It was a punitive end to a roller-coaster week. Dow Jones breached 11000 (a first time low in nearly two years) but pulled back to end at 11,100.54, losing 128 points. Standard & Poor’s 500 index lost 1.1% while Nasdaq composite shed 0.8% to remain above March lows.
Trading fears stemmed from possible insolvency of Fannie Mae and Freddie Mac which could lead to a government buyout. Losses were trimmed after reassurances that “both firms will be kept in their current condition” and an emergency discount window for direct borrowing from the Federal Reserve may be made available.
With nearly $5 trillion worth of mortgages (half of the America’s home-loan debt), failure of either company could be catastrophic for the already bleak financial sector. Investors who bought into high-yield mortgage-backed securities could be staring at worthless pieces of paper.
The sour mood sparked a broad sell-off in almost all financial services. Lehman Brothers lost another 16.6%, amid concerns that its $3 billion second-quarter loss last month could just be the tip of the iceberg.
AIG, Bank of America, Washington Mutual, Wachovia, and JP Morgan Chase were not spared either. Citigroup closed with modest losses, after the company said it is selling its German retail banking unit for $7.7 billion.
General Electric reported higher sales (exceeding analysts estimates) but weaker earnings. The company reiterated its estimate of $2.20 to $2.30 earnings per share for the full year as compared to analysts’ estimates of $2.22 per share.
Certainly, there is more pain to come before a bottom is reached. At this point of time, most financial firms need recapitalization to shore up their balance sheets but nobody is sure how the money is going to be raised or how deep the hole is.
However, if you adopt a long term investment approach, you can build positions in financial stocks slowly and whenever they take a battering. Do not expect the downward trend to reverse in the short term though. Writing off toxic assets is likely to continue in 2009 before the banks can pick themselves up again.