By William Patalon III
Managing Editor
Money Morning
Back in early October, after global banking giants Citigroup Inc. (C) and UBS AG (UBS) both announced massive write-downs, housing stocks soared and the Dow Jones Industrial Average rocketed to a record high over 14,000. Investors concluded that the global credit crunch had been fully “defined,” meaning investors could move forward – even buying into housing and financial stocks.
My assessment at the time: Don’t you believe it.
As it turns out, I was right. And each member of Money Morning’s panel of investment experts subsequently made identical predictions. Events have proved us correct, time and again. News events of the past few weeks have provided still more evidence that we were right.
Why do many investors have so much trouble understanding that the credit crisis is far from over? That’s simple: Wall Street continues to send out mixed messages. Anytime there’s any kind of news that could be interpreted as a positive development, Wall Streeters erroneously trumpet it as proof the crisis has ended.
This past week, for instance, the unemployment and non-farm payroll reports indicated that employees generally seem to be navigating the ongoing subprime mortgage mess pretty well (at least, so far). Indeed, a quick glance at the news of last week would seem to be additional evidence that the economy is humming along quite nicely, thank you very much: Gross Domestic Product (GDP) is surging; labor remains steady; and, as expected, U.S. Federal Reserve policymakers reduced interest rates by another quarter point.
But if that’s all true, then why are stocks (save for techs) plunging? What’s especially worrisome is that stock prices are forward-looking, reflecting not the situation we’re dealing with now, but rather what’s still to come. Well, apparently, the worst is yet to come, and the mortgage woes are nowhere near over. The troubles deepened at both Citigroup and Merrill Lynch & Co. Inc., (MER). Oil prices are soaring, setting record after record, meaning we can expect that inflation will soon get a firm foothold in the U.S. economy for the first time since the 1980s.
Apparently, equity valuations are still too high and financial services companies will guide the overall markets more directly than techs. If that’s the case, we can expect the bears will have more trading clout than the bulls (though market sentiment sometimes seems to change from one half-hour segment to the next. The Fed seems to think that it’s done its job for now and will return to its “speaking tour” approach to managing the economy. That’s just as well, since we have real questions about just how effective its rate-cutting campaign is actually going to be [although, in our free research report, “Five Ways to Profit as the U.S. Dollar Turns Into the ‘Bernanke Peso’,” we suggest moves to make to profit from the Fed’s ill-advised strategy. To access that report, please click here. A second Fed-related investment-research report is listed in the “related story links” at the end of this article.]
| Market/Index |
Previous Week |
Current Week |
YTD Change |
|
Dow Jones Industrial |
13,806.70 |
13,595.10 |
9.08% |
|
NASDAQ |
2,804.19 |
2,810.38 |
16.36% |
|
S&P 500 |
1,535.28 |
1,509.65 |
6.44% |
|
Russell 2000 |
821.39 |
797.78 |
1.28% |
|
Fed Funds |
4.75% |
4.50% |
-75 bps |
|
10 yr Treasury (Yield) |
4.39% |
4.29% |
-42 bps |
Change-up at Merrill as Stan the Man Whiffs
Poor, poor E. Stanley “Stan” O’Neal. All the guy did was to put in some very solid 9 to 5 days – every day – for 21 years at Merrill Lynch & Co. Inc. (MER) … so how does he get rewarded for his dedication and service? In a move that was labeled as an “early retirement” – fooling no one – Stan the Finance Man gets forced out by the very bureaucracy that he created. And for what? Oh sure, the company was forced to write down almost $8 billion in assets due to the ongoing mortgage crisis. And he did go behind their backs in an attempt to broker a buyout deal with Wachovia Corp. (WB), which may have paid him $250 million in a separation package. And his “greedy” investors remain upset that the stock price has plunged over 35% since early June.
While O’Neal was paid almost $50 million in compensation last year, he will not be receiving any severance and will have to live with retirement benefits and stock worth not quite $162 million, according to published reports. O’Neal’s departure marked the highest ranking Wall Street official to leave his duties as an “indirect” result of the current credit challenges. On the bright side, we can expect there may soon be some hiring at the top at such firms as The Bear Stearns Cos. Inc. (BSC), Citigroup, Bank of America Corp. (BAC), as well as some others, perhaps…. Good luck, Stan. Enjoy that well-deserved retirement.
While financial firms suffered through the Merrill announcement, a week of ratings downgrades, and other negative rumors and innuendoes, the Fed did its part to help support them by cutting the benchmark Federal Funds Rate by another quarter point, reducing it to 4.5%. While the move had been expected, investors are now concerned that Bernanke and friends may be done with such actions for awhile as they to balance the expected continued weakness against the very real potential of heightened inflationary pressures.
On the earnings front, this week’s reports were mixed at best (and somewhat confusing). Despite skyrocketing oil prices, both Exxon Mobil Corp. (XOM) and Chevron Corp. (CVX) posted weaker quarters as higher refining costs significantly cut into company margins. (Keep your chins up, guys – oil at $96 to $100 a barrel just has to be beneficial in the quarters to come – even if it’s not so hot for the overall U.S. economy).
While economists remained concerned about the pending disappearance of the “almighty consumer,” MasterCard Inc. (MA) announced a profit surge of more than 60% on greater-than-expected overseas spending. Additionally, retailer RadioShack Corp. (RSH) posted a favorable quarter and demonstrated that the reports of “the death of the consumer are greatly exaggerated.” [Given that I’m a nut about gadgets and electronics – including shortwave, or world-band, radio – my wife Robin asked just how much of beneficial role I played here, since this is one of my favorite stores. But since this past Saturday was my birthday, and I made sure to visit the local store, the real boost will likely be in the fourth quarter].
Finally, Procter & Gamble Co. (PG) warned that surging commodity prices would cut into future profits, and Office Depot Inc. (ODP) chose to take the quarter off (for a while) and not announce earnings, opting instead to offer that old reliable “accounting irregularities” excuse.
Investors digested the corporate news, Fed actions, and lower oil supply data, and scratched their collective heads about what the future holds. Early in the week, Google Inc. (GOOG) blasted through $700 a share (less than a month after eclipsing $600 – both of which we told Money Morning readers to expect) and techs propelled the Nasdaq Composite Index to a six-year high.
Like many other U.S. companies are doing right now, The Boeing Co. (BA) announced a new round of stock buybacks – typically a pretty good deal for investors, research studies show. Boeing is one of the global titans that several of our resident gurus favor as a stock that subscribers should research further [For a Money Morning research note update on Boeing, please click here. Like our other reports, this one is free of charge].
However, as oil prices moved closer to the dreaded $100 a barrel level, spiraling inflationary fears offset any euphoria from the expected rate cut and investors once again sought the safe-haven of treasuries. The Dow declined over 350 points on Thursday, and other major indexes followed (including those in Britain, Germany, France, etc.). The yield on the benchmark 10-year Treasury fell to about 4.30% on the latest allocation shift from stocks to bonds. With financials leading the bearish tone, O’Neal’s $161.5 million retirement package may not look quite so rich.
Economically Speaking…
* Reflects changes in interest rates over various time frames.
"Today's action, combined with the policy action taken in September, should help forestall some of the adverse effects on the broader economy…The committee judges that, after this rate cut, the upside risks to inflation roughly balance the downside risks to growth.” So after analysis and over-analysis of these (and other) statements by the central bank’s policymaking Federal Open Market Committee, economists and investors alike believe that the Fed may retire from the field, in terms of additional rate-cutting initiatives, and will instead take some time to really study the global financial battleground. Is inflation about to run wild? Is the economy slowing to a halt? Is the subprime-mortgage debacle today’s version of the Long-Term Capital Management hedge fund collapse, the dot-com Internet bubble, the Asian Contagion, and the Black Monday stock-market crash – but all rolled into one for added effect?
We hope not, but time will tell.
The two-day FOMC policy meeting was but one major story on the economic front last week. GDP advanced by a surprising 3.9% in the third quarter, its fastest clip in a year and a half, though doomsayers quickly predicted a weaker fourth quarter (with growth in the 1% range). While the unemployment rate held steady at 4.7% in October, 166,000 new jobs were added to the economy – an upbeat indication that the U.S. economy’s massive housing woes have not (yet) impacted the labor market. Even housing got a bit of a reprieve as September construction spending climbed to its best level in four months (though much of the activity was commercial-, or government-related). Manufacturing showed signs of a slowdown as the ISM index barely topped the crucial 50% level.
Oil finished the week at a still-steep $95.80 a barrel on the New York Mercantile Exchange, the U.S. greenback continues to weaken and gold finished the week at a stunning $808 an ounce – a level not seen since January 1980. For the week, the Dow was down 1.5%, the Standard & Poor’s 500 Index was off 1.7%, although the Nasdaq eked out a small gain.
All in all, however, the numbers were decent AND the Fed cut rates. So why are investors in such a tizzy? (Don’t answer…that was rhetorical.).
What to watch in the week ahead: ISM – Services (Today), Balance of Trade (Friday)
News and Related Story Links:
- Money Morning Investment Research Report:
Avoid the ‘Resurgent’ Homebuilding Sector and Go Global for Profits. - Money Morning Investment Research Report:
Five Ways to Profit as the U.S. Dollar Turns Into the “Bernanke Peso.” - Money Morning Investing Research Report:
Three Ways to Profit in Spite of the Fed’s Missteps. - USA Today:
Investors Cheer UBC, Citigroup Write-downs. - Money Morning News:
Investors Bolt From Citigroup in Light of Suggested Dividend Cut or Asset Sale. - Money Morning Investment Analysis:
Crude Oil Bull Could Bring About a Global Bear. - Money Morning Investing Research Report:
Google’s Stock Eclipses $600, Analysts Already Calling for $700. - Money Morning Investment Analysis:
Google to Hit $600 a share? Looks That Way, Media Writer Says. - Money Morning Investment Analysis:
Oil Heads For $100 a Barrel, While Some Speculators Brace for a Correction. - Money Morning Investment Research Report:
Boeing Announces $7 Billion Stock Buyback, Declares Dividend.
About the Author
Before he moved into the investment-research business in 2005, William (Bill) Patalon III spent 22 years as an award-winning financial reporter, columnist, and editor. Today he is the Executive Editor and Senior Research Analyst for Money Morning at Money Map Press.