Fear of the three D's - deleveraging, deflation and Depression - has gripped markets this week, with myriad problems faced by the economy weighing heavily on investors. The non-event that was last weekend's G20 meeting destroyed hope for coordinated economic rescue plans from the major industrial countries. Then early in the week Treasury Secretary Paulson said that he would not draw the second $350B tranche of TARP funding, electing to leave the funds in reserve until the new administration takes over next January. By Thursday GM was trading well below $2, Citigroup sank below $5 and the VIX volatility index, a widely followed measure of fear in the stock market, headed back above 80 for the first time since the October panic. Word that President Elect Obama had chosen New York Fed's Timothy Geithner as his treasury secretary sparked a late rally on Friday, making up a significant portion of the week's losses while eliminating one more chance for capitulation. For the week, the DJIA fell 5.3%, the Nasdaq composite dropped 8.8%, and the S&P 500 slumped 8.4%, hitting an 11 year low.
The fragile state of the US auto industry was on full display this week as Congress held two days of hearings on a potential auto industry bailout and then failed to even bring a rescue bill up for a vote. On Monday the White House foreclosed on any chance of drawing funds from TARP the auto industry turning the package into a political football as Democrats spurned any deal that would not be carved out of the TARP. Senators Levin, Bond and Voinovich made a last ditch attempt to work out a bipartisan aid bill on Wednesday and that would redirect the already authorized $25B in funding as financial support, but ultimately the effort failed. The Democratic Congressional leadership indicated that they were prepared to hold a legislative session in the first week of December on automakers aid, but insisted that the industry had to bring them a viable plan for reorganizing themselves before any package would be passed.
Shares in Citigroup have been declining steadily all year, but things took a dramatic turn this week after CEO Vikram Pandit announced substantial job cuts at a company-wide “town hall meeting” on Monday morning. Then on Wednesday Citi said it would bring $80B worth of assets from its SIVs back onto the balance sheet. The move unnerved shareholders, given that the holdings involved aren't garden-variety securities but rather tricky, potentially toxic assets like CDOs. Saudi Prince Alwaleed made a vote of confidence in the company's restructuring plans, pledging to boost his stake back up to 5% from about 4.3% prior, noting that he believes Citi is taking "all the right steps," and that its banking model is a "long-term winner," but things were looking dire on Thursday and Friday. Citi's shares broke $5.00 an hour after the open on Thursday and broke $4.00 not long after the open on Friday. The sharp declines fired up the rumor mongers, led by CNBC's Charlie Gasparino, who insisted that Citi was possibly looking for merger partners, including Goldman, Morgan Stanley and State Street. Nothing came of the rumors on Friday, but there's no doubt we will be hearing a lot more about Citi this weekend and through next week.
Yahoo co-founder and CEO Jerry Yang finally threw in the towel and announced on Monday that he is stepping down from the helm. Investors responded enthusiastically to the news at first, sending Yahoo's shares up around 16%, although the shares were making fresh five-year lows later in the week. Analysts and observers immediately began speculating on the probability that a Microsoft deal is back in play, although Microsoft CEO Steve Ballmer told investors at a shareholder meeting that talks with YHOO over an acquisition are finished and that MSFT has no active talks with Yahoo, although a search deal could be interesting.
Dow component Hewlett-Packard offered preliminary fourth-quarter data showing that earnings and revenue will be more or less in line with expectations. But other tech news was less reassuring. The Semiconductor Industry Association (SIA) projected that 2009 semiconductor sales will fall by 5.6% y/y, making for the first decline since 2001, while flash memory titan Sandisk cut its 2009 CAPEX guidance to $900M from $1.3B prior.
On Wednesday BASF, the world's largest chemical company, said it was slashing output, shutting plants and laying off workers due to massive declines in demand among key industries. The company plans to shut down 50% of its production capacity, shuttering nearly 80 plants worldwide and reducing production at another 100 plants. BASF said that customers in the automotive industry have canceled orders at short notice and noted that volumes are being negatively impacted by increased reduction of inventory due to a lack of credit in customer industries.
Most of the leading companies in the retail sector reported third quarter results this week. Generally speaking firms disclosed results that held up fairly well in the quarter, although this reporting period ended before the crisis in credit markets had fully spilled over into the “real” economy. Home improvement giants Home Depot and Lowe's came in ahead of earnings and revenue estimates, although both firms cut their full-year outlook slightly. Target met EPS targets, missed revenue estimates by a hair and suspended its stock buyback program. The Gap held things together, reporting in line with estimates, and even managed to maintain its outlook for the year.
The positive correlation between stocks and commodities has held good as investors around the world look to or are forced to sell a variety of assets as part of the dreaded deleveraging process. The woes continue in the energy complex as demand destruction and severe recession concerns hobble prices. Front-month crude closed the week below $50 for the first time since May 2005. Average gasoline prices in the US fell below $2/gallon for the first time since March 2005. Natural gas remains near multi-year lows despite a brief uptick early in the week upon the arrival of winter temperatures in the Northeast. Metals futures also remain under pressure led by the industrials. Front-month copper touched fresh three-year lows while aluminum traded at levels not seen since 2004. Gold futures rallied hard on Friday sending the December back above $800 for the first time in nearly a month. Speculation swirled that it was likely the Chinese in the market driving up prices after earlier in the week the Hong Kong Standard reported the PBoC was considering diversifying its currency reserves, and that it could result in the purchase of up to 4K tons of gold.
Trading in fixed income markets was dominated by what can best be described as a stampede to safety. Worries about the deteriorating economy and in particular the functioning of major financial institutions sent US Treasury yields to historic lows. Interbank lending rates remain well off the highs seen at the height of the credit crisis last month, but little if any improvement in actual lending activity was seen this week, enabling the US three-month TED spread gain traction above 210 basis points. Rumors of pending defaults in the commercial mortgage-backed securities market amplified risk aversion as the spreads spiked. The insatiable desire for cash and cash equivalents helped slash the yield on the three-month T-bill to 0.01%, a level last seen way back in 1940. On Thursday, the two-year cash yield moved below 1% for the first time and along with the long bond yield reached record lows before rebounding on Friday.
The surprise 100 basis-point cut by the Swiss National Bank spurred speculation that coordinated rate intervention was possible before next week's Thanksgiving Day holiday. Subsequent commentary from both Fed and ECB officials indicated they were likely to continue down the path of quantitative easing even as we move towards zero in the US. Midweek the Jan fed fund future priced in as much as a 40% chance the Fed cuts 75 basis points by year end before backing off, though that contract continues to fully price in a 50 basis point cut a next month's FOMC meeting. Trading is likely to remain thin next week with focus finding its way to Monday's existing home sales data and the 2 and 5-year note auctions.
The global recession inducted another member this week as Japan officially dipped into recession for the first time since 2001, with its Q3 GDP dropping to -0.1%, the second straight quarterly contraction. A monthly Japanese government report showed that the deepening financial crisis was spreading to Asia, lowering forecasts for the economy and export sector again. Global recession concerns are also highlighted by recent steel production statistics, which showed a decline of 12.4% in Oct from year-earlier levels with Chinese output dropping 17%. y/y. Meanwhile, a Goldman Sachs analyst revised his forecast for Q4 real US GDP to -5.0% from prior view of -3.5% and projected that the US unemployment rate would rise to 9% by the end of 2009 against its prior view of 8.5%. Warren Buffett also chimed in on unemployment, stating he expects the jobless rate to rise considerably higher than the Fed estimate of 7.1%-7.6% in 2009.
In Forex, the overall theme for the USD as the week commenced was the prospect for a trading range with EUR/USD pair seen between 1.24 to 1.28. European currencies moved higher as the week began on chatter that a Far Eastern central bank was covering its recent GBP short position. The USD exhibited some weakness mid-week but maintained its recent overall consolidation range. Looking at the big picture, the EUR/USD continued a broader consolidation after hitting lows back on Oct 27 at 1.2330 with 1.24 to 1.2850 seen continuing. Dealers noted that the five-week euro downtrend line was broken above the 1.2690 level on Wednesday
In regards to suspicions of intervention, one dealer noted that the USD weakness was complemented by good demand from “supra nationals,” prompting speculation that the moves could be some kind of stealth action to calm recent extreme FX moves. By Thursday the theme of risk aversion returned in a big way as multinationals continued to announce plans to reduce output and employment. The USD encountered some week-ending profit taking aided by comments from ECB's Mersch who noted that large rate cut would be counterproductive. Other ECB members, however, signaled they are still open to further rate cuts with Paramo stating that it is “not improbable” that the ECB will cut at its December meeting.
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