MarketView for September 28

 

 

Summary  

 

The major equity indexes slid backward once again on Wednesday as a drop  in energy and metals prices added to the Street’s ongoing concern over the seemingly never ending debt crisis in Europe. A seven percent decline in the price of copper, seen as a leading indicator for the economy, led to a drop of 4.5 percent in the S&P materials index. Among metal specific shares, Freeport-McMoRan Copper & Gold fell 7.3 percent to $32.29.

 

There was also considerable concern and worry as inspectors from the European Union and the International Monetary Fund were on their way to Greece to analyze Greece’s austerity plans. At the same time, German Chancellor Angela Merkel worked to defuse a revolt within her own party ahead of a vote to expand Europe's bailout fund on Thursday.

 

Wednesday's declines put the S&P 500 on course for its worst quarter since the high noon of the financial crisis in the fourth quarter of 2008 when it fell 22.6 percent. So far, the S&P 500 has fallen 12.8 percent this quarter. The drop also illustrates how sensitive the market has become to news on Europe's troubles.

 

Brent crude resumed its downward trend, falling more than $3.Needless to say that did not do much for energy stocks as Chevron fell 1.9 percent to close at $91.74.

 

News early in the afternoon that bans on short-selling stocks in France, Italy and Spain have been extended highlighted the regulatory risk faced by investors and increased selling pressure.

 

Furthermore, volume would likely be light and market movements accentuated during Thursday and Friday due to the Jewish New Year holiday of Rosh Hashanah.

 

One piece of good news on Wednesday was that Amazon.com gained 2.5 percent to $229.71 after it unveiled a new tablet computer with a $199 price tag. Apple, the only really key competitor, fell 0.6 percent to $397.01.

 

In earnings news, Jabil Circuit gained 8.2 percent to $18.81 a day after reporting fourth-quarter earnings that exceeded expectations, while Family Dollar Stores fell 1.6 percent to close at $53.31 after its results did not meet expectations.

 

In economic news, orders for long-lasting U.S. manufactured goods slipped in August on weak demand for motor vehicles, but a rebound in a gauge of business spending suggested the economy would avoid another recession.

 

Crude Supplies Rise

 

According to a report released by the Energy Department's Energy Information Administration on Wednesday morning, crude oil and gasoline supplies rose last week. Crude supplies increased by 1.9 million barrels, or 0.8 percent, to 341 million barrels, which is 4.7 percent below year-ago levels, the EIA said in its weekly report.

 

Gasoline supplies rose by 800,000 barrels, or 0.4 percent, to 214.9 million barrels. That was 3.5 percent below year-ago levels. Demand for gasoline over the four weeks ended Sept. 23 was 2.4 percent lower than a year earlier, averaging 8.9 million barrels a day.

 

Refineries ran at 87.8 percent of total capacity on average, a decline of 0.5 percentage point from the prior week. Analysts expected capacity to fall to 87.3 percent.

 

Supplies of distillate fuel, which include diesel and heating oil, rose by 100,000 barrels to 157.7 million barrels. Analysts expected distillate stocks to increase by 1 million barrels.

 

Durable Goods Orders Decline Slightly

 

The Commerce Department reported Wednesday morning that new orders for durable goods fell in August on weak demand for motor vehicles, but a rebound in a gauge of business spending supported views the economy would likely avoid another recession.

 

According to the Department durable goods orders, items ranging from toasters to aircraft meant to last three years or more, fell 0.1 percent after a 4.1 percent jump in July. Non-defense capital goods orders excluding aircraft, a closely watched proxy for business spending, increased 1.1 percent last month after a 0.2 percent fall in July.

 

This suggested that businesses, sitting on about $2 trillion in cash, had not responded to the recent financial market volatility by curtailing spending on capital goods.

 

Although manufacturing, which has done the heavy lifting for the fragile economy recovery, is slowing, August's durable goods report pointed to underlying resilience and offered hope output would continue to expand.

 

Orders last month were held back by an 8.5 percent drop in bookings for motor vehicles -- the largest decline since February last year. The drop came despite a 23.5 percent rise in orders for civilian aircraft last month. Boeing received 127 orders for aircraft, according to the plane maker's website, up from 115 in July. Delta Airlines placed an order for 100 aircraft.

 

Excluding transportation, orders also slipped 0.1 percent after rising 0.7 percent in July. However, outside of transportation and primary metals, which fell 0.8 percent, details of the durable goods report were relatively strong.

 

Orders for machinery edged up 0.1 percent, while computers and electronic products rose 1.3 percent. Demand for capital goods increased 4.2 percent and electrical equipment and appliances rose 1.3 percent.

 

Shipments of non-defense capital goods orders excluding aircraft, which go into the calculation of gross domestic product, increased 2.8 percent after rising 0.4 percent in July.

 

Bank of America Faces Additional Claims

 

According to a report in the New York Times Wednesday morning, Bank of America is facing a  a new potential liability from a lawsuit arising from its troubled Merrill Lynch acquisition. Brought by Bank of America shareholders, the suit claims that Bank of America and its executives, including its former chief executive, Kenneth D. Lewis, failed to disclose what would be a $15.31 billion loss at Merrill in the days before and after the acquisition. The plaintiffs contend that this staggering loss was hidden to ensure that Bank of America shareholders did not vote against the transaction.

 

 Bank of America disclosed this loss after Merrill was acquired. At the same time, Bank of America also disclosed a $20 billion bailout by the government. The bank's stock fell by more than 60 percent in a two-week period, a market value loss of more than $50 billion.

 

The lawsuit seeking about $50 billion was brought by some of the largest class-action law firms and is quietly advancing in the Federal District Court in Manhattan. The plaintiffs contend that Bank of America engaged in a deliberate effort to deceive the bank's shareholders.

 

According to the plaintiffs, who include the Ohio Public Employees Retirement System and a Netherlands pension plan that is the second-largest in Europe, Bank of America's senior management, including Mr. Lewis and Mr. Price, began to learn of large losses at Merrill Lynch in early November 2008, months before the deal closed.

 

Mr. Price met with the bank's general counsel, Timothy J. Mayopoulos, to discuss whether to disclose the loss - at the time about $5 billion - to Bank of America shareholders. Mr. Mayopoulos testified to the New York attorney general's office that while his initial reaction was that disclosure was warranted, he decided against it. Merrill had been losing $2.1 billion to $9.8 billion a quarter during the financial crisis, and so this loss would be expected by Merrill and Bank of America shareholders.

 

Plaintiffs in the private action and the New York attorney general's complaint claim that after this meeting, Mr. Price and other senior executives at Bank of America sought to keep this loss quiet and that Mr. Price in particular misled Mr. Mayopoulos.

 

Mr. Mayopoulos testified that on Dec. 3, 2008, Mr. Price told him that the estimated loss would be $7 billion. Mr. Mayopoulos concluded again that no disclosure was necessary. Plaintiffs contend that Mr. Price misled Mr. Mayopoulos as the forecasted loss at this time had now grown to more than $10 billion.

 

The Bank of America vote occurred on Dec. 5 without its shareholders knowing about this gigantic looming Merrill loss, which was now about $11 billion.

 

Mr. Mayopoulos has testified he was surprised at this higher number when he learned of it at a Dec. 9 board meeting. Mr. Mayopoulos sought to meet with Mr. Price about the new loss. The next day, Mr. Mayopoulos was fired and escorted out of the building.

 

The Merrill acquisition was completed on Jan. 1, 2009. Two weeks later, Bank of America disclosed for the first time that Merrill had suffered an after-tax net loss of $15.31 billion.

 

Bank of America has argued in its defense that the exact amount of the loss was uncertain during this time. Moreover, this disclosure was not necessary because Merrill's losses were within the range of previous losses and included a good will write-off of about $2 billion that was previously disclosed. The total loss was not material.

 

But if it is true that Mr. Price, with Mr. Lewis's assent, kept this information from Mr. Mayopoulos in order to avoid disclosure, this is a prima facie case of securities fraud. Would Bank of America shareholders have voted to approve this transaction? If the answer is no, then it is hard to see this as anything other than material information.

 

Plaintiffs in this private case have the additional benefit that this claim is related to a shareholder vote. It is easier to prove securities fraud related to a shareholder vote than more typical securities fraud claims like accounting fraud. Shareholder vote claims do not require that the plaintiffs prove that the person committing securities fraud did so with awareness that the statement was wrong or otherwise recklessly made. You only need to show that the person should have acted with care.

 

This case is not only easier to establish, but the potential damages could also be enormous. Damages in a claim like this are calculated by looking at the amount lost as a result of the securities fraud. A court will most likely calculate this by referencing the amount that Bank of America stock dropped after the loss was announced; this is as much as $50 billion. It is a plaintiff's lawyer's dream.

 

Bank of America is facing a huge liability from this claim. It is also facing even more liability for those who bought and sold stock during this period up until Jan. 15. In a ruling on July 29, the judge in this case allowed these claims to proceed against Bank of America, Mr. Price and Mr. Lewis. The judge had already ruled that the disclosure claim related to the proxy vote could proceed.

 

This case is on a relatively fast track, with an October 2012 trial date.

 

Given the $50 billion claim looming over it, Bank of America will most likely try to settle this litigation. The settlement value appears to be in the billions. Firing your main witness - Mr. Mayopoulos - and escorting him out the door no doubt only increases the cost.

 

Whatever the outcome of this case, it appears that Bank of America shareholders were sacrificed in December 2008 so that the Merrill deal could be completed.