MarketView for October 27

Summary 

 

Stock prices ended the day at their lowest levels in 5-1/2 years on Monday, extending a global sell-off as worry about the severity of a global recession and the bleak outlook for profits gripped investors. Hedge funds and mutual funds have been dumping stocks to raise cash to meet redemptions from their clients, exacerbating the late-day selling. The day’s volatile trading had stock prices falling sharply in the last half hour of trading. With just four days left in October, the S&P 500 is on track for its worst month ever in the post-World War II period.

 

Shares of energy companies led the decline on bets that a deep global slowdown will sap demand for energy. ConocoPhillips closed down 5.8 percent to $45.62 as domestic crude futures settled down 93 cents per barrel at $63.22.

 

Technology shares were hit hard with Microsoft a top drag on Nasdaq after the Wall Street Journal reported increased defaults on tech financings. Nonetheless, there were some signs of of an improvement in the credit markets. Overnight and three-month dollar-denominated London interbank offered rates eased slightly.

 

An index of the shares of regional U.S. banks rose 1.6 percent, after 16 banks, including BB&T, accepted more than $33 billion in government assistance by means of equity investments. The infusions are part of the second phase of a $250 billion recapitalization program launched this month by U.S. Treasury Secretary Henry Paulson.

 

Concerns over the impending global recession overshadowed hope as to the success of the Federal Reserve's efforts to thaw the deep freeze in short-term lending markets. The Fed set the interest rates it will charge companies for the commercial paper it will buy from them in a debut program, the New York Fed said on Monday. The program aims to increase the supply of funds for many corporations that rely on selling commercial paper to raise short-term money for their daily operations.

 

Not all the news was depressing on Monday. An announcement of increased earnings by Verizon was a bright spot among the Dow 30. Verizon's stock closed up 10.1 percent at $27.61.

 

Shares of General Motors slid 8.4 percent to $5.45 after people familiar with the merger talks between GM and Cerberus confirmed that the talks are progressing.

 

The markets are looking ahead to the Federal Reserve's interest-rate decision Wednesday. The Fed is expected to cut lending rates at a two-day policy meeting in response to unprecedented turmoil in financial markets and the threat of a global recession.

 

The consensus is for a half-point cut in the overnight fed funds rate to 1 percent, which would be the lowest since June 2004. The central bank is also expected to signal a willingness to lower borrowing costs again if needed, especially with inflation pressures fading fast.

 

Currency markets were unnerved by a statement from seven leading industrial nations Sunday warning of the "recent excessive volatility" in the value of the Japanese currency, which is rising against the U.S. dollar toward the 90 yen level and near 13-year highs.

 

Dealers had one wary eye on central banks, watching whether they would intervene in currency markets to sell yen and prop up other currencies. The yen's rise threatens Japan's export-heavy economy by making its goods relatively more expensive.

 

Shares of Toyota and Sony were hit hard Monday. The losses came despite a report that the Japanese government was considering a massive capital injection into struggling banks in a bid to calm jittery financial markets.

 

South Korea's central bank cut its key interest rate Monday by three-quarters of a percentage point, its largest-ever reduction. The country's stock market benchmark Kospi ended with a 0.8 percent gain. Elsewhere, central banks in Australia and Hong Kong added funds to their markets to boost liquidity.

 

New Home Sales Up – Prices Down

 

The Commerce Department reported on Monday, prior to the opening bell, that sales of new single-family homes rose in September and inventories shrank as builders slashed prices to their lowest level in four years. The annual sales pace of 464,000 homes was up 2.7 percent from the revised August figure of 452,000 that was up from the originally reported as 460,000 units.

 

However, the Department also said that the median sales price of $218,400 was 9.1 percent lower than the year-ago point and the lowest since the $211,600 level reached in September 2004, when the housing market was on the upswing. September sales were off 33.1 percent from their already deflated levels of a year ago.

 

A five-year run-up in home values ended in 2006. For the last two years, home builders have tried to find the highest price level that will entice buyers and help them burn off an overstock of homes. The lower prices of September seem to have attracted some buyers since the housing inventory of 394,000 was the lowest since the 383,000 homes for sale in June 2004.

 

The 7.3 percent decline in inventory from August was the sharpest on record. At the current sales pace, it would take 10.4 months to clear the overstock of homes compared to the 11.4 months reported in August.

 

Consumer mortgage rates are being closely watched as a major factor with regard to the ability of buyers to finance those new homes. For months, borrowing costs have climbed amid a global credit crunch and Washington policy-makers have had only mixed success in tapping down the costs of home loans. Rates for 30-year mortgages hovered below 6 percent in mid September but have since climbed slightly above that mark.

 

Across the regions, the strength of markets varied greatly with sales down 21.4 percent in the Northeast and up 22.7 percent in the West. The Midwest was down 5.8 percent while the South was up 0.7 percent.

 

Also on Monday, data on building permits showed a smaller decline than first reported for September. The Commerce Department said that permit activity had declined by 6.1 percent -- compared to the 8.3 percent decline first reported.

 

Crude Hits Lowest Level Since May 2007

 

The price of crude oil fell to an 18-month low on Monday as declining demand and the growing financial crisis offset OPEC plans to cut output. Domestic sweet crude settled down 93 cents per barrel at $63.22 a barrel, the lowest settlement price since May 29, 2007. London Brent crude settled down 64 cents per barrel at $61.41. Prices are down by nearly 60 percent from a record high of $147.27per barrel in July, as global economic turmoil dents world fuel consumption.

 

Demand has fallen in the United States, the world's top energy consumer, and in other industrial countries as the credit crisis infects the wider economy and begins to spread to emerging markets. In China, apparent oil demand rose by just over 2 percent in September, the slowest growth in 10 months.

 

Oil's losses came despite an agreement by the Organization of the Petroleum Exporting Countries made on Friday to cut 1.5 million barrels per day of output. Asian oil refiners said they had yet to receive notice of any curbs on their Gulf crude oil shipments, but most were expecting a 5 percent cut.

 

Iran's OPEC Governor Mohammad Ali Khatibi has said the group would reduce production further if the cut agreed in Vienna on Friday did not stabilize the market.

 

Treasury Set To Take First Step With Banks

 

The Treasury Department will kickoff the Holiday season early, doling out $125 billion to nine major banks this week to get credit flowing again, in hopes of staving off a protracted recession. Assistant Treasury Secretary David Nason said the deals with the nine banks were signed Sunday evening and that the government will begin undertaking the task of purchasing stock in the selected institutions this week. The purchases are designed to add to the banks' balance sheets so they will begin more normal lending. The move marks the first deployment of resources from the government's $700 billion financial rescue package passed by Congress on Oct. 3.

 

The bailout package has undergone a major change in emphasis since it was passed by Congress. Treasury Secretary Henry Paulson decided to use $250 billion of the $700 billion to make direct purchases of bank stock, partially nationalizing the country's banking system, as a way to get money into the financial system more quickly.

 

The plan is also aimed at clearing banks' balance sheets of bad assets. That effort has yet to begin although the administration expects to use $100 billion to purchase bad assets in coming months.

 

The deployment of the first $125 billion to the major banks was delayed while the government and the banks worked out a few kinks in the gift giving process.  Treasury is also starting to give approval to major regional banks with the goal of getting another $125 billion in stock purchases made by the end of this year.

 

KeyCorp said Monday it would issue stock for a $2.5 billion infusion of capital from the government. SunTrust also said it has received preliminary approval from Treasury for a $3.5 billion investment. In all, about 15 regional banks have received preliminary approvals for the government to make stock purchases.

 

Treasury said it was allowing each bank to announce its own deal once preliminary agreements were reached. Treasury will announce the final deals on its Web site each day once all the paperwork is completed and signed. By law, Treasury must announce the agreements within 48 hours after they are signed.

 

Treasury has given the go-ahead for stronger banks to use the money it receives in the rescue program to acquire weaker banks. That has prompted criticism the government should not be financing the consolidation of the banking system , which is viewed by some as helping to choose winners and losers.

 

The Fed also began a major new initiative Monday to unclog frozen credit markets by purchasing commercial paper, the short-term loans that businesses use to fund their daily operations.

 

The market for commercial paper dried up after the bankruptcy of Lehman Brothers last month and other troubles in the global banking system. The biggest buyers of commercial paper are money market funds, some of which took big hits when Lehman collapsed.

 

The convergence of a housing collapse and a lockup in bank lending has created the worst financial crisis in more than a half-century. Vanishing jobs and shrinking paychecks have forced consumers to put a lock on their wallets, as the watch their 401(k)s and other nest eggs are being crushed and the value of their homes drop. In turn, businesses have cut back on hiring and other investments as customers hunker down and credit problems make it harder and more costly to get financing.

 

Not even China's mighty economy was immune to the rising recession anxiety. Its benchmark index slumped to its lowest level in more than two years as investors reacted to dismal earnings reports.

 

Treasury Considering Possible Assistance in GM – Chrysler Merger

 

As if banks and commercial paper were not enough, the Treasury Department is looking at ways it can facilitate and assist in a possible merger between General Motors and Chrysler. The Word on the Street is that the Treasury Department is weighing aid of at least $5 billion, which could include capital injections and government purchases of bad auto loans. The emergency financing, at least initially, most likely would be focused on GM and Chrysler and not Ford, which is struggling but still better off financially than its colleagues. A Treasury decision could come as early as this week.

 

Any direct infusion of billions in capital would reverse the administration's long held reluctance to bail out the failing domestic automobile industry. However, Detroit's problems have become more acute during the global credit meltdown. At the same time, GM, Ford and Chrysler have all ruled out bankruptcy as an option. They are burning through cash and their performance outlook has worsened. On Monday, Moody's Investors Service downgraded GM's credit rating on continuing liquidity concerns.

 

The industry is mounting a furious lobbying campaign to tie the health of automakers to the needs of the general economy, and have elevated the bailout discussion to the presidential campaign. Carly Fiorina, an economic adviser to Republican presidential candidate John McCain, said on Monday that the government can assist automakers but not save the industry, meaning that taxpayers should not be on the hook for a long-term investment.

 

Federal aid is considered a requirement for completing the GM/Chrysler deal since larger GM has failed to find an outside investor to help fund its acquisition with sales plummeting, other sources have said. GM chief executive Rick Wagoner was in Washington in recent days to lobby administration officials. Former Treasury Secretary John Snow is the chairman of Chrysler owner, Cerberus Capital Management. Key congressional lawmakers have also pressured Treasury.

 

The word is that GM would need a minimum of $5 billion to start restructuring Chrysler's operations. The total amount needed could reach $10 billion, the sources have said. Terms of any assistance for GM were not immediately apparent. However, Treasury has already taken equity stakes in nine banks as part of its $250 billion capital injection program.

 

White House spokeswoman Dana Perino said officials from the Treasury, Energy, and Commerce departments have been in contact with automakers. The focus of their efforts so far has been on a package of $25 billion in government-backed loans to retool factories and develop new technologies to make more fuel efficient cars. The concern in Detroit is that the loans may not be available in time to help them.

 

At the same time, GM, Ford and Chrysler have faced increased scrutiny from creditors and investors about whether they have the cash to ride out a deepening downturn in sales. GM, which burned through over $1 billion a month in the second quarter, is in danger of running its cash holdings below the minimum of $11 billion it says it needs to run its far-flung business by late 2009, analysts have said.

 

The automaker's plan to sell assets have been slow-moving and the debt markets have been effectively closed to it borrowing more, putting in jeopardy its plan to raise $5 billion from asset sales and new borrowing through 2009.

 

Underscoring its need for cash, GM's bid for Chrysler has been motivated in part by a view that an acquisition would allow it to take whatever cash is left on the smaller automaker's balance sheet. Chrysler ended the second quarter with $11.7 billion in cash, according to Cerberus.