Market Update

Market Update
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Weekly Recap - Week ending 16-Jan-09

A bad start to the new year got worse this week as each of the major indices suffered material losses. The financial sector was at the heart of those losses as it plummeted 16% on the week amid a torrent of concerns about deteriorating credit quality and the seemingly unending need by the banks to raise capital to plug the gaping holes created by losses and writedowns on bad investments.

Bank of America (BAC) and Citigroup (C) were the biggest trouble spots this week. Shares of the former dropped as much as 46% at one point while shares of Citigroup fell as much as 59%.

Citigroup rattled investors with a decision to sell a controlling interest in its Smith Barney brokerage unit to Morgan Stanley (MS), which the market concluded was more of a forced sale than anything else to raise capital. Citigroup later announced, in conjunction with reporting an $8.3 billion fourth quarter loss, that it would be splitting into two units as it attempts to downsize its operations in meaningful fashion.

Ironically, it was Bank of America's effort to super-size its operations that got it into a heap of trouble with the market this week. Specifically, its acquisitions of mortgage giant Countrywide and former investment banking giant Merrill Lynch raised the bank's credit risk profile. That came back to hurt it in a big way as evidenced by Bank of America reporting its first loss in 17 years and needing an additional $20 billion in TARP funds to digest its Merrill Lynch purchase.

Bank of America said it lost $1.79 billion in the fourth quarter, yet that excludes a $15 billion loss at Merrill Lynch. The need for additional governmental aid rankled the market, which was dismayed by the seemingly poor due diligence performed by Bank of America ahead of the Merrill purchase.

What's done is done now, but the developments surrounding these two, major banks this week, as well as a disappointing earnings report from JPMorgan Chase (JPM) that was replete with an admission the bank is girding itself for a continued deterioration in the economy and additional loan losses, served as a wake-up call that there won't be a quick fix to the financial sector's problems.

Unfortunately, that also means there won't be a quick fix to the economy's problems.

President Obama (we'll give him the official title now with his inauguration only days away) has stressed on a number of occasions already the need to act quickly with a stimulus plan to get the economy growing again. His initial hope was to be able to sign a stimulus plan into law almost immediately upon taking office. It now sounds as if the congressional debate on the bill will extend into February.

In the past week House Democrats presented an $825 billion stimulus plan that calls for $550 billion in spending and $275 billion in tax cuts. There isn't any point in getting into the details since it will no doubt experience revisions, but it is worth noting that the overall figure is in the ballpark of what the market was expecting given views expressed by officials in the Obama administration.

The economic data in the past week certainly provided the new president with ample reason to stress the urgency of getting new stimulus flowing through the economy as soon as possible.

December retail sales were atrocious, declining 2.7% and falling for the sixth straight month. Industrial production in the fourth quarter declined at an 11.5% annual rate. The trade deficit narrowed sharply to $40.4 billion (from -$56.7 bln), with a $25 bln drop in imports and an $8.7 bln drop in exports reflecting a sharp contraction in overall global trade.

After two weeks below 500,000, weekly initial claims jumped 54,000 to 524,000. Although there was a 115,000 drop in continued claims, that improvement was quickly attributed to people having exhausted their jobless benefits. More companies, meanwhile, announced job cuts.

Both the PPI and CPI reports actually brought some relatively good news. Core prices stayed out of negative territory, providing a brief respite for the market from its deflation concerns but certainly not expelling them. CPI, for example, was up a scant 0.1% for 2008, which was the slowest rate of increase since 1954.

Separately, there wasn't much to cheer about on the earnings front. Alcoa came up short of lowered estimates, Intel reported a 90% drop in fourth quarter net income, and several companies, including Tiffany & Co. (TIF), KLA-Tencor (KLAC), Liz Claiborne (LIZ), NVIDIA (NVDA), Motorola (MOT), Genentech (DNA), Estee Lauder (EL), Johnson Controls (JCI), and Lubrizol (LZ) issued sales and/or earnings warnings.

In brief, the events that unfolded in the past week, which also included the ECB cutting its key lending rate another 50 basis points to 2.00%, the Senate approving the next $350 billion of TARP funds, GM providing a 2009 U.S. industry wide auto sales estimate that is the lowest in 27 years, and machinery orders in Japan being the lowest on record, provided a sobering reminder that this slowdown is global and deep.

To be sure, it made it apparent that rallies like the one seen at the end of 2008 are still to be viewed in a bear market context.

--Patrick J. O'Hare, Briefing.com

**For interested readers, the S&P 400 Midcap Index, which isn't included in the table below, declined 2.6% this week and is down 4.0% year-to-date.