A weaker U.S. dollar, spikes in oil and gold prices, and some disappointing profit outlooks spooked the market
Euphoria related to this week's interest rate cuts faded Thursday as the focus shifted to companies' lower profit projections for the year and worries about inflation, sending stocks and bond prices down. Federal Reserve Chairman Ben Bernanke and Treasury Security Henry Paulson, fielding questions from members of Congress, didn't offer any quick-fix solutions to the subprime loan crisis, while bad financial results from Bear Stearns and Circuit City also made investors hesitant.
On Thursday, U.S. stocks put the biggest two-day rally in the past four years behind them. The Dow Jones industrial average lost 48.86 points, or 0.35%, to 13,766.70. The broader S&P 500 index was down 10.28 points, or 0.67%, to 1,518.75. The tech-heavy Nasdaq composite index fell 12.19 points, or 0.45%, to 2,654.29.
On the New York Stock Exchange, 23 stocks traded lower for every 10 that rose, while the ratio on the Nasdaq stock market was 19 to 11 negative, S&P MarketScope said. Homebuilder stocks plummeted as Bernanke warned the credit squeeze may exacerbate the housing correction.
On Thursday, crude oil for October delivery in New York hit a new intraday high above $84 a barrel before settling $1.39 higher at $83.32 a barrel. The spike in prices came on concerns that storms in the Gulf of Mexico and declining imports could reduce U.S. supplies before demand peaks in the fourth quarter, Action Economics said. Roughly one-third of Gulf oil production has been shut in ahead of Tropical Storm Ivo, which could become a hurricane going into the weekend, as is apparently headed for production areas off the coast of Louisiana. BP plc and ConcocPhillips were among te companies urging non-essential employees in the Gulf to evacuate.
Continuing its downtrend, the U.S. dollar reached a record low against the euro and the yield spread between the two- and 10-year U.S. Treasuries widened, pushing the price of gold up $14.60, or 2%, to a 27-year high of $744.10 an ounce. Worries about inflation are bolstering demand for gold.
In his testimony before the House Financial Services Committee's hearing on mortgage foreclosures, Bernanke called for the need for more strict regulation of mortgage lending practices and said a thorough review of consumer protection regulations was being done under existing regulatory authority.
Treasury Secretary Henry Paulson said that allowing Fannie Mae and Freddie Mac to securitize mortgage loans above the current $417,000 limit could inject some short-term liquidity into the housing market, but said he was only in favor of such a move on a temporary basis and if it were accompanied by strengthening the currently inadequate regulatory oversight of government-sponsored enterprises.
Housing and Urban Development Secretary Alphonso Jackson said he estimates that new Federal Housing Authority loans will help about 240,000 delinquent borrowers avoid foreclosure on their homes by early 2008, but said he expected one-quarter of the 2 million adjustable-rate mortgages scheduled to reset in the near future to be foreclosured on.
The earnings reports coming out of the financial industry this week have been mixed. While the notable markdowns in the value of loan portfolios are evidence of the toll the credit crunch is taking, two of the four investment banks that have reported so far have missed wall Street estimates for the third quarter.
Goldman Sachs (GS) shares fell 1.0% after it exceeded analysts' estimates by posting a profit of $2.85 billion, or $6.13 a share, for the period ending Aug. 31, compared with $1.55 billion, or $3.26 a share, a year earlier. Revenue jumped 63% to $12.33 billion, despite the bank's having to write down the value of its leveraged buyout loans by $1.7 billion. Net revenue in its trading and principal investments business surged 70% to $8.23 billion, as losses on subprime loans and mortgage-backed securities were more than offset by gains on short positions on mortgage securities. Analysts had forecast a profit of $4.35 a share on $9.57 billion in revenue.
Bear Stearns' (BSC) reported a 62% plunge in third-quarter earnings, after paying preferred dividends, to $166.1 million, or $1.16 a share, vs. $432.2 million, or $3.02 a share, a year ago. Missing analysts' estimate of $1.78 a share, Bear Stearns had the largest exposure among thge investment banks to mortgages, making it more susceptible to the damage from the credit crunch. The shares slipped 0.2%.
FedEx Corp. (FDX) shares fell 2.9% after it reduced its earnings outlook for fiscal 2008 by 4% to between $6.70 and $7.10 a share, below analysts' estimated $7.19. The company said its prior forecast was based on expectations that the economy would improve by late summer or early fall. For its first fiscal quarter of 2008, FedEx reported a profit of $1.58 a share, which was up 4% from the same period a year ago and surpassed amalysts' $1.54 projection.
Circuit City Stores (CC) shares fell 18.0% after it said it swung to a net loss of 38 cents a share in its second quarter from a profit of six cents a share a year earlier due to a 7.9% drop in same-store sales and 6.2% decline in total sales. The electronics retailer sees continued weakness in the third quarter, but expects a narrower net loss from continuing operations than in the second quarter.
The Nasdaq Stock Market (NDAQ) entered into an agreement with Borse Dubai that will give Borse Dubai a 20% stake in Nasdaq but with only 5% voting rights and will allow Nasdaq to acquire all of Sweden's OMX shares to be purchased by Borse Dubai in its offer for OMX. Nasdaq will become a strategic shareholder and the principal commercial partner of Dubai International Financial Exchange. Borse Dubai has also acquired 28% of the total issued share capital in London Stock Exchange Group PLC from Nasdaq at a price of GBP 14.14 a share. Nasdaq shares gained 1.4%
VeriChip Corp. (CHIP) shares jumped 14.6% after it said it has generated initial revenue from Implantable Operations since its IPO, primarily from the largest sale of its VeriTrace System. The developer of radio frequency identification systems expects to report revenue from these sales during the third quarter, earlier than expected. The company also set a $1.5 million stock buyback.
Tuesday's half-point rate cut by the Fed is being interpreted by some as the surrendering of its vigilant stance toward inflation. Adding to concerns about the weaker dollar is speculation that Saudi Arabia may be considering dropping the peg of its currency to the dollar. One currency strategist speaking on CNBC said the Saudis opted not to lower interest rates in lockstep with the Fed's move because of inflation problems in that country and he said he didn't believe the Saudis would abandon the dollar peg.
Larry Smith, chief investment officer at Third Wave Global Investors in Greenwich, Conn., said he sees a neutral level for the the Fed funds rate around 4.50%. "In effect, what the Fed has done is remove its mild bias toward tightening and moved toward a neutral view on the Fed funds rate," he said.
While there are times when weakening in the U.S. dollar can preciptate a change in economic fundamentals and then cause the value of the dollar to bottom, Smith said this isn't what's occurring now.
"U.S. corporate earnings will be bolstered by a weak dollar because it increases the translation of foreign earnings and lowers the cost basis of U.S. goods," he said. But the declining value of the dollar will keep foreign capital from coming into the U.S., which "doesn’t bode well for U.S. equities market relative to other equities markets around the world."
Although he doesn't believe consumer spending will decline that much even as the economy slows, he added that until the economy rebounds, there won't be much capital flowing in the U.S. and supporting the dollar.
There was some good news on the economic front Thursday. Initial jobless claims fell 9,000 to a lean 311,000 in the third week of September, which was also the week during which the Bureau of Labor Statistics conducts its monthly survey. Initial jobless claims rose 5,000 to 320,000 the prior week. Continuing claims dropped 53,000 in the second week of September to 2,544,000 after a 6,000 increase in the first week of September to 2,597,000.
The decline in claims in September to levels below the 318,000 average for 2007 sharply refutes the notion that credit market turmoil is curbing job growth beyond some temporary disruption effects in August, Action Economics said.
The leading economic indicators index fell 0.6% in August, slightly more than the 0.5% decline that was expected, while the July gain was revised higher to 0.7%. The August drop reflected the immediate impact of credit market turmoil on many of the source-figures that will likely soon be reversed.
Eight of the 10 components in the index contributed negatively, led by consumer sentiment, initial jobless claims, the S&P 500 index and building permits, with positive inmput coming only from a gain in the real money supply and an unchanged factory workweek.
The Philly Fed index jumped to 10.9 in September from a flat reading in August and a 9.2 level in July. The gain was aided a more than doubling in new orders to 15.1 after falling to 7.1 previously, and a 4.5-point increase in shipments to 16.9, while the employment index fell to 7.5 after surging to 21.2 in August. The prices paid component was also up nearly 8 points, while prices received fell 3.5 points.
The September Philly Fed pop translates to an ISM-adjusted rise to 55.1 from 53.9 in August. The headline and ISM-adjusted gains went against credit crunch fears and exceeded Monday's otherwise respectable 14.7 Empire State reading that translated to an ISM-adjusted level of 54.5, Action Economics said.
World equity indexes were mostly lower on Thursday. In London, the FTSE 100 index fell 0.48% to 6,429,00. Germany's DAX index edged 0.20% lower to 7,735.09. In Paris, the CAC 40 index slipped 0.73% to 5,688.76.
In Japan, the Nikkei 225 index rose 0.20% to 16,413.79. In Hong Kong, the Hang Seng index gained 0.57% to 25,701.13. The Shanghai composite index climbed 1.39% to 5,470.06.
Treasury bonds sold off sharply amid renewed fears about inflation. Smith at Third Wave said the weakness in bonds is an overreaction and predicted the yield on the 10-year note would likely range between 4.50% and 4.75% and probably only attract investors above 4.75%.
The benchmark 10-year Treasury note dropped 1-08 to 100-12/32 for a yield of 4.70%, while the 2-year bond was down 07/32 to 99-25 for a yield of 4.11% and the 30-year bond fell 2-02 to 100-16/32 for a yield of 4.97%.