MarketView for July 15

Wall Street ended a another volatile day in negative territory on Tuesday, as fears of escalating instability in the financial sector kept the bears at the forefront of the day’s trading activity despite a steep retreat in oil. The Dow Jones industrials had their first close below 11,000 since July 2006.

 

The markets did benefit from some bargain-hunting as oil retreated from its near-record levels, but the uncertainty of the financial sector made that recovery hard to sustain. If oil prices stabilize or retreat, consumers might feel more comfortable spending on discretionary items, and in turn help the economy.

 

A barrel of light, sweet crude settled down $6.44 at $138.74 on the belief that the weak economy both in the United States and elsewhere will take its toll on global demand.

 

While some of the most battered bank stocks, including Washington Mutual, Lehman Brothers and First Horizon National finished higher, most bank stocks gave up their early gains by the closing bell.

 

Treasury prices traded higher, but pared earlier gains. The yield on the benchmark 10-year Treasury note, which moves opposite its price, fell to 3.83 percent from 3.86 percent late Monday.

 

The Labor Department reported that core inflation at the wholesale level, which excludes energy and food, ticked up by just 0.2 percent, but that overall wholesale prices jumped by a larger-than-expected 1.8 percent, the largest gain since last November. For the past 12 months, wholesale prices including food and energy showed an increase of 9.2 percent, the largest increase since June 1981.

 

The Commerce Department reported that retail sales edged up by 0.1 percent. Total sales were dampened by plummeting sales at car dealerships.

 

Fannie Mae fell $2.66, or 27.34 percent, to close at $7.07, while Freddie Mac fell $1.85, or 26.02 percent, to close at $5.26. In a bid to protect Fannie Mae and Freddie Mac, SEC Chairman Christopher Cox said to Congress Tuesday that the SEC will broaden existing rules prohibiting naked short selling of banks and broker dealers. Naked short-selling is when a trader makes such a bet without arranging to borrow the stock first.

 

Another big decliner was American International Group Inc., which suffered the worst percentage drop in the Dow on Tuesday. AIG shares fell $1.91, or 8.47 percent, to close at $20.64.

 

General Motors Corp. saw the largest rebound among the 30 Dow stocks after announcing plans to lay off salaried workers, reduce truck production, suspend its dividend and borrow $2 billion to $3 billion as it adjusts to a weakening domestic market for automobiles. GM shares rose $0.46 cents, or 4.90 percent, to close at $9.84.

 

Treasury Wakes Up Regarding GSEs

 

Housing finance giants Fannie Mae and Freddie Mac have the potential to pose systemic risks to the financial system and need a stronger regulator, Treasury Secretary Henry Paulson said on Tuesday.

 

Paulson, in prepared testimony before the Senate Banking Committee, urged Congress to pass legislation to reform oversight of the two government-sponsored enterprises, or GSEs, with modifications that provide them temporary government backstops for liquidity and equity capital.

 

"We have long maintained that the GSEs have the potential to pose a systemic risk and worked with Congress on legislation to create a GSE regulator with authorities appropriate to the task and on a par with other financial regulators. We must complete this work," Paulson said.

 

He said the proposal announced over the weekend to give the Treasury temporary authority to increase the GSES' credit line and purchase their shares if needed "was not prompted by any sudden deterioration in conditions at Fannie Mae and Freddie Mac."

 

Nonetheless, he said, steps were needed to respond to market developments and boost confidence in the two institutions that serve as the core of U.S. housing finance by providing assurances that they have access to liquidity and capital.

 

Persistent worries about shareholder dilution and the long-term stability of Fannie and Freddie, which provide liquidity to the housing market by buying and securitizing mortgages, have ravaged their stock prices in recent days.

 

"Given the difficulty in determining the appropriate size of the asked for credit line we are not proposing a particular dollar amount, Paulson said.”Flexibility is the best means of increasing market confidence in the GSEs and also the best means of minimizing taxpayer risk," he said.

 

Paulson stressed, however, that there were no immediate plans by Fannie or Freddie to access the proposed increased Treasury credit line, nor to seek Treasury purchases of its equity.

 

"If either of these authorities is used, it would be done so only at Treasury's discretion, under terms and conditions that protect the U.S. taxpayer and are agreed by both Treasury and the GSE," Paulson said.

 

Paulson said he was continuing to encourage Fannie and Freddie to raise capital and said confidence in the institutions was important to maintaining financial system and market stability.

 

"Fannie and Freddie play a central role in our housing finance system and must continue to do so in their current form as shareholder-owned companies," he said.

 

Bernanke Faces Difficult Task

 

A weakening housing market, a strained banking system, and rising oil prices threaten the U.S. economy, and restoring financial market stability is a top priority, Federal Reserve Chairman Ben Bernanke said on Tuesday. It was a gloomier assessment than the central bank's policy-setting panel gave in late June, when it said risks to economic growth had diminished somewhat.

 

Sluggish economic growth and stubborn inflation has made Bernanke's job more difficult as he tries to restrain inflation without tipping the economy into a deep recession. Meanwhile, pressure has grown, both inside and outside his policy-making committee, for the Fed to consider raising the benchmark federal funds interest rate after cutting it by 3.25 percentage points to 2.0 percent since mid-September.

 

Bernanke, in his semi-annual testimony on economic conditions to lawmakers on Tuesday, acknowledged that financial markets had grown increasingly anxious in recent weeks, particularly over the financial condition of mortgage finance companies Fannie Mae and Freddie Mac.

 

He stressed that the outlook for economic growth and inflation was unusually uncertain. Wall Street took that as a signal that the Fed would keep interest rates unchanged at least through August, and perhaps through the end of the year.

 

"The possibility of higher energy prices, tighter credit conditions, and a still-deeper contraction in housing markets all represent significant downside risks to the outlook for growth. At the same time, upside risks to the inflation outlook have intensified lately," he said.

 

Bernanke said the slumping housing market was "the most critical and central issue that we face," because it held the key to consumer spending as well as banks' financial health.

 

Stock prices initially tumbled after Bernanke's comments, but recovered later as oil futures suffered their largest one day price fall in 17 years. The dollar remained weak, after seeing a new record low against the euro overnight, while Treasury bond yields fell.

 

In its semi-annual monetary policy report to Congress, the Fed raised its projection for growth in 2008 to a range of 1.0 percent to 1.6 percent from the 0.3 percent to 1.2 percent range it forecast in April, on expectations of stronger consumer spending.

 

With energy costs rising, the Fed also raised its inflation forecast to a range of 3.8 percent to 4.2 percent, up substantially from its previous 3.1 percent to 3.4 percent projection.

 

Shortly before Bernanke testified, government reports underlined the dilemma. Sales at retail stores barely edged up in June but producer prices, which reflect wholesale inflation, jumped a larger-than-expected 1.8 percent, while the annual rate rose to 9.3 percent, its highest in 27 years.

 

Bernanke said the Fed's efforts to date, including the interest rate cuts and a series of new lending facilities for banks, had had a positive effect but the economy still faced "numerous difficulties."

 

"Many financial markets and institutions remain under considerable stress, in part because the outlook for the economy, and thus for credit quality, remains uncertain," he said. "Helping the financial markets to return to more normal functioning will continue to be a top priority of the Federal Reserve," he said.

 

General Motors Undertakes Desperate Moves

 

General Motors on Tuesday unveiled a plan to cut costs by $10 billion, suspend its common stock dividend and sell up to $4 billion in assets in a bid to shore up cash and survive a deep industry slump. The hurried restructuring, GM's second in just six weeks, was forced by high fuel prices, a consumer shift away from low-mileage trucks, the weakest market for automobiles in a decade and growing doubts on Wall Street regarding GM’s ability to ride out the downturn.

 

GM, which has lost $51 billion over the past three years, said the steps were aimed at addressing deepening concerns that have driven its stock price to 54-year lows and raised the cost of insuring its debt against default. GM  said it would cut white-collar costs by 20 percent, a step expected to mean the loss of thousands of jobs among the 40,000 salaried workers GM employs in North America.

 

Since Chief Executive Rick Wagoner took over in 2000, the shares have fallen in value about 80 percent. Meanwhile, GM's plan, intended to raise $15 billion in liquidity through 2009, addressed the most urgent Wall Street concerns about pressure on its $24 billion in remaining cash.

 

However, the company's turnaround is dependent on an economic recovery and on GM's ability to sell more fuel-efficient passenger cars, a market now dominated by foreign makers led by Toyota.

 

GM has also faced criticism for restructuring steps since 2005 that have consistently fallen short of what was required given the downward spiral in its results. GM said it would save $10 billion in cash through 2009 through a series of steps including cuts to white-collar jobs and retiree health-care and an elimination of executive bonuses for 2008.

 

Capital spending would be cut by $1.5 billion, and GM would accelerate plant closures announced last month, as it aims to move its vehicle line-up away from a reliance on SUVs and light trucks.

 

GM, which has not given a timeline for returning to profitability, warned it would post a "substantial" second-quarter loss, including charges related to supplier American Axle & Manufacturing Holdings and GMAC, which is 49 percent owned by GM.

 

GM has been under intensifying pressure to cut costs and raise capital because of the slump in U.S. auto sales that drove its first-half sales down 16 percent. In early June, Wagoner announced the company would close four North American truck plants and try to sell its Hummer SUV brand in response to higher gasoline prices.

 

By identifying $10 billion in cost-cutting as the central element in its restructuring, GM believes it can rely mostly on "self-help" rather than the capital markets to shore up liquidity. At the same time, GM set an initial target of raising just $2 billion to $3 billion in new financing, far more limited than Wall Street had expected. Wagoner said the automaker could borrow more if debt markets recovered.

 

Wagoner said GM's steps would provide it with ample liquidity through 2009, even assuming a continued weak U.S. market crimped by high oil prices. GM said it had retained advisers to look at asset sales expected to raise $2 billion to $4 billion. Executives said potential buyers had already expressed interest in the military-derived Hummer brand, but they gave no details.

 

GM will begin capturing savings from a cost-cutting deal with the United Auto Workers union in 2010. In a significant concession, union leadership quietly approved a deferral of $1.7 billion that had been scheduled for payment to a health care trust aligned with the UAW in 2008 and 2009, GM said.

 

That deferred payment means GM's major union will be effectively loaning it money at 9 percent interest until the deferred payments to the health care account are made.

 

Clorox Expects To Beat Expectations

 

Clorox said on Tuesday it expects to post fourth-quarter and fiscal 2008 earnings that would meet or beat Street expectations. Clorox said it sees fourth-quarter sales growth in the range of 10 percent to 11 percent, including about 3 percentage points of growth from last year's Burt's Bees acquisition.

 

Quarterly earnings are expected to be in the range of $1.10 per share to $1.13 per share.

The seller of Clorox bleach product, Fresh Step kitty litter and Glad bags, wraps and containers, said it now expects fiscal 2008 earnings in the range of $3.22 per share to $3.25 per share, compared with its previously issued forecast for earnings of $3.20 per share to $3.28 per share.

 

Johnson & Johnson Does Its Part

 

Johnson & Johnson's solid second-quarter results reported Tuesday suggested the weak economy hasn't slowed demand for procedures such as knee and hip replacements, a good sign for the medical device industry.

 

Shares of Zimmer Holdings, the largest maker of orthopedic devices, and Stryker each climbed about 2 percent Tuesday following the J&J results. The medical device sector has traditionally served as a safe haven for investors in tough economic times, and the current economic downturn has proved no exception.

 

However, some have worried that parts of the industry may be more vulnerable to an economic slowdown this time around as more Americans go without medical insurance, and as those who have it are forced to shell out larger co-payments for procedures. In the first quarter, sales of hip and knee replacements slowed across the industry, including for J&J.

 

Rising raw materials costs have also fanned concerns about the sector's resiliency. However, on Tuesday, J&J's DePuy orthopedic unit posted worldwide quarterly sales growth of 13.6 percent, or 8.5 percent excluding the impact of the weak dollar, which boosts the value of overseas sales when converted back into U.S. currency. Sales of surgical products in the company's Ethicon and Ethicon Endo-Surgery divisions were also strong. Strength in the medical businesses helped offset soft growth in pharmaceutical sales.

 

J&J Chief Financial Officer Dominic Caruso said the company saw no slowdown in orthopedic procedures in the latest period, and the first quarter's weakness was not the start of a trend. J&J also said higher materials prices so far were not having an impact on its businesses.

 

J&J's total U.S. medical device and diagnostics sales rose 4 percent from a year earlier, tempered by declining sales of J&J's Cypher drug-eluting stent to treat clogged heart arteries, which is under pressure from Medtronic and Abbott Laboratories.

 

Income Up At Intel

 

After the markets closed for regular trading on Tuesday, Intel reported a higher quarterly profit helped by higher sales of microprocessors used in notebook personal computers. Intel said it expects revenue in the current quarter of $10.0 billion to $10.6 billion.

 

"As we enter the second half, demand remains strong for our microprocessor and chipset products in all segments and all parts of the globe," Chief Executive Paul Otellini said in a statement.

 

Second-quarter net income rose to $1.60 billion, or 28 cents per share, from $1.28 billion, or 22 cents per share, a year ago.

Revenue rose to $9.47 billion from $8.68 billion. Analysts had expected $9.32 billion on average, according to Reuters Estimates.

 

Intel has been benefiting from brisk sales of notebook PCs, which are on track to outpace sales of desktop PCs this year.