By Chris Nagi
Sept. 22 (Bloomberg) -- The biggest declines in the U.S. stock market in seven years may slow after the government said it would bail out the nation's banks and crack down on speculators battering financial companies.
Shifting the burden of subprime-mortgage related losses to taxpayers ``put a floor under the equity markets,'' said Russ Koesterich, who helps manage $2 trillion at Barclays Global Investors. James Swanson, who oversees about $200 billion at MFS Investment Management in Boston, says the Standard & Poor's 500 Index may rise 15 percent after the Treasury immunized investors from ``the brunt of the economic cycle.''
Treasury Secretary Henry Paulson's plan to spend as much as $700 billion on soured mortgage securities buoyed stocks and the S&P 500 ended the week almost unchanged after suffering the steepest plunge since the Sept. 11 terrorist attacks. Any gains may be limited because the U.S. economy is slowing and profits at companies in the index are forecast to fall 5 percent this quarter, according to analyst estimates compiled by Bloomberg.
``The short reaction to all this is it's an unambiguous positive for stocks,'' said Koesterich, Barclays's head of investment strategy in San Francisco. ``The bad news is we're likely to see continued volatility given the slow growth in the economy, and investors should not look forward to a '90s style rebound.''
Profit Declines
A decline in third-quarter profits would make this streak of decreases the longest since the period ended in 2002, the year the benchmark index for American equities completed a 49 percent plunge from its March 2000 record. The S&P 500 has lost 20 percent since its all-time high reached in October 2007.
U.S. stocks dropped, with the S&P 500 falling 0.9 percent to 1,243.43 at 9:40 a.m. in New York. The index ended last week at 1,255.08, up 0.3 percent from the Sept. 12 close.
The rout that began when New York-based Lehman Brothers Holdings Inc. filed for bankruptcy, Merrill Lynch & Co. was sold to Charlotte, North Carolina-based Bank of America Corp. and the U.S. took control of American International Group Inc. ended with the biggest two-day jump in the S&P 500 in 21 years.
Paulson is seeking power from Congress to buy $700 billion in toxic assets from financial firms. The government also proposed setting up a fund to guarantee as much as $400 billion of money-market mutual funds.
`I'm Hopeful'
``This puts an end to the seemingly never-ending write- offs,'' said Bill Stone, the chief investment strategist at PNC Wealth Management in Philadelphia who oversees $66 billion. He predicts investors will sell Treasury bonds to raise cash for equity investments. ``I'm hopeful we've put in the lows.''
Price swings in S&P 500 stocks fell from a six-year high following Paulson's proposal and the Securities and Exchange Commission's ban on trades that profit when bank stocks fall.
The Chicago Board Options Exchange Volatility Index rose as much as 64 percent last week as the collapse of Lehman, once the fourth-largest U.S. investment bank, and New York-based AIG, the biggest U.S. insurer, spurred concern speculators manipulated financial shares to benefit from bearish bets.
The SEC barred so-called short selling on about 800 financial companies on Sept. 18, stiffened rules aimed at abusive trading and will require hedge funds to provide sworn statements about their biggest holdings. Investors profit from short sales by borrowing stock and selling it in the hopes of buying the shares later after the price falls.
Regulation Goes Global
Regulators in the U.K., Germany, France and Belgium echoed the SEC's move with similar bans. Australia restricted short selling unless they included hedging positions placed before today. Taiwan prohibited short selling of 150 stocks.
Goldman Sachs Group Inc. and Morgan Stanley, Wall Street's last independent brokerages, surged 20 percent after the SEC announced the policy, rebounding from record declines earlier in the week. Companies covered by the ban rose 12 percent, three times the S&P 500's advance, according to data compiled by Bloomberg.
``The main problem lately has been a psychological one as much as a fundamental one,'' said John Wilson, Memphis-based co- director of equity strategy at Morgan Keegan, which manages $120 billion. ``We got over the last few days the kind of catalysts we needed. The real question is, Where does this euphoria take us?''
The S&P 500 traded 26 percent below its October record before rebounding. Analysts at Societe Generale wrote Sept. 16 that the gauge must fall to 1,080, or 14 percent below its level now, to match the average retreat of past bear markets.
National Debt Grows
Barclays's Koesterich says U.S. returns will be limited because the government may have to spend almost $1 trillion to buy subprime-infected mortgage loans and take over AIG, Washington-based Fannie Mae and McLean, Virginia-based Freddie Mac, the nation's biggest providers of home-loan financing.
The plan, along with the money-market guarantees, would raise the ceiling on the national debt and cost as much as the combined annual budgets of the U.S. Departments of Defense, Education and Health and Human Services.
``We really do have a growing fiscal problem,'' he said. ``We had it before this event started, this has only exacerbated it. It's particularly problematic because we're dealing with this during a time of heightened inflation.''
Consumer prices in the U.S. are forecast to rise 4.5 percent this year, according to the median estimate of 76 economists surveyed by Bloomberg before last week's measures were announced. That would be the fastest since 1990, the midpoint of the U.S. savings and loan crisis that cost taxpayers $124 billion, according to the Federal Deposit Insurance Corp.
Cheap Valuations
The S&P 500 retreated 6.6 percent in 1990, the first annual drop since 1981.
U.S. economic growth may slip to 1.7 percent this year and 1.5 percent in 2009, the slowest since the last recession in 2001 and its aftermath in 2002, according to the median forecast of 80 economists compiled by Bloomberg.
Cheap valuations relative to other investments will keep stocks from falling further, says MFS's Swanson. Profits at S&P 500 companies may climb 64 percent in the next 12 months to $84.72 a share, pushing its ``earnings yield'' to 6.7 percent of the index's price, according to estimates compiled by Bloomberg. That's 76 percent above interest payments on 10-year U.S. Treasuries, the biggest advantage in more than 20 years.
``We've pretty much gotten valuations to the point where all this liquidity around the world is going to go to the equity market,'' said Swanson, chief investment strategist at MFS. ``We've nationalized a big chunk of the American economy. We've decided we don't want to bear the brunt of economic cycle.''
To contact the reporter on this story: Chris Nagi in New York at chrisnagi@bloomberg.net.
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