Coming Week: Bear(s) Set Agenda
Nat Worden
03/15/08 - 10:01 AM EDT
After propping up
Bear Stearns (BSC) with emergency cash last week, the
Federal Reserve will now attempt to rescue the U.S. financial system with more interest rate cuts aimed at shaking the credit markets out of a fear-induced paralysis.
The Fed, set to meet and unveil fresh cuts to its short-term rate target on Tuesday, needs investors to start trading mortgage-backed securities again or the U.S. economy could be facing a calamity of unprecedented proportions.
The central bank has already gone to extraordinary lengths to inject fresh liquidity into the markets, but so far, it has been unable to achieve its aim.
"The Fed is providing liquidity, but you still have to have buyers and sellers to match trades to revive the markets," says Paul Mendelsohn, chief investment strategist with Windham Financial Markets. "The problem is that you have sellers but you've got no buyers. The market is totally shut down. This is a potential systemic problem for the system. There's got to be other people having problems here if Bear Stearns is having problems here."
On Friday, Bear Stearns revealed that
JPMorgan Chase (JPM) was acting as a conduit for the Fed by borrowing emergency funds from its so-called discount window and relending them to the bank for 28 days so it could meet its obligations.
Loaded with mortgage-backed securities that are being spurned by investors amid the steepest declines in the U.S. housing market since the Great Depression, Bear Stearns said its "liquidity position in the last 24 hours had significantly deteriorated" amid rumors of a cash crunch. The investment bank's stock crashed 47%. Its desperate circumstances echoed earlier news that a big fund managed by the Carlyle Group, an elite private equity firm, was facing collapse.
Four days earlier, Bear Stearns CEO Alan Schwartz appeared on
CNBC and said the bank's "balance sheet, liquidity and capital remain strong." The sudden reversal reflects a market gripped by panic, and it only reinforced a mass loss of confidence that is spreading. Unless the Fed can stabilize financial markets, former Fed governor Lyle Gramley says more such disasters may be in store.
"We're in a situation now where, unlike previous recessions, pushing down on the monetary accelerator by the Fed doesn't seem to be working," says Gramley. "We're in a situation where we have to anticipate that the unemployment rate is going to go up, foreclosures are going to increase and home prices are going to continue under downward pressure. If the Fed is unable to turn this situation around, then we could be in quite a dire situation."
Gramley says other forms of government intervention will soon be necessary.
"The Fed can't bail out a bank -- certainly not an investment bank," he says. "If those institutions are going to be bailed out, it has to be something cooked up by the federal government. We have to be thinking outside the box about innovative ways we can deal with this situation. Because it's unlike anything I've ever seen before, and it poses some very serious risks to the economy."
Despite all the turmoil, the major stock indices were mixed for the week. The
Dow gained 0.5%, the
Nasdaq was flat, the
S&P lost 0.4% and the Russell 2000 was 0.4% higher.
Fed funds futures are pricing in a 75-basis-point rate cut from the Fed next week on top of the 225 basis points it has slashed from its fed funds rate target since September. Recent data from the government have shown signs of inflationary forces building amid the Fed's moves, but last week's consumer price index reading for February showed no rise in prices during the month, even with volatile energy and food prices included.
The benign report showed a decline in energy prices that stands in stark contrast to record gains for crude oil futures prices trading on the Nymex, which recently hit $111 dollars a barrel.
"Have you paid your heating bill lately or filled your gas tank?" asks Arthur Hogan, chief market analyst with Jefferies. "That report really doesn't wash with reality, so investors will be taking a close look at February's reading on the producer price index on Tuesday. That was such an eye-popper last month."
The Labor Department reported its producer price index rose 1% in January, more than twice the 0.4% increase expected. On a year-over-year basis, the index jumped 7.4% -- its biggest advance in more than two decades -- but the Fed signaled it would continue to cut rates to ease Wall Street's credit crisis.
"The Fed will drive through a red light right now," says Hogan. "The Fed has a dual mandate. One is to control inflation and the other is to promote economic growth, and they are completely putting inflation to the backburner right now given all this turmoil."
Meanwhile, Wall Street's major investment banks will start reporting first-quarter earnings next week, and investors are plugging their noses in anticipation of more big writedowns on mortgage-backed securities and other forms of consumer credit. Unlike the lead-up to fourth-quarter reporting, banks have issued no warnings about more writedowns this time around, but expectations for the industry's earnings performance have been falling off a cliff.
Thomson Financial analyst John Butters says that while analysts on Wall Street were expecting the financial sector to report an 11% year-over-year decline in first-quarter earnings when the period began, they're now expecting a 49% drop.
Bear Stearns will report after Monday's closing bell. At the beginning of the year, analysts on average were expecting the bank to report earnings for the quarter of $2.06 a share. Now they're predicting only 90 cents, according to consensus estimates reported by Thomson.
Lehman Brothers(LEH) is scheduled to report on Tuesday, and analysts are expecting earnings of 72 cents a share, down from the $1.62 they were expecting on Jan. 1.
Goldman Sachs(GS) is also on tap for Tuesday, and analysts are expecting earnings of $2.58 a share -- down from $5.64.
Morgan Stanley(MS) will report on Wednesday.
Citigroup(C) and
Merrill Lynch(MER), two investment banks that suffered big fourth-quarter losses due to writedowns on mortgage-backed securities, will report results in April.
Mendelsohn says he moved his clients heavily into U.S. Treasury money market funds back in August when the credit crisis began to protect against the risk of a major market selloff.
"There are certain steps one can take here to be defensive, but investors should not panic," Mendelsohn says.
He notes that stocks in some sectors -- such as technology, telecommunications and pharmaceuticals -- are trading at attractive valuations on a long-term basis.
"I was going to come in this morning and start to put on some positions just to give myself a little boost here coming into the end of the quarter," he told
TheStreet.com on Friday. "But with the news this morning about Bear Stearns, I've just put everything on hold, and I'm waiting for my computer modeling to absorb what it's seeing here and give me some direction."
