to again cut rates.

Many believe the country is on the brink of, or already in, its first recession since 2001.

 

"The outlook for economic growth has worsened," Bernanke said told the annual meeting here of the National Association for Business Economics.

 

All told, economic activity is likely to be "subdued" during the remainder of this year and into next year, Bernanke said. "The heightened financial turmoil that we have experienced of late may well lengthen the period of weak economic performance and further increase the risks to growth," he warned.

 

Consumers — major shapers of economic activity — have buckled under the weight of rising joblessness, shrinking paychecks, hard-to-get credit, declining net wealth and tanking home and stock values. All the strains are "now showing through more clearly to consumer spending," Bernanke said.

 

Inflation numbers are "very ugly right now," Bernanke acknowledged. Even so, he believed slowing growth in the United States and overseas will continue to damp prices for energy, food and other commodities, meaning a better inflation outlook ahead. Inflation will moderate "pretty significantly" over the next few quarters, he predicted.

 

Meanwhile, worsening sales prospects and a heightened sense of uncertainty have begun to weigh more heavily on businesses, making them more cautious to hire and to invest in their companies, he said.

 

Employers cut jobs in September at the fastest pace in more than five years, the government reported last week. Payrolls were slashed by 159,000 last month alone. It was the ninth straight month of job losses. A staggering 760,000 jobs have disappeared so far this year.

 

The financial and credit crises, which took a turn for the worst in September and continue to stubbornly persist, are likely to "increase the restraint on economic activity in the period ahead," Bernanke said.

 

Even households with good credit histories are now facing difficulties obtaining mortgages or home equity lines of credit, he noted. Banks are also reducing credit card limits and denial rates on auto loan applications are rising, he said.

 

Banks, too, are feeling the strain of a lockup in lending, particularly in the market for commercial paper.

 

To that end, the Fed on Tuesday announced a radical plan to buy massive amounts of this short-term debt in an effort to break through a credit clog that is imperiling the economy.

 

"The expansion of Federal Reserve lending is helping financial firms cope with reduced access to their usual sources of funding," Bernanke explained.

 

Invoking Depression-era emergency powers, the Fed will begin buying commercial paper — short-term funding that many companies rely on to pay their workers and buy supplies.

 

Bernanke believed the Fed's bold actions — along with the $700 billion financial bailout signed into law by President Bush on Friday — will help restore confidence in financial markets and help them function more normally.

 

"These are momentous steps, but they are being taken to address a problem of historic dimensions," he said.

 

He also defended the timing of the actions by the Fed and the Bush administration. "We have learned from historical experience with severe financial crises that if government intervention comes only at a point at which many or most financial institutions are insolvent or nearly so, the costs of restoring the system are greatly increased. This is not the situation we face today," he said.

 

Fed Saw Equal Risks

 

Even in the midst of a severe meltdown on Wall Street, Federal Reserve officials at their September meeting believed the risks from weaker growth and higher inflation were roughly equal.

 

The Fed officials discussed the financial turmoil during their closed-door meeting on Sept. 16, according to minutes released Tuesday. The meeting occurred a day investment bank Lehman Brothers collapsed. It was also hours before the Fed announced it was extending an $85 billion loan to rescue American International Group,

 

While concluding that it would not change interest rates at the September meeting, the minutes showed some members said a policy response from the central bank might be needed as it kept

the portion of the public statement discussing future actions balanced between worries about economic growth and inflation.

 

The Fed's action disappointed investors. The Street had been hoping for a stronger signal at the September meeting that the Fed was prepared to cut rates given the turbulence rocking Wall Street.

 

Only two days after the Fed meeting, Bernanke and Treasury Secretary Henry Paulson traveled to Capitol Hill to tell congressional leaders at a private meeting that the credit strains had become dire and emergency legislation was needed.

 

That plea resulted in the passage on Oct. 3 of the largest government bailout in history, a $700 billion package that will allow the government to buy bad mortgage-related debt off the books of financial institutions. The goal is to get financial companies to resume more normal lending.

 

In a speech Tuesday, Bernanke signaled the continued turmoil in financial markets had moved the central bank closer to cutting interest rates. Bernanke said the financial crisis had darkened the country's current prospects and was likely to prolong its economic malaise. He said the Fed will need to consider whether its current stance of holding interest rates unchanged "remains appropriate."

 

In the minutes, Fed officials had sounded a more upbeat tone, expressing hope that the government's takeover of mortgage giants Fannie Mae  and Freddie Mac  on Sept. 7 might help stabilize mortgage markets and give a boost to the beleaguered housing sector.

 

The minutes showed that Fed officials in September were still anticipating the possibility of future rate increases.

 

"With elevated inflation still a concern and growth expected to pick up next year if financial strains diminish, the committee should also remain prepared to reverse the policy easing," the minutes said.

 

Crude Rises Amid Concerns Over Supply Cut

 

Oil prices settled up over $2 per barrel on Tuesday as signs OPEC was considering a supply cut outweighed concerns about the global financial crisis. U.S. crude settled at $90.06 per barrel, up $2.25, after hitting an eight-month low on Monday as part of a four-day decline. London Brent settled at $84.66 per barrel, up 98 cents.

 

The spread of the credit crisis has intensified gloom about the global economic outlook and weakened prospects for oil demand and prices, and has led some investors to sell off commodities for safer havens.

 

Oil's recent price drop has caused worry for some members of the Organization of the Petroleum Exporting Countries. OPEC's next meeting is in December in Algeria. Earlier this week, Iran said OPEC may need to cut supply to prop up prices. Meanwhile, further support has come from the slow recovery of the U.S. oil sector from Hurricane Ike. According to the U.S. Mineral Management Service, 44.8 percent of Gulf of Mexico production remained shut on Tuesday following the storm.

 

The Energy Information Administration on Tuesday lowered its forecast for world oil demand growth in 2009 versus 2008. The agency cut its forecast by 140,000 barrels per day from its estimate published last month. At the same time, China bears watching as that country’s demand for energy could once again drive crude prices higher.

 

Tropical Storm Marco rolled over Mexico's Gulf coast on Tuesday, but all three of the country's main oil exporting ports remained open. On Monday, the storm prompted state oil company Pemex to shut down four offshore production platforms and close six wells at a natural gas field.