Morning Update

Fed Enthusiasm Diminishes

Yesterday's excitement that followed the Fed's rate cut and policy statement is being replaced by a round of profit-taking and a focus back on the dismal economic outlook. Morgan Stanley reported a much worse-than-expected loss and Hovnanian Enterprises offered nothing to suggest the housing market is nearing a bottom, but General Mills and Adobe Systems topped the Street's profit forecasts. Treasuries, however, are extending Tuesday's advance amid weakness in equities and plans by the Federal Reserve to ramp up buying of agencies securities and the potential of purchases of Treasury bonds. World markets are mixed.

As of 8:37 a.m. ET, the December S&P 500 Index Globex futures contract is 7 points below fair value, the Nasdaq 100 Index is 19 points below fair value, and the DJIA is 76 points below fair value. Crude oil is down $0.15 to $43.45 per barrel, and gold continues to advance and is up $15.60 per ounce at $858.30. The overnight LIBOR rate dipped 3 bp to 0.13%, and the three-month LIBOR rate dropped 27bp to 1.58%.

Morgan Stanley (MS $16) reported a 4Q net loss from continuing operations of $2.24 per share, well below the Reuters estimate of a loss of $0.33. Morgan Stanley blamed the shortfall on "unprecedented market turmoil." The asset management group posted a pre-tax loss of $1.2 billion amid principal investment losses and losses related to securities issued by SIVs held on the balance sheet. Institutional securities recorded a pre-tax loss of $2.1 billion, with mortgage-related losses of $1.2 billion compared with approximately $9.4 billion a year ago.

General Mills (GIS $61) said 2Q EPS ex-items rose 23% to $1.36, ahead of the consensus view of $1.23, as the company said it continues to see strong global demand for its products. The company reaffirmed its 2009 input cost inflation estimate of 9% and said that foreign currency translation is now expected to reduce reported sales and earnings for the year. But it raised its full-year range for its profit forecast by two cents per share to $3.83-3.87.

Adobe Systems (ADBE $22) reported 4Q EPS ex-items rose from $0.49 a year ago to $0.60, one penny above the Street's view, as revenues grew slightly to $915.3 million. The company issued 1Q profit guidance in line with estimates and said revenues in the new fiscal year should track 2008 patterns. The maker of Acrobat reader said it continues to look closely at costs.

Hovnanian Enterprises (HOV $3) reported 4Q revenues fell 48% to $721.4 million and posted a net loss of $450.5 million but said cash flow was a positive $175.1 million. The homebuilder said that since mid-September, the housing market has deteriorated in lock-step with the widening financial crisis and declines in broader economic conditions. Housing starts plummeted in November and sentiment among homebuilders is at record low levels. Hovnanian did not provide any commentary that might suggest a bottom is near but instead encouraged the federal government to pass a stimulus package aimed at assisting buyers of new and existing homes.

Treasuries extend advance, refinancings pick up

Falling mortgage rates helped lift the US MBA Refinance Index by 6.5% to 4156.0 in the latest week but potential buyers remain on the sidelines, with the Purchase Index falling 4.5% to 286.1. The announcement by the Fed to lower its target on the fed funds rate to zero to 0.25% and the decision to do whatever it takes to get the economy back on track is also being aimed at the languishing housing market. The Fed will continue to look at ways of using its balance sheet to support credit markets and economic activity. Rates at the middle and long end of the yield curve are adding to yesterday's advance and are at new lows, which may have the desired effect of driving mortgage rates even lower.

Elsewhere, the current account deficit narrowed from $180.9 billion in 2Q to $174.1 billion in 3Q, below Bloomberg estimate of $179.0 billion.

Europe slips on banking weakness

A rally in Europe was short-lived after the Fed announced yesterday it will target a fed funds rate as low as zero and will employ all tools necessary to promote growth as worries about banking stocks are pulling the major averages lower. BNP Paribas (BNPQY $30), which has avoided many of the problems in the financial sector, is coming under pressure after its corporate and investment division will incur a 710 million euro loss through the first eleven months of 2008. The France-based bank blamed the loss on dislocations in the financial market. Separately, paper makers are among the biggest losers after a Finish-papermaker cut its full-year profit forecast due to falling demand and prices.

As the recession worsens in the UK, the government reported its biggest monthly jump in unemployment benefits and said that the jobless rate rose from 3.1% in October to 3.3% in November, the highest in almost 8 years and topping the forecast of 3.1%. The Bank of England has become increasingly worried about economic output and has quickly cut interest rates in an effort to limit the fallout from the global recession plaguing the developed economies. The BBC reported that the BoE is looking at unconventional means to support the economy but the central bank did not comment.

Fed lends modest support to Asia, Hong Kong cuts rates

In Hong Kong, shares jumped 2.2% after the central bank cut rates by a full percentage point to 0.50%, nearly mimicking the move by the Federal Reserve. But gains around the rest of Asia were more modest. The Nikkei 225 Index jumped higher at the open after the Federal Reserve slashed interest rates while talk is growing that the Bank of Japan will follow, but enthusiasm waned through the session and stocks briefly fell into negative territory before finishing up 0.5%. The strength in the yen continued to hamper exporters and Japan's number two automaker fell over 4% on concerns it was ready to guide lower.

After the close, Honda (HMC $23) cut its full-year profit forecast for the third time this year, reducing its earnings outlook by a deeper-than-expected 67% due to the surging yen and falling global auto sales. The company now sees a profit in the year ending in March of 180 billion yen, down from 550 billion yen a couple of months ago. Fears that others in the industry may follow leaned on shares of Toyota (TM $70) and Nissan (NSANY $7).

Meanwhile, Standard & Poor's Ratings Services revised its outlooks to negative from stable on the long-term corporate credit ratings for Toyota. At the same time, it reaffirmed its 'AAA' rating but noted that profitability will come under considerable pressure and that sharply lower demand seems certain to continue into 2009.