MarketView for October 13

Summary

 

Wow...Wall Street wins a big one! It has been said a number of here that Wall Street has the capability of recouping past losses with the same speed or faster than the negative numbers came into being. Note that I said can, I did not say it would. Yes, we had a record gain on Monday but the proof of the pudding will be if the gains hold up through the week.

 

Nonetheless, still managed a rather miraculous recovery from its worst week ever with one of its best single days ever, as governments pledged to pour cash into struggling banks to restore confidence in what has become a rocky global financial system. Much of the gain was the result of bargain-hunting bottom feeders scouring the wreckage from eight days of losses that had eaten away more than 20 percent off the value of the benchmark S&P 500. Health care, utility and energy stocks chalked up the strongest gains in what was the first day of positive numbers this month for the both the Dow Jones industrial average and the S&P 500 indexes.

 

Morgan Stanley drove the rally in financial shares, rising 87 percent after Mitsubishi UFJ Financial Group completed its $9 billion investment in the bank.  Government support and arm twisting played a critical role in consummating the deal that many on Wall Street had feared would fall apart. Wachovia climbed 13.6 percent after the Federal Reserve approved the $12.46 billion takeover of the bank by Wells Fargo. Morgan Stanley shares spiked 87 percent to $18.10, while those of Wachovia rose 13.6 percent to $5.85.

 

Led by Britain, European governments agreed to multibillion-dollar guarantees for the banking system in moves that may become a crucial test of investor faith in government's ability to reverse the downward spiral. In addition, the Federal Reserve, the European Central Bank, the Bank of England and the Swiss National Bank indicated that they would lend commercial banks as much in the way of dollar liquidity as was necessary to ease clogged interbank lending rates.

 

As a result, the S&P financial index ended the day up 10.23 percent. The Dow rose 11.08 percent, its largest one-day point gain ever and its biggest percentage gain since March 15, 1933. The Standard & Poor's 500 Index also notched its best single-day point gain, while the NASDAQ gained 11.81 percent its largest one-day point gain since January 2001.

 

General Motors rose 33.1 percent to $6.51 after reports that the automaker has been in merger talks with rivals Chrysler and Ford, whose shares surged 20.1 percent to $2.39.

 

Defensive and consumer staples stocks were higher as the Street chased after shares in companies generally considered better positioned to weather an economic downturn. Johnson & Johnson rose 12.2 percent to $62.68.

 

Among tech shares, Apple rose 13.9 percent to $110.26, after Citigroup raised its recommendation on the technology hardware and equipment sector to "market weight" from "underweight." Microsoft gained 18.6 percent to $25.50.

 

Energy companies tracked the price of oil higher. Crude oil gained $3.49, or 4.49 percent, to settle at $81.19 a barrel on optimism over the governments' moves to shore up confidence in the banking system. Exxon Mobil gained 17.2 percent to $73.08, and Chevron climbed 20.9 percent to $69.89.

 

Morgan Stanley Wins

 

After heavy negotiations over the weekend that even saw the Treasury Department and the Japanese government play decisive roles, Morgan Stanley announced on Monday morning that it had received a much-needed cash infusion of $9 billion from Japanese bank Mitsubishi UFJ Financial Group in return for preferred shares.

 

The closing of the deal comes a day earlier than expected, and with revised parameters for what Mitsubishi will receive for its investment. The deal, which gives Mitsubishi a 21 percent stake in Morgan Stanley, was revised after Morgan Stanley lost nearly 60 percent of its value last week amid speculation the deal would not close.

 

The revised deal is more attractive to Mitsubishi, giving it only preferred stock, instead of a mix of preferred and common stock. That enables Mitsubishi to receive dividends on the entire investment. A portion of the preferred stock is convertible to common stock under the revised deal.

 

As part of the revised deal, Mitsubishi will receive $7.8 billion in convertible preferred stock that carries a 10 percent dividend and is convertible at a price of $25.25 per share. The Japanese bank will also receive $1.2 billion in non-convertible preferred stock, which also carries a 10 percent dividend.

 

Last month, Morgan Stanley agreed that Mitsubishi would invest $9 billion in equity for a stake in the New York-based investment bank. Mitsubishi initially planned to buy $3 billion in common stock at a price of $25.25 per share and acquire an additional $6 billion in convertible preferred stock that carries a dividend of 10 percent and a conversion price of $31.25 per share.

 

The deal came as the credit crisis worsened and Morgan Stanley was forced to change its status to a bank holding company, which in turn allows it to create a large deposit base. The change was precipitated by fears that stand-alone investment banks might no longer be viable operations as credit markets continue to worsen.

 

Mitsubishi is one of the world's largest banks with $1.1 trillion in deposits. Aside from the cash investment, Mitsubishi will receive one seat on Morgan Stanley's board of directors, and the pair plan to work jointly as part of a global strategic alliance. The pair said they have already identified multiple areas for potential collaboration, including corporate and investment banking, certain parts of retail banking and asset management, as well as lending activities such as corporate loans.

 

The deal also helps both companies expand their global footprints. The new capital helps Morgan Stanley increase its capital ratio and decrease its leverage ratio, two key statistics used to determine the health of a bank, especially amid the ongoing credit crisis.

 

On a pro-forma basis, Morgan Stanley now has a Tier 1 capital ratio of 15.5 percent, well above the Federal Reserve's 6 percent required to be considered "well capitalized."

 

Nobel Prize in Economics to Paul Krugman

 

The Royal Swedish Academy of Sciences announced on Monday that Paul Krugman, a professor at Princeton University and a New York Times columnist, won the Nobel Prize in economics for his analysis of how economies of scale can affect trade patterns and the location of economic activity.

 

Krugman is an unforgiving critic of the Bush administration and the Republican and has come out forcefully against John McCain during the economic meltdown, saying the Republican candidate is "more frightening now than he was a few weeks ago" and earlier that the GOP has become "the party of stupid."

 

"Krugman is not only a scientist but also an opinion maker," economics prize committee member Tore Ellingsen said. He added that Krugman's analyses tend to back free trade and his research gives no "support for protectionism." It is only the second time since 2000 that a single laureate won the prize, which is typically shared by two or three researchers.

 

The Royal Swedish Academy of Sciences praised Krugman for formulating a new theory to answer questions about free trade and said his theory has inspired an enormous field of research.

 

"What are the effects of free trade and globalization? What are the driving forces behind worldwide urbanization? Paul Krugman has formulated a new theory to answer these questions," the academy said in its citation.

 

"He has thereby integrated the previously disparate research fields of international trade and economic geography," it said.

 

The Nobel citation said Krugman's approach is based on the premise that many goods and services can be produced at less cost in long series, a concept known as economies of scale. His research showed the effects of that on trade patterns and on the location of economic activity.

 

Commenting on the global economic meltdown, Krugman told a news conference in Stockholm by telephone from the United States that some of his research was linked to currency crises and related issues.

 

"This is terrifying," he said, comparing it to the financial crisis that gripped Asia in the 1990s. "I had never thought that in my lifetime I would see anything that resembles the Great Depression, but this in fact does."

 

He said winning the Nobel award won't change his approach to research and writing.

"The prize will enhance visibility," he said, "but I hope it does not lead me into going to a lot of purely celebratory events, aside from the Nobel presentation itself."

 

Showing a sense of humor, Krugman's New York Times blog had an entry early Monday that read "A funny thing happened to me this morning...." with a link to the Nobel announcement.

Krugman's work on new trade theory also garnered him the John Bates Clark medal from the American Economic Association in 1991. That prize is given every two years to an economist under the age of 40.

 

In contrast to his treatment of U.S. financial officials, Krugman has praised leaders in Britain for their response to the global financial crisis. In an Oct. 13 column in the New York Times, Krugman wrote that British Prime Minister Gordon Brown and Chancellor Alistair Darling "defined the character of the worldwide rescue effort, with other wealthy nations playing catch-up."

 

Whereas U.S. Treasury Secretary Henry Paulson rejected a "sort of temporary part-nationalization" involving governments giving financial institutions more money in return for a share of ownership, the British government "went straight to the heart of the problem ... with stunning speed."

 

Krugman said the major European economies have "in effect declared themselves ready to follow Britain's lead, injecting hundreds of billions of dollars into banks while guaranteeing their debts."

"And whaddya know," Krugman continued, "Mr. Paulson — after arguably wasting several precious weeks — has also reversed course, and now plans to buy equity stakes rather than bad mortgage securities."

 

Krugman introduced his theory in 1979 in a 10-page article in the Journal of International Economics.

 

It posited that because consumers want a diversity of products, and because economies of scale make production cheaper, multiple countries can build a product such as cars. A nation like Sweden can build its own car brands for both export and sale at home, while also importing cars from other countries.

 

The article also outlined a new theory of economic geography. Krugman's idea was that if two countries were exactly alike, except one had a larger population, real wages would be somewhat higher in the more populous country because companies there could make better use of economies of scale, creating a greater diversity of goods, lower prices, or both.

 

Because this enhances the welfare of consumers in that country, its population would increase as more people moved there, which would lead to additional increases in real wages.

 

The Nobel Prizes in medicine, chemistry, physics, literature and economics will be handed out in Stockholm by Sweden's King Carl XVI on Dec. 10, the anniversary of prize founder Alfred Nobel's death in 1896.

 

Governments Investing In Banks Rather Than Buying Their Bad Debt

 

Governments around the world are investing hundreds of billions of dollars to rescue failing banks on Monday, sending stock markets soaring and giving Wall Street its largest one-day gain ever.

 

Britain, Germany, France, along with several other European countries, pledged more than 1 trillion euros ($1.36 trillion) for bank guarantees and equity stakes, while U.S. government officials said they were finalizing a similar plan.

 

Treasury Secretary Henry Paulson met with top Wall Street bankers on Monday in a scramble to finalize a plan to take government stakes in troubled banks, with an announcement expected as early as Tuesday. This was an about-face from a previous U.S. focus on buying bad debt from banks, after world finance ministers coalesced around a British proposal at weekend meetings in Washington.

 

In addition to the bank bailouts, the Federal Reserve, the European Central Bank, the Bank of England and the Swiss National Bank said they would lend commercial banks as much U.S. dollar liquidity they needed. That had an instant impact on bank-to-bank lending rates, which eased, but there was still no clear evidence of funds cascading from banks to companies.

 

British Prime Minister Gordon Brown called on world leaders to create a new financial architecture to replace the current system, which was set up at a conference in Bretton Woods, New Hampshire, in 1944.

 

"Sometimes it does take a crisis for people to agree that what is obvious and should have been done years ago can no longer be postponed," Brown said in a speech at the London offices of Thomson Reuters.

 

Britain's bank plan called for 37 billion pounds ($64 billion) of taxpayers' cash to bail out three major banks in a move that would likely make the government their main shareholder.

 

Germany, France, Italy and other European governments also announced rescue packages totaling hundreds of billions of dollars that were designed to combat the banking crisis, the worst since the Great Depression.

 

Iceland, forced over the past week to take over three big banks, shut down its stock market and abandon attempts to defend its currency, officially requested financing from the International Monetary Fund.

 

Japan said on Monday it was considering whether to guarantee all bank deposits, while the central bank said it might join further global efforts to boost dollar funding to strained money markets.

 

In Washington, Democratic leaders in the House of Representatives called for greater regulation of financial markets and a new stimulus plan to stave off recession. Better late than never.

 

U.S. Plan To Be Unveiled Tuesday

 

Treasury Secretary Henry Paulson met with top Wall Street bankers on Monday to finalize a plan for the government to buy shares in financial firms to restore confidence in rattled markets. The Wall Street Journal, citing people familiar with the matter, said the Treasury was expected to unveil a plan on Tuesday to take equity stakes in potentially thousands of banks totaling about $250 billion.

 

As part of the plan, the government would insure new preferred debt issued by banks and backstop all non-interest paying deposits, the paper said on its Website. The plan marks a quick about-face for Washington policy-makers, who until recent days had been focusing on building an apparatus to soak up bad assets from banks.

 

The new push could provide faster relief to a paralyzed banking system and would put the United States more in line with Europe, where governments on Monday pledged billions of dollars to recapitalize banks or guarantee lending.

 

The heads of Bank of America Corp, Goldman Sachs, Citigroup, JPMorgan Chase & Co, Morgan Stanley and New York Mellon Corp were among the executives scheduled to attend the 3 p.m. meeting, which lasted about two hours. U.S. Federal Reserve Chairman Ben Bernanke and New York Federal Reserve Bank President Timothy Geithner also took part.

 

Paulson had previously opposed the idea of Washington buying a stake in banks, which is also permitted under the new law, but officials said they are now retooling the aid package to provide a direct capital injection.

 

"It's hard to avoid the sense that Mr. Paulson's initial response was distorted by ideology. Remember, he works for an administration whose philosophy of government can be summed up as 'private good, public bad,'" economist Paul Krugman, who won the Nobel price for economics on Monday, wrote in the New York Times.

 

The head of the Treasury's $700 billion financial rescue program, Neel Kashkari, said the program would be designed to encourage healthy banks to participate.

 

Crude Jumps in Price

 

The price of crude oil rose more than 4 percent on Monday as global markets rallied after governments launched bailout schemes to shore up banks.

 

Sweet domestic crude futures for November delivery settled up $3.49 per barrel at $81.19, after concerns about the effect of the financial crisis on demand and a flight of investors into safer havens sent prices to the lowest level since September 10, 2007, on Friday. London Brent crude settled up $3.37 per barrel at $77.46.

 

The recent decline in the price of crude oil has prompted some members of OPEC to call for a reduction in production levels when the cartel holds an emergency meeting on November 18. Iraq's Oil Minister Hussain al-Shahristani said on Monday OPEC will consider cutting output if the world does not need its oil.

 

"There has been a reduction in demand and the current production of OPEC is more than the market can absorb," he said.

 

Top exporter Saudi Arabia, OPEC's most influential member, cut November supplies to one major European refiner, according to a trade source, but told major Asian refiners shipments would not be changed.

 

Goldman Sachs, a long-standing commodity bull, became a near-term bear on Monday after conceding that global financial turmoil would take a far bigger toll on demand and that oil prices could hit $50 if the crisis deepened.

 

"We have underestimated the depth and duration of the global financial crisis and its implications on economic growth and commodity demand," Goldman's commodity markets research team said.

 

The bank cut its year-end U.S. crude oil target to $70 a barrel, down from a previous forecast of $115 a barrel, and slashed its average 2009 forecast by a third to $86 a barrel.