Markets Reflecting Recession Concerns

A majority of worldwide financial markets finished lower last week as concerns grew over the prospect of the U.S. economy entering a recession.

On Tuesday, phone giant AT&T (T) warned that a slower economy is hurting its consumer businesses. The renewed worries that consumer spending is slowing prompted the Dow to drop over 200 points by the close of the day.

Ben Bernanke attempted to soothe the markets on Thursday by noting that “further policy easing may be necessary” in order to prevent an economic recession. After the report by Bernanke, bond traders began pricing in a 50 basis point cut by the FOMC at their upcoming Jan 30^th meeting. The prospect for more aggressive interest rate cuts sparked a rally in global equities during a volatile day of trading.

Financial companies were in the news once again during the week. MBIA (MBI), a bond insurer, reduced its quarterly dividend and issued $1 billion of new debt (at a 14% interest rate) to buoy its balance sheet. Both Capital One (COF) and American Express (AXP) lowered their earnings forecasts due to increased loan loss reserves. American Express anticipated that increased customer defaults would continue throughout 2008. Countrywide (CFC), which fought off bankruptcy rumors earlier in the week, was formally acquired by Bank of America (BAC) on Friday for approximately $7 per share. Investors may recall that in August of 2007, Bank of America purchased $2 billion of Countrywide preferred convertible shares at $18 per share.

Defensive sectors of the market, including healthcare and consumer staples, have handily outperformed the market during the opening two weeks of trading for 2008. Meanwhile, the riskier areas of the market, with the notable exception of emerging markets, have underperformed. The shift in risk by investors has been ongoing since 2007 and favors overweight position in large cap equities, particularly defensive names like healthcare (Eli Lilly (LLY), Merck (MRK), Pfizer (PFE)) and consumer stables (Pepsi (PEP), Coca-Cola (KO)), bonds on an opportunistic basis, as well as non-correlated asset classes (Newmont Mining (NEM), Barrick Gold (ABX), etc).