MarketView for July 29

Summary

 

The market retraced its steps on Tuesday, giving back what it took away on Monday as the major equity indexes chalked up gains in excess of 2 percent on another sharp slide in oil prices. In addition, Merrill Lynch announced its latest write-down and share sale, which to the Street hinted at a possible turning point in the credit crisis.

 

Merrill Lynch saw its share price increase nearly 8 percent after the brokerage house announced late on Monday that it will write down $5.7 billion and raise $8.5 billion by selling new stock. After the share sale, sentiment on financial stocks began to shift, with investors saying Merrill's latest write-down may be a sign that banks are nearly through purging their balance sheets of bad mortgage debt.

 

Aiding the day’s momentum was data indicating that the rate of monthly price declines in the housing market is slowing and a separate report showing the mood of American consumers improved for the first time in six months in July.

 

Crude prices fell more than 2 percent, relieving some concern about inflation and consumer spending and brightening the outlook for a wide range of companies, including retailers and airlines. Crude for September delivery settled down $2.54, or 2.04 percent, at $122.19 per barrel. That was about $25 below an all-time high set earlier this month and helped stocks reverse the prior session's losses.

 

A major bank index gained 8.7 percent as Citigroup shares erased early losses to rise 5.9 percent to $18.45 and Bank of America rose 14.8 percent to $32.22. Financial shares were also helped by expectations that the Securities and Exchange Commission would extend an emergency rule banning so-called naked short selling later on Tuesday in 19 companies including Fannie Mae, Freddie Mac, Citigroup, Goldman Sachs and Merrill Lynch.

 

Amgen, the top biotechnology company, saw its share price rise 3 percent to $62.28, driving the NASDAQ higher, after the firm reported higher-than-expected quarterly profit late on Monday and raised its 2008 forecast.

 

Shares of Colgate-Palmolive were up 8.2 percent to $74.15 after the consumer products maker reported quarterly earnings that beat Street's expectations. US Steel posted a record second-quarter profit that easily beat the Street’s consensus forecast, sending its share price up 14.1 percent to $165.76.

 

Energy companies were the largest decliners on the S&P 500, with ConocoPhillips losing 1.9 percent to $80.27.

 

Consumer Confidence Virtually Unchanged

 

The New York-based Conference Board said that its Consumer Confidence Index stands at 51.9 for July; half of what it was a year ago, but the reading was slightly higher than the revised 51.0 in June. The improvement, albeit slight, also reverses a six-month slide since February.

 

The Expectations Index, which measures shoppers' outlook over the next six months, increased a bit to 43.0 from 41.4. The Present Situation Index, which measures their current assessment of the economy, was virtually flat at 65.3, compared to 65.4 in June.

 

"Consumers' assessment of current conditions was little changed, suggesting there has been no significant improvement, nor significant deterioration, in business or labor market conditions," said Lynn Franco, director of The Conference Board Consumer Research Center, in a statement.

 

She added, however, that while consumers remain grim about short-term prospects, the modest improvement in their outlook provides some glimmer of hope. The slight improvement in the outlook "bears careful watching over the next few months," she said.

 

Economists closely monitor sentiment as consumer spending represents about two-thirds of all economic activity. The reading comes as the nation's retailers are entering the critical back-to-school season, the most important period behind the holiday season.

 

The report, derived from responses received through July 22 of a representative sample of 5,000 U.S. households, showed that consumers' worries about business conditions and jobs aren't going away.

 

Those saying jobs are "hard to get" edged up to 30.3 percent from 29.7 percent in June, while those claiming jobs are "plentiful" declined to 13.5 percent from 14.1 percent.

Consumers' outlook, while slightly improving from last month, continues to be grim.

 

Those anticipating business conditions to worsen over the next six months did ease a bit to 32.4 percent from 33.5 percent, while those expecting conditions to improve edged up to 9.3 percent from 8.5 percent in June. But the percent of consumers expecting fewer jobs in the months ahead increased to 37.1 percent from 35.7 percent, while those anticipating more jobs remained virtually unchanged at 8.2 percent.

 

The Consumer Confidence survey has a margin of error of plus or minus 2.5 percentage points.

 

Crude Falls Again

 

The price of crude oil fell to its lowest level in nearly three months on Tuesday, extending a steep slide since mid-July on mounting evidence high prices and a souring economy were cutting into world energy demand. The drop coincided with a firmer dollar.

 

OPEC President Chakib Khelil said on Tuesday oil could fall further to $70 to $80 a barrel in the long term but added he did not think the producer group should consider cutting output at this point. Domestic sweet crude settled down $2.54 at $122.19 per barrel after dipping as low as $120.42, the lowest price since May 6. Brent crude settled down $3.13 per barrel at $122.71.

 

Crude prices have fallen from a record peak of $147.27 set on July 11, pressured by signs that high prices and an economic slowdown are curbing demand, especially in the United States, the world's largest oil consumer.

 

The chief executive of BP Plc, Tony Hayward, said on Tuesday he saw demand destruction of 5 percent to 10 percent for gasoline in developed OECD economies as people drive less due to high fuel prices.

 

The Energy Information Administration said on Monday that the demand for oil during May was 660,000 barrels per day less than previously expected. A separate government report said motorists drove 2.4 percent less during the first five months of the year than they did in the same period of 2007.

 

Limiting oil's drop, Shell declared force majeure on Tuesday on its Nigerian Bonny Light oil exports for July to September following Monday's attack by militants on an oil pipeline in the Niger. Tension over Iran's nuclear program also provided support. Iran is the second-largest producer in the Organization of the Petroleum Exporting Countries.

 

Attention on Wednesday will focus on the latest snapshot of U.S. oil supplies.

 

Citigroup May Write-Off Another $8 Billion

 

Citigroup may write off about $8 billion in the third quarter from its exposure to collateralized debt obligations (CDOs) after Merrill Lynch agreed to sell its CDOs at a sharp discount, Deutsche Bank analyst Mike Mayo wrote to clients. The analyst also forecast a third-quarter loss and widened his 2008 loss estimate for Citigroup.

 

Citigroup has $22.5 billion of net CDO exposure, and based on Merrill's write-downs the New York-based bank could have another $7 billion of write-downs, Deutsche Bank's Mayo said. The bank may also incur a $1 billion loss on its remaining $2 billion exposure to the bond insurers, Mayo added.

 

"Citi should still be able to absorb much of these charges and credit costs in general given an estimated $20 billion of second-half 2008 pre-provision, pre-tax earnings and the sale of its German retail business...but the decision about raising new capital could be closer than we previously thought," Mayo wrote in a note to clients.

 

Mayo cut his third-quarter estimate by $1 to a loss of 59 cents a share. For 2008, he expects Citigroup to post a wider loss of 80 cents a share, from a loss of 66 cents a share.

 

On Monday, Merrill Lynch agreed to sell $30.6 billion of CDOs, a kind of repackaged debt, to an affiliate of private equity fund Lone Star Funds for just $6.7 billion, or about 22 cents on the dollar.

 

"We do think the CDO sale is large and diversified enough to be applicable to others with similar exposure and will pave the way for similar enough transactions," analysts at UBS said. They said Citigroup has the largest exposure to both CDOs and that investors could expect further incremental write-downs in coming quarters.

 

On Monday, Merrill also said it would take a $5.7 billion third-quarter write-down as it unloads huge amounts of risky debt, and would raise $8.5 billion by selling new stock.

 

The fire-sale nature of Merrill's CDO deal will add to concerns that the global credit crisis, which has already led to more than $400 billion of write-downs and losses at major banks, still has a long way to run.

 

"The read across of the new clearing price on ABS CDO (22 cents on the dollar) is causing stress tests everywhere. Of the US names we cover this has the largest impact on Citigroup," a note from a Merrill Lynch stock salesperson said. Goldman Sachs analyst William Tanona agreed.

 

"The biggest read across to other firms will be Citigroup which has been far less aggressive in their marks on CDOs, in our view," Goldman's Tanona wrote in a note to clients.

 

He said that if Citigroup were to mark its exposure to a level similar to that of Merrill, it would imply a $16.2 billion write-down and roughly $2 per share impact.

 

"Though Citi defends their marks, due to their earlier vintages and high concentration of commercial paper, we continue to believe they would struggle to obtain their prices in the marketplace today," Tanona wrote.

 

In a separate report, J.P. Morgan Securities analyst Kenneth Worthington said Merrill's sale of its CDO portfolio brings transparency to the market, but means more write-downs for peers.

 

"Given the sale of Merrill's $30.6 billion ABS CDO portfolio, we expect peers will adjust marks, eliminating an incentive to hold on to impaired assets," Worthington said. "We see this as a part of the cleansing process and expect increased liquidity in the CDO market and mortgage markets."

 

He also expects Goldman Sachs Group and private equity companies, with excess capital and fund-raising ability, to be the main beneficiaries from a credit market that appears in the early stage of being on the mend.