MarketView for September 2

Summary

  

It started out to be a very buoyant day on Wall Street as we began a holiday shortened work week and the first day of a new month. All the indexes were in positive territory prior to lunch and the Dow Jones industrial average was up about 250 points. However, then everything seemed to fall out of bed and before you knew it, the Dow was in negative territory and that is how it ended the trading day.

 

One key reason for the sharp reversal was that a steep decline in the price of oil and other commodities hammered energy and materials companies while tech shares fell amid jitters a global economic slowdown would crimp technology spending.

 

The market had initially soared upward as the price of crude oil fell to a five-month low over heart felt relief that damage to energy infrastructure from Hurricane Gustav appeared to be limited. The lower oil prices also had buoyed hopes of a recovery in consumer and business spending.

 

However, as fears faded that Gustav would cause a prolonged disruption to energy supplies, the focus shifted to one of the reasons for oil's decline since its record peak in July: fears of slowing world energy demand.

 

After the closing bell another potential reason for the market's reversal emerged, when Ospraie Management told investors it would close down a fund that lost 27 percent in August amid a sell-off in energy, mining and resource equity holdings. Lehman took a 20 percent stake in Ospraie in 2005. Lehman's shares were down more than 4 percent in after-hours trading.

 

In addition, worries that tech companies will suffer as the global economy slows, which sent markets tumbling on Friday after Dell warned that companies worldwide are cutting back on technology spending, continued to worry the markets on Tuesday. Dell's shares fell 4.1 percent to $20.83. Apple fell 2 percent to $166.19, while Research In Motion was down 2.7 percent to $118.35.

 

Concerns a sharp slowdown in global economies could dent demand also hurt commodity-related companies such as miner Freeport McMoRan Copper & Gold and Exxon Mobil, which in turn led the S&P 500 index lower.

 

Sweet domestic crude for September delivery settled down $5.75 per barrel at $109.71, sending it below its 200-day moving average of around $111. The lower price of oil did help airline and retail stocks.

 

In a sign of more fallout from the credit crisis, Fitch Ratings cut its ratings on the preferred stock of housing finance companies Fannie Mae and Freddie Mac over concern of a lack of access to fresh capital that could in turn lead both mortgage giants to suspend their dividend payments.

 

On the economic front, factory activity unexpectedly shrank somewhat during August, according a report by the Institute for Supply Management. The report suggests the factory sector is still struggling, along with the rest of the economy, to overcome the effects of the worst housing slump since the Great Depression of the 1930s.

 

Trading was tepid on the New York Stock Exchange, with about 1.1 billion shares changing hands, well below last year's estimated daily average of roughly 1.9 billion, while on Nasdaq about 2 billion shares traded, also below last year's daily average of 2.17 billion.

 

Crude Falls Sharply

 

Oil fell below $110 a barrel on Tuesday for the first time since April as traders bet the U.S. oil industry would recover quickly from Hurricane Gustav. Early indications that oil installations suffered only minor damage from the storm returned the market's focus to bearish factors including slowing global energy demand growth, rising inventories and a stronger U.S. dollar.

 

U.S. crude settled down $5.75 at $109.71 a barrel after trading as low as $105.46. London Brent crude settled down $1.07 at $108.34 a barrel.

 

U.S. crude settled below its 200-day moving average price for the first time since May 2007, which is considered by many traders evidence that prices may fall further. Oil prices have tumbled nearly $40 a barrel since the July 11 record high of $147.27 as bullish sentiment has evaporated.

 

A third of U.S. refining capacity has been affected in some way by Gustav, with at least 10 plants completely shut down. Early inspections have not turned up any significant damage at the shuttered facilities.

 

All of the 1.3 million barrels per day of oil production in the Gulf of Mexico, a quarter of U.S. domestic production, was shut, though no damage to platforms or any oil spills were noted during inspection flights conducted by the U.S. Coast Guard on Tuesday.

 

Oil traders have been nervous about hurricanes since hurricanes Katrina and Rita devastated the U.S. oil industry in 2005, wrecking over 100 offshore platforms and shutting several major refineries for months of repairs.

 

Tropical Storm Josephine, the 10th named storm of the Atlantic hurricane season, formed off West Africa on Tuesday.

 

The International Energy Agency, which had been prepared to release emergency oil stocks in the event Gustav caused severe damage, announced on Tuesday it saw no need for emergency supplies.

 

Hurricane Ike continued to move westward across the Atlantic and was projected to be in the vicinity of the Bahamas by Sunday, according to the U.S. National Hurricane Center.

 

August Manufacturing Declines

 

Factory activity declined unexpectedly in August while inflation pressures also eased, according to the Institute for Supply Management.  The ISM reported on Tuesday that its index of national factory activity edged lower to 49.9 in August from July's 50.0, the level separating contraction from expansion.

 

The report suggests the factory sector is still struggling, along with the rest of the economy, to overcome the effects of the worst U.S. housing slump since the Great Depression of the 1930s.

 

Officials at the Federal Reserve are likely to be relieved by the moderation in price pressures, which were reflected in a drop in the prices paid index. The prices paid index fell to 77.0 in August from 88.5 in July. That was its lowest prices paid index since 75.5 in February this year and marked its biggest one-month drop since October 2006.

 

Freddie Debt Auctions Go Smoothly

 

Freddie Mac's bill sales drew fewer bids than similar issues a week ago, but these bids as well, as demand for a note deal on Tuesday, is a strong indicator that the company maintains debt market access.

 

Concerns that a lack of fresh equity capital could lead Freddie Mac and its larger mortgage funding rival Fannie Mae to suspend dividend payments spurred Fitch Ratings on Tuesday to cut its ratings on the companies' preferred shares. Moody's Investors Service and Standard & Poor's late last month took similar actions.

 

On the debt side, where senior securities maintain top-notch credit ratings, Freddie Mac sold $1 billion each of 3-month and 6-month bills early Tuesday.

 

Interest rates were mixed from similar auctions a week ago, but demand was weaker based on bid-to-cover ratios that measure the amount of bids compared with the amount offered. Still, demand did not fall off sharply from recent sales.

 

The bid-to-cover on the shorter maturity declined to 3.73 from 3.95 last week. Demand for the six-month bills was lower based on a bid-to-cover ratio of 2.67 compared with 3.42.

 

Among more extended maturities, Freddie Mac also sold $1 billion of five-year notes on Tuesday in a reopening of an existing issue that is now $4 billion in size. The offering was auctioned via the Internet at a 3.975 percent rate, or about 95.6 basis points more than Treasuries, and drew 3.545 bids for every note offered.

 

Freddie Mac tests demand for its shorter-dated debt again on Wednesday when it sells $3 billion of new two-year notes through underwriters led by JPMorgan, Lehman and UBS.

 

KDB Says It Is Talking To Lehman

 

State-owned Korea Development Bank confirmed on Tuesday it was in talks with Lehman Brothers over a possible joint investment in the U.S. bank with other Korean banks, sending Lehman shares higher but depressing local bank shares.

 

Lehman, which has racked up crippling losses and still bears more than $60 billion of mortgage and commercial real estate exposure, is under pressure to raise capital ahead of its earnings announcement this month. The fourth largest investment bank has explored shedding assets, spinning off its money management arm and selling a significant stake to outside investors.

 

"Our CEO said talks are ongoing and cannot disclose the content of them," KDB spokesman Sung Joo-young said, referring to Chief Executive Min Euoo-sung. Min ran Lehman's Korea operations until June.

 

Shares of Lehman rose more than 3 percent in morning trade on the New York Stock Exchange. The firm's stock has soared 27 percent since Aug 19 amid speculation Lehman would strike a deal that would raise needed funds.

 

Lehman's shares slumped more than 70 percent this year and trade at about half their book value, yet another casualty of the ongoing credit crunch. Lehman has a market value of about $11 billion.

 

Buying a top bank could catapult South Korea's financial services firms into the top ranks of global investment houses, which have been battered by heavy mortgage write-downs, and which have seen their share prices tumble.