MarketView for October 20

Summary 

 

It was a good day on Wall Street on Monday, as the Dow Jones industrial average chalked up a gain of more than 400 points on signs of a possible thaw in the credit market as Federal Reserve Chairman Ben Bernanke spoke out in favor of taking additional steps to aid the economy. All the major equity indexes except the NASDAQ were up over 4 percent and the NASDAQ was up over percent.

 

Indicating the times might be improving, albeit slowly, was an increase in bank-to-bank lending as inter-bank lending rates eased. The improvement in lending rates helped temper concerns that tight credit will contribute to a prolonged recession, but Bernanke still warned that the economy is likely to be "weak for several quarters, and with some risk of a protracted slowdown."

 

But he also told the House Budget Committee that a fresh round of government measures might help ease the country's economic weakness. There were no details but the White House said it was open to ideas that Congress might put forth.

 

"The market liked what Bernanke had to say, and there were hints that he's leaving the door open for further moves in terms of rate cuts or economic stimulus," said Ryan Larson, head of equity trading at Voyageur Asset Management. "And, with credit easing in slow baby steps, the market has started to realize that this is going to be a process."

 

There was also less demand for Treasury bills, another sign that the credit markets are gradually returning to a healthier state. However, at the same time, Wall Street was also sifting through the first of hundreds of earnings reports expected this week, seeking clues about future business conditions.

 

Among those reporting, Halliburton topped estimates, and CEO Dave Lesar told investors and analysts in a conference call, "We expect that any major macroeconomic disruptions will ultimately correct themselves."

 

Trading was orderly for much of the day, but the final hour again saw frenetic activity, this time to the upside, with the Dow rising nearly 140 points in the last 25 minutes. The market's tone was clearly better than during the previous two weeks as trading took on a tone of confidence that the worst of the market's losses was behind it.

 

Still, with back-and-forth trading a hallmark during recoveries volatile price swings are probably going to be with us for some time. Monday’s rally marked the Dow's 23rd triple-digit move in 26 sessions. Most sessions have brought losses, however, with 11 of the past 14 showing declines.

 

The S&P  500 index rose 4.77 percent, while the Nasdaq was up 3.43 percent.

Despite the advances of recent sessions, the major indexes remain well below their peaks of a year ago.

 

The credit markets were gradually responding to the series of bailout measures by governments around the world, including a joint U.S. and European plan to buy stakes in private banks to boost their lending. Demand for Treasury bills, regarded as the safest assets around, lessened Monday but remained relatively high in a sign that there was still much fear in the markets.

 

The three-month Treasury bill Monday yielded 1.12 percent, up from 0.82 percent late Friday. That's better than the 0.20 percent of last Wednesday, and the first time it surpassed 1 percent in more than a week.

 

Investors were also optimistic about the steady decline in interbank lending rates, down now for six consecutive days. The London interbank offered rate, or Libor, for three-month dollar loans fell 0.36 percent to 4.06 percent, the biggest daily drop since January. The benchmark 10-year Treasury note rose. The yield, which moves opposite its price, fell to 3.87 percent from 3.93 percent late Friday.

 

Treasury Secretary Henry Paulson also fleshed out a little his plans to roll out a $250 billion plan to recapitalize banks. Paulson said the government will own shares in the banks that should be paid back with a reasonable return, and expects that the investment will eventually make money.

 

Meanwhile, there were some optimistic data that showed the economy's health improved for the first time in five months in September as supplier deliveries and new orders pushed the Leading Index higher. The Conference Board said its monthly forecast of future economic activity rose 0.3 percent.

 

Light, sweet crude settled up $2.40 per barrel at $74.25.

 

OPEC Likely To Cut Crude Supply

 

At an emergency session this week OPEC ministers are expected to cut output, but debate on how much oil to choke off could be intense as they balance their own price needs against the risks to a fragile world economy. The group's president said at the weekend OPEC could not afford to see the market drop below $70-$90 a barrel. He also said any output cut could be introduced in stages.

 

Some in the group have said up to three million barrels per day (bpd) needed to be removed from the market over time, starting with a cut of around one million bpd. Others have said a token reduction would be more appropriate. The one million bpd figure echoes OPEC's monthly market report, which implied a need to cut by an average of one million bpd from September levels to meet average demand next year.

 

As a starting figure, it has also been taken up by OPEC producers like Iran, which is estimated by some to need a price of close to $100 a barrel to balance its books, compared with the roughly $55 required by leading exporter Saudi Arabia.

 

Last week domestic crude hit a low of $68.57 per barrel, more than 50 percent below the record of $147.27 struck in July. Prices had recovered to above $70 on Monday, partly in anticipation OPEC will cut supplies.

 

But the Saudi-owned al-Hayat newspaper on Monday quoted an unnamed OPEC source as saying a deep cut might not be necessary. The source also stated the need to reassure turbulent financial markets.

 

Even those with most room for maneuver still face the prospect of a big build up in stocks as economic downturn reduces demand, which could eventually send the market to a level uneconomic for all producers, as well as for oil firms.

 

For the Organization of the Petroleum Exporting Countries, the speed of the descent revives bad memories of the 1998 price collapse when oil fell to less than $10 a barrel. OPEC also knows to that output discipline has been weaker in times of economic downturn, as in 1998, because oil exporters tend to produce all they can to try to offset the impact of a lower price on their revenues.

 

Displaying a sense of urgency, OPEC last Thursday -- the day oil fell below $70 -- announced it had brought forward its emergency talks, originally scheduled for November 18, to October 24. Qatar's Energy Minister Abdullah al-Attiyah said the rescheduling was to allow members to "take action before solutions become more difficult Prices have plunged in a very big way."

 

Since abandoning in 2005 an agreed price band, the group has preferred not to state officially where it wants the market to be, but OPEC's President Chakib Khelil of Algeria felt it was again time to speak out.

 

"Normally, OPEC has no price target. The market decides on prices. But people say that the bottom price, the bottom cost below which we cannot step down, is between $70 and $90 a barrel," Khelil was quoted as saying in Algerian daily El Watan.

 

To help achieve that, OPEC members would typically expect Saudi Arabia, which this year has pumped well above its official target, to be responsible for the largest share of any production cuts. For its part, Saudi Arabia would expect cooperation from the rest of the group.

 

Some interpreted the kingdom's decision to sign up to an unexpectedly tough output deal in September as an attempt to win unity ahead of challenging times. Even though oil was then around $100 a barrel, the unanimous September agreement said OPEC would strictly adhere to its production ceiling, in theory shaving around 500,000 bpd from output.

 

Credit Thaw May Have Begun

 

It appears that lending between banks is beginning to thaw, while Fed chairman Ben Bernanke gave his blessing to a second stimulus package on Monday, providing hope the world's financial crisis may be easing. The three-month Libor rate fell more than one-third of a percentage point, its biggest one-day drop in nine months in one sign that banks may have the confidence to lend to each other again, crucial to reactivating the world economy.

 

The chairman of the U.S. Federal Reserve told Congress on Monday that another round of stimulus spending may be needed as the economy limps through what could be an extended period of subpar growth.

 

"With the economy likely to be weak for several quarters, and with some risk of a protracted slowdown, consideration of a fiscal package by the Congress at this juncture seems appropriate," Fed chief Ben Bernanke said in his first endorsement of a second stimulus package.

 

The comparative optimism follows weeks of market-rattling weekend announcements since Lehman Brothers collapsed in mid-September. The world's financial stewards have used previous weekends to announce emergency measures to combat the worst financial crisis since the 1930s Great Depression.

 

Governments have promised $3.3 trillion, about equal to the economic output of Germany, to guarantee bank deposits and bank-to-bank lending, and in some cases have taken stakes in banks with toxic assets. The latest bailout came from South Korea, which released a $130 billion rescue package.

 

Home Prices Expected To Fall Another 10 Percent

 

The price of homes is likely to fall another 10 percent according to Fitch Ratings. National home prices have declined a full 22 percent from the peak hit in 2006, the agency said in a note. Fitch has a peak to trough forecast for prices to decline 30 percent.

 

The additional 8 percent decline is equal to another 10 percent decline from current levels, it said. Most of that correction will take place in the next several quarters before prices exhibit stability in 2010, the agency said.

 

Fitch's analysis indicates that expected drop will reverse the home price increases seen between 2004 and 2006.

 

"Should economic conditions become much worse than expected, home prices would decline more than Fitch's projection and price stabilization would be delayed," said Huxley Somerville, group managing director and head of U.S. residential mortgage backed securities.

 

"Higher mortgage rates and tighter underwriting also will continue to put downward pressure on prices."

 

Government measures, including the Treasury's Troubled Asset Relief Program and expanded mandates for housing agencies Fannie Mae, Freddie Mac and the Federal Housing Administration to boost loan purchases and originations, may improve liquidity in the housing markets, said Suzanne Mistretta, senior director at Fitch. That could have a positive impact on prices, she said.

 

Fitch's analysis indicates that the 29 percent rise in home prices in the period between 2004 and 2006 has now been reversed. The spike was the largest price growth ever recorded. Prices have now returned to early 2004 levels and need to return to levels seen in 2003 before the pace of decline will moderate.

 

Banks Must Use Government Money

 

Treasury Secretary Henry Paulson said on Monday that banks who apply to sell equity to the federal government would be expected to make use of their new capital and boost lending.

 

Issuing regulatory guidelines for the new $250 billion equity purchase plan created last week, Paulson said there was interest from a broad group of banks of all sizes.

 

The Treasury previously announced it was investing $125 billion in nine of the largest U.S. banks, acquiring preferred stock. It intends to create a systematic program under which a broad range of financial institutions can access U.S. government capital.

 

U.S.-controlled institutions who are interested must apply to their regulatory agency before November 14 and their applications will be reviewed by the Treasury's new Office of Financial Stability.

 

"Our purpose is to increase confidence in our banks and increase the confidence of our banks, so that they will deploy, not hoard, their capital. And we expect them to do so, as increased confidence will lead to increased lending," Paulson said in a statement.

 

Paulson said the purchase program was not being implemented on a first come-first served basis.

 

All transactions will be publicly announced within 48 hours, but the department said it would not announce any applications that are withdrawn or denied.

 

"This is an investment, not an expenditure, and there is no reason to expect this program will cost taxpayers anything," Paulson said.

 

Paulson said he expects the participating banks to strengthen their efforts to help struggling homeowners avoid foreclosure.

 

Leading Indicators Up For September

 

The economy's health, as portended by the Conference Board’s monthly leading indicator survey, rose 0.3 percent in September, and the first increase in five months, as supplier deliveries and new orders strengthened. The index had fallen a revised 0.9 percent in August and 0.7 percent in July. The increase in the money supply from the federal government’s expensive bailout packages helped September's index.

 

In September, the government seized control of Fannie Mae and Freddie Mac, the largest funders of mortgages in the U.S. It made an $85 billion emergency loan to American International Group Inc. The Federal Reserve and central banks in Europe pumped $180 billion into money markets to free up lending between banks and the government undertook a $700 billion rescue of troubled bank assets.

 

Ken Goldstein, a labor economist at the Conference Board, indicated that, "Data on hand reflect a contracting economy, but not one in free fall. More likely, what's going in the financial market is a stretching of the recovery process, which could take a full year to develop."

 

Six of the ten indicators that make up the leading index increased in September, including the money supply and the index of consumer expectations. The spread between long-term and short-term interest rates, an indicator of credit conditions, also narrowed. The negative contributors were building permits, unemployment claims, stock prices and weekly manufacturing hours. The cutoff day for data in the index was Oct. 17.