MarketView for October 8

Summary

Despite an emergency interest rate cut, stock prices fell for the sixth straight day. Trading was erratic right from the opening bell, after the Federal Reserve and other leading central banks cut rates in the hope that credit markets would soon relax and that banks would begin lending more freely to businesses and consumers.

The Fed lowered the target for its federal funds rate by a half-point to 1.5 percent from 2 percent, saying in a statement that the turmoil in financial markets posed a further threat to an already shaky economy; it was joined in the rate cut by the European Central Bank, Bank of England, The Bank of Canada, the Swedish Riksbank and the Swiss National Bank.

Although the rate cut met with a positive response from Wall Street, there is still an overriding concern that the credit markets remain tied up because banks are reluctant to lend. That mix of emotions had the major indexes wavering between gains and losses until Paulson in late afternoon said financial markets remain severely strained. He also said it would be several weeks before the government's $700 billion financial rescue plan makes its first purchases of banks' troubled mortgage-backed assets.

With its precipitous drop of the past few weeks, Wall Street is approaching the magnitude of the losses it suffered during the bear market in the early part of this decade. By the time the Dow reached its low of 7,286 on Oct. 9, 2002, it had fallen 37 percent from its record high close of 11,722, set in January 2000.

The Dow has now fallen about 35 percent from the closing high of 14,164 reached a year ago Thursday. This week alone, the Dow has lost 1,067 points, or 10.3 percent. It has lost 1,592, or 14.68 percent, over the past six sessions.

The worries on the Street have been exacerbated by the spread of the U.S. credit problems overseas. Several banks in Europe have had to be bailed out, and earlier this week, the governments of Germany, Ireland and Greece took steps to guarantee private bank deposits. At the same time, the markets are mindful of the fact that the government's $700 billion financial rescue plan is in its early stages of implementation and will take some time to have an impact on banks' balance sheets.

It is likely that stocks will not begin a steady recovery until Wall Street is certain the credit markets are functioning in a more normal fashion. There are also severe economic problems including heavy job losses and high unemployment that will also need to show improvement. The uncertainty in the market has driven up the price of anything deemed safe, including gold and government debt.

As a result, the demand for short-term Treasuries has remained high because of their safety; investors are willing to take extremely low returns just to have their money in a secure place. The yield on the three-month Treasury bill, which moves opposite its price, dropped to 0.63 percent from 0.81 percent late Tuesday. However, longer term Treasury bonds fell because they are considered to be less attractive when the Fed cuts rates. The yield on the 10-year note rose to 3.65 percent from 3.51 percent late Tuesday.

The first third-quarter earnings reports are showing signs of strain on companies, and that is adding more uncertainty to the stock market. Retailers' reports of poor October sales are not helping matters.

Wal-Mart said sales rose in September but issued a tepid forecast for October. Often discounters do better than other retailers during tough economic times so the forecast from the world's largest retailer caused some worries about overall consumer spending.

AIG Receives Additional Loan

The Federal Reserve on Wednesday agreed to provide American International Group with a loan of up to $37.8 billion, on top of one made to the troubled company last month. Specifically, the Federal Reserve Bank of New York will borrow up to $37.8 billion in investment-grade, fixed income securities from AIG in return for cash collateral. These securities were previously lent by AIG's insurance company subsidiaries to third parties. The arrangement will help AIG secure funds on an as-needed basis, the New York-based insurer said in a statement.

In return for the two-year loan, the government received warrants to purchase up to 79.9 percent of AIG. As of Sept. 30, AIG had drawn $61 billion on the credit facility, of which about $54 billion has gone toward its securities lending and AIG's financial products area. The rest of the money has been for other liquidity needs amid an "unprecedented" freezing of credit markets, Chief Executive Edward Liddy said last week.

Last week, AIG said it would sell off a number of business units to pay off its massive government loan. The company didn't specifically disclose all the assets it would sell or the expected prices from the sales. However, the insurer said it plans to retain its U.S. property and casualty and foreign general insurance businesses, and also plans to retain an ownership interest in its foreign life insurance operations.

The deal for the additional Fed loan comes as AIG has been castigated by lawmakers and the White House for spending hundreds of thousands of dollars on a posh California retreat just days after getting the federal bailout.

Lawmakers investigating AIG's meltdown said they were enraged that executives of AIG's main U.S. life insurance subsidiary spent $440,000 on the retreat, complete with spa treatments, banquets and golf outings.

AIG issued a statement Wednesday saying that the "business event" was planned months before the Sept. 16 bailout and that it was held for top-producing independent life insurance agents, not AIG employees. Of the 100 attendees, only 10 worked for the AIG unit hosting the event, it said.

Liddy sent a letter to Treasury Secretary Henry Paulson  "clarifying the circumstances" of the event. In the letter Liddy assured Paulson that AIG is "reevaluating the costs of all aspects of our operations in light of the new circumstances in which we are all operating."

Crude Falls On Recession Concerns

The price of crude oil continued to fall on Wednesday as concerns over the impact of the global financial crisis on demand and rising inventories outweighed a move by central banks to cut interest rates.

News that OPEC members were considering an emergency meeting in November to discuss the impacts of the financial crisis on oil demand also underpinned prices.

Domestic crude futures for November delivery settled down $1.11 per barrel at $88.95. London Brent settled down 30 cents per barrel at $84.36.

Crude inventories rose 8.1 million barrels last week as they recovered from storm disruptions, according to the U.S. Energy Information Administration's weekly report. The EIA report also showed gasoline stocks increased 7.2 million barrels, compared with forecasts for a 1.1-million-barrel build, while total demand for products over the past four weeks dropped 8.6 percent when compared to a year ago.

Members of the Organization of the Petroleum Exporting Countries were consulting on whether to hold an emergency meeting on November 18, ahead of their next scheduled meeting in December, to discuss the impact of the global financial crisis on the oil market, Libya's top oil official said on Wednesday. Venezuelan President Hugo Chavez also said on Wednesday that OPEC was calling for an extraordinary meeting.

Some OPEC members have said oil production rate cuts may be needed, if oil prices continue to drop. Nigeria's oil minister on Wednesday was among the latest to say OPEC might need to reduce output.

Pending Home Sales Rise

Pending sales of existing homes rose unexpectedly in August to the highest level in over a year, the National Association of Realtors ) NAR) said. The NAR’s pending home sales index, based on signed contracts, rose 7.4 percent in August to 93.4 from an upwardly revised 87.0 in July on pent-up demand as affordability improved.

The August reading was 8.8 percent higher than a year earlier and was the highest since 101.4 in June 2007.

"What we're seeing is the momentum of people taking advantage of low home prices," the association's senior economist Lawrence Yun said in a statement.

"Home buyers in July were hampered by overly stringent lending criteria in the months before the government takeover of Fannie and Freddie," in early September, he said. "August shows some unleashing of pent-up demand before the credit crisis accelerated in September."

Yun said it is unclear how contract activity will be disrupted by the crisis on Wall St, "but we're hopeful most of the increase will translate into closed existing-home sales."

Pending home sales gained across all regions in August: up 18.4 percent in the West, 8.4 percent in the Northeast, 3.6 percent in the Midwest and 2.3 percent in the South.