Stock rally fizzles on bad news

For the week ended January 30, 2009

• Economy shrank, prices fell last quarter
• More companies post losses, cut jobs
• Ongoing unemployment rises
• Home prices decline but home resales rise
• ndex of leading economic indicators edges up

To no one’s surprise, the U.S. economy shrank in the fourth quarter of 2008. But the announced 3.8% drop in gross domestic product (GDP) was actually better than many economists had expected. However, excluding a buildup of inventories, the economy contracted 5.1% in the quarter. The U.S. stock market responded to the Friday morning announcement by declining broadly.

Despite continuing negative economic reports, sobering corporate earnings announcements, and widespread layoffs, U.S. stocks had enjoyed a four-day positive run through Wednesday. However, markets reversed course on Thursday, after several sobering economic reports.

Just a day earlier, stocks had risen on anticipation of a massive stimulus plan and possible action by the Obama administration to buy so-called bad “assets” from banking firms. This plan would free banks to provide fresh financing to get the economy moving again. Financial stocks played a key role in setting the tone for the market, on its way up and down.

Meanwhile, Congress grappled with a proposed $800 billion-plus stimulus plan that included tax cuts and infrastructure spending. The House of Representatives, voting along partisan lines, passed its version of the plan. The Senate is about to debate it. Few people could debate the urgent need for action.

U.S. economic news

The same report that announced sharply lower economic activity confirmed that prices fell substantially as well. Although the core price index, which excludes food and energy, rose 0.6% in the fourth quarter, the “headline consumer inflation,” which includes all spending, dropped at a record 5.5% annual rate.

Housing market news continued to weigh heavily on the stock market. The announcement by the U.S. Department of Commerce on Thursday that sales of new single-family homes had fallen 14.7% to a record low in December halted the multi-day market rally, and financial stocks fell 7.2%.

On the bright side, home resales rose 6.5% in December, to a 4.74 million annual rate, from a yearly pace of 4.45 million in November, according to the National Association of Realtors. However, one reason for the increase in sales was the prevalence of discounted prices in distressed housing markets. The median home price fell 15.3% in a year, from $207,000 in December 2007 to $175,400 in December 2008.

Another glimmer of hope came in the form of The Conference Board’s announcement that the composite index of leading indicators rose 0.3% in December. Four of the 10 indicators rose — real money supply, the interest rate spread (the gap between the rate banks pay on deposits and what they charge on loans), manufacturers’ new orders for consumer goods and materials, and new orders for nondefense capital goods.

The U.S. Department of Labor reported that as of mid-January, almost 4.8 million Americans were receiving unemployment benefits, the most since it began keeping track in 1967. And 588,000 new claims for unemployment benefits were filed last week, on a seasonally adjusted basis.

U.S. and global corporate news

The list of companies that announced layoffs this week was long, with 62,000 job cuts revealed on Monday alone. Caterpillar said it would cut 20,000 jobs (18% of its work force) in response to sharply lower demand. Sprint Nextel is planning to lay off 8,000 people by March 31. Other companies that announced layoffs during the week: Home Depot: 7,000; General Motors: 2,000; Eastman Kodak: 3,500 to 4,500; Japanese electronics giant NEC: 20,000; Swiss banking and insurance firm ING: 7,000; German electronics company Philips: 6,000.

However, not all corporate news was bad. While oil giant Exxon Mobil announced that its fourth-quarter net income was down 33% to $7.8 billion on tumbling oil prices, its full-year profit was a record $45.2 billion, an 11% rise from the previous record, set in 2007. The second-largest U.S. oil producer, Chevron, had a slight increase in profit, to $4.9 billion, boosted by a $600 million asset-exchange transaction.

Other good news: Amazon.com posted a 9% increase in profit, which exceeded Wall Street’s expectations, on surging sales in the fourth quarter, as aggressive discounting, free shipping, and ever-expanding product categories paid off for the Internet retailer.

Swiss drug-maker Novartis also bucked the negative trend, with a 70% increase in its net profit in the fourth quarter compared with year-earlier results. And despite an increasingly challenging market, the firm said it anticipates another year of record results.

Other firms reporting sharply lower net income or substantial losses included Ford Motor Co., a fourth-quarter $5.9 billion loss; Wells Fargo, a $2.5 billion fourth-quarter net loss; AT&T, a 24% decline in quarterly net income despite ongoing growth in its wireless business; and Japanese digital camera and electronics firm Canon, a 91% decrease in its fourth-quarter net profit on plummeting export demand and a strong yen, which cut into the value of overseas earnings.

Global economic news

Japan’s recession, which began in November 2007, according to a government statement Thursday, deepened in December, according to data released Friday. Preliminary industrial production fell 9.6% last month, its second consecutive month of record decline.

The U.K. economy has fallen into a recession, with the announcement of a second consecutive quarterly decline in real gross domestic product.

In the same week that the International Monetary Fund cut its 2009 forecast for the eurozone economy to a 2% contraction, from a previous prediction of a 0.5% decrease, data from Germany and France showed that consumer confidence steadied at the beginning of 2009, as lower energy prices helped salaries stretch further. Meanwhile, the eurozone’s unemployment rate rose to a two-year high of 8% in December, up slightly from 7.9% in November, on the basis of data from the European Union statistics agency Eurostat.

German business confidence, as measured by the closely watched Ifo survey of business sentiment, edged up to 83 in January from 82.7 in December, which was a record low level. Falling interest rates and fuel prices helped to pick up business sentiment.

Stay focused and diversified

In any market environment, we strongly believe that investors should stay diversified across a variety of asset classes. By working closely with your financial advisor, you can help ensure that your portfolio is properly diversified and that your financial plan supports your long-term goals, time horizon, and tolerance for risk. Diversification does not guarantee a profit or protect against loss.

The views expressed here are those of MFS^®and are subject to change at any time. These views should not be relied upon as investment advice, as securities recommendations, or as an indication of trading intent on behalf of any MFS investment product. Individual securities mentioned are for illustrative purposes only and may not be relied upon as investment advice or as an indication of trading intent on behalf of any MFS product.

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The Dow Jones Industrial Average (DJIA) measures the U.S. stock market; the Standard & Poor’s 500 Stock Index (S&P 500) measures the broad U.S. stock market; and the NASDAQ Composite Index measures domestic and foreign-based stocks traded on the National Association of Securities Dealers Automated Quotation system.

Sources: MFS research; The Wall Street Journal; The Wall Street Journal Online; Bloomberg News; Financial Times.