Major U.S. stock indexes gave up early gains and finished lower on Monday, as a rally in financial stocks sputtered and oil prices showed more strength, overshadowing encouraging M&A activity and some better-than-expected earnings reports.
On Monday, the Dow Jones industrial average fell 29.23 points, or 0.25%, to 11,467.34. The broader S&P 500 inched down 0.68 points, or 0.05%, to end at 1,260.00. The tech-heavy Nasdaq composite index finished down 3.25 points, or 0.14%, at 2,279.53.
Some deal news helped lift the mood early Monday after Swiss pharmaceutical maker Roche Holdings AG (RHHBY) offered $43.7 billion in cash for the remaining shares of its U.S. biotech partner Genentech (DNA), adding to the 55.9% of the company it already owns. The offer translates to $89 per share, 8.8% above Genentech's closing price on Friday and 19% higher than the price a month ago. Roche is taking advantage of the weak U.S. dollar to get a bigger share of earnings from Genentech drugs such as Avastin, which treats cancer. The deal is expected to add to Roche's earnings in the first year of full ownership.
But the drug sector got some bad news in the afternoon. Merck (MRK) and Schering-Plough (SGP) shares dropped after results from a clinical trial showed no significant difference in reducing aortic valve disease between groups using the cholesterol drug Vytorin and those given placebos, but the subsidiary safety analyses showed greater instances of cancer among those treated with Vytorin. Earlier Monday, Schering postponed the release of its second-quarter financial results until after Monday's market close, instead of the previously scheduled 8 a.m. EDT release. Also earlier, S&P maintained its hold opinion on Schering, and Goldman upheld its buy rating. Shares of Merck, Schering's partner in Vytorin, were also down, but not as sharply as Schering.
Financial stocks came off highs of the session. Bank of America (BAC) shares rose on better-than-expected second-quarter earnings of 72 cents a share, vs. $1.28 a share a year ago, as merger and restructuring costs offset a 3.5% rise in revenue and a 26% rise in net interest income. Analysts had projected earnings of 53 cents in the latest quarter. The bank said its provision for credit losses increased by $3.45 billion from a year ago to $6.55 billion. The latest results excluded Countrywide Financial Corp., which Bank of America acquired on July 1. Standard & Poor's upgraded the stock to sell from strong sell.
A Securities and Exchange Commission's emergency rule that limits short-selling of 19 financial stocks went into effect on Monday and boosted some of those stocks. Among the top gainers were home mortgage giants Fannie Mae (FNM) and Freddie Mac (FRE).
Freddie Mac said it may purchase fewer home loans from banks and bonds backed by housing debt to fortify its capital amid record delinquencies. The company is also considering selling securities and cutting its dividend as it prepares to issue $5.5 billion of stock.
The recent bounce in financial stocks aside, the 87% drop in the S&P 500 Thrifts and Mortgage Finance Industry Index from peak to trough so far exceeds the peak-to-trough decline in the Nasdaq after the tech bubble burst and "reflect[s] the outlook for more write-downs, asset sales, dividend cuts, dilutive capital infusions, bank failures, and the many years it will take to return the financial sector profits to the levels of a year ago," Jeffrey Kleintop, cheif market strategist at LPL Financial Research, said in his weekly market commentary published July 21.
A deep and prolonged recession, if it develops, combined with the failure of some of the largest U.S. banks due to trouble raising capital to meet requirements, would likely further depress prices in the financial sector, Kleintop added. Speaking on CNBC on Monday, Treasury Secretary Henrry Paulson said the failure of five banks so far this year is quite small compared with the failure of more than 250 banks in the early 1980s.
Kleintop said the credit market isn't reflecting worsening conditions, which are a necesary precursor to a prolonged credit crunch. He cited more narrow credit spreads in high-yield bonds than in mid-march when Bear Stearns failed. The pricing of credit default swaps show the credit markets are pricing in a lower risk of failure by major U.S. banks than in mid-March, and firms are becoming less reluctant to lend cash in short-term money markets, he added.
In other news Monday, Yahoo (YHOO) said it reached a settlement with activist investor Carl Icahn that will give him and two of his nominees seats on an expanded board of directors and avert a battle over control of the company that was expected at an Aug. 1 shareholders vote. Under the agreement, eight members of the current board will seek re-election. Icahn will be appointed to the board, and two other seats will be filled based on a list of nine candidates recommended by Icahn. With Robert Kotick planning to step down from the board, the board will end up with 11 members after Icahn's slate is added.
Oil prices broke above $130 a barrel and gained some momentum thanks to concerns that Tropical Storm Dolly, developing in the Gulf of Mexico, could turn into a hurricane, as well as from failed talks about Iran's nuclear program over the weekend.
August WTI crude oil futures climbed as high as $132.05 before slipping back to settle $2.16 higher at $131.04 a barrel on Monday.
In a quiet week for new economic data, the Index of Leading Economic Indicators slipped 0.1% in June, with positive contributions from building permits (+0.30), the yield curve (0.21), and Institute for Supply Management deliveries (+0.09) offset by negative contributions from money supply (-0.27), stocks (-0.18) and jobless claims (-0.17).
The second-quarter survey by the U.S. National Association of Business Economists showed a bit more optimism on growth than in April's assessment. Consistent with signs from recent government data releases, more firms reported higher sales, but also higher material costs and lower profits. Economists were evenly split between those economists looking for the economy to grow by more than 1% or less over the second half of the year, with only 10% expecting the economy to shrink by December. Employment was said to be holding up reasonably well. But a record 75% of respondents said they paid more for materials in the second quarter and expect to pay more in the third quarter, too, highlighting the rising inflation threat.
While the survey shows improved activity, "the forward-looking details of the report are not encouraging as 45% of respondents were more pessimistic about the outlook for the year as a whole compared with their views in April, versus only 13% who were more optimistic," economist John Ryding of RDQ Economics said in an email note. Also, businesses appear more cautious on hiring for the second half of 2008 and there is more evidence of input-price pressures, cost pass-through, and rising inflation expectations in this report, he said.
However, given Fed Chairman Ben Bernanke's comments on Capital Hill last week that he's not a concerned about rising inflation expectations as much as how those expectations affect wages, "the Fed may not as concerned as we are about the inflation details within this survey," since wage trends remain subdued, Ryding said.
Among other stocks in the news on Monday, Timken Co. (TKR) shares rose after the company said it now sees third-quarter earnings of about 96 cents and full-year earnings of $2.95 to $3.10 a share, both excluding the impact of special items. It previously expected to earn 73 to 83 cents in the third quarter and $2.75 to $2.95 for all of 2008. Timken said it expects continued strong global industrial demand to more than offset weakness in the North American automotive market. Separately, BB&T Capital upgraded the stock to buy from hold.
Arthrocare (ARTC) shares plunged after the company said it will restate its financial statements for the years ended Dec. 31, 2006 and 2007, and for the quarters ended Sept. 30, 2006, and Dec. 31, 2006, plus each of the quarters of 2007 and the quarter ended Mar. 31, 2008. The company expects the effect of the restatement to be a non-cash reduction in revenue in 2006 of $4.0 million to $7.0 million and $20 million to $25 million in 2007. The restatement is also expected to reduce revenue in the first quarter of 2008 by $2.0 million to $5.0 million.
Charlotte Russe Holdings (CHIC) shares fell after the mail-based specialty retailer posted 31 cents a share in third-quarter profit, vs. 40 cents a year ago, on 6.5% lower same-store sales and a 7.2% gain in total sales. Given the difficult economic environment and pressure on consumer spending, the company expects same-store sales and earnings to be lower in the fourth quarter. The company also appointed Leonard Mogil as interim CEO, replacing Mark Hoffman, who retired.
Major European indexes were trading higher Monday. In London, the FTSE 100 index gained 0.52% to trade at 5,404.30. In Paris, the CAC 40 rose 1.74% to 4,299.36, while Germany's DAX index advanced 0.66% to 6,424.84.
In Asia, Japan's Nikkei 225 finished 0.65% lower at 12,803.70, while Hong Kong's Hang Seng index jumped 3.01% to end at 22,532.90.
Treasury yields slid back from earlier gains resulting from Bank of America's beating of low earnings expectations. The 10-year note moved up to 98-22/32 for a yield of 4.04%, and the 30-year rose to 96-02/32 for a yield of 4.62%.