MarketView for June 3

MarketView

 

Events defining the day's trading activity on Wall Street

 

Lauren Rudd

 

Tuesday, June 3, 2008

 

 

 

 

Summary

  

Stock prices were lower for the second consecutive day on Tuesday after a report that Lehman Brothers may have to raise additional capital compounded the Street’s concerns that the financial sector faces another round of large losses as a result of the crisis that began with the subprime debacle and exploded from there. At the same time, Lehman denied rumors it had borrowed directly from the Federal Reserve.

 

The resultant fears regarding the shares of the major financial houses contributed to a big move out of stocks and into safe-haven government bonds. The Wall Street Journal reported that Lehman was considering raising as much as $4 billion of additional capital. Lehman ended the day down $3.22, or 9.52 percent, to close at $30.61.

 

Goldman Sachs, Morgan Stanley and Merrill Lynch were all down more than 1 percent. Goldman closed down $1.76, or 1.02 percent, at $170.58, Morgan Stanley was down $0.45, or 1.04 percent, at $42.65, as Merrill ended the day down $0.73, or percent 1.71at $41.89. Meanwhile, the S&P financials sub-index ended at its lowest point since March 17, the day when the S&P 500 hit a 2008 low.

 

The nervous mood was exacerbated in early afternoon when Tyson Foods TSN said it was eradicating chicken flock exposed to a mild strain of bird flu. Shares of Tyson, the largest domestic producer of chicken, beef and pork, fell $1.47, or 7.97 percent, to $16.98.

 

Shares of General Motors ended a volatile day in terms of share price up $0.14, or 0.80 percent, at $17.58, after the automaker said its domestic auto sales fell 30 percent in May. Earlier, GM shares had risen as much as 4 percent after it announced a reorganization plan.

 

Stocks rose in early trading after a factory orders report brightened the view of the manufacturing sector, and after Federal Reserve Chairman Ben Bernanke said interest rates were at the right level for an economy facing both price pressures and threats to growth.

 

The dollar rallied after Bernanke spoke, which triggered a three percent drop in the price of crude oil, helping energy-sensitive sectors like airlines.

 

Toll Brothers, the largest domestic luxury home builder, led the Dow Jones home builders’ index 3.8 percent higher after it posted a smaller-than-expected loss. Its shares rose $ 0.64, or 3.05 percent, closing at $21.60.

 

Manufacturing Orders Rise

 

Orders for manufactured goods posted a surprisingly strong increase in April as demand rose across a number of industries. According to a report released on Tuesday by the Commerce Department, orders were up 1.1 percent in April following a 1.5 percent increase in March. Orders had fallen in January and February as a spreading slowdown in the overall economy depressed activity in manufacturing.

Orders in the auto industry and in the volatile commercial aircraft sector did fall sharply but other areas showed strength from rising demand for iron and steel to increased orders for appliances and heavy machinery. Demand for petroleum was also up sharply, reflecting surging oil prices.

The better-than-expected reading on orders for manufactured goods followed news Monday that a key gauge of manufacturing rose to a reading of 49.6 in May, up from 48.6 in April. While the Institute for Supply Management manufacturing gauge remained at levels indicating a continued contraction, the upward movement was seen as a possible sign that the economy may be more resilient that previously thought.

At the moment, manufacturing is being buffeted by a prolonged slump in housing, which has cut into demand for building supplies, and soaring energy prices, which have hurt auto sales. However, these adverse factors are being offset by continued strong demand for exports, domestic products become more competitive on overseas markets due to the ever weakening dollar.

For April, demand for durable goods, items expected to last at least three years, fell by 0.6 percent, with that weakness led by a 24.4 percent drop in demand for commercial aircraft and a 4.2 percent decline in motor vehicles.

This weakness was offset by strength in many other areas. Orders for iron and steel were up by 5.5 percent while orders for mining and oil field equipment jumped 48.6 percent and orders for electrical equipment and appliances jumped 28.1 percent.

Orders for non-durable goods rose by 2.8 percent, led by a big jump in demand for petroleum products, reflecting higher prices. Demand for food and beverages also rose sharply.

 

Domestic Auto Industry Pays For Past Sins

 

Domestic auto sales fell sharply in May as consumers spurned pickup trucks and SUVs in the face of record gasoline prices, driving General, Ford and Chrysler to double-digit declines in sales. Honda outsold Chrysler for the first time to emerge as the new No. 4 domestic. automaker, while Toyota closed the gap with GM as the leading player in the U.S. market, despite reporting lower sales than a year before.

 

Honda's Civic and Accord and Toyota's Camry and Corolla sedans outsold Ford's F-Series pickup truck. It was the first time a sedan outsold the perennial Ford bestseller since 1991.

 

"It is a watershed month. It's a sign of the times," said Jim Farley, Ford's head of marketing, who joined the U.S. automaker last year after 17 years at Toyota. Honda and Nissan were the two major automakers to buck the declining trend, posting sales increases of 11 percent and 4 percent, respectively.

 

GM sales fell 30 percent, Ford sales fell 19 percent and Toyota's fell 8 percent. Sales were adjusted for an additional sales day compared with the year earlier. GM also announced plans to close four pickup and SUV plants in North America and expand output at two car plants to align its production to a market increasingly dominated by concern about fuel efficiency.

 

Overall, domestic auto sales fell to 14.25 million units on an annualized basis in May, down from 14.4 million in April and 15.2 million on average in the first quarter. GM's domestic market share slid to 19 percent in May, a record low for the embattled automaker that commanded 45 percent in 1980.

 

Car sales, which had accounted for less than half of industry volume in 2007, surged to 57 percent in May. On the losing end, truck sales hit their lowest rate since 1995.

 

Toyota said it no longer expected 2008 sales to match last year's record results, owing to the decline in truck demand and the slump in the U.S. economy. The weak sales results add to concerns the auto market is headed for its worst year in a decade amid high oil prices, weak consumer confidence and tighter credit.

 

The shift toward more fuel-efficient cars and crossovers has hit Detroit-based automakers and their truck-heavy lineups, particularly hard. Sales for GM's Hummer SUV line dropped 60 percent in May as the automaker said it would sell or revamp a brand that has become synonymous with gas-guzzling excess.

 

GM also lowered its second-quarter production forecast, but set a third quarter production target just over 1 million vehicles that was 3 percent higher than year-ago levels.

 

JP Morgan analyst Himanshu Patel wrote to clients that the higher production suggested GM was looking to rebuild inventories. A three-month strike at its supplier American Axle & Manufacturing had cut deeply into GM production through May.

 

Declining domestic sales prompted Ford to announce an incentive plan on its F-Series pickup trucks allowing customers to pay the same price as the automaker's employees in June. The company is looking to run down pickup truck inventories ahead of a new model launch this fall.

 

Lehman In Trouble

 

Lehman Brothers Holdings saw its share price fall to a 5-year low on Tuesday on concern that Wall Street's smallest surviving major brokerage may need to raise more capital. The upheaval at Lehman, which has already cut thousands of jobs and raised $4 billion to cushion the impact of previous write-downs, was the latest reminder that it and larger rivals may be struggling to put the credit crunch behind them.

 

Lehman shares temporarily cut their losses after the company denied market rumors that it had borrowed directly from the Federal Reserve in recent days, but still fell 9.5 percent, the steepest drop since the Bear Stearns meltdown in March.

 

Lehman said it last used the Fed credit line on April 16 "for testing purposes." It also said in an e-mailed statement that the company "finished the second quarter well above $40 billion" in terms of liquidity. Lehman spokeswoman Kerrie Cohen declined to comment on a report in The Wall Street Journal that Lehman was considering raising billions of dollars in fresh capital.

 

The decline in Lehman shares dragged the broader market lower and the Standard & Poor's Financials index closed at its lowest level since the broader market's 2008 low of March 17, the day JPMorgan agreed to buy Bear Stearns at the fire sale price of $2 per share, a number that was eventually raised to $10.

 

The Journal quoted analysts and Wall Street executives as saying Lehman was likely to seek $3 billion to $4 billion. The paper said the plans suggest the investment bank would post a second-quarter loss deeper than the $300 million that analysts expect.

 

Despite the share drop and Standard & Poor's decision on Monday to cut its counterparty risk ratings for Lehman, other Wall Street companies do not appear to be pulling back from trading with it.

 

According to one equity derivatives trader who declined to be identified, Lehman is perceived to be "pretty well capitalized." While bank risk managers may have the firm on their radar screens, it would take a multiple-notch downgrade before firms stop trading with Lehman.

 

"We would only be concerned if it got much, much worse," he said, adding: "They're a solid company. They're not a small regional bank or a regional airline."

 

But others were not as sanguine. Lehman might issue common stock, diluting current shareholdings and will probably reveal its capital plans when it reports quarterly results the week of June 16, the Journal reported.

 

Lehman's market value was about $16.9 billion based on Tuesday's closing price, according to Reuter’s data, down almost $2 billion from what it was worth at Monday's close.

 

According to recent analysts' research notes, Lehman has been hurt by hedges used to offset losses in various securities. Second-quarter losses from asset write-downs and ineffective hedges are likely to have topped $2 billion, the Journal said. The bank will also realize losses tied to job cuts, it said, citing a person familiar with the matter.

 

In May, Lehman decided to cut around 1,300 jobs, or nearly 5 percent of its work force, a person briefed on the matter said. It has laid off more than 5,000 people since the middle of 2007.

 

Overall, financial institutions globally have suffered more than $350 billion in write-downs or credit losses tied to risky subprime mortgages and other debt. Many have raised billions of dollars in capital, including Merrill and Morgan Stanley S&P cut its credit ratings for Lehman, Merrill and Morgan Stanley on Monday, saying write-downs "may continue to depress earnings." Lehman is no stranger to worries about its cash problems. In 1998, it had to fight off concern about its survival after the Long Term Capital Management hedge fund collapsed.

 

Bernanke Hints No More Fires - No More Rate Reductions

 

Federal Reserve Chairman Ben Bernanke on Tuesday issued a rare warning on the inflationary risk posed by a weak dollar, but said interest rates were "well positioned" for an economy facing both price pressures and threats to growth.

 

"We are attentive to the implications of changes in the value of the dollar for inflation and inflation expectations," Bernanke said by satellite to a conference on monetary policy in Barcelona, Spain.

He added that the Fed and the U.S. Treasury were continuing to "carefully monitor" currency market developments.

 

Officials usually defer on any comment on the value of the dollar to the Treasury secretary, and analysts said Bernanke's remarks were highly unusual.

 

The dollar, which has declined steadily in value in recent years against other major currencies .DXY, rose broadly and Treasury debt prices dipped after Bernanke's remarks. The cost of oil, which is priced in dollars, fell.

 

Bernanke said the Fed's interest-rate cutting campaign, which has taken benchmark rates to 2 percent from 5.25 percent since mid-September, and its infusion of billions of dollars into the financial system to ease a credit crunch have helped put a floor under the economy.

 

"For now, policy seems well positioned to promote moderate growth and price stability over time," he said. "We will, of course, be watching the evolving situation closely and are prepared to act as needed to meet our dual mandate," he said.

 

Bernanke said until the U.S. housing market stabilizes the economy would continue to face the risk of further weakness. He cited oil prices, which have hit record highs in recent weeks, as another factor weighing on economic growth.

 

"Activity during the current quarter is likely to be relatively weak," Bernanke said. "We may see somewhat better economic conditions during the second half of 2008."

 

However, the Fed chief also underscored concerns about inflation from the rising costs of oil and other commodities, although he said that so far they have had only a muted impact on broader prices.

 

"The pass-through of high raw materials costs to domestic labor costs and the prices of most other products has been limited, in part because of softening domestic demand," he said. At the same time, he warned that "the continuation of that pattern is not guaranteed and will bear close attention."

 

Bernanke said that if commodity prices stabilized as futures markets predict, there would be a "relatively rapid moderation of inflation," but he said the possibility commodity costs continued to mount presented an important risk to the outlook.