(From BARRON'S)
Stock-market indexes rose modestly last week, as a rally in technology and
transportation stocks offset sharp declines in financials, particularly the
banks, which were dragged down by further worries about the housing bust.
The Dow Jones Industrial Average added 56 points over the five trading
sessions to end at 11,062.78. The S&P 500 tacked on 11 points to end at 1176.19,
while the Nasdaq, the week's best performer, rose 66.86 points, to 2468.
Technology shares enjoyed a banner day Friday after Google's strong
earnings report helped propel the Internet advertising company's stock (ticker:
GOOG) 11% in the session. Not far behind were Apple's shares (AAPL), which added
7% on the week.
Federal Reserve Chairman Ben Bernanke confirmed in a speech Friday that
the central bank has every intention of trying to force down interest rates and
juice the economy by purchasing Treasuries for the Fed portfolio. Expectations
of such a move have helped propel industrial and other economically sensitive
shares.
Offsetting the optimism were the financials, which can't seem to shake the
sins of years past. Fears that the banks will be forced to repurchase billions
of dollars of improperly documented loans that typically were sold through
securitizations hurt shares in the industry. In addition, the banks' improper
documentation of many loan foreclosures has attracted scrutiny from the state
attorneys general and the Office of the Comptroller of the Currency.
Bank of America (BAC) shares dropped 11% to 11.98 on the week, while
JPMorgan Chase (JPM) and Citigroup (C) lost roughly 5% each. All told, the 25
largest banks lost roughly $57 billion of their market capitalization just in
the past three trading sessions, estimates Jason Goldberg an analyst at Barclays
Capital.
While the headlines were dominated by scary tales of improper foreclosure
documentation, this problem, at least, seems manageable. The banks might have to
amend the documents and could face lawsuits, but the documents in question
generally involve customers who haven't been paying their mortgages. Loans that
were improperly originated and often sold into securitizations in years past
might prove a thornier and more expensive problem. If investors can prove that
the loans were improperly originated, they can force the banks to repurchase
them.
JPMorgan disclosed last week in its quarterly earnings announcement that
it had boosted its mortgage-repurchase reserve by $1 billion, to a total of
$3 billion. It took $500 million in losses in the latest quarter due to the
repurchases, says Goldberg. Even so, the bank still made north of $4 billion
in the quarter and turned in $1.01 in earnings per share, above the 90-cent
consensus.
The subject is sure to stay in the headlines this week as both Bank of
America and Citibank report earnings. Calculating how much the banks might have
to pay to repurchase improperly originated mortgages is anyone's guess, and
estimates vary widely. One hedge fund, Branch Hill Capital, has estimated that
Bank of America alone might have to repurchase $74 billion of loans. Barclays'
Goldberg, doing a back-of-the-envelope estimate, comes up with a potential $10
billion shortfall for the whole industry, after adjusting for the taxes and
existing reserves.
In a recent interview with Bloomberg discussing both the foreclosure and
mortgage-repurchase issues, Barbara Desoer, head of Bank of America's home
lending, said, "The facts about the potential costs to the banks are grossly
distorted."
Given the $57 billion in lost market share that the banks suffered last
week, the problem looks to be more than priced into the market.
Transportation stocks are chugging along nicely this year, with the Dow
Jones Transportation Average up almost 15%, approaching its spring high. It got
a nice boost last week after CSX (CSX) reported that quarterly earnings rose 43%
from a year ago, beating analysts' expectations. CSX shares jumped 3.6% to 59.54
during the week, and Norfolk Southern (NSC) came along for the ride, rising
1.6%.
Gains haven't been limited just to the railroad sector. FedEx (FDX) shares
are up 25% since bottoming in July and CH Robinson Worldwide (CHRW), a logistics
company, has enjoyed a 40% rally from its February lows.
"These companies all do very well when the economy is growing," says Ed
Yardeni, president & chief investment strategist at Yardeni Research. They're
also benefitting from a boom in the transportation of agricultural products and
imports.
Market bulls should take comfort from the transports' rally, as Dow Theory
posits that when stocks of the companies that make products (the industrials)
and stocks of the companies that move products (the transports) are both doing
well, it's a positive sign for the broader market, explains Louise Yamada of LY
Advisors. Yamada believes we're in a cyclical bull market.
That said, Richard Russell, editor of the Dow Theory Letters, is bearish
despite the positive signals from the Dow transports. Stock valuations are
stretched and dividend yields are paltry, he says, noting "the valuation is
characteristic of a top." Russell is investing in gold.
But it's hard to ignore CSX's experience in the trenches, where unit
volume grew 10%, and revenue 16% in the third quarter. While the company
acknowledged that shipments related to housing are dormant, shipments of coal,
agricultural and automotive products, and chemicals are strong.
Executives see that strength continuing. CSX forecasts that U.S.
industrial production will rise 4.9% in the fourth quarter, and management sees
"good, slow steady growth" for the whole economy next year. Rick Paterson, an
analyst at UBS, has an above-consensus 2011 earnings estimate of $5 a share.
He rates CSX a Buy, with a 12-month price target of 80.
If CSX is right, that's good news not just for the company's shareholders
but the stock market generally.
Some of last week's best-performing stocks were targets of acquisitions.
King Pharmaceuticals (KG) agreed to be purchased by Pfizer (PFE) for $3.6
billion in cash. Its shares soared 37%.
Yahoo! (YHOO) benefited from rumors it might get a bid from private-equity
outfits and AOL (AOL), which sent Yahoo! shares up 12% on the week. Western
Digital (WDC) rose 10% even though the company never even got a buyout offer.
But rival Seagate Technology (STX) soared on hopes that a private-equity firm
might make a deal.
Deal activity is about 20% higher so far this year, at $584 billion,
than in the same stretch of 2009. Richard Peterson, a director at Standard &
Poor's, expects deal volume to finish the year at $800 billion, far below a
peak of $1.4 trillion in 2007, but sharply higher than last year's $692
billion.
"The takeaway from the M&A [merger and acquisition] activity is that
stocks are too cheap," says Jerry Harris, president and market strategist at
Sterne Agee Asset Management in Birmingham, Ala.
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VITAL SIGNS
Friday's Week's Week's
Close Change % Chg.
DJ Industrials 11062.78 +56.30 +0.51
DJ Transportation 4694.78 +66.39 +1.43
DJ Utilities 406.23 +2.32 +0.57
DJ 65 Stocks 3841.33 +30.40 +0.80
DJ US Market 294.20 +2.95 +1.01
NYSE Comp. 7520.60 +42.18 +0.56
Amex Comp. 2100.63 +29.48 +1.42
S&P 500 1176.19 +11.04 +0.95
S&P MidCap 819.76 +8.39 +1.03
S&P SmallCap 373.82 +6.19 +1.68
Nasdaq 2468.77 +66.86 +2.78
Value Line (arith.) 2593.15 +32.26 +1.26
Russell 2000 703.16 +9.34 +1.35
DJ US TSM 12326.75 +130.55 +1.07
Last Week Week Earlier
NYSE
Advances 1,821 2,202
Declines 1,318 948
Unchanged 55 46
New Highs 634 518
New Lows 22 24
Av Daily Vol (mil) 4,793.9 4,155.3
Dollar
(Finex spot index) 77.04 77.33
T-Bond
(CBT nearby futures) 126-08 127-10
Crude Oil
(NYM light sweet crude) 81.25 82.66
Inflation KR--CRB
(Futures Price Index) 296.06 295.11
Gold
(CMX nearby futures) 1371.10 1344.20
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