On Bear and Credit Woes

Currently docked in Marseille (managed to get a Financial Times yesterday in Monaco, so I feel slightly less cut off from the symbol world) and catching up on the grim market news of yesterday.

It seems that the equity markets are getting the message that things are bad enough in the credit markets so as to affect the real economy, as opposed to merely a few isolated funds and certain types of investments. Even though the Bear downgrade by S&P was the proximate cause, there has been a barrage of bad news this week: subprime-related casualties, a worsening outlook for housing due to banks restricting credit even to reasonably solid borrowers, weakening employment stats.

The odd thing is that all these outcomes were predictable provided one acknowledged that the housing market was as inflated as it is being proven to have been. The other credit excesses, namely LBOs and CDOs, have yet to work themselves through, but their main impact is likely to be indirect. They have the potential to impair the capital bases (or merely the risk appetite) of the major investment banks, which would prolong the credit contraction and in a downside scenario, might produce a systemic seize-up.

Finally, there are rumors that Bear will be acquired. I can’t imagine someone will want to catch that falling safe, but DeutscheBank, in a similar value-destroying exercise, acquired Bankers Trust roughly a decade ago. Note my negative view isn’t based primarily on the worth of Bear’s franchise. If that were the only consideration, it might be a very good time to snap up the firm. Investment bank acquisitions have a terrible track record, and Bear has a particularly entrepreneurial, sharp-elbowed culture. I can’t see it as a fit with any other financial services firm.

The high (or, more accurately, low) points from the yesterday’s market action Bloomberg. The one item this Bloomberg story misses is a similarly predictable weakening in consumer spending, and we feature a Financial Times story on that topic after the Bloomberg story.

First, from Bloomberg:

Stocks tumbled on evidence losses in the mortgage market may slow the economy and reduce bank profits, sending the Standard & Poor’s 500 Index to its worst three-week retreat since 2003.

Bear Stearns Cos., the manager of two hedge funds that collapsed last month, helped carry financial shares to their biggest decline in five years after S&P cut the company’s credit outlook. Energy shares fell to the lowest since May, led by Exxon Mobil Corp. and Chevron Corp., on speculation weaker job growth and falling oil prices will hurt earnings.

The S&P 500 erased its gain for the week, falling 39.14, or 2.7 percent, to 1433.06 in its worst day since Feb. 27. The Dow Jones Industrial Average slumped 281.42, or 2.1 percent, to 13,181.91. The Nasdaq Composite Index sank 64.73, or 2.5 percent, to 2511.25.

The sell-off exacerbated a rout last week that wiped $2.1 trillion in value from global equity markets. Shares declined in Europe, with benchmark indexes dropping in all 18 western European markets except Luxembourg. An index of market volatility in the U.S. rose to a four-year high.

“We’re just seeing more and more credit problems,” said Michael Strauss, who helps manage $40 billion at Commonfund in Wilton, Connecticut. “It’s going to be difficult for the market to trade with any confidence.”

Almost 12 stocks fell for every one that rose on the New York Stock Exchange as all 24 industry groups in the S&P 500 and all 30 members of the Dow fell.

The yield on the benchmark 10-year Treasury note fell 9 basis points, or 0.09 percentage point, to 4.68 percent. The dollar fell the most in almost a month against the euro, trading within a cent of its record low. Some 2.1 billion shares changed hands on the NYSE, 29 percent more than the three-month average.

Stocks opened the day lower after the Labor Department said employers added fewer jobs than economists forecast in July and a private report showed growth in U.S. service industries slowed.

Bear Stearns

Bear Stearns had its credit-rating outlook cut to negative by S&P on concern declining prices for mortgage-backed securities will decrease earnings. The perceived risk of owning the New York-based company’s bonds rose to the highest in at least six years.

Stocks fell to their lows of the day after the firm said its return on equity in July may be close to the lowest ever and borrowing costs may slow mergers and acquisitions.

‘As Bad as I’ve Seen It’

“I’ve been out here for 22 years, and this is as bad as I’ve seen it in the fixed-income markets,” Chief Financial Officer Samuel Molinaro said on a conference call with analysts. He compared the crisis to 1998, when hedge fund Long-Term Capital Management collapsed and Russia defaulted on its debt. Bear Stearns fell $7.28, or 6.3 percent, to $108.35, the lowest since 2005.

The S&P 500 Financials Index fell 3.8 percent, its steepest loss since 2002, and contributed the most to the drop in the overall S&P 500. An index of brokerages and money managers in the S&P 500 has fallen 15 percent since reaching a record on May 30…..

Credit-market losses stemming from subprime lending are leading to a tightening of funds available for investment, and helping to drive up the cost of borrowing for consumers and companies…

‘Big Logjam of Credit’

“You’ve got a big logjam of credit that can’t clear,” said Brian Barish, who helps oversee about $10 billion at Cambiar Investors in Denver. “Add a lot of fear and rumor, and it makes for a tough situation.”…

Volatility Surge

The Chicago Board Options Exchange Volatility Index rose to 25.16, the highest since April 2003. Higher readings in the so- called VIX, derived from prices paid for S&P 500 options, indicate more risk in stocks.

In economic reports, the Labor Department said 92,000 jobs were added to payrolls in July compared with a forecast for an increase of 127,000 in a Bloomberg survey of economists. The jobless rate rose to 4.6 percent in July from 4.5 percent in June. Economists in a Bloomberg survey had expected it to remain at 4.5 percent.

The report said homebuilders cut payrolls by 12,000 after a 3,000 increase the previous month as the housing slump continues.

Homebuilders Slump

A gauge of homebuilders in S&P indexes dropped 5.3 percent as a group as all 16 of its members declined. D.R. Horton Inc., the second-largest U.S. builder, slipped 69 cents to $16.46. Pulte Homes, the third biggest, lost $1.40 to $18.59.

After the employment report, JPMorgan pushed back its forecast for when the Federal Reserve will change interest rates. The firm expects an increase in the middle of next year, compared with its prior prediction of around the end of this year.

The Institute for Supply Management said its non- manufacturing index dropped to 55.8 last month, from 60.7 in June. Economists in a survey had expected a reading of 59 for July. The index, which shows service industries still expanding, has averaged 56.8 in the past 12 months.

The Russell 2000 Index, a benchmark for companies with a median market value of $647 million, dropped 3.6 percent to 755.42. The Dow Jones Wilshire 5000 Index, the broadest measure of U.S. shares, fell 2.7 percent to 14,432.34. Based on its decline, the value of stocks decreased by $497 billion.

Today’s sell-off left the S&P 500 with a 1.8 percent drop for the week and a 1 percent advance for the year. The Dow lost 0.6 percent this week and is up 5.8 percent in 2007.

Now, the Financial Times, in “US consumer spending slows“:

US consumer spending rose at the slowest pace in nine months in June in a sign of cooling household demand.

Spending rose 0.1 per cent after a gain of 0.6 per cent the previous month, according to the Commerce Department.

The slowdown is likely to be a source of concern for policymakers, although many economists expect consumer spending to hold up amid strong hiring and rising incomes.

Incomes rose 0.4 percent in June for the second month, according to the report, slightly less than economists were expecting.

Consumer spending accounts for more than two-thirds of the economy but has been replaced as the main driver of growth in recent months as business activity picks up.

The Federal Reserve’s preferred gauge of inflation rose less than forecast, increasing 0.1 per cent for the fourth straight month.

The core personal consumption expenditure index – excluding volatile food and energy prices – was up 1.9 per cent from a year ago, the smallest increase in three years.