Morning Update

Massive M&A Not Enough to Keep Stocks Out of the Fray

Stocks remain lower in morning action despite the announcement from billionaire investor Warren Buffett’s Berkshire Hathaway that it will acquire the remaining shares it does not already own of railroad firm Burlington Northern Santa Fe for $34 billion, while announcing a 50-for-1 stocks split of its class B shares. Traders may be treading cautiously ahead of tomorrow’s monetary policy announcement from the Federal Reserve and before Friday’s labor report, while continuing to contemplate the sustainability of an economic recovery without global stimulus efforts. Warren Buffet’s M&A announcement is not the only major report on the equity front, as Stanley Works and Black & Decker agreed to an all-stock merger valued at $4.5 billion, Dow member Johnson & Johnson announced a 6-7% global workforce reduction, and MasterCard easily topped analysts’ profit expectations. Treasuries are higher amid the weakness in equities and lingering economic uncertainty, with factory orders set to be released later in morning action. Overseas, stocks in Asia were mostly lower as Australia raised interest rates for the second time in a month, while financials are pressuring Europe after UBS’ fourth-consecutive quarterly loss.

As of 8:50 a.m. ET, the December S&P 500 Index Globex future is 7 points below fair value, the DJIA is 56 points below fair value, and the Nasdaq 100 Index is 8 points below fair value. Crude oil is lower by $0.82 at $77.31 per barrel, and the Bloomberg gold spot price is down $1.00 at $1,058.50 per ounce. Elsewhere, the Dollar Index—a comparison of the US dollar to six major world currencies—is up 0.5% to 76.65.

Berkshire Hathaway (BRKA $98,750) announced that its has reached an agreement to acquire for $100 per share in cash and stock the remaining 77.4% it does not already own of Burlington Northern Santa Fe (BNI $76), valued at approximately $44 billion, including $10 billion of outstanding debt, making it the largest acquisition in Berkshire Hathaway’s history. Berkshire Hathaway said its $34 billion investment in BNSF is a huge bet on that company, CEO Matt Rose and his team, and the railroad industry. Berkshire’s Chairman and CEO Warren Buffett said that, “Most important of all, however, it’s an all-in wager on the economic future of the United States,” adding that “I love these bets.” Separately, Berkshire Hathaway announced that its Board of Directors approved a 50-for-1 split of its Berkshire Hathaway Class B Common Stock (BRKB $3,265), subject to shareholder approval.

In other M&A news, Stanley Works (SWK $45) and Black & Decker Corp. (BDK $47) announced that they have entered into a definitive merger agreement, to create an $8.4 billion firm named Stanley Black & Decker, in an all-stock transaction valued at about $4.5 billion.

Meanwhile, Dow member Johnson & Johnson (JNJ $59) announced global restructuring initiatives, including a workforce reduction of 6-7%, designed to strengthen the company’s position. JNJ said it is taking steps to prioritize its innovation efforts around health care and execute aggressively on bringing key new products to market. The company said its plans are expected to increase its operational efficiency and generate annualized, pre-tax cost savings of $1.4-1.7 billion when fully implemented in 2011. JNJ said it expects to take a $1.1-1.3 billion restructuring charge in 4Q 2009.

Earnings continue to hit the street, with MasterCard (MA $223) reporting 3Q EPS ex-items of $3.48, easily beating the estimate of Wall Street analysts, which called for the credit card processor to report earnings of $2.94 per share. Revenues grew 2% versus the same period last year to $1.4 billion, slightly higher than the $1.3 billion that the Street had forecasted. MA had an increase of 7.6% in the number of transactions processed to 5.8 billion and pricing changes contributed to approximately six percentage points of net revenue growth, but partially offset by the impact of slightly lower cross border volumes compared to last year.

Factory orders on tap, Fed begins its monetary policy meeting

Treasuries are higher in early action ahead of the only major report on the today’s economic calendar, which will be the release of factory orders for September later in morning trading, forecast to increase 0.8% after falling 0.8% in August.

Although the policy statement and interest rate decision are due out tomorrow, traders are treading relatively cautiously amid today’s commencement of the two-day Federal Open Market Committee (FOMC) meeting. No changes are expected to interest rate policy at the meeting but investors’ focus centers on the timing and pace the exit strategies the Fed would employ to unwind the extreme measures undertaken. While we have seen signs of recovery, the Street is worried about the removal of the government’s training wheels. As Schwab’s Chief Investment Strategist Liz Ann Sonders and Director of Sector and Market Analysis, Brad Sorensen, CFA, note in their bi-weekly Schwab Market Perspective: Earnings Verdict? Recovery on Track, the Fed has a delicate task of removing stimulus before inflation creeps in, while preserving recovery. Liz Ann and Brad believe the Fed will raise rates sooner than many believe, and remind investors that the near 0% we are currently at is extremely low when taken in historical context. Read more at www.schwab.com/marketinsight.

Financials fall to bring down Europe

Stocks in Europe are solidly lower in afternoon action as financials are under heavy pressure amid some key news out of the sector. The lion’s share of the disappointing data from the financial sector came courtesy of Switzerland’s largest bank UBS (UBS $17), which is down about 8% after reporting its fourth-consecutive quarterly loss, which was wider than analysts had expected, led by charges and outflows of funds from its key wealth and asset management units. Adding insult to injury, the company’s management said in a letter to shareholders that, “We do not expect an immediate recovery in client net new money flows.” However, there was a relative bright spot, as the company’s operating profit ex-items nearly doubled. Also weighing on the banking group, Royal Bank of Scotland (RBS $13) and Lloyds Banking Group (LYG $5) are under pressure after Lloyds announced that it will execute the world’s largest rights issue of 13.5 billion pounds ($22.1 billion) to exit the UK government’s asset insurance program, which leaves RBS as the lone bank in the program.

However, not all was bad in the eurozone financial sector, with the world’s second-largest reinsurer, Swiss Re (SWCEY $41), is up sharply after it reported an unexpected 3Q profit, on investment gains and fewer catastrophe claims that boosted profitability in its property and casualty unit. In economic news, the European Commission raised its 2010 GDP outlook from a previous forecast of a 0.1% contraction, to a 0.7% expansion, but the favorable revision is having little impact on limiting losses in Europe.

Asia mostly lower as Australia hikes rates again

Stocks in Asia were lower for the most part, excluding China’s Shanghai Composite Index, which gained 1.2%, as concerns about the ability of the economic recovery to continue as stimulus efforts from around globe begin to be reined in. Trading in Australia was in focus for the Asia/Pacific region, with Japanese markets closed for a holiday, as the Reserve Bank of Australia increased its key lending rate by 25 basis points for the second time in a month to 3.5%, which was expected by economists surveyed by Bloomberg. Last month the RBA became the first G20 nation to increase rates since the global financial crisis and recession. Australia’s S&P/ASX 200 Index dipped 0.2% following the announcement. RBA Governor Glenn Stevens said the global economy has resumed growth and economic conditions in Australia have been stronger than expected, with inflation likely to continue to moderate in the near term, but now will probably not fall as far as earlier thought. Stevens added that with the risk of serious economic contraction in Australia now having passed, the Board’s view is that it is prudent to lessen gradually the degree of monetary stimulus that was put in place when the outlook appeared to be much weaker.

Elsewhere, Hong Kong’s Hang Seng Index fell 1.8%, led by weakness in real estate firms amid lingering concerns about government intervention to cool off the market, exacerbated by comments yesterday from a government official the government is “closely” following the local property market and has the tools available to stabilize if necessary. Meanwhile, South Korea’s Kospi Index declined 0.6% with losses being limited by strength in automakers.