Midday Market Comments

Canada

 

At midday, equities in Canada are materially lower with weakness in the Financial subsector of the S&P/TSX which accounts for about a quarter of the index's total weight, rattled by the bankruptcy of Lehman Brothers and persistent worries over the health of the U.S. financial system. 

 

We recommends patience, as today's losses may not be the only losses this week as the market takes time to digest and understand the magnitude and extent of the weekend's events.  Equities will likely continue to fall this week.  You do not need to be a buyer today if you are sitting on cash and waiting for a pullback.

 

All major Canadian banks are posting negative returns, led by Canadian Imperial Bank of Commerce (CM), down 4.3%.  The bank announced that its mark to market exposure to Lehman Brothers net of collateral is immaterial at $25 million.  Despite this, the bank continues to sell off.

 

The Energy subsector dropped 3.8% in-line with lower energy prices.  Canadian Natural Resources (CNQ) slid 5.5% while EnCana (ECA) fell 2.9%.

 

Teranet Income Fund (TF-UN) advised its unitholders not to take any action regarding the formal takeover bid from Borealis Infrastructure Management Inc.  The company commented that investors should wait while the fund seeks alternatives. Teranet is trading lower by 1.4%.

 

Teck Cominco Ltd. has secured European antitrust approval to buy Fording Canadian Coal Trust. The European Commission, the European Union's antitrust regulator in Brussels, announced the approval in a statement today. Teck has scheduled a shareholder vote on the acquisition for Sept. 30 and anticipates finalizing the deal by the end of October, according to Greg Waller, head of investor relations at Teck Cominco.

 

U.S.

 

At midday, U.S. equities are materially lower with all ten subsectors of the S&P 500 posting negative returns led by Financial and Energy subsectors. This is a historic moment for the U.S. financial services sector, after Lehman Brothers (LEH US) filled for bankruptcy protection and Merrill Lynch (MER US) agreed to be acquired by Bank of America (BAC US).   Lehman has been suspended from trading on NYSE and continues to trade on electronic trading systems at 20 cents a share.  Merrill Lynch is up 17.3%, and Bank of America fell 16.2%. 

 

American International Group (AIG US) is in further trouble as the company was expected to deliver a plan to sell assets to raise capital and avoid a downgrade by rating agencies. AIG rejected an offer from private equity firms. AIG plunged earlier by 70%.   Headlines at 12:30 -- saying that AIG has reached deals with the New York state insurance officials authorizing it to access $20 billion of capital in its subsidiaries to free up liquidity effectively making a bridge loan to itself for that amount.   AIG is rallying, now down 51%.

 

International

 

In Europe, equities fell led by banking shares after the bankruptcy of Lehman Brothers over the weekend.  Worthy of mention are Barclays Plc which pulled out of talks to buy Lehman Brothers and slid 13%, it's biggest loss in 20 years.    Britain's biggest mortgage lender HBOS Plc, dropped a record 27% while Royal Bank of Scotland fell 13%.  All major European indices are currently posting losses in excess of 3%.   

 

Equities in Asia are on a holiday today with markets in Hong Kong, Japan and Taiwan closed. 

 

Currencies & Commodities

 

Gold advanced $20 and is trading at $785.1 per ounce after Lehman Brother's bankruptcy sent investors scrambling for a safe heaven.  Crude oil fell to $97.33 per barrel, near it's lowest level in six months, as refiners in the Gulf of Mexico escaped damage from Hurricane Ike and investors eased fears over supply-disruptions.  The U.S. dollar dropped the most in a decade against the yen after investors sold assets financed by loans in Japan.  The Swiss franc also showed strength and rose against every other major currency. 

 

TradeTech reports that the spot price of uranium dropped $1.50 this week to US$63.00/lb U3O8. The group noted that demand is highly discretionary and spot supply is more than adequate to satisfy spot requirements. In addition, new spot supply continues to emerge.

 

Morning Market Comments

Quick Summary

1. Lehman Brothers filed for bankruptcy
2. Merrill Lynch (MER) has agreed to be bough out by Banc of America.
3. The Federal Reserve has widened the collateral it accepts for loans to securities firms.
4. The Fed also has boosted its program for lending Treasuries to bond dealers by $25 billion, brining it to $200 billion
5. A group of 10 banks including JP Morgan (JPM), Goldman Sachs (GS) and Citigroup (C.N) have formed a $70 billion fund to ensure market liquidity
6. The European Central Bank and Bank of England pumped emergency funds into their financial systems this morning as did the central banks of Switzerland and Australia.
7. The Federal Reserve meets tomorrow and is speculated to make either a 50 or 75 basis point cut.  It may even move today if warranted.
8. AIG Group (AIG) is seeking a $40 billion bridge loan from the Federal Reserve after weekend talks failed to raise capital for the company.


A history making weekend for the U.S. financial services sector as Lehman Brothers (LEH) said it would seek bankruptcy protection and Bank of America (BAC) said it would acquire Merrill Lynch (MER) for 0.8595 of a share of BAC for each share of MER. The transaction values Merrill at U$24.75 based on BAC's current share price in pre-market trading.

Lehman's filing threatens the Credit Default Swap (CDS) market as nobody is really sure how to settle or unwind these positions. Lehman ranked as the seventh-largest credit derivative counterparty by Fitch Ratings in a survey released last year. Scotia's fixed income strategist believes there are about U$1 trillion worth of counterparty transactions that flow through Lehman. Reuters noted the private nature of the market, however, makes the size of its books impossible to quantify.

The next shoe to fall could very well be American International Group (AIG). The shares are down 50% again this morning after they were pummeled last week on concerns about ratings downgrades that would require the company to post additional collateral. A significant portion of AIG Financial Products unit guaranteed investment agreements and financial derivatives transactions include provisions that would require the company to post additional collateral or repay its positions. According to a Financial Times article, it was estimated that a downgrade of AIG's long-term senior rating to A1 by Moody's and A+ by S&P would permit counterparties to make additional calls for up to U$13.3 B of collateral. AIG apparently turned down a capital infusion from a group of private equity firms led by JC Flowers because of an option tied to the offer that would give these investors control of the company. The press is saying AIG has asked the Federal Reserve for a U$40 B bridge loan. Some analysts think the Fed will extend them the necessary credit to stay afloat.

We do not believe this is the beginning of the end of troubles in the U.S. and global financial system. Banks are likely to hoard more cash and further reduce their willingness to lend money to consumers and businesses. This will delay a recovery in the housing market and prolong the downturn in the U.S. economy. Former Fed Governor, Alan Greenspan said this is a once in century event, the worst he has seen in his career. He believes the crisis still has a way to go and will be a corrosive force until the price of home in the U.S. stabilize.

A volatile day is ahead...

Obviously we expect all capital markets to be volatile in the near term after the weekend's announcments.