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Central Banks Intervene to
Calm Volatile Markets

VIKAS BAJAJ / New York Times 11aug2007

 

Central banks around the world acted in unison yesterday to calm nervous financial markets by providing an infusion of cash to the system. But stocks still fell sharply in Asia and Europe, and in early trading in New York, before they recovered and closed essentially flat for the day on Wall Street.

As in recent weeks, the markets moved in wild swings — sharp drops were followed by steep gains and vice versa — underscoring the uncertainty. Investors weighed concerns that losses in the American mortgage market would deepen and spread against their faith in the ability of a strong global economy to withstand additional shocks.

Hoping to provide some comfort that there is ample cash available, the Federal Reserve made its largest intervention since the markets reopened Sept. 19, 2001, in the wake of the terrorist attacks. The central bank injected $38 billion into the financial system on top of the $24 billion it put in on Thursday.

The intervention steadied the markets — at least for the day. The Standard & Poor’s 500-stock index closed at 1,453.64, a gain of 0.55 point, and the Dow Jones industrial average closed down 31.14 points, to 13,239.54. For the week, the Dow was up 0.4 percent, the S.& P. 500 rose 1.4 percent and the Nasdaq was up 1.3 percent.

The question that remains is just how exposed the financial system and the economy are to losses in the credit markets and the increase in borrowing costs. The answer will set the agenda at the Federal Reserve, which finds itself confronting its first major financial crisis under the leadership of Ben S. Bernanke, who took over last year.

The Fed will be guided by its assessment of how much do banks, hedge funds, pension funds and others stand to lose and whether consumers and businesses will be able to stomach higher interest rates and stricter loan underwriting.

“There are a lot of risks in front of us,” said Liz Ann Sonders, chief investment strategist at Charles Schwab. “Financial crises, in the past, when not accompanied with a recession have been good for the markets.”

But, she added, “if the economic landscape deteriorates much from here, then we are going to have to suffer through a more difficult market period.”

That debate, Ms. Sonders and others agree, will not be resolved anytime soon, which suggests that markets will remain choppy as information about failing hedge funds and mortgage companies dribbles out.

Investor anxiety has been so heightened in recent weeks that days of stability have been shattered by the first sign of trouble tied to the debt markets.

Volatility, as measured by one popular index of options trading, has surged to its highest levels in more than four years, though it remains far lower than it was early this decade and in the late 1990s.

The financial sector has been among the most volatile — stocks there fell by as much as 1.7 percent during the day, only to climb as much as 1.1 percent before closing little changed.

Shares of Countrywide Financial, the nation’s largest mortgage lender, and Washington Mutual, the sixth-biggest lender, opened sharply lower after both companies said they were facing a harder time selling loans and could potentially have problems raising money.

While those stocks recovered much of their losses for the day, they are both down significantly for the year.

A common pattern has been a surge in trading late in the afternoon, around 3 p.m., that has often sent stocks higher, as it did yesterday — though on some days, like Thursday, the move has been just as sharp on the downside.

Richard X. Bove, an analyst at Punk Ziegel & Company, noted the trend in a recent note to investors and suggested that the reason was strong buying from portfolios that use computer models to buy and sell quickly, a practice known as program trading, or a foreign source like the investment arm of the Chinese government.

“We are talking about such a sizable amount of buying and volume goes up and stocks react strongly one way or the other,” Mr. Bove said. “What I have trouble with is trying to figure out where it’s coming from.”

But he acknowledges that the pattern will probably not last long, because as sophisticated traders figure it out they will jump in on the other side to profit from the trades.

Using data from the New York Stock Exchange, Ms. Sonders of Charles Schwab estimates that program trading accounted for about 40 percent of all trades on the Big Board in recent days, up from the 30 percent range earlier this year.

“That’s why we are getting these swings, this is professional- to-professional trading,” she said. “This is money that has a time horizon measured in minutes.”

Indeed, there is evidence that the average individual investor has not been a big player in recent days.

Flows into mutual funds that specialize in American stocks were essentially flat for the week that ended on Wednesday, according to AMG Data Services. But investors put $36.2 billion into money market accounts, the largest weekly inflow this year. Investors often put cash into money market funds, which earn more than savings accounts, that they eventually plan to invest in the market.

It is not surprising that individuals are sitting on the sidelines, given the sharp moves in the market. Yesterday, for instance, all three major American indexes fell immediately after the opening bell, and at one point the Dow Jones industrial average was down 212 points. By noon, stocks were on the rebound and the indexes were briefly in positive territory, then declined. The Nasdaq finished at 2,544.89, down 11.60, or 0.4 percent.

“You can’t invest into a market that does that,” Mr. Bove said. “You have a better chance at making money on the craps table than in this market.”

Treasury prices were little changed yesterday. The 10-year note fell 9/32, to 99 18/32 and the yield, which moves in the opposite direction from the price, rose to 4.81 percent, from 4.77 percent on Thursday.

Earlier, stocks in Japan, Hong Kong and Australia dropped by more than 2.5 percent. The benchmark Kospi in South Korea fell 4.3 percent, the biggest decline since June 2004. Most major European indexes plunged by 3 percent or more.

In both Asia and Europe, fears about the American housing market prompted investors to sell assets and forced commercial banks to reel in credit lines.

Central banks around the work stepped up efforts to slow the losses. The Bank of Japan added liquidity for the first time since the market problems began.

The European Central Bank injected money into the system for a second day, adding another 61 billion euros ($84 billion), after providing 95 billion euros the day before. The Federal Reserve yesterday added $19 billion to the system through the purchase of mortgage-backed securities, then another $19 billion in three-day repurchase agreements.

In Washington, Treasury Secretary Henry M. Paulson Jr. spent the day in what his aides said was hourly contact with the Fed, other officials in the administration, finance ministries and regulators overseas and people on Wall Street — where until last year he had worked as an executive at Goldman Sachs.

“We’ve been in touch with our colleagues in other agencies and among the financial regulators and are monitoring the situation carefully,” said Michele Davis, the Treasury Department spokeswoman. “Beyond that, we are not commenting.”

As investors in Asia sold off assets considered relatively risky, like Philippine stocks, they bought those considered safer, like Japanese government bonds. Asian currencies like the Thai baht also retreated against the dollar and more liquid and stable currencies like the yen.

“Everyone’s been talking about a credit crunch, and not surprisingly it turned into one,” said Jan Lambregts, head of Asia research at Rabobank.

While Asian banks did not seem to be directly affected, he said, “the main problem is we don’t know who is bearing the losses, and that kind of uncertainty is creating the situation that we’re in right now.”

Wayne Arnold, Steve Weisman and Jeremy W. Peters contributed reporting.

source: 11aug2007

Central Banks Again Intervene

Europe, Japan Join U.S. To Provide Liquidity; Betting on a Fed Cut

JOELLEN PERRY and GREG IP / Wall Street Journal 11aug2007

 

Central banks pumped money into distressed markets for the second day to relieve strains in money markets, while investors concluded the Federal Reserve is increasingly likely to cut rates soon and that rate increases in Europe and Japan may be deferred.

Explaining that it was "providing liquidity to facilitate the orderly functioning of financial markets," the Fed injected $38 billion, following Thursday's $24 billion. The European Central Bank, saying that its "liquidity-providing fine-tuning operation" was aimed at assuring orderly market conditions, added $83.56 billion following the $130 billion it injected to euro-zone markets Thursday.

The Bank of Japan, meanwhile, put in one trillion yen ($8.46 billion), while central banks in Australia, Singapore, Canada Norway and Switzerland also pumped money into their markets. Others said they were prepared to do so if necessary.

Until the past few days, most monetary policy makers were emphasizing their concerns about mounting inflation pressures rather than problems emanating from the troubles of the U.S. subprime-mortgage market. But that may be changing. "This is a disinflationary event," said economist Richard Berner of Morgan Stanley. "If it continues, inflation risks are mitigated. That gives the Fed and other central banks latitude to step up the timetable for moving rates back to neutral or below neutral if necessary." A neutral rate neither stimulates nor damps economic growth.

The Fed statement, its first since the latest turn in markets, made clear that it wasn't cutting the target for its key short-term rate at this point but was prepared to pump in as much money as needed to keep short-term rates close to its 5.25% target. Early Friday, markets pushed the federal-funds rate, charged on overnight loans between banks, to 6%. By day's end, the Fed's maneuver had brought it down to the target level.

Futures markets place high odds on the Fed cutting the rate target to 5% at its Sept. 18 meeting, and some possibility of a cut before then. The decision turns on how conditions in credit markets develop in coming days. If they don't improve, officials would probably be inclined to cut rates to offset the negative impact.

Further deterioration in markets before Sept. 18 or signs that a growing number of healthy institutions and households are unable to borrow could prompt the Fed to consider a rate cut sooner. "Signs of a broadening deterioration in financial market conditions could force their hand," Bruce Kasman, chief economist at J.P. Morgan Chase, said in a note to clients Friday. The deterioration in financial conditions so far this year has been enough to knock a percentage point off total spending growth in the economy, estimated Lewis Alexander, chief economist at Citigroup.

Meanwhile, futures trading indicated waning expectations for interest-rate increases in Europe and Japan. Traders, who had been pricing in a nearly 100% chance that the ECB would increase rates by a quarter-point to 4.25% on Sept. 6, put the odds Friday at less than 50%. "A combination of raising rates and supplying emergency liquidity would not represent a viable strategy for a credible central bank," said Lena Komileva, economist at London brokerage house Tullett Prebon. "This money-market crisis of confidence looks likely to last, and in this environment, a continued hawkish bias by the ECB and the Bank of England would lack credibility."

Many euro-zone economists, though, argue that if the ECB's efforts to calm markets are successful, the central bank still is likely to raise rates in September and perhaps again in early 2008.

In Japan, where the Bank of Japan's key rate is a low 0.5%, signs of healthier growth and a long-term upturn in consumer prices had analysts expecting a quarter-point increase from the Bank of Japan either at the Aug. 22-23 meeting or in September. But the outlook is now less certain, and some economists think the possibility of a rate increase in August looks slim.

"If the market stabilizes in the next two weeks, I think the BOJ will go ahead and raise rates," said Chotaro Morita, a strategist for Deutsche Bank in Tokyo. " If volatility persists, I'd guess the chance of that happening will be just 50%."

Elsewhere in Europe, the Bank of England signaled in its recent quarterly Inflation Report it would need one more quarter-point increase, to 6%, to bring inflation in line with its 2% target by the end of 2008. But according to prices for interest-rate futures, investors' expecations of a rise are now 50%, down from 70% on Wednesday.

Markets are also less certain that the Swiss National Bank will raise interest rates, now at 2.5%, further at its Sept. 13 meeting. Futures still point to a better than 50% chance of a quarter-point increase, but that is down from 100% earlier this week.

Moving Money

Central banks around the world have been injecting funds into markets in response to a spike in short-term rates that suggested demand for reserves was outstripping supply.

Bank               Funds Injected                                     .

source: p.A3 11aug2007

Subprime Turmoil Catches Funds Off Guard

ELEANOR LAISE / Wall Street Journal 11aug2007

 

Some of the most highly regarded mutual funds are getting beaten up by the mortgage meltdown -- and investors are yanking money out of U.S. stock funds.

Still, a few fund categories are holding up well this year, despite the recent turmoil. In fact, in what should come as little surprise, the only stock-fund category to post gains recently is bear-market funds: They're up 6.7% for the month ended Aug. 9, according to Morningstar Inc.

Some top stock funds haven't fared so well, largely because of heavy investments in housing-related stocks. For instance, Weitz Value and Legg Mason Value Trust, which have stellar long-term track records, also have hefty positions in stocks like home lender Countrywide Financial Corp., according to fund filings.

Countrywide's stock has fallen roughly 34% this year. It took a hit Friday after it said its financial condition could be hurt by "unprecedented disruptions" in debt and mortgage-finance markets.

Weitz Value is down 3.8% this year and lost about 8.9% over the past month, while Legg Mason Value Trust is down 2.3% so far this year and lost 8.5% in the past month, according to Morningstar data through Aug. 9.

Both funds are lagging behind most of their category rivals so far this year, according to Morningstar. Troubles in such funds illustrate that even some of the savviest stock-pickers may have been caught off guard by the extent of the housing slowdown and mortgage-market woes.

For fund investors, the risk is making investment decisions based on short-term swings. Advisers say investors should view the volatility as a reminder to stay diversified. Alternative investments like commodities tend to behave differently than stocks and bonds, reducing the risk of the overall portfolio. Indeed, many commodities-related funds have weathered the recent storm, given their distance from the mortgage debacle.

Overall, the average losses at U.S. stock funds in the past month range from 1.7% in health-sector funds to 10.7% in small value-oriented funds, according to Morningstar.

Overseas diversification didn't necessarily help: Emerging-markets funds are down 5.5% and Europe stock funds lost 6.7% in that period.

The market turmoil is driving investors to pull money out of domestic stock funds at a rapid clip. Investors pulled nearly $300 million out of stock funds in the week ended Aug. 8, according to AMG Data Services.

That is a reversal from July, when money poured in as the Dow Jones Industrial Average climbed toward 14000.

A number of fund managers whose holdings have been hit by housing-related woes say they'd like to buy more of these stocks as their prices fall -- but they don't have the cash to do it because investors are withdrawing money from their funds.

"I've had pretty steady redemptions and haven't had a chance to come up for air," says David Ellison, manager of FBR Small Cap Financial fund.

In recent weeks, mortgage-related holdings have seen steep declines. American Home Mortgage Investment Corp. said earlier this month that it had stopped taking mortgage applications amid the deteriorating market conditions and in recent days filed for bankruptcy-court protection. The stock sank to under $1 from over $20 in little more than a month.

Also seeing declines are home builders, building-materials companies, and big banks like Washington Mutual Inc., down about 15% over the past month.

The housing and mortgage jitters are reflected in the worst-performing domestic-stock-fund categories this year: Real-estate funds are down 7.1% for the year through Aug. 9, and financial-stock funds are down 6.1%. Natural resources and communications have been the top-performing domestic stock-fund categories this year, up 15.6% and 10.6%, respectively.

American Home's troubles are likely the main cause of a sudden reversal of fortune for at least one highly respected value-fund manager. The Schneider Small Cap Value Fund, the top-performing small-company value fund over the past five years, is the worst-performing fund in that category in the month through Aug. 9, with a 20.9% decline, according to Morningstar.

Its major holdings as of May 31 included American Home as well as Luminent Mortgage Capital Inc., which recently suspended payment of its second-quarter dividend.

Arnold C. Schneider III, manager of the Schneider Small Cap Value Fund, declined to comment.

A number of managers say they didn't anticipate the housing troubles would be so severe or widespread. "We have been surprised by the extent of this," says John Buckingham, manager of Al Frank Fund, which holds home builders like Beazer Homes USA Inc., down nearly 70% this year, and KB Home, down about 31%, as well as other housing-related stocks.

The fund is down more than 9% over the past month but still up 3.9% this year through Aug. 9.

Many managers firmly defend their housing-related holdings and say their long-term prospects are still bright.

"We think the good companies will do very well long term," says Ron Muhlenkamp, who holds stocks like Countrywide Financial, Washington Mutual, and home builder NVR Inc. in his Muhlenkamp Fund. The fund's 10-year returns place it near the top of its large-company value category, according to Morningstar. But it falls near the bottom of the category so far this year and over the past month, when it dropped 9.6%.

Some of the managers have been defending their housing-related holdings in recent communications to shareholders. In a July 19 letter to shareholders, managers Wally Weitz and Brad Hinton, who devoted nearly 18% of their Weitz Value fund's assets to mortgage-services stocks as of June 30, noted that such stocks have dragged down performance but wrote that "we feel very good about our mortgage-related holdings."

In an interview, Messrs. Weitz and Hinton say they still like holdings like Countrywide but are scrutinizing them. "As questions arise out in the marketplace and fears blossom and hedge funds go broke and so on, we recheck our assumptions," Mr. Weitz says.

Bill Miller, the Legg Mason Value Trust manager, also defended his housing stocks in a July 30 letter to shareholders.

"If we did not own housing or housing-related stocks (such as Countrywide Financial) we would be buying them now, amidst the panic selling currently underway," he wrote.

A number of managers feel their stocks are being unfairly punished. Anton Schutz, manager of Burnham Financial Services Fund, says holdings like People's United Financial Inc., a bank stock down 23% this year, have suffered even though they don't have big problems with subprime mortgages.

"If someone would give me some more money, I would love to buy more," Mr. Schutz says. Burnham Financial Services fund is down about 13% this year through Thursday.

source: B1 11aug2007

Market Turmoil May Halt Rate Rise

DAVID SMITH & DOMINIC O'CONNELL / Sunday Times (UK) 12aug2007

 

TURMOIL in the world’s financial markets could delay a rise in interest rates signalled by the Bank of England last week. It may even mean that the rise, which the Bank said was necessary to bring inflation down to the 2% target, does not happen.

The Bank seems determined, however, not to cut interest rates, which it did six years ago when markets fell in response to the 9/11 attacks on America.

Andrew Sentance, a member of the Bank’s interest rate-setting monetary policy committee, says in an interview with The Sunday Times today that the world economy remains strong and that the Bank is still concerned about the inflationary impact of the powerful global upturn.

“Financial market developments will only impinge on inflation and the real economy in so far as they have substantial effects on businesses and households and the way they behave,” he says.

He adds: “The broader global picture has been very strong. Asia has a lot of impetus and the European economy has rebounded. Our view is that global economic growth still has a lot of momentum.”

City traders will be looking for stock markets to calm tomorrow after a steadier performance from Wall Street on Friday. However, central banks are ready to pump more cash into money markets to prevent the financial system grinding to a halt.

Central banks, led by the European Central Bank (ECB) and the US Federal Reserve, pushed more than $300 billion (£148 billion) into the banking system over a 48-hour period last week to avert a financial crisis. The Bank of England did not join in.

Experts say the strength of the global economy and Britain’s long upturn - which has lasted for 15 years - make a recession unlikely, although the British Chambers of Commerce, in a forecast due out this week, will warn of a slowdown in growth.

The Federal Reserve is expected to cut interest rates to boost the American economy, with the ECB likely to postpone a planned rate increase.

source: 11aug2007

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