MarketView for October 31

Summary 

 

If you had thought that October would live up to its reputation as a month of black Mondays, a month of miserable stock returns, well, you were right. Stocks ended the day on Friday by chalking up one of worst months on record. The only good news is that signs of further thawing in credit markets lifted battered shares for the day.

 

Friday's rally resulted in stocks clocking in a higher finish for two sessions in a row -- the first consecutive gains in over a month. Financial shares, led by a gain of almost 10 percent in JPMorgan Chase, lifted Wall Street as the interest rate that banks charge each other for short-term loans continued to ease.

 

Hammered by worries over the extent of the damage the credit crunch has inflicted on the global economy, the Dow Jones industrial average logged its worst monthly decline in a decade, while the S&P 500 had its worst month since the October 1987 market crash.

 

Meanwhile, the decrease in overnight interbank borrowing costs prompted hopes that global efforts to bolster confidence in credit markets are taking hold following the Federal Reserve's interest-rate cut earlier this week and spurred investors to search for bargains.

 

For the week, the Dow gained 11.3 percent, its best one-week percentage gain since October 1974. The S&P 500 rose 10.5 percent, its best weekly percentage gain since at least January 1980. The NASDAQ advanced 10.9 percent, its best weekly percentage gain since April 2001.

 

October, though, was a different story. The Dow lost 14.06 percent, its worst one-month percentage drop since August 1998, while the S&P 500 lost 16.83 percent, its worst one-month percentage slide since October 1987.

 

However, economic data on Friday indicated that consumers are tightening their belts, more evidence of a deep slowdown, though the market appeared to shrug it off. Consumers cut their monthly spending for the first time in two years during September, according to a Commerce Department report.

 

In other economic news, an index of consumer sentiment suffered its steepest monthly drop on record, according to the Reuters/University of Michigan Surveys of Consumers' final reading for October. And the Chicago Purchasing Management Index showed that business activity in the Midwest came to a halt in October as production and new orders plummeted.

 

After trading on both the up and down side of Friday's ledger, Chevron ended up 0.6 percent at $74.60 after it reported quarterly profit that beat expectations.

 

The price of crude oil, which had slipped earlier and pressured the stock, also rebounded, settling up $1.85 per barrel at $67.81 but recorded its largest monthly drop ever. In October, the price of crude fell a record 32.62 percent.

 

Shares of Express Scripts Inc jumped 5.3 percent to $60.61 on the NASDAQ after the pharmacy benefit manager reported quarterly profit that beat expectations after Thursday's closing bell. Also on the NASDAQ, Electronic Arts ended the day down 17.9 percent to $22.78 after it reduced its full-year profit forecast due to slowing demand.

 

Crude Down 36% During October

 

Price of crude oil chalked up its largest monthly price drop since futures trading began 25 years ago, the result of a contracting economy that could suppress the demand for energy well into 2009. Oil's monumental collapse, prices are down 36 percent for the month and 56 percent from their July record, has stunned oil-producing countries while giving cash-strapped consumers a rare dose of relief. Pump prices have fallen by half since their summer peak above $4 a gallon — a huge drop that's expected to result in over $100 billion in annual savings for American households.

 

Friday's oil decline was tied to a significantly stronger dollar. Oil market traders often buy oil as a hedge against inflation when the dollar falls and sell those investors when the greenback rises. The dollar has rallied in recent weeks as the financial crisis begins hurting economics in Europe and elsewhere, prompting investors to shift funds into the greenback as a safe-haven.

 

Light, sweet crude for December delivery settled down $1.35 per barrel at $64.61 on the New York Mercantile Exchange, after earlier falling as low as $63.12. Prices closed at $100.64 a barrel on the last trading day in September. That gives oil the biggest monthly slide since the launch of the Nymex crude futures contract in 1983. The previous record was a 30 percent drop set in February 1986. In London, Brent crude settled down $2.00 per barrel at $61.71 on the ICE Futures exchange.

 

At the pump, a gallon of regular gasoline fell another 4.3 cents overnight to a new national average of $2.504, according to auto club AAA, the Oil Price Information Service and Wright Express. Gas now costs about half as much as it did on July 17, when prices hit a record $4.114 a gallon.

 

Cheaper gas has been a rare bit of good news for consumers rattled by huge drops in the stock market, rising mortgage payments and difficulty in obtaining credit. According to Deutsche Bank research, for every dollar that comes off pump prices, households save a staggering $100 billion a year, money that could be spent on other goods and services to help jolt the economy.

Deutsche Bank estimates that the $100 billion would be worth 3 million new jobs.

 

But even with cheaper energy, Deutsche Bank predicts the weak global economy will weigh on fuel demand well into 2009, bringing oil to a quarterly average of $50 a barrel for that year. OPEC and international energy agencies earlier this year predicted oil demand would rise by 800,000 barrels a day next year, driven by growth from developing economies like China and India.

 

The drop in oil has come despite moves by OPEC to prop up prices. Last week, OPEC announced plans to cut 1.5 million barrels of production per day at an extraordinary meeting in Vienna. Venezuela's Oil Minister Rafael Ramirez says OPEC, which controls about 40 percent of world crude oil production, will need to cut production by at least another 1 million barrels per day to boost falling prices.

 

Price hawks like Venezuela and Iran need prices at near $100 a barrel to balance their national budgets, while Saudi Arabia and other members would like to see prices stabilize at around $80. Opinion, however, is mixed on whether all members of the cartel will follow through on the cuts, or keep churning out as much crude as they can on fears that prices will plummet more.

 

In other Nymex trading, gasoline futures fell 3.95 cents to $1.4275 a gallon, while heating oil fell 2.22 cents to $1.9774 a gallon. Natural gas for December delivery was up 5.7 cents at $6.791 per 1,000 cubic feet.

 

Bernanke Speaks Out On Housing

 

Federal Reserve Chairman Ben Bernanke said Friday that the housing finance system being constructed following the collapse of the current system will need better safeguards to allow it to function during times of stress.

 

Whatever shape the new system takes should ensure that the institutions that support the financing of home mortgages do not pose a systemic risk to our financial markets and the economy, Bernanke said in a speech prepared for a housing conference in Berkeley, Calif.

 

He outlined a number of possible ways to structure housing finance in the future, but did not state his own preferences.

 

The issue of how financing should be restructured was a good one for policymakers to address during what he called the current "time out" when Fannie Mae and Freddie Mac are both under the control of the federal government, Bernanke said.

 

The two mortgage giants were placed into conservatorship on Sept. 7, part of a series of events that have unfolded as the biggest financial crisis in seven decades has hit the U.S. economy.

 

Speaking about the credit crisis that started in August 2007, Bernanke said it began with the end of a prolonged housing boom in the U.S. that exposed "serious deficiencies in the underwriting and credit rating" for mortgages, particularly subprime mortgages, loans made to borrowers with weak credit histories.

 

Banks and thrifts are still making new mortgage loans during the current credit squeeze but have tightened terms considerably, "essentially closing the private market to borrowers with weaker credit histories," Bernanke said.

 

But he said the credit problems went far beyond housing.

 

"The boom in subprime mortgage lending was only part of a much broader credit boom characterized by under pricing of risk, excessive leverage and the creation of complex and opaque financial instruments that proved fragile under stress," he said. "The unwinding of these developments is the source of the severe financial strain and tight credit that now damp economic growth."

 

He did not make any predictions on when the credit crisis will end or discuss the overall economy more broadly. On Wednesday, the Fed cut the federal funds rate, the interest that banks charge each other, by a half-point to 1 percent, which ties the lowest level seen in the past half century.

 

While the Fed held out the prospect of further rate cuts to keep the economy out of a severe recession, Bernanke did not address that issue Friday.

 

He did say that private companies have basically stopped all of their activities to purchase mortgages and collect them into large pools to be sold as securities, something now only being done by Fannie, Freddie and Ginnie Mae. By contrast, private companies accounted for half of the market for mortgage-backed securities in 2005 at the height of the housing boom.

 

"That experience suggests that, at least under the most stressed conditions, some form of government backstop may be necessary to ensure continued securitization of mortgages," Bernanke said.

 

Bernanke laid out various options that policymakers could consider for overhauling housing finance, from keeping Fannie and Freddie under government control permanently, to breaking up the two giants into smaller organizations that would be privately owned.

 

Bernanke did not rank the various options he explored, but said that policymakers must design a new system that would meet the goal of providing adequate financing for home mortgages while ensuring the safety of the entire financial system.

 

"Regardless of organizational form, we must strive to design a housing system that ensures the successful funding and securitization of mortgages during times of financial stress but that does not create institutions that pose systemic risks to our financial markets and the economy," he said.

 

Troubled Firms Owe Executives Billions of Dollars

 

Troubled financial giants getting cash infusions from the U.S. government owed executives more than $40 billion for deferred pay and pensions as of the end of 2007, the Wall Street Journal reported in an analysis.

 

The sums owed are mostly for special executive pensions and deferred compensation, including bonuses, for prior years, according to the paper's website.

 

The Journal cited investment banks Goldman Sachs, which owes its executives $11.8 billion; JPMorgan Chase, which has a payment of $8.5 billion pending; and Morgan Stanley, which owes between $10 billion and $12 billion.

 

A Goldman Sachs spokesman said the $11.8 billion cited in the report was almost entirely cash compensation, payroll taxes and benefits paid out to employees earlier this year for fiscal 2007. A Morgan Stanley spokeswoman confirmed the accuracy of the report and said these obligations were already largely funded.

 

Criticism of executive pay has gained momentum this election year, with presidential candidates from both major parties lashing out over rich payouts for CEOs of companies that have suffered big losses in the U.S. housing market bust and ensuing credit crisis. As a result, the government has sought to rein in executive pay at banks getting federal money as part of the Bush administration's $700 billion bailout program.

 

Across the industry, bank executives and directors are discussing how they will handle the need to remain competitive in paying top people without incurring the anger of lawmakers and regulators.

 

People familiar with the situation inside several of the top U.S. banks told Reuters most compensation decisions will not be made until next month. These people also say the firms still intend to compensate valued employees. "The government cutting or controlling pay is a non-starter. Bank heads think it's dangerous and it sets a bad precedent," one bank insider said.

 

Goldman, Morgan Stanley and Merrill Lynch have set aside $20 billion as compensation in the first three quarters, with two-thirds typically earmarked for year-end performance bonuses. These amounts were put in reserve before August 31, ahead of Lehman's collapse and last month's Treasury intervention.

 

Compensation is accrued throughout the year and usually equals 45 percent to 55 percent of revenue. For instance, nine banks paid out an estimated $50 billion in bonuses in 2007, based on the total compensation expense for the companies and assuming that, for investment banks, about 60 percent of total compensation was allocated for bonuses, while commercial banks allocated about 20 percent for that purpose.

 

The total of these obligations at some firms exceed what they owe in pensions to their entire workforces, the Journal said.