Worries about big banks' plan to prop up the commercial paper market, weaker earnings, and a move in crude oil above $86 prompted selling
It was the worst day for the benchmark U.S. equities index since Sept. 7, and the main reasons behind the weakness were familiar: concerns about the health of the credit market and worries about companies' quarterly earnings.
Major U.S. stock indexes ended lower on Monday, as investors chewed on the potentially more serious implications of a new superfund created by the nation's three largest banks to ease the credit crunch, fueling selling pressure throughout the session.
With half the 30 Dow components and about 20% of the companies in the S&P 500 reporting quarterly earnings this week, investors were also nervously awaiting signs of continuing weakness into the fourth quarter and seemed to shrug off surprisingly strong data from the New York Federal Reserve Bank. Citigroup (C) warned that credit woes could mar its fourth-quarter results and Eaton Corp. (ETN) narrowed its 2007 profit outlook and issued a disappointing forecast for the fourth quarter.
On Monday, the Dow Jones industrial average rebounded slightly from earlier losses to finish 108.28 points, or 0.77%, lower at 13,984.80, its biggest drop since before the Fed rate cut on Sept. 18. The broader S&P 500 index fell 13.09 points, or 0.84%, to 1,548.71. The tech-heavy Nasdaq index gained back some ground from its lowest levels to end 25.63 points, or 0.91%, down at 2,780.05.
On the New York Stock Exchange, 24 stocks were down for every nine that showed gains, while on the Nasdaq market, the breadth was 21 to nine negative, thanks to some disappointing earnings reports, MarketScope said.
Responding to a call by the U.S. Treasury, Citigroup, JPMorgan Chase & Co. (JPM) and Bank of America (BAC) announced the creation of a superfund called the Master Liquidity Enhancement Conduit, or M-LEC, to ease ongoing problems in the credit markets. The fund will have between $80 billion and $100 billion, which will be used to buy high-rated, high-quality assets from structured investment vehicles, which have had trouble selling commercial paper since the subprime meltdown over the summer.
The fund, which is expected to be up and running within 90 days, is primarily meant to forestall banks' dumping assets backed by mortgages and other securities onto the market in a disorderly way or having to move them onto their books, both of which would limit the banks' ability to issue new loans to consumers and companies.
While the fund purports to inject enough liquidity into the market to make investors more confident about buying commercial paper, some traders see hidden problems, while some analysts don't appear concerned, said S&P MarketScope.
"If the banks are contemplating putting [the fund] together, the problem may be worse than earlier reported by some of the firms," said Scott Armiger, a portfolio manager at Christiana Bank & Trust in Greenville, Del. "There may be some jumping to conclusions."
The banks clearly believe there's a real risk that a big chunk of the $400 billion in mortgage assets held in SIVs set up by Citigroup and other banks could be unloaded onto the market at the same time, dramatically slashing the value of all this commercial paper. But another reason for the superfund is that the banks want to ensure there's ample liquidity available so that credit markets don't seize up as they did over the summer, said William Rutherford, president of Rutherford Investment Management LLC in Portland, Ore.
Given that the three banks themselves are putting up the money for this fund, Rutherford speculated on whether they will have to take further losses and, if so, how those would be reflected since these conduits aren't on their books.
To pass muster with the U.S. Securities & Exchange Commission, the banks' 10-Q filings need to fully disclose the value of all assets and liabilities. "How is this going to be done without reflecting losses from these conduits?" he asked.
"I think we're in the early chapters -- maybe the first chapter -- of this story," Rutherford added. He said he wouldn't put financial stocks back into the separately managed accounts he oversees "until they tell us where the bodies are buried."
Another driver of the equity selloff, said Armiger at Christiana Bank & Trust, was anticipation of lower third-quarter profits, since many companies have been revising down their estimates. In addition, there may be some profit-taking after the bounce stock markets have had since the lows in mid-August, he added.
This week's report from Reuters Estimates shows that Wall Street strategists and industry analysts now see aggregated earnings for the S&P 500 companies rising by 2.7% in the third quarter from a year ago, down from a 3.2% estimate last week, but slightly ahead of a 2.5% forecast when the period began on July 1. Healthcare and technology were the two sectors expected to have the largest gains, 14% and 12%, respectively, while the weakest results are anticipated from cyclical consumer goods and services and the financials.
In economic news Monday, the Empire State Manufacturing Index surged to 28.8 in October, after falling to 14.7 in September.
The unexpectedly robust reading was the highest headline reading since July, 2004, and was led by increases in new orders, shipments and hours in the work week. Gains in capital spending to 27.91 and in technology spending to 19.77 were encouraging signs for business investment in the aftermath of August market turmoil, with the October level for these measures back in line with strong readings seen through much of the last three years, Action Economics said. The component data correspond to a hefty Institute for Supply Management reading of 59.9, up from 54.5 in September.
While Rutherford doesn't see recession on the horizon for the U.S. economy, he said the economy is clearly slowing and may take some time to bounce back to healthy growth levels.
Crude oil for November delivery in New York finished $2.44 higher at a new all-time high of $86.13 a barrel on concerns about a possible Turkish military incursion against Kurdish rebel bases in northern Iraq, where one-third of the world's crude reserves are located. Turkey's parliament is expected to vote this week on allowing the military attacks within the next year. Further weakening of the U.S. dollar also put upward pressure on oil prices. MF Global predicted the price of oil would hit $100 a barrel by year-end.
Among stocks in the news Monday, Citigroup shares fell 3.4% after the bank reported a 57% drop in third-quarter earnings to 47 cents a share from $1.10 a share a year ago, as fixed income results and higher credit costs in global consumer circles offset a 5.8% gain in revenue.
Eaton Corp. shares ended 3.5% lower after it said it expects adjusted earnings for the fourth quarter to be between $1.65 and $1.75 a share, below a consensus estimate of $1.84 by Wall Street analysts. The diversified industrial manufacturer also narrowed its full-year forecast to between $6.50 and $6.60 a share from a prior range of $6.50 to $6.70 a share, citing weak sales for trucks in North American.
Mattel Inc. (MAT) posted a third-quarter profit of 61 cents a share, just below the 62 cents a share it earned in the year-ago period. Charges and incremental costs of about $40 million related to product recalls offset a 3% revenue increase. S&P lowered its 2007 earnings estimate but reaffirmed a strong buy rating. Mattel shares fell 1.0%.
Tektronix Inc. shares soared 33.6% (TEK) on news the company has agreed to be acquired by Danaher Corp. (DHR) for $2.8 billion, including debt, transaction costs and net of cash acquired. Tektronix shareholders will receive $38 in cash for each share they own.
Biogen Idec Inc. shares jumped 18.8% (BIIB) after it said it's evaluating whether third parties would have an interest in acquiring the company at a price and on terms that would represent a better value for its stockholders than having Biogen continue to be as a stand-alone entity. The therapeutics developer has engaged Goldman Sachs and Merrill Lynch for advice about putting itself up for sale.
Medtronic Inc. (MDT) shares dropped 11.2% on news it has voluntarily suspended worldwide distribution of the Sprint Fidelis family of defibrillation leads because of the potential for lead fractures, which it believes may have be tied to five patients' deaths. The company is also recommending against new implants of the leads. S&P upheld its buy rating on the stock and its fiscal 2008 profit forecast of $2.71 a share but cut its target price by $7 to $60.
Nautilus Inc. (NLS) shares dropped 9.6% after it said it will cut about 9% of its workforce and trim expenses by more than $10 million on an annualized basis. RBC Capital widened its 2007 loss estimate to 27 cents from two cents a share and reduced its target price by $2 to $9, citing lack of company earnings guidance. target.
Major European equity indexes finished lower Monday. In London, the FTSE 100 index dropped 1.28% to trade at 6,644.50. Germany's DAX was down 0.89% to 7,969.47. In Paris, the CAC 40 slipped 0.62% to 5,807.44.
Asian markets ended higher. In Japan, the Nikkei 225 inched up 0.16% to 17,358.15. In Hong Kong, the Hang Seng index gained 2.44% to 29,540.78. The Shanghai composite index rose 2.15% to 6,030.09.
Treasuries closed mixed Monday as a drop on back of a jump in the October Empire State index failed to attract follow-through selling. The recovery partly reflected a decline in the stock market, which attracted some funds to bonds. The 10-year note rose 03/32 in price to 100-20/32 for a yield of 4.67%. The 30-year bond eased by 03/32 to 101-15/32 for a yield of 4.90%.