MarketView for May 5

MarketView

 

Events defining the day's trading activity on Wall Street

 

Lauren Rudd

 

Monday, May 5, 2008

 

 

 

 

Summary

 

After two days of positive gains, stock prices retreated on Monday as worries over the economy and the financial markets resurfaced once again. The negative attitude began with concerns over the possibility that Bank of America will walk away from buying Countrywide Financial. At the same time, record oil prices above $120 a barrel brought forth increased concerns over the viability of continued consumer spending. Microsoft’s decision to withdraw its $50 billion offer to buy Yahoo added to the day’s gloomy mood, causing the market to break that two-day winning streak.

 

Early in the day’s trading session, the stock market managed to trim its losses briefly when a report from the Institute for Supply Management showed unexpected growth in the vast U.S. services sector last month. The ISM's non-manufacturing index came in at an April reading of 52.0, confounding economists' forecasts for a reading of 49.1, and up from 49.6 in March. A reading above 50 indicates growth.

 

On the NASDAQ, Yahoo shares suffered their biggest decline in nearly two years, finishing down $4.30, or, 15.00 percent, at $24.37. Shares of Microsoft slipped 16 cents, or 0.55 percent, to close at $29.08. Shares of Google, a competitor of both Yahoo and Microsoft, ended the day up $13.61, or 2.34 percent, to close at $594.90 on expectations that the company will benefit from the failure of Microsoft to acquire Yahoo. Furthermore, the Street is now of the opinion that Yahoo is likely to push for an advertising partnership with Google.

 

Financial stocks felt the brunt of the sell-off after a brokerage firm indicated that Bank of America, was likely to renegotiate its deal to buy Countrywide, the largest U.S. mortgage company, or might even scrap the deal altogether. When the Countrywide buyout was announced in January, the markets took it as a sign that an outright collapse of the mortgage company would be averted.

 

As a result, Countrywide’s share price fell more than 10 percent, while Bank of America ended the day down 82 cents, or 2.06 percent, to close at $38.97. However, it was Citigroup that led the retreat in banking stocks. Citigroup ended the day down 64 cents, or 2.43 percent, to close at $25.75, while the S&P financial index closed down 1.5 percent.

 

Berkshire Hathaway's shares fell more than 2 percent after Warren Buffett's holding company posted a large decline in earnings, primarily due to weakness in its insurance operations. The class A shares closed down $3,600, or 2.7 percent, at $130,000, while its Class B shares declined $114.50, or 2.57 percent, to close at $4,333.50.

 

Shares of consumer-oriented companies, including retailers, fell on the belief that consumers may be forced to further cut discretionary spending, a key pillar of corporate profits and economic activity as a result of factors such as the rapidly rising price of gasoline. The price of crude oil for June delivery settled up at a record $119.97 per barrel, after climbing as high as $120.36, a new all time high amid a weak dollar and renewed tensions with Iran. The resulting worries over consumer spending and retail sales sent the shares of Home Depot down 75 cents, or 2.49 percent, to close at $29.37, while Wal-Mart ended the day down  53 cents, or 0.92 percent, to close at $56.97.

 

Service Sector Expands – Inflation Remains a Problem

 

The service sector grew in April for the first time in four months, according to a report by the Institute for Supply Management (ISM) on Monday. Unfortunately, the report was overshadowed by a Federal Reserve survey showing the banking sector remained in the grips of a credit crunch.

 

According to the ISM, its non-manufacturing index rose to 52.0 in April from 49.6 in March. The result was above the level of 50 that indicates growth in the service sector and also beat expectations. At the same time, a Federal Reserve survey showed banks in the United States kept tightening lending standards and terms for both business and consumer loans over the past three months out of concern about a weakening economic outlook.

 

The April survey of senior loan officers at 56 domestic banks and 21 U.S. branches and agencies of foreign banks also underlined that demand for loans from businesses and consumers was weaker.

 

Government bonds, which usually benefit from weak economic data, initially fell after the ISM release, which showed the jobs gauge for the sector posted its biggest improvement in seven months and inflation pressures at their highest in five months. However, bonds found a slightly firmer footing later as Wall Street began to consider the data in the wider context of an economy that is not performing particularly well and may still be teetering on the brink of recession. In fact, Warren Buffett said on Sunday that the economy was already in the midst of a recession.

 

The service sector represents about 80 percent of U.S. economic activity, including businesses such as banks, airlines, hotels and restaurants. The ISM's non-manufacturing employment index rose to 50.8 from 46.9 in March. It marked the biggest gain in the jobs measure for services since September 2007.

 

The index of prices paid rose to 72.1, the highest since 73.7 in November, from 70.8 in March, indicating that persistent inflation was an issue for service providing companies.

 

Will Bank of America Walk

 

Bank of America may not walk away from its proposed deal to buy Countrywide, but many on the Street are giving increasing credence to the possibility that BOA will lower its purchase price. Friedman, Billings Ramsey has indicated that they believe BOA will cut its price to the $0 to $2 level or could possibly walk away from the deal. Friedman downgraded Countrywide to "under perform" from "market perform."

 

Friedman analyst Paul Miller, in a note to clients, said Countrywide's loan portfolio has deteriorated so rapidly that it currently has negative equity and the proposed takeover of the company will be a drag on Bank of America's earnings because of the elevated credit expenses at Countrywide. Miller cut his target on Countrywide's stock to $2 from $7.

 

"Bank of America announced that it might not guarantee Countrywide's debt, which is most likely the first step in renegotiating the entire deal," Miller wrote to clients. "We estimate that if fair-value adjustments to the loan portfolio could exceed approximately $22 billion, this would increase the odds of Bank of America renegotiating the transaction or walking away."

 

He said Bank of America's current purchase price allows for some adjustments to loan values as it is below Countrywide's first-quarter net tangible equity of $11 billion. 

 

Analysts at S&P Equity Research expect Bank of America to complete the deal but at a lower price due to the rapid deterioration of Countrywide's credit portfolio. Bank of America, which agreed in January to buy Countrywide for $4 billion, said in a filing last week there was no assurance that any of the mortgage lender's outstanding debt would be redeemed, assumed or guaranteed. S&P Equity Research analysts said they were "particularly wary of Countrywide's option ARM portfolio because we do not believe that it has yet been stress-tested."

 

"Indeed, one of our major concerns about Bank of America is the potential inheritance of Countrywide's option ARM portfolio," they added. S&P Equity Research analysts maintained their "hold" rating on both Countrywide and Bank of America.

 

On Friday, Standard & Poor's cut the credit rating of Countrywide to junk status on concerns that Bank of America may not support as much as $24 billion of the mortgage lender's debt once it completes its proposed takeover.

 

Countrywide, in a February regulatory filing, had said a loss of its investment grade rating would result in the acceleration of some secured debt obligations and hurt its ability to manage and hedge its inventory of loans.

 

In addition to increasing Countrywide's financing costs and potentially hurting its ability to attract and retain bank deposits, up to $4.2 billion of its custodial deposits could be transferred to another bank if it were cut below investment grade, the Countrywide said.

 

Deutsche Telekom Could Be Looking At Sprint

 

Supposedly under pressure from the German government, which is still about a one-third owner, word on the Street is that Deutsche Telekom is coming under pressure to undertake some large acquisitions with the hope of raising its sagging stock price.

 

One possibility would be for Deutsche Telekom to attempt to buy-up Sprint Nextel in a move that is unlikely to face competition or resistance in the marketplace.  Asked about Telekom being interested in Sprint Nextel, German Finance Minister Peer Steinbrueck told reporters in Berlin he considered it to be "a rumor, like so much else".

 

Deutsche Telekom's chief executive, Rene Obermann, has said he wants to grow the group's mobile phone business through acquisitions to compensate for a dwindling fixed-line business and has linked his performance to boosting the share price.

 

Picking up Sprint would have Deutsche Telekom's T-Mobile USA unit leapfrog past AT&T and Verizon to the number one spot among domestic mobile phone service providers. The key question is whether Deutsche Telekom has the wherewithal to pull it off.

 

Sanford C. Bernstein & Co analyst Craig Moffett estimated that Sprint commands 19 percent of the U.S. wireless market by subscribers, while T-Mobile holds 12 percent. Combined, they would exceed AT&T's 27 percent share, he said.

 

Sprint, which has been struggling with network and customer service problems, has been running two networks that are different from T-Mobile's GSM infrastructure. Its new third-generation UMTS systems are expected to launch by mid-year.

 

In March, a research report by Merrill Lynch fuelled speculation Deutsche Telekom might consider a takeover of Sprint. Deutsche Telekom's T-Mobile USA is the fourth-biggest U.S. operator.

 

Merrill said Sprint's operational problems would cause it to cut prices in an effort to keep and attract customers, potentially starting a price war among domestic operators, but an acquisition would avert such a development.

 

Whether the German government would ultimately agree to Deutsche Telekom essentially becoming a U.S. company is an open question, analysts have said. Deutsche Telekom in September acquired SunCom Wireless for $1.6 billion in cash and VoiceStream in 2000 for $35 billion.