MarketView for July 11

It was another difficult day on Wall Street on Friday as Stocks tumbled on Friday as fears about the stability of the top two home financing providers Freddie Mac and Fannie Mae, combined with oil at a record above $147, clouded the economic outlook.

 

Friday's slide capped a tumultuous week, in which the S&P 500 joined the ranks of the major indexes in bear territory. The NASDAQ and the Dow Jones industrial average are already there. In addition, it was the sixth consecutive weekly decline for both the NASDAQ and the S&P 500 equity indexes, their longest weekly losing streaks since 2004.

 

A jump in U.S. crude oil prices to a record above $147 per barrel further soured sentiment on Wall Street as concerns over the impact of higher fuel costs on corporate profits and consumer spending took hold.

 

For the week, the Dow dropped 1.7 percent, its fourth straight weekly decline. The S&P 500 index fell 1.9 percent and The NASDAQ Composite was down 0.3 percent for the week. However, all three indexes ended the trading day off their session lows. That may not sound like a big deal, but at one point all three indexes were down more than 2 percent, with the Dow briefly dipping below the 11,000 level for the first time since July 2006.

 

Domestic sweet crude for August delivery settled up $3.43, or 2.4 percent, at $145.08 per barrel, after earlier hitting a record of $147.27.

 

Financial shares were among the biggest drags on the S&P 500 as new signs of distress in financial market spooked investors. An S&P financial index fell 2.6 percent. Shares of American International Group were beaten down as investors worried the giant insurer, already suffering from mortgage write-downs, may have to post even more losses. Citigroup cut its estimates and price targets on several banks, including JPMorgan Chase and Bank of America, due the assumption of higher losses on credit card, home equity, residential construction, combined with a sustained weak capital markets environment.

 

Lehman Brothers shares slid on supposedly discredited rumors of customers pulling back their exposure to the investment bank. The cost to insure Lehman’s debt against default surged on Friday, as its stock price plunged for the second day. Credit default swaps on the debt widened 55 basis points to 380 basis points, or $380,000 per year for five years to insure $10 million in debt.

 

Chevron was the top drag on both the Dow and the S&P 500, after the company said it expects its refining and marketing operations to post a loss in the second quarter, somewhat restraining earnings that will be mostly driven by record oil and natural gas prices.

 

Shares of Anheuser-Busch moved higher after a source said Anheuser and Belgian-Brazilian rival InBev have begun negotiations for a friendly merger.

 

On the economic front, the Reuters/University of Michigan Surveys of Consumers showed consumer confidence rose unexpectedly in June with the help of retail discounts.

 

What Is Next For Fannie Mae and Freddie Mac

 

Pressure mounted on Friday for the government to act more swiftly to prevent the housing crisis from dragging down the nation's top mortgage finance agencies.

 

Sen. Christopher Dodd, the Connecticut Democrat who chairs the Senate Banking Committee, said the Federal Reserve was considering allowing Fannie Mae and Freddie Mac to borrow directly from the central bank, increasing speculation that the Fed may take action as early as this weekend.

 

According to Dodd, Fed Chairman Ben Bernanke and Treasury Secretary Henry Paulson are looking at various options, including opening access to the discount window, at which the Fed acts as a lender of last resort for our banking system.

 

Many on Wall Street are concerned that the mortgage agencies, which finance nearly half of all homes, might run short of capital, placing the economy at even greater risk and deepening the housing slump. Dodd sought to reassure financial markets about the health of the two companies.

 

"These institutions are fundamentally sound and strong," Dodd said at a news conference. "There is no reason for the kind of reaction we're getting."

 

Paulson has said previously that the primary focus was supporting Fannie and Freddie "in their current form as they carry out their important mission." The reference to keeping Fannie and Freddie in their current form was a signal the government wanted to see them survive as congressionally chartered but privately held companies.

 

Concern about Fannie and Freddie burgeoned after The New York Times said the administration was considering a plan to put the companies, thought to have implicit government backing, into a conservatorship if their problems worsened. A conservatorship is where regulators appoint a person or entity to run a troubled financial institution until it can be stabilized.

 

A former Fed policy-maker said on Friday that it was crucial that the government bolster Fannie and Freddie and their huge assets.

 

"It would produce a worldwide financial crisis of unspeakable magnitude if they were allowed to default," said former St. Louis Federal Reserve president William Poole.

 

Fannie and Freddie own or guarantee $5 trillion of debt, close to half of all domestic home mortgages. They have been hit hard by the nation's housing crisis, suffering billions of dollars of losses and higher borrowing costs as many investors lose confidence they can raise sufficient capital to stay afloat. Since the crisis began, Fannie and Freddie have lost more than $11 billion, and raised some $20 billion of capital. The shares of the two companies have lost close to 90 percent of their value since August.

 

If Fannie and Freddie found themselves unable to borrow or that it was too costly to borrow, they would not be able to buy mortgages from lenders. This would make it far more difficult, and perhaps impossible, for people to obtain home mortgages, which could cause the housing market to grind to a halt.

 

Investors view Fannie and Freddie as the last bastions of support for a U.S. housing market in its worst downturn since the Great Depression. Putting them into conservatorship could wipe out shareholders, and obligate taxpayers to cover losses on home loans Fannie and Freddie own or guarantee.

 

Some on Wall Street speculated the Federal Reserve might announce some sort of action this weekend, much like it did in March when Bear Stearns was on the brink of bankruptcy and the central bank stepped in on a Sunday to orchestrate its sale to JPMorgan. Apart from the idea of opening the discount window, another possibility might be increasing their credit lines from the Treasury, currently at $2.25 billion each.

 

Crude Touches Record High

 

Oil prices jumped $5 to a record high above $147 a barrel on Friday amid growing worries about threats to supplies from Iran and Nigeria and a strike by Brazilian oil workers next week.

 

Analysts said oil's rally could run further if problems with U.S. mortgage companies Fannie Mae and Freddie Mac feed into the commodities boom by reducing the chances of an interest rate hike by the Federal Reserve.

 

The troubles with the mortgage giants -- which control $5 trillion in debt -- helped pare crude's gains after it hit new highs as dealers focused on U.S. economic turmoil that has already slowed oil consumption in the world's top energy user.

 

U.S. crude settled at $145.08 a barrel, up $3.43, after climbing as high as $147.27 earlier in the day and adding to gains of $5.60 from Thursday. London Brent crude settled at $144.49 a barrel, up $2.46.

 

"I'm seeing profit-taking here after the run-up to a new record, but we are going into a weekend and with all these things being reported on Iran, you wouldn't want to go short," said Daniel Flynn, an analyst at Alaron Trading.

 

In addition, Iraq's Defense Ministry said on Friday that it had no knowledge of Israeli air force drills in its airspace, contrary to a media report carried on the Jerusalem Post website that sparked crude early Friday. An Israeli security source also said the report was wrong.

 

"As martial rumors are denied, participants are reverting their gaze on the deteriorating global economy," said Mike Fitzpatrick, vice president at MF Global in New York.

 

Missile tests this week by Iran, against a backdrop of rising tensions with Israel and the United States, has left the oil markets worried about a potential supply disruption from the world's No. 4 exporter.

 

Iran has threatened to strike back at Tel Aviv and U.S. interests in a key oil shipping route if it is attacked over its nuclear program, which Israel and the West fear is aimed at making weapons.

 

Support also came from supply threats in Nigeria and Brazil. The main militant group in OPEC nation Nigeria's oil-producing region said it was abandoning a cease-fire to protest against a British offer to help tackle lawlessness.

 

Workers at Brazil's Petrobras plan to launch a five-day strike on Monday that would affect all 42 Campos basin offshore platforms, which pump than 80 percent of the nation's 1.8 million bpd of output.

 

Oil prices have risen seven-fold since 2002 amid surging demand from China and other emerging markets, and jumped 50 percent this year alone, battering the economies of consumer nation's already hit hard by the global credit crunch.

 

Concern in the United States that Fannie Mae and Freddie Mac could run short of capital added to inflation worries. Analysts said the U.S. Federal Reserve could be hindered in any efforts to raise interest rates by the problems.

 

"Mounting anxiety about the health of Fannie and Fred now effectively guarantees the Fed will remain on the sidelines for the next few months -- whatever happens to inflation," said John Kemp, commodities analyst at RBS Sempra in London.

 

Investors also have flocked to oil and other commodities this year as a hedge against inflation and a weak dollar.

 

Consumer Confidence Rises But...

 

Consumer confidence rose unexpectedly in early July from a 28-year low with the help of retail discounts, but the vast majority think the country is in a deepening recession, according to the Reuters/University of Michigan Surveys of Consumers, released on Friday. The preliminary July reading for its index of consumer sentiment rose slightly to 56.6 from June's final result of 56.4. The June reading was the lowest since 51.7 in May 1980, which was also the weakest reading ever. The index dates back to 1952, though the survey has been conducted since 1946.

 

The Surveys of Consumers, in a release, also said one-year inflation expectations jumped to the highest since the stagflation of 1981, rising to 5.3 percent from June's 5.1 percent. Five-year inflation expectations held steady at the peak of 3.4 percent it occupied in both May and June, which was the highest in 13 years.

 

The low overall consumer sentiment and high inflation expectations leave the Federal Reserve in a bind. The U.S. central bank must decide whether to keep interest rates low to support growth or raise them to damp price increases.

 

"Consumer confidence remained unchanged from June at just above its 50-year low due to surging prices and mounting job losses," the Surveys of Consumers said in a statement.

 

"Continued declines in consumers' evaluations of their personal finances were offset by the availability of larger discounts on household durables and vehicles."

 

The index of consumer expectations fell to its lowest since May 1980, hitting 48.3 after June's 49.2.

 

The report said more consumers complained about higher food and fuel prices and smaller income gains than ever before, and the fewest expected improvement in their finances than at any other time in the history of the survey.

 

"More than nine in 10 consumers think that the economy is now in recession, and a deepening downturn was widely anticipated during the year ahead," the report said.