Morning Update

Gloom Deepens

Stocks are extending losses in early trading after US retail sales fell much more than expected in December, confirming that the poor economic climate continues to depress consumer activity. Worries about the financials continue to mount amid a profit warning from Deutsche Bank and talk that HSBC Holding may need to boost capital and cut its dividend, while Citigroup and Morgan Stanley confirmed they will combine their brokerage units. Meanwhile, Tiffany & Co. reported a sales decline and offered cautious commentary, while import prices fell less than forecast. Treasuries are higher, and world markets are mixed.

As of 8:37 a.m. ET, the March S&P 500 Index Globex futures contract is 14 points below fair value, the Nasdaq 100 Index is 17 points below fair value, and the DJIA is 120 points below fair value. Crude oil is up $0.21 to $38.00 per barrel, and gold is up $0.50 at $821.20.

Citigroup (C $6) and Morgan Stanley (MS $19) confirmed they have reached a definitive agreement to combine Citi's Smith Barney and Morgan Stanley's Global Wealth Management Group into a new joint venture that will be called Morgan Stanley Smith Barney. Citigroup will exchange its 100% ownership in Smith Barney for a 49% stake in the joint venture and a cash payment of $2.7 billion. MS will receive a 51% stake in the new company. At closing, Citi will recognize a pre-tax gain of approximately $9.5 billion, or about $5.8 billion on an after-tax basis, and will create approximately $6.5 billion of tangible common equity. Cost savings of about $1.1 billion are anticipated.

Separately, Citigroup plans to announce steps to shed two consumer-finance units and the company's private-label credit-card businesses and scale back on trading, according to reports in the Financial Times, the Wall Street Journal and other media outlets. People familiar with the matter said the company could place assets worth more than $600 billion, roughly one-third of its balance sheet, into a "non-core unit." Citi did not comment but such a move would mark the end of its strategy of being a "financial supermarket."

Tiffany & Co. (TIF $22) said global sales for the November-December 2008 holiday period fell 21% to $687.4 million. Sales dropped the most at its US stores and to a lesser degree in Asia-Pacific and Europe. Deteriorating global economic conditions were clearly reflected in "cautious spending by customers" across the entire range of jewelry categories and price points, the company said, and it believes these conditions will continue well into 2009.

Terrible retail sales

Advance retail sales fell 2.7% in December, well below an expected drop of 1.2%, and November was revised modestly lower. Ex-autos, sales dropped 3.1%, more than double a projected decline of 1.4%. November was revised from -1.6% to -2.5%. If gasoline and autos are removed, sales at retailers plunged 1.5%, indicating that consumers are holding back amid the steep decline in economic activity and focusing on necessities and savings. Treasuries are modestly higher.

Led by a 21.4% decline in petroleum, the Import Price Index dropped 4.2% in December, less than an expected decline of 5.3%. Non-petroleum prices were down 1.1%.

The US MBA Refinance Index jumped 25.6% in the latest week to 7414.1, signaling that the refi boom continues as mortgage rates languish near or at historic lows. But the modest advance in purchases came to an end, with the Purchase Index falling 14.1% to 295.8, suggesting that job losses, weak consumer sentiment, tight credit conditions, and worries about falling home prices continue to hinder potential home buyers.

The Beige Book will be out later today and will provide anecdotal information on economic conditions in each of the twelve Federal Reserve districts. The last Beige Book released in early December showed that economic conditions had weakened from the prior survey. The Fed had said there was stress on consumers and signs that the labor market was slowing and residential real estate remained at a slow pace. Manufacturing had declined noticeably, and retailers were widely discounting prices in anticipation of a soft holiday season. Commercial real estate had also weakened broadly.

Europe stumbles on banks

Today's action in Europe may be shaping up to produce the sixth-consecutive down day amid uncertainty springing from the latest outlooks and brokerage comments. Deutsche Bank (DB $32) is pacing losses among the financials after announcing that it expects to post a 4Q net loss of 4.8 billion euros due to exceptional market conditions that "severely impacted" its sales and trading businesses. A year ago, Germany's largest bank posted a profit of 1 billion euros, and the admission that the quarter that just ended will produce a big loss is sending shares down by more than 10%.

HSBC Holding (HBC $46) is also much lower after Morgan Stanley said the UK-based bank will probably cut its dividend in half and be forced to raise up to $30 billion in new capital. HSBC did not comment. And Siemens (SI $64) is trading down and weighing on manufacturers. The German industrial conglomerate said 1Q orders have fallen "significantly" because of delays by customers amid what it called a "challenging market environment."

Tokyo shrugs off early sluggishness

The trading day in Japan began on a sour note but the benchmark Nikkei 225 Index quickly moved into positive territory, but nervousness about the upcoming earnings season limited the advance to 0.3%. Toshiba (TOSBF $4) and Fujitsu (FJTSY $22) aided shares after Toshiba said it is in talks to acquire its rival's hard-disk drive business. Investors warmed to the idea of the sale and sent shares of Fujitsu higher because the firm may discard a money-losing division. Shares of Toshiba, the world's largest maker of hard drives for laptops, also advanced. Separately, preliminary data showed that machine tool orders in Japan fell 29.0% in December and are down 71.9% from a year ago, the worst reading in at least 20 years. Falling capital spending appears ready to deal another setback to the struggling Japanese economy.