MarketView for September 5

Summary

  

Although the Dow Jones industrial average managed to eke out a small gain on Friday, the financial markets still posted their worst week since May, as a rally in financial stocks helped reverse losses sparked by a government report showing the employment rate reaching a five-year high. The Labor Department said 84,000 jobs were lost in August

 

The trading day started with the Dow falling more than 100 points after news that the unemployment rate jumped to 6.1 percent added to worries that consumer spending was on the rocks, which in turn added to the fears that the global economy was facing a major slowdown. Those fears have battered stocks all week, leaving the S&P 500 with its worst five-day performance since last May.

 

Financial shares rebounded in afternoon trading, amid hopes the Treasury Department would take steps over the weekend to rescue mortgage finance companies Fannie Mae  and Freddie Mac. After the closing bell, The Wall Street Journal reported the Treasury is close to finalizing a plan to backstop Fannie and Freddie.

 

Also helping financial stocks was Lehman Bros after word hit the Street that the Blackstone Group and Kohlberg Kravis Roberts are each looking to buy parts of Lehman's real estate and asset management units.

 

The NASDAQ lagged the other indexes on Friday and had its worst week since January, led lower by large cap technology stocks. Technology is among sectors most vulnerable to a global slowdown due to its exposure to overseas markets.

 

The Dow ended the week down 2.8 percent; the NASDAQ was down 4.7 percent, while the S&P 500 Index ended the week down 3.2 percent.

 

On the NASDAQ, Qualcomm fell 1.8 percent to $47.67, while Apple declined 0.7 percent to $160.18. SanDisk rose 31.1 percent to $17.64 after Samsung Electronics said it was considering acquiring the flash memory maker in a deal that could reshape a struggling industry.

 

Altria is in advanced talks to buy Skoal and Copenhagen smokeless tobacco maker UST. UST saw its share price tack on a gain of 25.1 percent to $67.55.

 

Government To Take Over Fannie Mae and Freddie Mac - Possibly This Weekend

 

The government is expected to take over Fannie Mae and Freddie Mac as soon as this weekend in a monumental move designed to protect the mortgage market from the failure of the two companies, which together hold or guarantee half of the nation's mortgage. Some of the details of the intervention, which could cost taxpayers billions, were not yet available, but are expected to include the departure of Fannie Mae CEO Daniel Mudd and Freddie Mac CEO Richard Syron

 

Federal Reserve Chairman Ben Bernanke, Treasury Secretary Henry Paulson and James Lockhart, the companies' chief regulator, met Friday afternoon with the top executives from the mortgage companies and informed them of the government's plan to put the troubled companies into a conservatorship.

 

The news, first reported on The Wall Street Journal's Web site, came after stock markets closed. In after-hours trading Fannie Mae's shares plunged $1.54, or 22 percent, to $5.50. Freddie Mac's shares fell $1.06, or almost 21 percent, to $4.04. Common stock in the companies will be worth little to nothing after the government's actions.

 

The news also followed a report Friday by the Mortgage Bankers Association that more than 4 million American homeowners with a mortgage, a record 9 percent, were either behind on their payments or in foreclosure at the end of June.

 

That confirmed what investors saw in Fannie and Freddie's recent financial results: trouble in the mortgage market has shifted to homeowners who had solid credit but took out exotic loans with little or no proof of their income and assets.

 

Fannie Mae and Freddie Mac lost a combined $3.1 billion between April and June. Half of their credit losses came from these types of risky loans with ballooning monthly payments. While both companies said they had enough resources to withstand the losses, the Street believes their financial cushions could wither away as defaults and foreclosures mount.

 

Many in Washington and on Wall Street hadn't expected Paulson to intervene unless the companies had trouble issuing debt to fund their operations. This summer, Congress passed a plan to provide unlimited government loans to Fannie and Freddie and to purchase stock in the two companies if needed. The open-ended nature of the rescue package could expose taxpayers to billions of dollars of potential losses.

 

However, the Bush administration had little choice but to support Fannie and Freddie, which together hold or guarantee $5 trillion in mortgages, almost half the nation's total.

 

Concern has been growing that a government rescue of Fannie and Freddie could not only wipe out common stockholders, but also be costly for scores of investment, banking and insurance companies that hold billions of dollars in their preferred shares.

 

Paulson has been in contact in recent weeks with foreign governments that hold billions of dollars of Fannie and Freddie debt to reassure them that the United States recognizes the importance of the two companies. The two companies had nearly $36 billion in preferred shares outstanding as of June 30, according to filings with the Securities and Exchange Commission.

 

Fannie Mae was created by the government in 1938, and was turned into a shareholder-owned company 30 years later. Freddie Mac was established in 1970 to provide competition for Fannie.

A government takeover could cost taxpayers up to $25 billion, according to the Congressional Budget Office.

 

But the epic decision highlights the size of the threats facing the housing market and the economy. On Friday, Nevada regulators shut down Silver State Bank, the 11th failure this year of a federally insured bank.

 

The Chickens Come Home To Roost

 

Did you think that the economic policies and horrendous deficit spending brought about in no small part because of the war in Iraq was not going to have a negative effect going forward for many years? If you thought the worst was over, it is not as evidenced by the latest unemployment figures that showed unemployment reaching a five-year high of 6.1 percent in August as employers slashed 84,000 jobs, dramatic proof of the mounting damage that a deeply troubled economy is inflicting on workers and businesses alike.

 

The Labor Department's report, released Friday, showed the increasing toll the housing, credit and financial crises are taking on the economy. With the employment situation deteriorating, there's growing worry that consumers will recoil, throwing the economy into a tailspin later this year or early next year.

 

The jobless rate jumped to 6.1 percent in August, from 5.7 percent in July. And, employers cut payrolls for the eighth month in a row. Job losses in June and July turned out to be much deeper. The economy lost a whopping 100,000 jobs in June and another 60,000 in July, according to revised figures. Previously, the government reported job losses at 51,000 in each of those months. So far this year, job losses totaled 605,000.

 

Wachovia Corp., Ford Motor Co., Tyson Foods Inc. and Alcoa Inc. were among the companies announcing job cuts in August. GMAC Financial Services this week said it would lay off 5,000 workers.

 

Job losses in August were widespread, the government report showed. Factories cut 61,000 jobs, with housing-related manufacturers and automakers among the hardest hit. Construction firms eliminated 8,000 jobs, retailers axed 20,000 slots, professional and business services slashed 53,000 positions and leisure and hospitality got rid of 4,000. Those losses swamped employment gains in the government, education and health.

 

Job losses at all private employers - not including government - came to 101,000 in August.

The government said workers age 25 and older accounted for all the increase in unemployment in August.

 

All told, the number of unemployed rose to 9.4 million in August, compared with 7.1 million a year ago. Economists predict more job losses ahead, pushing the jobless rate to 7 percent by the fall, according to some projections.

Workers saw wage gains in August, however. Average hourly earning rose to $18.14 in August, a 0.4 percent increase from July. Over the past year, wages have grown 3.6 percent, but paychecks aren't stretching as far because of high food and energy prices.

 

The grim news comes as the race for the White House kicks into high gear. The economy's troubles are Americans' top worry. Democratic presidential nominee Barack Obama has called for a second round of government stimulus, while his GOP rival John McCain has favored free-trade and other business measures to spur the economy. Both candidates seized on the job figures Friday to take swipes at each other.

 

Mortgage Delinquencies Hit Record High

 

A record 9 percent of homeowners with a mortgage were either delinquent in their payments or in foreclosure at the end of June, as damage from the housing crisis continues to mount, the Mortgage Bankers Association said Friday. However, the source of trouble in the mortgage market has shifted from subprime loans made to borrowers with poor credit to homeowners who had solid credit but took out exotic loans with ballooning monthly payments.

 

The problem is also concentrated in a handful of states, the worst being California and Florida. The real estate markets in those two states were fueled by some of the riskiest lending practices and rampant speculation during the housing boom that has turned into a devastating bust.

 

The latest quarterly snapshot of the market broke records for late payments, homes entering the foreclosure process and for the inventory of loans in foreclosure. The trade group's records go back to 1979.

 

The percentage of loans at least 30 days past due or in foreclosure was up from 8.1 percent in the January-March quarter, using figures that were not adjusted for seasonal factors.

New foreclosures were concentrated in eight states: Nevada, Florida, California, Arizona, Michigan, Rhode Island, Indiana and Ohio.

 

But for the first time since the mortgage crisis started, delinquencies on subprime adjustable-rate loans declined. While more than one out of every five homeowners with a subprime ARM is still in default, that portion dipped 1 percentage point from the first quarter to 21 percent. What's driving the delinquency rate up now is the number of homeowners with risky, adjustable-rate prime loans made with little or no proof of the borrowers' income or assets.

 

Many of these loans allowed the borrower to pay only the interest on the loan for a fixed period of time. Others gave borrower the option to "pick-a-payment," adding any unpaid interest to the principal balance.

 

More than one out of 10 borrowers with a prime adjustable-rate loan is now delinquent or in foreclosure. That portion, 11.3 percent, was up from 9.7 percent in the first quarter and is expected to continue to rise as more homeowners see their monthly payments spike.

 

Nokia Losing Market Share

 

Nokia said it expects to lose market share in the third quarter as it fights to maintain profit margins. The company warned its third-quarter market share would fall from the 40 percent notched up in the second three months of the year, compared with a steady market share it forecast earlier. It said it expected the mobile device market in 2008 to be hit by weak consumer confidence in many markets and also cited tough competition in developing markets, its stronghold.

 

Nokia said it would ramp up one mid-range model more slowly than planned, with analysts saying the comments were likely related to the 5320 music phone. Due to the confluence of negative factors, Nokia said margins at its core Devices & Services unit would fall below 20 percent in the third quarter.

 

"In certain markets and in certain areas, including in some of the low end, we are meeting certain aggressive pricing that we believe may not be sustainable," Nokia Chief Financial Officer Rick Simonson told a conference call. "So it really is not margins. What we're talking about is units," he said.

 

Even below 20 percent, Nokia's phones operating profit margin could still be superior to rivals -- margins at Samsung and LG were below 15 percent in the second quarter, while Sony Ericsson and Motorola are struggling to make profits.

 

Nokia stuck to its forecast of overall market volume growth of at least 10 percent and said it still targeted an increase in its device market share over 2008 as a whole.

 

Nokia's gloomy comments followed recent cautious comments on the cell phone market from Qualcomm and Texas Instruments earlier this week. Qualcomm Chief Executive Paul Jacobs told a TV interview consumers in developed markets were taking longer to replace their cell phones, while Texas Instruments CFO Kevin March called the mobile market uninspiring.

 

Nokia has turned its attention over the last year to a broader range of offerings than just its core business of cell phones, branching out into music deals and trying to establish its own social networks. Nokia will report third-quarter results on October 16.

 

Altria Planning To Acquire UST

 

Altria Group is in advanced talks to buy UST, best known for its Skoal and Copenhagen smokeless tobacco products. The New York Times reported that a deal worth more than $10 billion could be announced on Monday or even sooner. The source could not confirm the price or say when a deal might be announced.

 

At $10 billion, the bid would value UST at almost $68 a share, based on shares outstanding as of July 31, a price some analysts think is rich for the company, given its focus on premium brands that face pricing pressure.

 

Buying UST would be a quick way for Altria to expand in the growing smokeless tobacco market as the company looks to branch out from a U.S. cigarette market in steady decline. Altria, whose Philip Morris unit manufacturers Marlboro cigarettes, has already tried to expand by test-marketing smokeless tobacco products under the Marlboro name.

 

UST is the industry leader with almost 58 percent of the domestic smokeless tobacco market in the 26 weeks ended June 14, according to the company's latest earnings report. However, its main business, the premium segment, has been pressured by soaring gasoline prices and the weak economy.

 

Domestic cigarette consumption has fallen steadily since 1981 as more bans on smoking in public areas have been put in place and health messages against cigarettes become more prevalent and aggressive. Cigarette makers also face marketing limitations from a 1998 tobacco litigation settlement with U.S. states. The restriction of cigarette use has also helped spur growth in the smokeless tobacco market.

 

Altria has long been seen as the likely buyer of UST. Speculation about a deal picked up in February as Altria was spinning off its international tobacco arm, Philip Morris International.

 

On Thursday, Morningstar analyst Gregg Warren said Altria would need to offer $65 to $70 per share to make the deal attractive to UST shareholders. Some analysts think UST, which also markets premium wines, will have to cut prices in order to compete with lower-priced products. So far, UST has used only targeted promotions in certain markets to protect its market share.

 

One issue that exacerbates the price gaps is that smokeless tobacco is taxed based on price, which means higher-priced products like Copenhagen cost even more for consumers than lower priced brands like competitor Grizzly. Altria rival Reynolds American bought Grizzly smokeless tobacco maker Conwood in 2006 and has also tested smokeless tobacco products under the Camel brand, adding to the competitive pressure on UST.

 

Reports of Altria buying UST fueled speculation about other consolidation in the tobacco market, which helped lift shares of potential takeover target Lorillard 3.7 percent to $72.25. Lorillard makes Newport cigarettes.