MarketView for October 19

Summary 

It was a down day on Wall Street on Tuesday as share prices chalked up their largest loss in two months on fears banks might be on the hook for billions of dollars in souring mortgage bonds. The biggest scare came on news that Bank of America, and possibly others, may be forced to take back billions of dollars in mortgages that should not have been bundled into bonds. The broad selloff came on high volume in a pattern similar to last week's when fears over banks surfaced. The selloff hit markets already reeling from an unexpected credit tightening by China and disappointing financial results from Apple and IBM.

Bank of America closed down 4.4 percent to $11.80, its lowest close since June 2009, after a Bloomberg report, citing people familiar with the matter, said investors PIMCO and BlackRock, along with the New York Federal Reserve Bank, were seeking to force the lender to repurchase $47 billion in mortgage bonds.

The S&P 500 fell the most since mid-August when equities were in a steep selloff. The index closed below its 10-day moving average, which some traders see as a bearish sign.

In an almost perfect storm for equity markets, China's decision to raise interest rates drove the dollar higher as investors cut exposure to risk, putting downward pressure on commodities and related stocks. Selling in commodities accelerated as fears in the mortgage market grew. Copper prices finished near the sharply lower levels hit on Tuesday, while crude oil futures fell 4.5 percent to under $80 per barrel.

Exxon Mobil fell 1.8 percent to $65.12, while Caterpillar ended the day down 2.1 percent to $78.55 and was among the biggest drags on the Dow Jones industrial average. Gold, which has rallied in recent weeks as a safety play against a weaker dollar, fell nearly 3 percent. The Arca gold bugs index, which tracks 16 big gold miners, fell 5.1 percent. Barrick Gold was the largest drag on the index, down 4.9 percent to $45.46.

Apple's shares fell 2.7 percent to $309.49 and weighed on the Nasdaq after iPad sales fell short of some analysts' expectations. Only the day before Apple shares had hit a lifetime high. IBM fell after it won fewer technology service deals than expected in the third quarter. Its shares were down 3.4 percent at $138.03, even as it announced stronger profits and raised its full-year outlook.

Goldman Sachs Group said net trading revenues fell by more than a third in the quarter, but the company's profits exceeded Street estimates, sending its shares up 2 percent to $156.72. Investors' jitters coincided with the anniversary of the 1987 stock market crash when the Dow fell over 20 percent in one day. The CBOE volatility index .VIX, a measure of market volatility, rose 8.1 percent. That is a possible sign that investors may be expecting turbulence ahead.

Housing Starts Hit a 5-Month High

According to a report released Tuesday by the Commerce Department, new homes starts scaled a five-month high in September; another sign the housing market is bottoming, though permits for future building fell. While Tuesday's data was encouraging, housing starts remained at depressed levels and added to the case for more monetary stimulus to shore up the sluggish economic recovery.

According to the Department, housing starts advanced for a third straight month, gaining 0.3 percent to a seasonally adjusted annual rate of 610,000 units in September. August starts were revised up to a 608,000-unit pace from 598,000 units. Compared to September last year, housing starts were up 4.1 percent.

The housing market is starting to settle down after hefty declines following the expiration of a government tax credit for home buyers. A survey on Monday showed sentiment among home builders edged up this month. However, recovery will likely be feeble amid an overhang of unsold homes and stubbornly high unemployment, even though mortgage rates are near record lows.

New building permits dropped 5.6 percent to a 539,000-unit pace last month after a 2.1 percent increase in August. Permits were dragged down by a 20.2 percent tumble in multifamily units. Permits for single-family homes rose 0.5 percent.

Groundbreaking last month was lifted by a 4.4 percent increase in single-family home construction. Starts for the volatile multifamily segment fell 9.7 percent. Meanwhile, the Street keeping a close eye on the foreclosures investigation, which they fear may stall the housing market's recovery as banks hold back on planned foreclosures. The White House warned banks on Tuesday it would pursue them for any mortgage practices that violated the law.

Fed Continues To Hint

A string of Federal Reserve officials on Tuesday talked around the idea that the central bank will soon offer further monetary stimulus to the economy, with one saying $100 billion a month in bond buys may be appropriate. Although there is still some internal reticence to the unconventional policy, the consensus view at the Fed sees the economy as weak enough to warrant further support, most likely through increased purchases of Treasury debt. The debt purchases would help lower long-term interest rates in the hope of boosting demand.

Atlanta Fed President Dennis Lockhart's willingness to cite a specific dollar figure for purchases, one largely in tandem with market expectations, was seen as another hint that planning is actively underway.

"If we're going to pursue another round of quantitative easing, it has to be a large enough number to make a difference," Lockhart said in an interview on CNBC television.

"As a monthly number ($100 billion) is fairly consistent with what we did before, and so I think it would certainly be in the range of numbers one might consider ... but if you were talking about $100 billion as simply the overall program, I think that's too small," he said.

Two especially dovish speeches, from the Chicago Fed's Charles Evans and New York Fed chief William Dudley, suggested some officials would like to consider explicitly raising the Fed's inflation target for a time, a controversial proposal. Dudley said both inflation and employment are likely to remain below levels that are consistent with the Fed's mandate.

"Viewed through the lens of the Federal Reserve's dual mandate -- the pursuit of the highest level of employment consistent with price stability, the current situation is wholly unsatisfactory," Dudley said, repeating an argument he made earlier this month.

The view that further stimulus was needed appeared to hold sway at the central bank, but was not unanimously held. Dallas Fed President Richard Fisher said that while the economy is barely growing fast enough to create new jobs, the case for further monetary easing has not been made conclusively.

"The efficacy of further accommodation using nonconventional policies is not all that clear," he said in comments prepared for delivery to the New York Association for Business Economics. His counterpart at the Minneapolis Fed, Narayana Kocherlakota, also appeared skeptical about how much stimulus further bond purchases or quantitative easing could provide.

"My own guess is that further uses of QE would have a more muted effect on Treasury term premiums," because markets are functioning much better now than in early 2009, said Kocherlakota, who will rotate into a voting seat on the Fed's policy-making committee next year.

On the other end of the spectrum, the Chicago Fed's Evans not only backed more easing but repeated his call for a price-level target, a bolder move than inflation targeting, saying that there was little chance the U.S. unemployment rate, now at 9.6 percent, would fall below 8 percent by 2012.

Dudley is a permanent voter on the Fed's policy-setting panel, while Evans moves into a voting slot next year. Lockhart won't have a vote on monetary policy until 2012.

The prospect of further Fed easing, which helped push the dollar to a 10-month low, has drawn the ire of emerging market economies contending with a flood of capital as investors chase higher yields. The dollar surged on Tuesday after the surprise Chinese central bank interest rate increase.