World Economy: Investors Remain Jittery

Bears have reigned supreme on Wall Street so far in September thanks to growing concern about economies worldwide, but their grip on stocks faces a big challenge after the US government's weekend seizure of control of mortgage finance giants Fannie Mae and Freddie Mac.

Since late spring stocks have been caught in a vise of investor anxiety about the fate of the two linchpins of the US mortgage market, which between them own or guarantee more than half of the $US12 trillion outstanding US home loans.

With home prices continuing to spiral lower, Fannie Mae's and Freddie Mac's losses deepening by the week and sources of fresh private capital increasingly scarce, investors worried that any collapse of the two would trigger a global financial catastrophe.

But analysts said Sunday's move to place them under government control should alleviate worry about the worst-case scenario and removes a veil of uncertainty that markets loathe.

``It's probably a good move for the markets in the short term,'' said Peter Kenny, managing director at Knight Equity Markets in Jersey City, New Jersey.

``I think the stock market is going to take this as a positive,'' agreed William Larkin, fixed income portfolio manager at Cabot Money Management in Salem, Massachusetts.

``It's going to hurt Treasuries because that flight to quality that was occurring will probably go the opposite direction.''

``The government is going to be basically pulling a lot of this stuff onto the US government's balance sheet and that may be a concern for the dollar, but it is going to be a positive for our financial system,'' Larkin said.

The government decision to place Fannie Mae and Freddie Mac in conservatorship will not provide universal relief, however. Their common shareholders are likely to be left with little value, and preferred shareholders will also take a hit, a move that could hurt a number of small banks with preferred holdings that are significant relative to their overall capital.

Still, US regulatory agencies said ``they are prepared to work with these institutions to develop capital-restoration plans pursuant to the capital regulations.''

It also remains unclear how successful the government action would be in shoring up the broader economy, which has been in the doldrums for the last year largely as a result of the worst US housing market since the Great Depression.

Recent data that showed the US economy continues to shed jobs and warnings from a raft of companies about diminished global demand slammed equity markets over the past week.

The three main US indexes lost more than 2.8% each, with the S&P 500 coming perilously close to a 2008 low set in mid-July. European and Asian markets also fell sharply.

Markets have struggled even as the price of oil has continued a steady slide, down about 27% from its July record above $US147 a barrel. While positive for consumers, lower oil prices are also a symptom of slowing global demand.

Companies, too, have forecast tougher times ahead, with Dell Inc predicting slower corporate technology spending and chip maker Qualcomm saying consumers have grown slower to upgrade their mobile phone handsets.

``There's been a strong contingent of economists who have been feeling that the economy was going to avoid a recession,'' said Sasha Kostadinov, portfolio manager at Shaker Investments in Cleveland, Ohio.

``I think now those people who have been holding out are throwing their beliefs out the window. We've got a soft economy, credit is tight and the consumer is really struggling.''

Eyes on the US economy

As if the weekend's events surrounding Fannie Mae and Freddie Mac weren't enough to digest, investors must also pore over reports on retail sales, first-time jobless claims and pending home sales.

Analysts said signs of further weakness, particularly after Friday's data showed US unemployment hit a five-year high of 
6.1% in August while 84,000 jobs were lost, would add to the stock market's woes.

``It will fuel expectations that the economy is in really bad shape and we'll see people talking about it falling into recession,'' said John Praveen, chief investment strategist at Prudential International Investments Advisers in Newark, New Jersey. ``I don't think it will, but the recession talk will resurface, and that will have a negative impact.''

While the US economy is undoubtedly fragile, Praveen said weak data could, along with a stronger US dollar and lower oil prices, put to rest one market fear: inflation.

That may set investors thinking that the Federal Reserve has room to cut interest rates again, which could boost consumer and business spending. To that end, he said, producer price data on Friday will be scrubbed for signs of softening price pressures.
 
Banks woes Hurricane Ike looms

There are other hurdles to clear, though, and some of them may prove high. Wall Street analysts have forecast additional write-downs in the third quarter for a number of financial firms, which Praveen said will keep pressure on the sector.

And only a week after dodging a bullet with Hurricane Gustav, Wall Street will be tracking the path of Hurricane Ike, which by Sunday had grown to a dangerous Category 4 storm on a path for the oil-rich Gulf of Mexico.

Meanwhile, a firmer US dollar, which hit a year-to-date high against a basket of major currencies last week, may take the shine off export-driven companies, undercutting the one area of the economy that has been a top performer.

Signs of slower growth in the euro zone and Japan make that an even bigger concern. European shares shed some 5.8% over the last week on growth worries, their worst weekly loss in 5-1/2 years.

``This feeds concern that growth will weaken further, because exports were the one prop the economy had, and that prop is being removed,'' Praveen said.

Reuters

Reuters