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Markets & Finance

Stocks Keep Spiraling Down

A fifth straight day of losses ends with the Dow down 508 points, the S&P 500 under 1,000, and markets facing their worst year since 1937

When will the selling stop? That's the mystery.

Economic and credit worries sent U.S. stocks spiraling down for a fifth straight session Tuesday. The Dow Jones Industrial average lost another 508 points, while the broader S&P 500 index fell below the key 1,000 mark.

Tuesday's declines bring the Dow's loss for 2008 to almost 29% -- making it the worst year since 1937's decline of 32.8%. The S&P 500 is now down 32% -- also the worst drop since 1937, while the Nasdaq has lost nearly 34% this year. The markets still have a ways to go to beat the worst year of the Great Depression, 1931, when the Dow fell 52.7% and the S&P 500 plunged 47.1%.

"It's just a downward spiral of fear," says Richard Sparks, senior equities analyst at Schaeffer's Investment Research. He says he had hoped that today's action on the part of the Federal Reserve to buy commercial paper would help the market more than a rate cut that the market hoped for, but the market didn't stay up for long on that news. "The market hates uncertainty, and it's all we have."

Investors are uncertain about whether the financial rescue plan is the right one, if it will be enough to heal the credit markets, how it will affect world economies, and what will happen to corporate earnings, Sparks says. The outcome of the presidential election is another wild card.

Federal Reserve Chairman Ben Bernanke said in a speech Tuesday afternoon that recent economic data and financial developments show the outlook for economic growth has worsened and hinted that the Fed might cut interest rates. Bernanke said economic activity is likely to be "subdued" during the remainder of this year and into next year. He also defended the timing of the central bank's actions to cope with the severe financial crisis. Bernanke told the National Association for Business Economics that the outlook for inflation, while still a problem, has improved somewhat as oil and other commodity prices have eased.

Sentiment was also hurt by a dismal profit report from Bank of America Corp. (BAC), which also slashed its dividend in half and said it would sell shares to raise $10 billion in new capital. Other big financial names like Goldman Sachs (GS) and Merrill Lynch (MER) fell in sympathy. Morgan Stanley (MS) came off session lows after indicating that Mitsubishi UFJ Financial's (MTU) $9 billion investment in the firm is on track to close.

Selling picked up as investors continued to give up on stocks Tuesday. The blue-chip Dow Jones industrial average tumbled 508.39 points, or 5.11%, 9,447.11. The broader S&P 500 index lost 60.66 points, or 5.74%, to 996.23. The tech-heavy Nasdaq composite index dropped 108.08 points, or 5.80%, to 1,754.88, paced by weakness in Google (GOOG), which fell on an analyst downgrade.

On the New York Stock Exchange, 28 shares fell in price for every 4 that advanced. The ratio on the Nasdaq was 24-4 negative.

The Dow's drop below the psychologically important level of 10,000 on Oct. 6, followed by Tuesday's move below 1,000 for the S&P 500, is creating more fear in the market, Sparks says. He believes the VIX, considered a fear index for stocks, has to go even higher than Tuesday's close of 53.78 -- levels not seen since the early 1990s. "We need to have enough fear to have a washout and then build out a base to go higher," he says. He also notes that a bottom for stocks usually doesn't occur until you see more put option contracts (a bet that prices will fall) being bought than call option contracts (a bet that prices will rise). Now, more call options are being purchased than puts, Sparks says.

On the earnings front, the first look at September-quarter results are starting to trickle in. After the market close, Alcoa (AA) reported a 52% drop in third-quarter earnings because of sharply lower prices, weaker demand and higher costs. The aluminum producer said EPS was 33 cents, vs. 63 cents a year earlier (including a net gain of 25 cents for a sale). Revenue edged down 2% to $7.23 billion. Analysts on average were expecting earnings of 50 cents per share and revenue of $7.139 billion, according to Reuters Estimates.

Among industry groups on the move Tuesday, the S&P Other Diversified Financial Services index skidded nearly 13% after the BofA news. The S&P Automobile Manufacturers index was down almost 12% amid concerns about the credit crisis and how it's impacting the economy. Also losing ground: Automotive Retail (-8.3%) and Department Stores (-5.5%).

On the upside, Commodity Chemicals (+13%) was attracting investor attention after recent weakness.

Treasuries moved lower but traded well off early lows Tuesday afternoon. The 10-year note fell 05/32 to 104-11/32 for a yield of 3.47%, while the 30-year bond tumbled 18/32 to 108-19/32 for a yield of 4.00%.

Crude oil rose $2.28 to $90.09 a barrel on news that the Bank of England was finalizing an $80 billion plan to rescue its banks and the decision of the Reserve Bank of Australia to cut its rates 100 basis points. The news raised hopes that these actions would revive economies and increase demand for commodities. Gold futures also rose.

There were new developments Tuesday in the global financial crisis, including attempts by the Federal Reserve to revive the moribund U.S. commercial paper market, along with word that the Reserve Bank of Australia cut its key interest rate by 100 basis points. The move sparked speculation other central banks would follow suit, giving slumping economies a boost.

European finance ministers were meeting in Luxembourg about the crisis, and reached agreement on deposit guarantees.

In a speech at the National Association of Business Economics annual meeting Tuesday, Fed Chairman Bernanke said that market turmoil poses a higher threat to growth, and the Fed will need to "consider whether its current policy stance remains appropriate." He also added the inflation outlook has improved, but remains uncertain nevertheless.

"While the Fed chief is clearly leaving the door open for a rate cut ahead, amid downside expectations for growth, it's not clear it is a done deal yet, especially considering the recent liquidity actions," says Action Economics.

In a Q&A session after the speech, Bernanke said the inflation outlook is still "ugly," though it's gotten a "little better," and he expects the slowdown in global growth to help bring down commodity prices further. He also sees signs in wage and expectation data that inflation risks are lower. But, he reminded that the inflation outlook is very uncertain, the Fed hasn't done a good job in forecasting prices, and warns not to be complacent.

Bernanke said the "expansion of Federal Reserve lending is helping financial firms cope with reduced access to their usual sources of funding." Invoking Depression-era emergency powers, the Fed will begin buying commercial paper under a plan to buy massive amounts of this short-term debt in an effort to break through a credit clog that is imperiling the economy.

Bernanke said he believed the Fed's bold actions will help restore confidence in financial markets and help them function more normally. "We have learned from historical experience with severe financial crises that if government intervention comes only at a point at which many or most financial institutions are insolvent or nearly so, the costs of restoring the system are greatly increased. This is not the situation we face today," he said.

The release of the notes from the August FOMC minutes showed that inflation remains worrisome.

The Fed announced the creation of the Commercial Paper Funding Facility (CPFF). The Fed will provide liquidity through a special purpose vehicle (SPV), taking on three-month unsecured and asset backed commercial paper. The SPV will be funded by the Treasury. The Fed tentatively plans to run the unit through April 30.

In a knee-jerk reaction, the overnight commercial paper rate fell 74 basis points to 2.94%, reports Action Economics, but the 7-day rate climbed 125 basis points to 4%, while the 30-day rate rose 16 basis points to 4.16%.

"We believe that the Federal Reserve must now act as a clearing house, guaranteeing that institutional transactions clear (and investors receive) their Big Macs at the second window," wrote PIMCO managing director Bill Gross in his monthly website posting. "They must also take another bold step: outright purchases of commercial paper. They should also cut interest rates to 1%, because we are experiencing asset deflation, and the threat of headline inflation is long past."

Gross also predicted a lengthy recession, though not a depression.

There was more news from the U.S. banking sector Tuesday, and it was not good. Bank of America Corp. (BAC) posted its third quarter results early, reporting earnings per share of 15 cents, vs. 82 cents one year earlier, with the current quarter hurt by a significant increase in provision expense, as credit costs continued to rise, partially offset by advances in various income categories largely as a result of its acquisitions of Countrywide Financial and LaSalle Bank. Revenue net of interest expense rose 21% to $19.9 billion.

BofA reduced its quarterly dividend 50% to 32 cents, and commenced a public offering of about $10 billion of of common stock. The two capital-raising initiatives target an 8% Tier 1 capital ratio for the bank.

S&P Ratings Services revised its outlook on Hartford Financial Services (HIG) to negative from stable. S&P affirmed its A counterparty credit rating on Hartford and its AA counterparty credit and financial strength ratings on all of Hartford's core insurance operating units. The negative outlook reflects Hartford's reduced financial flexibility because of the increase in leverage and related material reduction in fixed-charge coverage levels resulting from the investment in the company by Allianz SE (AZ) and an expected softening of its operating performance. A.M. Best placed its rating under review with negative implications.

The Reserve Bank of Australia, in a stunning move, cut its benchmark interest rate 100 basis points to 6.0% -- the biggest cut in 16 years -- in an attempt to insulate banks, households and firms from a meltdown in global financial markets. The reduction following RBA's monthly meeting was twice the size analysts had expected and the biggest single cut since May, 1992.

The cost of borrowing in dollars overnight in London jumped as U.K. lenders held talks with the government on emergency funding and Iceland nationalized its second-biggest bank amid an unprecedented credit squeeze. The London interbank offered rate, or Libor, that banks charge each other for such loans rose 157 basis points to 3.94% on Tuesday, the British Bankers' Association said. The corresponding rate for euros climbed 22 basis points to 4.27%, the highest in four days.

Bloomberg reported the seizure in global credit markets is deepening on speculation central bank attempts to revive lending between financial institutions won't work, resulting in more bank failures.

A report by the BBC suggests the UK's three largest banks, RBS (RBS), Lloyds TSB (LYG), and Barclays (BCS), estimate they need 15 billion pounds sterling each, with 7.5 billion pounds paid up front and a further 7.5 billion pound guarantee by the UK Treasury. On Monday, S&P Ratings Services lowered long- and short-term counterparty credit ratings for RBS to A+/A-1 from AA-/A-1+.

Bloomberg reports Spain will set up a €30 billion fund to buy bank assets in an effort to spur lending, Prime Minister Jose Luis Rodriguez Zapatero said. The fund, which may be increased to €50 billion, will buy "assets of the highest quality" and will be shut down when market conditions normalize, Zapatero said.

Iceland said it's negotiating a €4 billion (US$5.43 billion) loan from Russia and took control of Landsbanki Islands hf, its second-largest lender.

On Tuesday, European indexes were mixed as they attempted to regain their footing after a sharp sell-off Monday. In London, the FTSE 100 index was higher by 0.35% to 4,605.22. In Paris, the CAC 40 index rose 0.55% to 3,732.22. Germany's DAX index shed 1.12% to 5,326.63.

In Japan, the Nikkei 225 index fell 3.03% to 10,155.90. Hong Kong stocks were closed for a holiday, Shanghai stocks fell 0.73%.

Among other U.S. stocks in the news Tuesday, Advanced Micro Devices (AMD) and Advanced Technology Investment Co. (ATIC) of Abu Dhabi created a semiconductor manufacturing company, known as The Foundry Co. Mubadala Development Co. will increase its current investment in AMD to 19.3% on fully diluted basis. AMD will contribute to new company its manufacturing facilities, related assets, and intellectual property rights. ATIC will invest $2.1 billion to purchase its stake in The Foundry Co.

Genentech (DNA) and Biogen Idec (BIIB) report a Phase III study of Rituxan in combination with fludarabine and cyclophosphamide chemotherapy met its primary endpoint of improving progression-free survival, as assessed by investigators, in patients with previously treated CD20-positive chronic lymphocytic leukemia compared to chemotherapy alone.

Barclays reportedly downgraded IBM Corp. (IBM) to market weight from overweight.

TRW Automotive (TRW) announced the withdrawal of its 2008 sales and earnings guidance provided on July 31, 2008. The company expects a net loss for the third quarter on lower than anticipated sales and significantly higher restructuring expenses and increased commodity costs.

Landry's Restaurants (LNY) says it been informed by Tilman Fertitta, the company's chairman and CEO, that in view of the closure of the company's Kemah and Galveston properties, instability in credit markets, and deterioration in casual dining and gaming industries, the debt financing required to complete the pending merger transaction is in jeopardy at its current $21 per share price. The company notes Fertitta has further advised that he's in negotiations with Jefferies and Co. (JEF) about the financing for a transaction at a substantially reduced price.

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