Stocks Tumble amid Subprime Turmoil

Financial issues plunged Friday on a spate of negative mortgage headlines. The Fed will be in a tricky position at next week's meeting

Who said Summer is dead on Wall Street? Major U.S. stock indexes started August with another wild week, capped by an honest-to-goodness rout Friday. Once again, the main culprit behind the sell-off was investor fears over the subprime-loan mess, and the degree to which hobbled credit markets may hinder U.S. economic growth.

On Friday, the Dow Jones industrial average fell 281.42 points, or 2.09%, to 13,181.91. The broader S&P 500 index was off 39.14 points, or 2.66%, to 1,433.06. The tech-heavy Nasdaq Composite index dropped 64.73 points, or 2.51%, to 2,528.89.

There was plenty of bad news to go around. A move by ratings agency Standard & Poor's to lower its credit outlook on Bear Stearns Cos. (BSC) to negative also weighed on sentiment, as did a comment by the firm's CFO on a conference call with analysts that fixed-income market turmoil is the worst in 22 years. Meanwhile, mortgage lender American Home Mortgage (AHM) basically closed up shop amid financing difficulties.

Investors also weighed a disappointing report on job growth in July and a decline in a service-sector sentiment gauge for the month, both of which suggested the economy isn't growing at the pace some people had hoped.

Investment banking and homebuilding stocks were among the groups plunging on the credit-market fears.

Subprime: The Pain Spreads
S&P Index % Chg. (8/3/07)
Real Estate Mgt Dev -4.86%
Consumer Finance -4.66%
Invest Banking & Brokerage -4.41%
Thrifts & Mtge Finance -3.44%

Volatility in the major indexes escalated over the past week as investors haven't seen reassuring signs that the subprime credit mess has run its course. Indeed the CBOE volatility index, or VIX, widely regarded as a fear gauge on Wall Street since it tracks market volatility, moved higher Friday. The broader market continued its negative tone, with 28 issues declining in price for each 5 issues rising on the NYSE, while Nasdaq breadth was 24-6 negative.

What could next week hold? Earnings season will be winding down, and even though profits have come in ahead of expectations, the market is focused more on subprime worries, according to Richard Sparks, senior equities analyst for Schaeffer's Investment Research. "The biggest worry out there is whether or not there are more shoes to drop, so to speak."

Subprime issues could keep investors less focused on the Federal Reserve's policy meeting on Tuesday, notes Sparks. "We're ignoring modestly weak economic numbers that will allow the Fed not to have to raise interest rates." Since the market is fixated on subprime news, says Sparks, "if we do have good economic numbers and better earnings, it may not matter."

Tuesday's FOMC meeting is expected to result in no change in interest rates, and likely retention of the bias toward inflation risks amid expectations for moderate economic growth, according to Action Economics. While policymakers may also acknowledge risks to the outlook from the volatility in the markets and weakness in the housing sector, "such a statement should be more of an aside as the Fed won't want to rattle the market further", says Action.

If worries of a major credit crunch have dampened investors' outlook for economic growth, the smaller-than-expected rise in nonfarm payrolls reported Friday didn't provide any relief. In July, payrolls climbed by 92,000, far short of the 130,000 consensus forecast, following a downward-revised gain of 126,000 in June.

A slowdown in hiring was also evident in unemployment edging up to a six-month high of 4.6%, while the average hourly wage gain of 0.3% was in line with expectations.

The silver lining in the negative report was that much of the increase in hiring in July came from the private sector while government jobs fell 28,000. Construction jobs dropped 12,000, as if people needed more convincing of the slowdown in the housing market.

The Institute for Supply Management's July non-manufacturing index slipped to 55.8, lower than the forecast of 58, and down sharply from the 60.7 reading in June. The data showed new orders and prices ticked down, while the backlog was higher.

Growing concerns about subprime loan exposure and the damage it could eventually wreak in the broader credit market have pummeled financial stocks in recent weeks. The stocks have now given nearly all the gains seen over the past year.

Morgan Stanley released estimates for the leveraged loan pipeline for some of the bigger investment banks, led by $37.2 billion of loans at JP Morgan and $30.8 billion at Citigroup. Morgan Stanley said it assumes an overall 7% markdown on loans the banks will be left holding if they can't convince institutional investors to buy them, according to CNBC Business News.

No matter where you turned in the mortgage industry Friday, the news was bad. American Home Mortgage's (AHM) shares headed below $1 Friday after the company, which raised fears this week that it may become insolvent, said Thursday it has stopped taking mortgage applications and is cutting most of its staff of more than 7,000 effective Friday, according to an Associated Press report.

Accredited Home Lenders (PG) said that auditors' opinion on its 2006 financial statements doesn't include a "going concern" qualification. It also warned that there's no guarantee its pending merger with Lone Star will close, but it expects a tender offer to be concluded in the third quarter.

Countrywide Financial (CFC) shares slipped after a Morgan Stanley analyst cut his price target on the stock because he underestimated the severity of the meltdown in the mortgage and credit markets, according to the AP.

Wachovia (WB) suspended the issuance of so-called Alt-A, or low-documentation, home loans through brokers, while temporarily halting Alt-A lending through its in-house Vertice Unit.

In the energy markets Friday, September West Texas Intermediate crude oil futures were down $1.31 to $75.55 a barrel as the weaker than expected employment and ISM service reports raised concerns demand might fall if the economy slows.

Among stocks in the news on Friday, Procter & Gamble (PG) posted 67 cents a share in earnings for its fourth quarter, vs. 55 cents a share a year ago, on an 8% rise in sales. The company expects organic sales growth of 4% to 6% in the first quarter to result in a profit of 88 to 90 cents and said it will buy back $24 billion to $30 billion in stock over the next three years.

Network Appliance (NTAP) shares dropped after the company lowered its first quarter non-GAAP EPS guidance, citing continued softness in enterprise storage spending.

Jones Soda (JSDA) shares fell after the company posted breakeven second-quarter results despite a 30% revenue rise as results were hurt by a sharp rise in operating costs.

European stock markets finished lower on Friday as global markets continued their volatile run, with losses accelerating in late trading. In London, the FTSE 100 index was down 1.21% to 6,224.3. Germany's DAX index fell 1.31% to 7,435.67. In Paris, the CAC 40 index slid 1.48% to 5,597.89.

Asian markets traded mostly higher on Friday. In Japan, the Nikkei index edged down 0.03% to 16,979.86. In Hong Kong, the Hang Seng index rose 0.42% to 22,538.44. In China, the Shanghai Composite index jumped 3.47% to 4,560.77.

Treasury Market

Investment capital shifted out of equities and into the relative safety of Treasuries Friday amid ongoing concerns over the deterioration in the subprime lending industry. The 10-year note climbed 17/32 in price to 98-15/32 for a yield of 4.69%. The 30-year bond rallied 23/32 to 98-06/32 for a yield of 4.87%.

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