The credit crunch will remain market participants' foremost concern next week as they take the weekend to digest the stock market's plunge.
For investors who have withstood several mini-corrections over the past few years without a 10% pullback, the typical response to a bad week has been to buy the dips. Friday afternoons often meant loading up long positions and waiting for the merger and acquisition deal announcements to flow. Merger Mondays became status quo.
Not this week. The major stock market indices may be on their way to a more serious decline.
"Much of the market's recent gains were undoubtedly riding on the back of what was still-ample global liquidity and takeover speculation," writes Liz Ann Sonders, chief investment strategist at Charles Schwab. "Because some of that liquidity was of the 'financially engineered' variety and appears to be drying up a bit -- and the pace of takeovers is now in question -- the bears took the reins."
Dow Jones Industrial Average
fell 4.2% in the week and is 5.2% below its 14,000.41 high on July 19. The bulk of the losses occurred in the 311-point and 200-point drops on Thursday and Friday. It closed the week at 13,285.47 after a brief attempt at a rebound.
finished at 1458.95, down 4.9% in the week and 6.2% from its high. The
fell 4.7%, putting it 5.8% lower than its July high.
Small-cap companies, housing-related stocks and financials were hit hardest amid concerns that consumer debt delinquencies that led to a mispricing of risky assets tied to mortgages are spelling tighter lending standards for investors like hedge funds and for corporations.
These sectors are likely to remain under pressure next week as any news about the slowing pace of consumer spending and housing will likely hurt the markets.
On Tuesday, June's counts of personal income and spending and construction spending come in. Personal spending is expected to rise just 0.1% in the month, much weaker than May's 0.5% rise.
Also, with the news of backed up and delayed M&A deals streaming in, instead of feeling confident that
Kohlberg Kravis Roberts
might unveil its latest prey Monday morning, investors are scared that deals will dry up as underwriting banks are increasingly saddled with the financing on their own balance sheets.
This will continue to have investors nervous about the investment banking sector, where the likes of
, among others, have committed financing to some nearly $300 billion of looming deals in the junk bond and loan pipeline.
Indeed, market participants seem worried that already-announced deals may not go through amid much tougher financing conditions. Certainly, troubled companies in troubled industries have only a harder road ahead, public or private, if they can't finance their growth cheaply.
Also, hedge funds suddenly under pressure from credit market weakness may be unwinding some of their merger arbitrage bets, according to news reports.
Could real estate magnate Sam Zell back out of his $8.2 billion bid to buy
? Or is the $45 billion deal for Texas utility company
just too big?
Tribune posted weak profits this week, and TXU, which would be the largest leveraged buyout ever, is being pressured by a recent decline in the price of natural gas, according to reports. Another large deal looming on the horizon is the $29 billion buyout of
First Data Corp
, which investors say they expected mid-July, but was pushed to after Labor Day.
Tribune closed at $28 per share Friday, a 17.6% discount to the $34 a share offering price Zell has on the table. TXU is trading at a 5% discount to the bid price from TPG and KKR, and First Data is below KKR's bid by 5.7%.
The flow of deals that has in the past provided a floor for the stock market is not the only fear factor for traders next week.
Investors will get their latest read on inflation with the core personal consumption expenditures index that is reported with personal spending and income on Tuesday. The consensus of analysts expects the measure to come in 0.2% higher in June. Currently core PCE is running at 1.9% year over year and is within the
so-called comfort zone.
If inflation ticks up however, the markets are likely to fret over a new crunch for the central bank. With the recent credit market woes, market participants have started to unwind the "Goldilocks" economy theory, instead pricing in the potential for a rising default rate, and a Fed rate cut.
According to Miller Tabak, the market is putting 100% odds on a Fed rate cut by year end for the first time since May 2. Last week, the odds were just 36%.
Meanwhile, the Treasury market is expected to continue to receive the flight-to-quality bid, which has pushed the yield on the 10-year note to levels not seen since May, as well. The 10-year ended the week at 4.78%, down from 4.96% last Friday.
The prevailing winds have shifted, and the sentiment, which is becoming more bearish in stock and credit markets, seems to also be growing bearish on the economy.
"With risk more aggressively priced, tightening credit conditions may further deepen and elongate the housing correction and increase consumer and business caution," writes Peter Kretzmer, chief economist at Bank of America. "We expect businesses to reduce hiring and increase layoffs in coming months, leading policymakers to focus more on downside risks."
Lastly, earnings season continues next week, with
among the names on the schedule.
In keeping with TSC's editorial policy, Rappaport doesn't own or short individual stocks. She also doesn't invest in hedge funds or other private investment partnerships. She appreciates your feedback. Click
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