Market Week Wrap-up

Another week of crisis. A week that evoked gallows humor: "Apocalypse Dow" said one quipster. The credit freeze hardened all week long, with overnight dollar libor fixings rising to a weekly high of 5.38% on Wednesday, not far from the 6.88% level reached seven days prior, while three-month dollar libor marched steadily upwards through Friday to 4.75%. On Tuesday the Fed offered to lend directly to companies needing short-term credit in an attempt to defrost CP--a radical move that failed create an instant jolt of confidence, but showed some evidence of lubricating the CP market by the end of the week, as overnight CP rates began to fall. Then the long-rumored coordinated rate cut slammed into markets on Wednesday morning, with most major central banks cutting 50 basis points, but this too was not enough to unstuck the credit market. The coordinated rate action led to a brief equity rally, but stocks fizzled by the end of the day and fell sharply the next. The Treasury followed up on Thursday by promising to use the powers granted to it under TARP to inject cash directly into banks in return for ownership positions. The SEC let the short selling ban expire without an attempt at renewal, garnering praise and condemnation from various quarters. Fear completely took over by Friday, with the Nikkei posting its worst week on record as it lost over 2500 points to close at 8,276, and European markets dropped sharply. US markets took a sickening nosedive from the open (leading the VIX volatility index to hit all-time highs above 70 by early afternoon), plunging over 700 points, and then turned around for an equally ebullient rally before the close on very heavy volume.

On a technical basis, Friday's action may have signaled a capitulation bottom for the time being, though the return from the brink may have been aided by the dubious hope that the G7 or the Treasury may ride to the rescue again with more dramatic announcements this weekend. The DJIA ended the week down 18.2% at 8452, its biggest one week drop on record. The S&P500 lost 18.4% and the Nasdaq Composite lost 15.5%.

Events in Europe exacerbated volatility in US trading throughout the week. The race downwards got underway early on Monday, with European indices losing 8-10% after Euro Zone finance ministers failed to work out any kind of plan for dealing with the crisis at their weekend conference. On Tuesday, the UK and Icelandic banking sectors rocked the boat in a big way: in the UK, Prime Minister Brown said the government would invest $79B in a bailout of the country's three largest banks, while Iceland took possession of Landsbanki, the nation's second-largest lender. European governments and finance ministers spent the rest of the week responding to (or bickering over, if you will) the British proposal. On Friday, Italian Prime Minister Berlusconi ad-libbed that world leaders might seek to halt markets for a global bank holiday, but then withdrew the statement.

The shape of the yield curve looked more like the streets of San Francisco as it wavered between steeping and flattening shapes throughout the week. US two-year and 10-year remained at the 209 bps area and various swaps remained highly elevated. After approaching multi-year and in some cases historic lows US Treasury yields are moving higher. The two-year yields dipped towards 1.3% before rallying some 15 basis points. The US benchmark curve did get as steep as 210 basis points. There has been only marginal improvement in US TED and LIBOR OIS spreads. Although various market participants have affirmed their support for this morning's coordinated rate cut, several notable names have indicated more cuts will likely be needed. To that end the Nov fed fund future is close to fully pricing in another 25 basis point cut by the next FOMC meeting.

With their rivals either bankrupt or acquired, Morgan Stanley and Goldman Sachs had the chance to spend a week in the hot seat under siege by nervous investors. Morgan Stanley took the bulk of the abuse, as rumors and commentary circulated all week long that Mitsubishi UFJ would imminently revoke its $9B investment in the firm. Both companies repeatedly insisted that the deal was on, but nothing helped the stock. Meanwhile, Moody's placed the long-term debt ratings of Morgan Stanley on downgrade review. Morgan Stanley fell about 60% on the week, well below the $25.25/shr level at which Mitsubishi announced it would take a stake, and ending the week with a market capitalization of only $10.3B. The catalyst for Goldman seems to be comments early in the week that Goldman was a significant counterparty for AIG, with "billions in CDS." Goldman is down more than 30% on the week. The uncertainty around the Lehman CDS auction conducted Friday, also weighed on the former investment banks. In the end, auction set the value at $0.08625 on the dollar, which may force sellers of Lehman CDS protection to make cash payments of over $270B according to some reckonings.

Elsewhere in financials, Citigroup and Wells Fargo looked liked they would engage in full-fledged legal combat over Wachovia early in the week, before signing a "litigation standstill" on Tuesday, to work out a deal to split up Wachovia's assets. By Thursday, however, Citigroup ceded all of Wachovia to Wells Fargo, but vowed to press forward with a suit seeking $60B in damages citing breach of contract, and "tortious interference."

The energy complex tumbled all week as fears of a global recession mounted. Crude fell almost 14% closing the week at just over $80/bbl, its lowest level in over a year. Natural Gas and Heating Oil futures also hit a one year lows, even with winter just around the corner. Other commodities and their related stocks also continued their historic fall. The Oil Service Holders (OIH) dropped 30%, while copper futures slumped 17% to two and half year lows.

This commodities slump was reflected in Alcoa's earnings report on Tuesday, ringing in the new earnings season. Alcoa noted that it sees 2008 global aluminum demand up 6% (down from the prior 8% forecast). GE reported third-quarter results in-line with expectations before the bell; the firm also reiterated its full-year guidance and maintained its dividend. CEO Immelt insisted that he believes the dividend is safe, and that if the economy is not as bad as feared full-year earnings could come in at the high end of the predicted range. Costco reported earnings and revenue that were stronger than expected, complementing their strong same-store sales showing. Monsanto lost much less than expected for the quarter, although the fertilizer name also guided well under estimates for FY09. And in a sign of more bad news to come, many companies cut guidance in advance of earnings, in attempts to shape expectations. In attempts to get out ahead of the ugly market, many well known names such as Bank of America, Macy's, eBay, Ace Ltd., and Prudential all preannounced disappointing results. IBM announced its earnings on Wednesday afternoon in an attempt to reassure jittery investors, disclosing earnings for the quarter well ahead of the Street and y/y increases in gross margins. The CEO insisted that the numbers show the company's competitive edge "in good times and bad."

Insurance firms have been plagued with uncertainty every since Senate Majority Leader Reid hinted last week that he had information showing an unnamed major insurance company was close to collapse. Nearly all of the major US insurance companies have faced severe declines in their share prices this week, with assurances from sources that Senator Reid was talking about a private insurance company not calming anyone. Early in the week MetLife sold 75M common shares and pre-announced results, noting that its premiums, fees and revenues are up y/y but withdrew its full-year outlook. Both Prudential and Lincoln National got hit by panicky investors on Thursday, with Lincoln spiking down more than 20% and Prudential spiking down more than 30%. Prudential said it is facing the impact of multiple charges from losses and suspended its buyback. Lincoln pre-announced results that were not so far below estimates, itemized its sources of liquidity and cut its dividend.

The week's September same-store sales reports showed US retail firms under pressure, with a few exceptions. Note that many companies reported early due to the Yom Kippur holiday, helping to add to the negative sentiment ahead of Wednesday's coordinated rate cuts. In line with recent months, discount big-box retailers Wal-Mart, BJ's and Costco maintained positive sales, with Costco leading the pack with sales up 9%. High-end, specialty retailers Buckle and American Apparel have also defied the general downtrend, with both reporting sales +15% or more for the month. Higher end department stores were hit particularly hard, with JC Penny sales down more than 12%, Saks falling more than 10% and Dillard's down 12%. Kohl's and Target fell slightly less, at -5.5% and -3%, respectively. Nearly all of the remaining reports were negative, with the overwhelming majority citing the difficult economic conditions behind the declines.

The continuing credit market seizure has caused bank bailouts to spread through Europe and this has deeply impacted sentiment on the equity front as Europe Safe have flows into Government bonds coupled with a continued rotation out of stocks and commodities. Gold displayed a decoupling effect against the USD. One dealer defined it as the 'Revenge of the carry trade" as thin liquidity conditions usually associated with calendar yearend markets appear to take hold in early October. The USD was also benefiting from the lack of coordinated action from European and G7 in addressing the financial market crisis. The Ecofin issued a Communiqué noted that the EU would support "systemic" financial companies, adding that the support should come from national governments.

All eyes are turning toward G7 as the finance minister gather today in Washington. European leaders may also hold an emergency meeting on Sunday in Paris, and there were rumors of a formal G8 summit of World leaders might be called soon to discuss the financial market situation. But dealers are skeptical as to what the central banks and politicians can do, with one summarizing the 'panic' as being driven by the vicious cycle of continuing deleveraging, margin related calls coupled with declining fundamentals. As the G7 convenes there are calls for another round of coordinated interest rate cuts and speculation that currency intervention could result. Ideas range from blanket guarantees of all deposits, freezes on foreclosures and unlimited massive liquidity injections, public provision of credit, massive direct government stimulus, public recapitalization of banking system, and borrower-lender agreements at the state level to maintain orderly financing of deficits. But even before the meeting and the expected 6pmET press release from the summit, the Italian finance minister said he would not sign the statement because of the 'weak' language.

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