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Monday, July 30, 2007

Credit worries fail to halt Wall St bounce

Credit worries fail to halt Wall St bounce
By Michael Mackenzie in New York
Copyright The Financial Times Limited 2007
Published: July 30 2007 13:58 | Last updated: July 30 2007 15:47


Wall Street stocks were trading modestly firmer at midmorning on Monday, and while solid earnings from several companies had boosted sentiment, investors were scrutinising weakness in the credit market.

Last week, fears that markets face a credit crunch sparked a sharp slide in US stocks. The S&P 500 index experienced its worst performance since September 2002.

“Last week’s stock market swoon came just as crude prices retested the highs, housing prices continued their fall and business investment spending showed weakness heading into the second half of 2007,” said William O’Donnell, strategist at UBS. “This toxic mix of headwinds for the consumer bodes ill for the US economy.”

In overnight trading action Asian equities were mainly higher, while European stocks were firmer after Wall Street’s open.

Less than an hour after the opening bell, the S&P 500 was 0.4 per cent higher at 1,465. Volatility as measured by the Chicago Board Options Exchange’s Vix was down 6.2 per cent at a reading of 22.67. Vix has nearly doubled in value this year.

The Nasdaq Composite was up 0.2 per cent at 2,567.75.

The Dow Jones Industrial Average was 0.25 per cent higher at 13,298.96.

Small cap stocks were also firmer with the Russell 2000 index up 0.3 per cent. The Russell remains 1 per cent lower for the year to date, and the sharp rise in volatility and concerns over future deal activity has hit smaller companies hard.

The yield on the 10-year bond was a touch lower at 4.78 per cent. US Crude oil prices were weaker, and had reversed a brief rise above $77 a barrel earlier in the day.

Equity investors remain focused on the credit market. Anxiety over a pending flood of new debt issues, in the region of $300bn that are linked to this year’s record pace of mergers and buyout deals, and worries about further losses from mortgage-related investments has cast a pall over sentiment for credit. Premiums for credit derivative indices that track US and European investment grade and high yield bonds have more than doubled in cost since mid-June and continued to move higher on Monday.

In early trade, the CDX investment grade index widened above 100 basis points from a close of 77bp on Friday. In Europe the iTraxx crossover index that tracks corporate debt rated between high grade and junk, rose above 500bp for the first time.

“While the repricing of credit wider may yet lead to a significant bounce back on short covering, we think it is still too early to step in front of this moving train,” said analysts at Banc of America Securities.

The recent rise in volatility and in credit risk premiums has weighed on stock prices for many pending deals and also on the banks that could potentially be left holding bridge loans. This led analysts at Goldman Sachs to note on Monday that 22 pending leveraged buyouts deals currently offer investors an annualised return of 36 per cent if they are completed.

“It is impossible even for a wizard like Harry Potter to reconcile two facts: Stocks cannot both melt down because the market fears financial institutions will have to fund and hold levered loan commitments while at the same time shares of target companies sell off on the belief the same transactions will not close,” said Goldman. “This inconsistency presents an attractive entry point for investors.”

Shares in TXU, the Texas utilty, are currently trading at $65.92, below the $32bn or $69.25 a share buyout price offered by Kohlberg Kravis Roberts & Co. and Texas Pacific Group. The financing for the TXU deal includes an $11bn bridge loan and the banks behind the buyout include Citigroup, Goldman Sachs, JPMorgan, Morgan Stanley, Credit Suisse and Lehman Brothers.

While the S&P Investment bank index had rebounded 0.6 per cent higher on Monday, it remains 9.7 per cent lower for the year to date.

Among other pending buyout deals, First Data was trading at $31.90, below KKR’s $29bn buyout of $34 a share.

Penn National, the racetrack and casino operator which Fortress Group has offered to buyout for $67 a share was trading at $58.14 on Monday.

Hilton Hotels, which recently received a $47.50 a share buyout from Blackstone was trading at $44.10.

While the credit market was under pressure on Monday, some good news on the earnings front had helped stabilise sentiment in stocks.

Verizon, the second largest U.S. phone company reported a 4.5 per cent rise in second quarter. The Dow stock was down 2 per cent at $41.16. Verizon Wireless said it had agreed to buy Rural Cellular for $2.67bn in cash and debt. Rural was 34.4 per cent higher at $42.75.

Shares in Archer Daniels Midland were 0.5 per cent higher at $34.21. The grain processor’s fiscal fourth-quarter profit more than doubled to $954.8m.

Humana, the health insurer said its second quarter profit more than doubled to $216.8m and the stock was up 1.5 per cent at $65.78.

Wrigley, posted a 20 per cent rise in quarterly results and the stock was down 0.1 per cent at $57.04.

Meanwhile, Virgin Media was up 1.8 per cent at $25.15 on talk that John Malone’s Liberty Global is weighing a $23bn bid for the UK cable operator.

In other deal news, attention will focus on whether the $5bn bid for Dow Jones by News Corp will meet the approval of the Bancroft family, which control a majority of the company’s voting stock. A decision is expected late on Monday. Dow Jones was trading at $53.88, below the $60 a share offer made by News Corp.

Economic data was sparse on Monday, but the rest of the week is replete with reports capped by the July employment report and a manufacturing survey from the Institute for Supply Management on Friday. Economists expect a gain of 135,000 jobs last month after 132,000 were created in June. The unemployment rate is seen steady at 4.5 per cent for the fourth consecutive month.

At the close of trading in New York last week, the S&P 500 index was down 4.9 per cent for the week at 1,458.95 while the Nasdaq Composite Index was 4.7 per cent lower at 2,562.24. The Dow Jones Industrial Average was 4.2 per cent lower at 13,265.47.

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