Stocks Fall on Worries about Banks

Investors resumed their cautious stance and took profits on the last two days' gains amid renewed worries about weaknees in global financial sector

Major U.S. stock indexes ended a turbulent week lower on Friday as the optimism over a wave of positive earnings reports and talk of a takeover of troubled bond insurer Ambac Financial (ABK) gave way to renewed concerns about the financial sector.

On Friday, the Dow Jones industrial average finished down 171.44 points, or 1.38%, at 12,207.17. The broader S&P 500 index fell 21.46 points, or 1.59% to 1,330.61. The tech-heavy Nasdaq composite index slid 34.72 points, or 1.47%, to 2,326.20.

Trading in the equity markets will probably continue to be volatile, as most of the problems in the credit markets persist, says Bruce McCain, head of investment strategy at Key Private Bank in Cleveland, Ohio.

"We may have put a low in place just because sentiment was so bad, but it will take a while before any [fiscal or monetary stimulus] measures that have been taken start to help, and it will take a while for markets to stabilize and free up a bit," he said.

Higher sensitivity to moves in overseas stock markets reflects a growing awareness that other economies are slowing down and won't be there to carry the U.S. economy through this period of weakness as had been hoped, McCain said.

In Europe, banking shares came back under pressure late in their session Friday amid speculation about fresh profit warnings for Dutch banking and insurance groups such as ING Groep NV (ING) and Fortis in Belgium, Action Economics said. Fortis has since said it's not aware of anything that could explain the drop in its shares, but traders are selling first and asking questions later after their experience with Societe Generale, Action Economics said.

Earlier in the day, Microsoft's near doubling of its second-quarter earnings to 50 cents per share on a 15% rise in revenue (excluding year-ago deferrals) kickstarted the markets and lent support to the technology sector overall, but pre-weekend caution among investors made those gains short-lived.

Billionaire vulture fund operator Wilbur Ross is in takeover talks with Ambac, whose recent financial crisis was a major factor in the Fed's dramatic intermeeting interest rate cut on Tuesday, according to the Evening Standard. Standard & Poor's said it's not surprised a third party has entered the fray and upheld its hold rating on the stock. Ambac shares were trading 5.5% higher. Some analysts are skeptical that Ross, who favors already-bankrupted companies, is seriously considering buying Ambac, especially after its impressive comeback this week from all-time lows last week.

All was quiet on the economic data front on Friday, but the markets will have a smorgasbord of reports to sink their teeth into next week, starting with December new home sales on Monday, followed by December durable goods orders and January consumer confidence on Tuesday and preliminary fourth-quarter GDP on Wednesday.

Those numbers will likely influence what comes out of the Federal Reserve's policy committee meeting on Wedneday and Thursday. The Fed funds futures are pricing in another 50-basis-point cut in interest rates, but the Fed could decide that their emergency 75-point cut on Jan. 22 was enough, especially as more comes to light about Societe Generale's trades.

At the end of next week, nonfarm payrolls for January will either confirm recent declines in initial jobless claims or show there's still cause for concern in the labor markets.

If the unemployment rate can hold at or below 5.5%, the likelihood of a recession is small, said Max Bublitz, chief strategist at SCM Advisors in San Francisco. Unemployment ticked up to 5.0% in December from 4.7% in November.

Consumer confidence is deteriorating rapidly as people watch the value of their real estate and stock assets decline, he said. Workers may keep their jobs but without meanningful hikes in wages, it will be hard for them to keep up their spending, he added.

Since the news about Societe Generale's unwinding of fraudulent trades, the Fed has been criticized for over-reacting to the sharp drop in stock markets outide the U.S. on Monday, with some people claiming a 75-basis-point interest arte cut was unncessary. Fed officials say they were spurred to act less by Monday's market moves than by the cumulative decline in stocks through January, as well as ratings downgrades on bond insurers that cause more loan defaults and ongoing deterioration in home and other asset prices and consumer confidence.

Bublitz said he doesn't doubt the 75-point cut was needed and is calling for an additional easing by 50 points next week and a reduction in the Fed funds rate to 2.5% by June. But he does believe that the central bank has lost credibility because of its poor communication skills after undersized rate cuts in the fall, along with persistent statements about inflation risks.

He sees a repeating pattern of the market freaking out, the Fed lurching into a response and the market ticking up on that response and then calming down.

"To a certain extent, that is the pattern of a bear market and I'm not sure it’s been broken," Bublitz said. "The Fed needs to impact psychology more than anything. It's psychology that can cause earnings forecasts to go down, that causes forced selling and flights to quality."

If Bernanke & Co. can become "more sober in their analysis of what’s going on, then I think they’ve done their job," he said.

While he agrees that the 75-point cut on Tuesday was warranted, McCain at Key Private Bank said it will be difficult for the Fed to get out of cutting rates by another 50 points since that's the market expectation. Given the remaining crisis of confidence, it's better for the Fed to risk going too far and dropping rates by too much with an understanding they it can take the cuts back in a reasonably short time span if the economy stabilizes, he said.

Oil prices lost some upward momentum after the equities rally fizzled, but traders seem to be taking their cues more from economic news than from slightly bearish inventory reports, which showed a 2.3 million barrel build in U.S. crude supplies last week. On NYMEX, the March crude contract settled $1.30 higher at $90.71.

A week ahead of the Feb. 1 meeting of the Organization of the Petroleum Exporting Countries, Iraq's oil minister said that oil markets were well supplied and that OPEC won't need to boost production levels, in line with sentiments expressed by other OPEC members earlier this week.

Among other stocks in the news Friday, Eastman Chemical (EMN) shares climbed 7.6% on news that it expects its strategic initiatives to double profits to $10.00 per share by 2012. The company said it expects to increase earnings per share each year from 2008 to 2012, with 2009 earnings expected to be 10% to 15% higher than in 2008.

SunOpta (STKL) shares fell 36.7% after the company said inventories within its Fruit Group's berry operations require a write-down to their net realizable value. A preliminary estimate shows an adjustment of $9 million to $11 million for this issue and related items is necessary. The operator of natural and organic food markets expects 2007 earnings of 12 to 14 cents per share.

Synaptics (SYNA) dropped 23.4% after the company posted a second-quarter profit of 50 cents vs. 32 cents per share a year ago on a 30% revenue increase. The developer of customized interface solutions expects third-quarter revenue to drop to between $76 million and $82 million from $98.7 million in the second quarter and sees 11% to 19% revenue growth for the fourth quarter of fiscal 2008. While the third-quarter revenue forecast is lower than consensus, Oppenheimer said it thinks the worst should be over in the third quarter and would be a buyer on the stock price pullback.

VistaPrint (VPRT) shares rose 11.6% after the online supplier of graphic design services posted earnings of 24 cents poer share in the fourth quarter vs. 18 cents a year ago on a 64% jump in revenue. Standard & Poor's raised its earnings estimate and target price, but maintained its hold rating.

ScanSource (SCSC) shares shot up 19.2% after the company reported second-quarter GAAP earnings of 59 cents vs. 34 cents per share a year ago on 17% higher sales. The wholesdale distributor of specailty technology products sees third-quarter revenue of $550 million to $570 million and said it's received written notice from the Securities and Exchange Commission that its investigation into the company's historical stock option grant practices had been completed and that no enforcement action was recommended. Bear Stearns upgrades the stock to peer perform from underperform.

Asian stock indexes finished much stronger. Japan's Nikkei 225 index closed 4.10% higher at 13,629.16, while Hong Kong's Hang Seng index jumped 6.73% to trade at 25,122.37.

European equity markets reversed earlier gains to finish lower on Friday. In London, the FTSE 100 Index inched down 0.12% to 5,869.00. In Paris, the CAC 40 Index slid 0.76% to 4,878.12, and in Germany, the DAX Index was off 0.06% at 6,816.74.

Treasury market

Treasury bonds were one again benefiting from a flight to safety. The 2-year note climbed 07/32 to 101-31/32 for a yield of 2.19%. The 10-year note rose 1-07/32 to 105-20/32 for a yield of 3.56%. The 30-year bond leaped 2-07/32 to 112-05/32 for a yield of 4.27%.

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