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Rate Cut a 'Close Call'; GDP Growth Shrouded in Uncertainty - Fed Minutes

Minutes from last month's FOMC meeting released Tuesday indicate the Fed's decision to cut interest rates by 0.25% to 4.5% was a "close call." Ultimately, though, "most members saw substantial downside risks to the economic outlook and judged that a rate reduction at this meeting would provide valuable additional insurance against an unexpectedly severe weakening in economic activity" (full text). The dissenting vote of Fed governor Thomas Hoenig was because he "saw the risks to both economic growth and inflation to be elevated and preferred to wait, watch, and be ready to act depending on how events developed." The Fed sounded an encouraging note on consumer spending: "Available data suggested that consumer spending had been well maintained over the past several months and that spillovers from the strains in the housing market had apparently been quite limited to data," while noting "anecdotal reports" of a softening in retail sales in some areas. Newly enhanced Fed forecasts indicated the Fed was more sure-footed in its inflation outlook than in its view of economic growth: Fed officials said growth would slow to 1.8%-2.5% in 2008, down from about 2.45% in 2007. The Fed sees 2.6% growth in 2009-10. Core inflation as measured by the PCE index is seen as remaining staedy at 1.7-1.9% over the period. However, the minutes noted, "most participants judged that the uncertainty attending their October projections for real GDP growth was above typical levels seen in the past. In contrast, the uncertainty attached to participants' inflation projections was generally viewed as being broadly in line with past experience."

Two-Year Interest-Rate Swap Spread Closes at 18-Year High

The spreads on two-year U.S. interest rate swaps widened to record levels Tuesday on growing credit fears and rising short-term interbank loan rates. The two-year swap spread traded as wide as 101.25 basis points before settling at 97 basis points versus 96 on Monday. The last record spread was 97 basis points in March 1989, during the savings-and-loan crisis. The five-year spread widened six basis points to 95.75 and the 10-year spread seven basis points to 80.75. "The widening of swap spreads is a function of tight lending and a de-leveraging in the financial system and the high cost of money," said William O'Donnell of UBS Securities. "The last two times we saw these meteor-like spikes in swap spreads in the U.S., they were followed by a recession." Banks are increasingly reluctant to lend to one another, as reflected in the rise of the three-month LIBOR rate on dollar deposits to 5%, its highest in three weeks and fifth consecutive daily increase. Tuesday saw an acceleration of investors' flight to safety, spurred in part by a report of heavy subprime losses at mortgage finance company Freddie Mac (full story). "As long as the liquidity crisis goes on, with Libor rates rising, and people keep buying Treasuries, these spreads will remain wide," said Fidelio Tata of RBS Greenwich Capital. "Banks, and financial institutions in general, are short credit and really don't want to lend. It won't get much better until after year-end."

WSB Sponsor

Paulson Offers Gloomier Outlook for Home-Loan Defaults

Treasury Secretary Henry Paulson, in an interview with The Wall Street Journal, said he is "aggressively encouraging" the mortgage-service industry to provide help "broadly" to struggling borrowers of resetting adjustable rate loans, instead of an earlier strategy of handling problems individually case-by-case. Mr. Paulson's outlook has become gloomier and more worrisome. He said the resetting mortgage problems will be "significantly bigger" next year because mortgages taken out in 2006 had lower underwriting standards, no amortization and no down payments. "This is not business as usual. This is an extraordinary situation," said Mr. Paulson in response to Oklahoma Republican Sen. Tom Coburn's objection to a Congressional bill that would allow the Federal Housing Administration to assist borrowers. Mr. Paulson called the Senate's failure to pass legislation to allow Fannie Mae and Freddie Mac (the nation's largest mortgage purchases and credit guarantors) the ability to play a bigger role in the market "very disappointing." One possible fix, at least temporarily and possibly through 2008, is to freeze rates on resetting adjustable rate mortgages for troubled homeowners. California and four major-loan servicers including Countrywide Financial endorsed such a temporary rate freeze measure on Tuesday. Meanwhile, stocks in Asia fell across the board Wednesday and European benchmarks are broadly lower intra-day on heightened concerns over the U.S. economy, resulting in further weakness in the dollar amidst record oil prices and reduced expectations of further Fed rate cuts.

TECHNOLOGY

Ericsson Drops on Weak Q4 Guidance

Ericsson, the world's biggest maker of mobile-network gear, on Tuesday predicted sales and margins for Q4 would be at the lower end of the forecast range it had given last month, due to tightening U.S. and European demand and unrest in emerging markets. The news sent shares in the telcom giant down 11% to their lowest since 2004. In October, Ericsson shares plummeted 30% after the company warned of weak Q3 earnings, and said Q4 sales would be between $8.4 and %9.6 billion and operating margins would be in the mid-teens. Analysts' Q4 estimates have been for sales of about $8.79 billion. Disappointed Ericsson gave no indication when improvements would be seen, and analysts and investors have begun to express concern about the company's ability to monitor business performance. CFO Hans Vestberg, who replaced CFO Karl-Henrik Sundstrom within days of the October announcement amid promises of better monitoring and avoiding market shocks in future (full story), told investors that wireless network building projects in Europe where operators involved in mergers and acquisitions are slowing spending on upgrades would weigh on Ericsson's margins for several quarters. Piper Jaffray lowered its price target from $33 to $26, but maintained its Neutral rating. "This makes it obvious that something must be wrong in their reporting systems," said Redeye AB analyst Greger Johansson. "I don't have much confidence in the company or management."

Sources: Bloomberg, Reuters, AP, LightReading, ERIC)+to+$26/3141981.html" rel="nofollow">StreetInsider
Commentary: Tuesday's Options Report: EricssonEricsson's Outstanding Value: Patience is KeyDon't Write Off Ericsson, Especially at This Valuation
Stocks to watch: ERIC. Competitors: ALU, NT, MOT, NOK.
Earnings call transcript: Telefon AB LM Ericsson Q3 2007

RETAIL

Burger King To Offer $1 Double Cheeseburger - WSJ

In a tactic that could set off a price war with its biggest rival, Burger King is taking aim at one of McDonald's bestselling offerings: the $1 double cheeseburger. Burger King plans to test its own, 30% larger $1 double cheeseburger in three as-yet unspecified U.S. markets, starting early in 2008. "[T]he dollar double cheeseburger is the most powerful weapon our competitor has to continue their growth and steal disproportionate share from the category," Burger King's CFO told employees in an email notifying them of the test. Burger King franchises are allowed to set their own prices, and a handful of L.A.-area Burger Kings are already selling the sandwich for $0.99. Widening the challenge could ultimately be harmful to both Burger King and its rivals; as the WSJ notes, the "burger battles" of 2000 and 2003 took a toll on many industry participants. Still, the company appears to believe it has no choice. "The fact remains that we are still at a double-digit disadvantage to McDonald's and Wendy's in 'Best Value for the Money' ratings," said Russ Klein, president of global marketing, strategy and innovation. Burger King's Value Menu represents approximately 12% of total sales, while McDonald's Dollar Menu accounts for 23% of revenue and Wendy's Super Value Menu accounts for 25%.

Sources: Wall Street Journal, Reuters
Commentary: Burger King Beats; Announces Secondary OfferingEleven Fast Food Stocks To Take A Bite Out Of
Stocks to watch: BKC. Competitors: MCD, WEN, YUM. ETFs: FXD
Earnings call transcript: Burger King F1Q08

Limited Trips on Earnings Miss, Soft Guidance

Shares of clothing retailer Limited Brands fell 1% in after-hours trading Tuesday as the company missed consensus analyst estimates in its latest quarter and issued soft guidance for the holiday shopping season. Q3 net income tumbled 48.5% to $12.1 million, good for EPS of $0.03, versus EPS of $0.06 a year ago. Discounting a $0.04 a share pretax gain, adjusted EPS was -$0.01. Sales fell 9% to $1.92 billion. Consensus analyst estimates were for adjusted EPS of $0.01 on sales of $1.95 billion. Operating income fell operating income fell 8% Y/Y to $61.1 million while same store sales were down 3% Y/Y after the company had predicted flat same-store sales. Looking ahead, Limited expects Q4 EPS of $0.90 to $1.05 (mid-point $0.975), versus $1.08 a year ago. Consensus analyst estimates are for Q4 EPS of $1.09. Said portfolio manager Greg Estes: "It's just not a good time for consumers, and I'm not very optimistic that the holiday season's going to have very good results."

ENERGY AND MATERIALS

Exxon Up 4.4% on Analyst Upgrade, Libya Deal

Shares of Exxon Mobil finished more than 4% higher Tuesday, after UBS analysts recommended buying the oil company. UBS increased its price target for Exxon to $96 from $92. The stock had fallen 10% this month, even as oil prices have advanced. "The market sell-off has provided an attractive opportunity to buy arguably the world's best oil company," UBS analyst William Featherston said. Crude futures climbed to 1.8% to finish at $96.33/barrel Tuesday. Exxon shares also got a boost after the company announced it signed a deal to explore for oil and gas off Libya's coast. The deal between the company and African nation was struck without an auctioning process, and will give Exxon access to the Sirte Basin, a deepwater area 110 miles off the Libyan coastline in the Mediterranean Sea. Exxon agreed to pay a signing fee and provide a training program and other forms of educations for Libyans. The company's shares finished 4.4% higher to $87.82 on the close Tuesday.

Ethanol Producers Face Price Pressures, Fundamental Questions

The profitability of ethanol producers has been hit by rising commodity prices and a sharp reduction in the price of ethanol. Corn has risen to about $3.80 a bushel on the Chicago Board of Trade from less than $2.50 in September 2006, whereas ethanol fell to about $1.86 a gallon versus $4.33 in June 2006. Ethanol production in August, at 10.3 million barrels, was 32% higher than a year earlier. But restrictions by Georgia and Florida on use of ethanol during the summer, when the fuel easily evaporates, cut demand by about 3 billion gallons -- or 45% of current national demand -- according to Friedman, Billings, Ramsey. Despite ethanol plant closures, new mills are expected to come on line next year, raising output to 11.3 billion gallons by year-end. Without a relaxation in fuel regulations by Georgia and Florida, demand is likely to grow slower than supply. David Pimentel, a professor of ecology and agriculture at Cornell, claims that manufacturing ethanol from corn requires 29% more energy than ethanol itself produces. Michael Wang, an environmental engineer at the Argonne National Laboratory outside Chicago, disputes the inclusion of energy spent on making fertilizers and pesticides in the calculation, and therefore estimates that ethanol production results in a 33% gain in combustible energy. According to Ron Oster, a principal at Broadpoint Capital, "Ethanol companies are near breakeven at best; that's not a good recipe when you have $100 oil."

FINANCIAL

Countrywide Denies Bankruptcy Talk; Swaps Soar

The perceived risk of corporate default on debt rose Tuesday as mortgage lender Freddie Mac posted a record loss (full story). Trading in credit-default swaps suggested that investors fear other mortgage lenders, including industry leader Countrywide Financial, might face serious funding shortfalls. Countrywide shares sank up to 22% Tuesday, a seven-year low, before rebounding to close down 3.2% at $10.23. After Freddie Mac reported its $2.02 billion net loss (triple what some analysts had forecast), its swaps rose 14 basis points to 69, a four-year record, before settling at 64. Countrywide contracts followed suit, skyrocketing 150 basis points to 900. Investors have begun to demand upfront payments of up to 13% on top of 500 basis points a year for five years. "The chatter is that [Countrywide] might file for bankruptcy," said trader Paul Berliner of the Schottenfeld Group, a rumor Countrywide denied as "absolutely false." In a statement, the bank said it "has sufficient liquidity available to meet its projected operating and growth needs and has accumulated significant contingent liquidity in response to evolving market conditions." Fox-Pitt Kelton analyst Harold Shapiro nevertheless downgraded Countrywide on Tuesday, writing that the lender's "survival strategy has depended on access to the secondary markets" through Fannie Mae and Freddie Mac -- a strategy that is "less viable" now that Fannie and Freddie are "capital constrained." "The financial sector is melting," said Peter Plaut of hedge fund manager Sanno Point Capital. "It's a wake-up call to the Fed, and I am not convinced that even significant rate cuts will stabilize the situation in the near-term."

Freddie Mac May Need to Raise $6B

Number-two residential mortgage lender Freddie Mac (FRE) may need to raise as much as $6 billion to bolster its waning reserves, Fox-Pitt Kelton analyst Howard Shapiro said Tuesday. The government-sponsored company told investors Tuesday it will require a 'large transaction' to boost its reserves. Other analysts say the company likely needs about $5 billion. "It's not going to be a small number," Portales Partners analyst Gary Gordon said (Bloomberg). In its Q3 earnings call Tuesday, CEO Dick Syron said, "Look this is a very, very difficult time. This is not happy news... We have a difficult situation in front of us but we are confident and we are committed that we can work through it in a way that benefits both our shareholders in our mission to the mortgage market and the U.S. economy," (transcript). Freddie Mac said it may slash its $0.50/share quarterly dividend. Another option may be to issue $3 to $4 billion in preferred stock. Spokesman Michael Cosgrove said the company hasn't set a specific target as to how much capital it will raise. With less money to buy new mortgages, troubles at Freddie and number-one lender Fannie Mae (FNM) could be cause for concern in an already troubled residential mortgage markets. "This is a disaster for the broader mortgage capital markets," Shapiro said. "To the extent that Fannie Mae and Freddie Mac cannot grow, you are taking even more liquidity out of the markets," (Bloomberg). Freddie Mac plummeted 29% Tuesday; Fannie Mae fell 25%.

HEALTHCARE/BIOTECH

FDA Raises Safety Concerns About Pfizer Anti-Smoking Drug Chantix

Pfizer's hopes anti-smoking drug Chantix will soon become a blockbuster (any drug with global sales of $1 billion annually) hit a major bump in the road Tuesday when the FDA issued an 'early warning' for the drug. The agency's concerns are twofold: first, it believes Chantix may cause "suicidal thoughts and aggressive and erratic behavior," and second, the drug may cause drowsiness, leading to the associated dangers of operating cars and heavy machinery. The FDA has placed the first concern on labels of the drug, while warning doctors to be on the lookout for the second concern. The FDA specifically questioned whether the death of a Dallas man taking Chantix was caused by the drug. The man's relatives had complained his behavior had undergone a drastic transformation following the beginning of treatment. A Pfizer Spokesperson claims, "There is no scientific evidence that establishes a causal relationship between Chantix and these reported events." Chantix differs from other anti-smoking treatments in that it contains no nicotine and is instead believed to block nicotine's ability to bind with key receptors in the brain. The loss of Chantix is a major concern for Pfizer and its shareholders; Chantix recorded $241 million in sales in Q3 alone. Pfizer shares are lower by 1.54% in pre-market trading Wednesday.

Sources: Wall Street Journal, Reuters, Financial Times
Commentary: Does Big Tobacco Actually Love Pfizer's Anti-Smoking 'Chantix' Pill? [24/7 Wall St.] • Pfizer Stumped On Torcetrapib RiskCramer on PFE
Stocks to watch: PFE. Competitors: MRK, JNJ, NVS, BMY. ETFs: FDL, IYH
Earnings call transcript: Pfizer Q3 2007

Shares of Novo Nordisk Rise on Diabetes Drug Data

Novo Nordisk said Tuesday Phase II clinical data for its diabetes drug candidate liraglutide showed the drug was more effective in helping to lower weight in obese patients than GlaxoSmithKline's orlistat. Liraglutide, given once a week for 20 weeks at the highest dose, helped people lose 7 kg versus the 3 kg the average person lost in the placebo group. "We are very encouraged by these new results. They give us reason to believe that liraglutide has the potential to become a new and important treatment option in the fight against serious obesity," said Mads Krogsgaard Thomsen, chief science officer at Novo. Liraglutide is part of the new class of diabetes drugs known at GLP-1 analogues. Shares of Novo Nordisk jumped on the news, closing 5% higher to $127.19, while shares of GlaxoSmithKline traded 0.4% higher to $48.21.

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ETFs: Fed and Yields Headed Down
Sound Money: Date at Work
Jim Cramer: Latest stock picks
Transcripts: Office Depot Q3 2007Barnes & Noble F3Q07BJ's Wholesale Club Q3 2007GameStop F3Q07Saks Q3 2007Target Q3 2007Ross Stores F3Q07Freddie Mac Q3 2007D.R. Horton F4Q07Limited Brands Q3 2007Whole Foods Market F4Q07Hot Topic Q3 2007Home Inns Q3 2007China Finance Online Q3 2007Aruba Networks F1Q08Pacific Sunwear of California Q3 2007LTX F1Q08Jamba F3Q07QAD F3Q08Hibbett Sports F3Q08ValueVision Media Q3 2007Blue Coat Systems F2Q08Eaton Vance Corp. F4Q07Brady F1Q08New York & Company Q3 2007Hormel Foods F4Q07Zales F1Q08Jacobs Engineering Group Analyst Meeting TranscriptDycom Industries F1Q08Giant Interactive Q3 2007Hurray! Q3 2007

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