Eating Isn’t Option When Minnesota Corn Burns in Houston Cars

By Peter Robison

Dec. 16 (Bloomberg) -- Mike Vis hooks a pump to a grain silo in Minnesota and siphons out enough of his corn to feed 91 people for a year. This batch will fuel vehicles in Houston for 21 seconds.

American roads, hungry for corn in the form of the motor fuel ethanol, never figured in the livelihoods of earlier generations of Rock County growers. In the 1930s, some considered it a sin to burn corn in home furnaces.

“They felt it was a food, and there’s always hungry people in the world,” said Andy Steensma, the mayor of Luverne, the county seat.

Today, burning crops like corn, soybeans and sugar cane for fuel is policy in the U.S., Brazil and the European Union -- while almost 1 billion of the world’s 6.8 billion people are hungry, the most in a generation. About 95 percent of what Vis grows feeds vehicles in the western U.S. -- the destination for ethanol produced in his local plant -- not people or animals.

“It does not make sense to put our food into the gas tank,” said Jeffrey Sachs, a Columbia University economist who advises the United Nations on reducing hunger. “It’s not a healthy link, that’s for sure.”

President George W. Bush mandated using ethanol distilled from corn to stretch gasoline supplies in 2005, and President- elect Barack Obama has said he supports the policy.

One Shipment’s Journey

The journey of a single ethanol shipment from America’s corn belt to the concrete beltways of Houston shows what the mandate delivers to American drivers and withholds from a hungry world. Batch 4,516 of ethanol began as grain from fields around Rock County. After being crushed, fermented and distilled at Agri- Energy LLC in Luverne, it traveled by railcar 1,000 miles to the Houston suburbs, where some of it landed in the tank of a Ford Cobra convertible.

When David Kolsrud persuaded 200 Rock County corn growers to chip in $3 million and borrow from local banks to start Agri- Energy a decade ago, the country had fewer than a dozen farmer- owned ethanol plants. There was no federal mandate. Crude oil hovered around $20 a barrel, one-seventh of its peak this year.

Kolsrud, who owns the farm next to Vis, said the distillery was a way to keep money local in a rural area where the average resident made less than $20,000 in 2000.

At the time, Luverne, population 4,600, was best known for a midsummer hotdog festival. Growers joked that every train leaving town had 100 cars, 99 carrying corn and one for departing teenagers.

‘Going Broke’

“We were going broke raising the crops,” said Kolsrud, 60. There was another reason for pushing into ethanol. He kept livestock to supplement his crops, and his doctor told him the animals could make his asthma terminal.

Agri-Energy opened in 1998. By 2001, the operation was purchasing a third of Rock County’s corn supply and paying members $1 a bushel over the market price. The value of a share in the plant soared sixfold, to $60,000, Kolsrud said. As the company prospered, he backed other ethanol plants and a wind- turbine company. Today, there are 180 ethanol distilleries across the U.S.

Homegrown enterprises aren’t the only winners. Exxon Mobil Corp. and other refiners get a 51-cent tax refund for every gallon of ethanol they blend with gasoline, or $4.5 billion this year. Biofuel advocates include Archer Daniels Midland Co. of Decatur, Illinois, the world’s biggest grain processor; Deere & Co. of Moline, Illinois, the largest maker of tractors; and Wilmington, Delaware-based DuPont Co., which makes seeds.

Exports Up

The companies say concern about ethanol’s effect on the food chain is overblown. While ethanol production consumed a record amount of last year’s corn crop, so did exports, said Doyle Karr, a DuPont spokesman.

“In a year when we had as much grain as ever going into ethanol, we had as much export as ever leaving the country to feed people,” he said.

Ethanol has been more reliable for Vis than raising livestock. Just 22 when Agri-Energy opened, he went bankrupt two years later trying to manage the family pig farm for his ailing father. Kolsrud took his young neighbor under his wing. Stocky and slow-moving, with a mop of white hair, the older man had little time to tend his fields. Now Vis works both farms in exchange for use of Kolsrud’s equipment.

Six-foot-four, with tanned arms, Vis resembles a children’s book portrait of a farmer. The farthest he ever traveled from Minnesota was Las Vegas, for his honeymoon.

‘Make More Money’

As a vacuum sucked the corn he’d grown into a semi tractor- trailer in July, he marveled that he worked harder going bankrupt. He estimated he would gross a record $500,000 this year, about two-thirds more than usual.

“I can sit down and do nothing and make more money than getting out in the field every day,” he said, shaking his head.

The U.S. mandate will only increase demand. Almost a third of the 2008 U.S. crop will be used to generate the required 10.5 billion gallons of ethanol from corn next year, or 7.5 percent of U.S. motor fuel consumption, government estimates show. By 2015, the mandate rises to 15 billion gallons. The EU, China and Brazil all have their own biofuel targets.

Meanwhile, global inventories of corn, wheat and soybeans will shrink to a 67-day supply before next year’s Northern Hemisphere harvest, about half the peak in the 1980s and close to the lowest level in 45 years, according to U.S. data.

At the Luverne plant, where silver vats and pipes rise from the fields like an overgrown chemistry set, rotating mechanical hammers pounded Vis’s corn into a fine flour. After being mixed with water and enzymes, the sugary mash dropped into a fermentation tank at 1 a.m. to stew with yeasts and be converted into alcohol.

Obama’s Support

Shawn Davis, 56, monitored the batch on a computer screen. This job saved him when a local meatpacker closed, he said. Luverne Mayor Steensma credits the plant, which has a payroll of 30 and an average salary of $40,000, with keeping the town’s population steady as others decline.

Obama, a former Illinois senator, says he supports the ethanol mandates because they create jobs and reduce U.S. dependence on imported oil. At an April speech in Indiana, he called corn ethanol a “transitional technology” as the U.S. develops advanced biofuels from non-food substances.

Ethanol also lowers pump prices. The U.S. Department of Energy said on June 11 that a gallon of gasoline, then more than $4, would have cost as much as 35 cents more if it didn’t contain the biofuel.

Farming has changed since his grandparents refused to burn corn, Steensma said. Back then, farms yielded fewer than 50 bushels of corn per acre. Brown stalks mingled with green in mid- season. Now, identical rows of green stalks yield 175 bushels or more. Growers needed a way to profit from their abundant corn, he said.

Pig Farmers’ Costs

“I really like to see nice cars and new pickups and good houses,” said Steensma, 66, reclining in an armchair in his home near a newly renovated city baseball diamond.

Kolsrud opened a suite of offices last year in nearby Brandon, South Dakota, stocked with complimentary sodas and golf towels for visitors.

“Not bad for a bunch of poor, dumb dirt farmers,” he said.

A few miles across the border in Iowa, pig farmer Rick Moser pushed back his cap and exhaled at the mention of the plant in Luverne. Corn makes up 60 percent of the diet for his 6,000 sows and with higher feed prices, Moser figured he’s losing 2 cents to 4 cents a pound on every pig.

About 6,200 miles away, Park Ho Kon, who raises pigs near Seoul, saw feed costs jump 70 percent this year.

‘Powerful Country’s Logic’

“The rest of the world is suffering from famine, but the U.S. is making fuel from corn,” Park said. “Well, isn’t that a powerful country’s logic?”

The average person needs 1.57 pounds of grains a day for a healthy life, said Seeva Ramasawmy, a statistician with the UN Food and Agriculture Organization in Rome. By that standard, Vis’s 52,360 pounds of corn might have fed 91 people for a year. Instead, it satisfied 0.00024 percent of Houston’s average daily gasoline demand, based on estimates by Larry Padfield, vice president at U.S. Development Group LLC, which handles ethanol shipments in Houston.

“There’s nothing we seem to be gaining,” said Anne Krueger, former deputy managing director of the International Monetary Fund in Washington. Policy makers who mandated corn ethanol “weren’t realistically looking at what would be involved.”

U.S. food prices may climb 6 percent this year, the most since 1980, the Department of Agriculture has estimated. Without biofuel production raising costs of corn-fed animals that supply meat, milk and eggs, food inflation might be 0.7 percentage points lower, the USDA has said.

Distillers’ Grains

Higher prices are a larger issue in developing countries, where the poorest spend as much as 70 percent of their incomes on food, Krueger said. In the U.S., the average is 10 percent. She estimated biofuels might cut caloric intake 8 percent in Africa.

Matt Hartwig, a spokesman for the Renewable Fuels Association, a Washington trade group, disputed that assessment. Increased demand, investor speculation and higher transportation costs all had more effect on food prices than biofuels, he said. Ethanol may save U.S. families more than $500 a year when lower pump prices are taken into account, he said.

Critics also ignore dried distillers’ grains, a byproduct of the ethanol process that can be fed to pigs and cattle, he said. Each bushel, or 56 pounds, of corn yields 2.75 gallons of ethanol and 18 pounds of the grains.

“It’s also a food source,” Hartwig said.

Moser, the pig farmer, said he doesn’t use the grains much because the concentrated corn oils make for fatty, yellow bacon.

Bargain for Blenders

Fed to livestock, the corn in Vis’s truck could have supported the production of 5,236 pounds of beef, or 29,920 pounds of chicken, the Iowa Corn Growers Association estimated.

The grain became part of Batch 4,516 instead, a 29,100- gallon shipment of ethanol that arrived in early August in a Pasadena, Texas, rail yard. From there a truck delivered it to a blending terminal owned by Motiva Enterprises LLC, a Houston joint venture of Royal Dutch Shell Plc and Saudi Aramco. Motiva mixes the ethanol into gasoline at a concentration of 10 percent for the city’s Shell stations.

Customers ultimately benefit from the 51-cent tax credit, said Al Mannato, a spokesman for the American Petroleum Institute in Washington. It declines to 45 cents on Jan. 1.

“The real reason for that credit is to make ethanol less expensive and therefore more attractive economically,” he said.

Corn and Oil

Economists worry about longer-term effects. Intended to reduce dependence on oil, the mandates have instead made food prices more reliant on scarce fossil fuels, said Bruce Babcock, a corn grower and an agricultural economist at Iowa State University in Ames.

As the biofuel becomes a larger part of the fuel supply, traders see corn as a commodity interchangeable with oil, said Jim Damask, managing director of BiofuelsConnect LLC, an ethanol broker in Heathrow, Florida.

By one gauge, the degree to which daily corn and oil prices track each other has risen since the ethanol mandates were imposed. The so-called correlation coefficient was 0.67 for the year through Dec. 15, compared with 0.04 in 2004. The scale ranges from 1, when returns move in lockstep, to -1, when they are opposite.

Oil climbed to a record $147.27 in July before falling 72 percent to $40.50 by Dec. 5. Corn reached $7.99 per bushel in June and then dropped 62 percent to $3.05 in the same period.

“I tell corn growers here that if they really want to make money producing ethanol, they should get on a plane to Saudi Arabia and ask them to cut production,” said C. Ford Runge, professor of applied economics and law at the University of Minnesota in Minneapolis.

VeraSun’s Bankruptcy

The global recession may reduce plantings of corn, keeping grain costs higher. Futures contracts on the Chicago Board of Trade show corn will rise 19 percent by mid-2010, to $4.45. At $3.75 yesterday, corn prices were already 44 percent higher than the $2.61 average from 1997 to 2007.

High corn costs backfired on ethanol producers this year. VeraSun Energy Corp. of Brookings, South Dakota, the second- largest U.S. distiller, sought bankruptcy protection in October. Farmers may be in trouble next. After paying more for seeds and fertilizers, Vis sees smaller profits in 2009.

“It seems like once farmers started making a little bit of money, then the rest of the world got pissed off,” he said.

One beneficiary of Batch 4,516 was in Spring Valley Village, Texas, a Houston suburb of gated driveways and brick mansions lined with hurricane-resistant water oaks. The day after the Blalock Road Shell station’s tanks were filled, William Collins, a film producer, pulled up in his restored, blue-striped AC Ford Cobra two-seat convertible.

Driving the Most

Houston’s 2.8 million residents drive 36 miles per capita every day, the most among Americans, according to the Bureau of Transportation Statistics. Collins questioned whether that sort of model is sustainable. “You can’t have 9 billion people living like this,” he said.

He laughed when asked whether he was happy that corn from a Minnesota farm was helping power his car and keeping gas prices lower.

“I prefer to eat,” he said.

(Recipe for Famine: Part 7 of 7.)

To contact the reporter on this story: Peter Robison in Seattle at robison@bloomberg.net.

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Inpex Seeks Partners for LNG Projects to Raise Funds

By Shigeru Sato and Yuji Okada

Dec. 16 (Bloomberg) -- Inpex Corp., Japan’s largest energy explorer, wants to sell stakes in liquefied natural gas projects worth $30 billion in Indonesia and Australia as the global credit crunch curbs funding options.

“Almost all oil-majors and super majors have offered to jointly develop” the Abadi project in Indonesia, Chairman Kunihiko Matsuo said in an interview at the company’s headquarters in Tokyo. Inpex plans to sell part of its 76 percent stake in the Ichthys venture in Australia to Japanese utilities, he said without naming potential investors in the two projects.

The worst financial crisis since the Great Depression is forcing the explorer to look beyond its cash reserves and access to low-cost borrowing to almost double investment in the next five years. Total SA has a 24 percent stake in the $20 billion Ichthys project in Darwin. Inpex owns 100 percent of the Abadi field, where it plans the world’s first floating LNG plant.

“Bringing a super-major partner to augment technical competence if a floating LNG development is selected would seem completely logical,” said David Hewitt, a Tokyo-based energy analyst at CLSA Asia Pacific Markets. “Linking off-take agreements to minority stakes in LNG development projects is a well-trodden path for leading Japanese utilities.”

Inpex targets 2016 for the startup of the Abadi floating plant, which will cost more than $10 billion and produce as much as 4.5 million tons of LNG a year, said Matsuo, 73. The Indonesian government will complete screening the initial project plan in “several” months, he said.

Equity Financing

Matsuo favors building a floating plant after considering the cheaper option of shipping gas from the Abadi field to the Ichthys plant, he said. “Initially we planned to send gas to Darwin from Abadi through a pipeline, but the Indonesian government wants us to process gas at a plant in their territory,” he said.

Matsuo said the company’s investment plans won’t be affected by the global financial crisis, and cited access to cheap loans from the state-run Japan Bank for International Cooperation and cash reserves of about 500 billion yen ($5.5 billion). Inpex’s annual spending may increase above 600 billion yen in the next five years from an estimated 330 billion yen in the year ending March, he said.

“We’re not going to suspend or freeze our substantial investment for the Ichthys and Abadi projects,” Matsuo said. “First we are going to tap our 500 billion yen cash and rely on a dollar-denominated loan from JBIC, and if needed we would seek equity financing.”

Shares Decline

Inpex’s shares have lost more than half their value in the last six months, outstripping the 41 percent decline in the benchmark TOPIX index. They dropped 4.2 percent to 624,000 yen at 1:57 p.m. in Tokyo trading.

Inpex and partner Total plan to design the Ichthys plant with an annual capacity of more than 8 million metric tons of LNG, 1.6 million tons of liquefied petroleum gas, and 100,000 barrels a day of condensate, a type of light oil. Production may start in late 2014 or early 2015. The partners will decide whether to move ahead with the project late next year or early 2010 after initial engineering work finished.

Inpex wants to more than double its oil and gas output at home and abroad to as much as 1 million barrels a day by 2020, equivalent to a quarter of Japan’s current oil needs, Matsuo said. The company currently produces about 400,000 barrels a day.

Crude oil in New York has lost more than $100 after touching a record $147.27 a barrel on July 11. It traded at $44.60 at 2:05 p.m. in Tokyo.

The so-called super oil majors do business ranging from exploration and production to refining and retailing of oil products. They include Royal Dutch Shell Plc., Exxon Mobil Corp., BP Plc., Chevron Corp., Total and ConocoPhillips.

LNG is natural gas that has been cooled to liquid for shipping to markets beyond the reach of pipelines.

To contact the reporters on this story: Shigeru Sato in Tokyo at ssato10@bloomberg.net; Yuji Okada in Tokyo at yokada6@bloomberg.net.

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Korean Won Gains as Foreign-Exchange Shortage Eases; Bonds Rise

By Kim Kyoungwha

Dec. 16 (Bloomberg) -- South Korea’s won rose for a second day on signs dollar hoarding is easing, helping banks and companies pay their foreign debt. Bonds rose.

The won is headed for its first monthly gain since July as policy makers cut interest rates at an unprecedented pace to stem an economic slowdown and currency swap deals with China and Japan are expanded to help ease a shortage of foreign exchange. The Bank of Korea sold $50 million to local banks in the swap market, less than a planned $1 billion, the bank said today, adding to evidence dollars are becoming more available.

“Trading is very shallow as many market players closed books before year-end,” said Kim Yule, a currency dealer with BNP Paribas in Seoul. “There’s a slight improvement in the shortage of dollars.”

The won rose 0.7 percent to 1,357 per dollar as of 12:40 p.m. in Seoul, after earlier weakening as much as 0.5 percent, according to Seoul Money Brokerage Services Ltd. The currency is still down 31 percent this year, Asia’s worst performance.

The one-year cross currency swap stood at 0.9 percent, having recovered from a record low of minus 0.7 percent on Dec. 4. The rate, a gauge of the availability of dollar funding, averaged 3.3 percent this year before the collapse of Lehman Brothers Holdings Inc. in mid-September triggered a seizure in global credit markets.

Standard Chartered recommended buying a three-month won call option at 1,280 and selling put options at 1,350 as it predicts the won will climb to 1,300 per dollar in the first quarter before further strengthening to 1,150 by the end of 2009.

Bonds Buyback

Bonds rose after the finance ministry said yesterday that the government will buy back 1.2 trillion won ($879 million) of bonds on Dec. 19. The buyback will include 1 trillion won of government bonds that mature in March and June of 2009 and 200 billion won of inflation-linked debt due March 2017, the ministry said in a statement in Gwacheon yesterday.

The yield on the benchmark bond due September 2013 fell eight basis points to 4.28 percent, according to the Korea Exchange. The price rose 0.37, or 37 won per 10,000 won face amount, to 107.76. A basis point is 0.01 percentage point.

To contact the reporters on this story: Kim Kyoungwha in Beijing at kkim19@bloomberg.net.

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Asian Money Costs May Extend Drop on $8.5 Trillion Extra Cash

By Garfield Reynolds and Patricia Lui

Dec. 16 (Bloomberg) -- Asian money-market rates may extend declines on speculation banks will revive lending as policy makers lower borrowing costs worldwide and the U.S. rolls out $8.5 trillion of bailouts and spending plans.

The difference between the rate Australian banks charge each other for three-month loans and the overnight swap rate, a gauge of cash scarcity, dropped 17 basis points to 74 basis points as of 2:19 p.m. in Sydney. The London interbank offered rate, or Libor, that banks say they charge each other for three- month U.S. dollar loans, slid five basis points to 1.87 percent yesterday, the lowest level since September 2004.

“Rates have continued to come off thanks to central bank liquidity injections and aggressive rate cuts,” said Ho Woei Chen, an economist at United Overseas Bank Ltd. in Singapore. “I expect liquidity to remain stable going into year-end but next year there is a possibility rates could spike up in the first quarter as there remains much stress in credit markets.”

Borrowing costs in U.S. dollars fell yesterday on speculation the Federal Reserve will cut interest rates at a meeting today to revive an economy punctured by the collapse in lending. Money markets, which froze after Lehman Brothers Holdings Inc. collapsed Sept. 15, remain dislocated with banks paying more to borrow than before the credit crunch started in August 2007.

Default Swaps

The cost of protecting Asia-Pacific bonds from default rose on concern corporate earnings will fall due to the global recession and that the alleged fraud by investment manager Bernard Madoff will trigger forced selling by hedge funds.

Hong Kong’s interbank offered rate, or Hibor, for three- month loans declined two basis points to 1.5 percent, the lowest level since February 2005, at the 11:15 a.m. local time fixing. Singapore’s three-month rate for U.S. funds dropped five basis points yesterday to 1.90 percent.

The rate Australian banks charge each other for three-month loans declined for a second day, slipping eight basis points to 4.43 percent.

The Reserve Bank of Australia pumped A$949 million ($635 million) into the financial system today after estimating the shortfall would be A$891 million. Banks increased deposits at the RBA by A$128 million yesterday to A$3.67 billion, the central bank said today on its Web site.

Traders reduced bets the RBA will cut rates in February by the most in more than 18 years after policy makers lowered their inflation forecast, according to minutes of their most recent meeting released today.

‘Expansionary’

The Australian central bank’s one percentage point rate cut this month puts monetary policy at an “expansionary setting” to stoke business and consumer confidence, the RBA board said today in the minutes of its Dec. 2 meeting.

There’s a 15 percent chance the RBA will lower rates by 1.25 percentage points in February, down from 41 percent odds yesterday, according to a Credit Suisse index based on overnight interest-rate swaps.

Australian money rates jumped to the highest in almost two months on Dec. 12 as sales of government-backed bonds failed to bring down funding costs. Lenders including Commonwealth Bank of Australia sold more than A$13 billion of government-backed debt in the past week.

The yield on fixed-rate debt sold by Commonwealth, part of the first domestic offering of debt under the guarantee, was priced at a spread of 217 basis points over the equivalent Australian sovereign bond. The spread between the bank’s A$750 million of three-year bonds maturing in June 2011, which aren’t backed by the federal government, and benchmark sovereigns stood at 199 basis points.

Writedowns

Governments and central banks are seeking to spur growth as more than $990 billion of losses and writedowns tied to mortgage-related securities worldwide plunged the global economy into its worst slump since the Great Depression.

The Libor-OIS spread, a gauge of cash scarcity, narrowed six basis points yesterday to 156 basis points. Libor is still 87 basis points higher than the Fed target, up from an average of 16 basis points in the seven years to August 2007, when the credit freeze began. The TED spread, the difference between what the U.S. government and banks pay to borrow for three months, declined five basis points yesterday to 186 basis points, the lowest level since Nov. 11.

“Money markets have shown considerable improvement across the board this week,” Citigroup Inc. said yesterday in a report. “Ample central bank liquidity infusions could see a repeat of last year’s year-end funding pressures being avoided.”

The Markit iTraxx Australia index rose 10 basis points to 402 as of 11:51 a.m. in Sydney, Citigroup Inc. data show. The Markit iTraxx Japan index was 5 basis points higher at 335 in Tokyo, according to Barclays Capital.

Credit-default swap indexes are benchmarks for protecting bonds against default and traders use them to speculate on changes in credit quality. The swaps pay the buyer face value in exchange for the underlying securities if a borrower fails to adhere to its debt agreements. A basis point, or 0.01 percentage point, is worth $1,000 on a swap protecting $10 million of debt.

To contact the reporters on this story: Garfield Reynolds in Sydney at greynolds1@bloomberg.net; Patricia Lui in Singapore at plui4@bloomberg.net.

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Dollar Trades Near Two-Month Low on Outlook for Fed Rate Cut

By Stanley White

Dec. 16 (Bloomberg) -- The dollar traded near a two-month low against the euro on speculation the Federal Reserve will cut the target rate for overnight lending to a record low today.

The greenback was also near the weakest level in 13 years against the yen before a U.S. Commerce Department report that economists say will show housing starts dropped last month to the least since records began in 1959. The Fed may also provide details today on whether it will buy government debt to push down Treasury yields and stimulate lending.

“Selling the dollar is the most likely scenario,” said Osao Iizuka, head of foreign-exchange trading at Sumitomo Trust & Banking Co. in Tokyo. “Whatever the Fed comes up with, it’s not likely to spark a sudden turnaround in the U.S. economy. It’s difficult to expect a recovery in the dollar.”

The dollar fell to $1.3727 per euro, the weakest level since Oct. 14, before trading at $1.3716 at 1:26 p.m. in Tokyo from $1.3688 late yesterday in New York. The dollar was at 90.51 yen from 90.65 yen. It dropped to 88.53 yen on Dec. 12, the lowest level since August 1995. The euro was at 124.15 yen from 124.09 yen. The dollar may decline to $1.3750 today, Iizuka said.

The U.S. currency gained 6.4 percent against the euro this year, 30 percent versus the British pound and 6.3 percent against the Danish krone as investors bought the greenback to flee riskier assets and repay dollar-denominated loans from lenders reining in credit.

Annual Gain

The yen strengthened 61 percent against the Australian dollar and 82 percent against South Africa’s rand in 2008 as $990 billion of credit-market losses sparked a reversal in carry trades, where investors get funds in a country with low borrowing costs and buy higher-yielding assets. Japan’s 0.3 percent target rate is the lowest among major economies.

Futures on the Chicago Board of Trade showed a 68 percent chance the Fed will trim its 1 percent target rate for overnight lending between banks today to an all-time low of 0.25 percent, compared with zero odds a month ago.

The U.S. central bank has limited room to lower interest rates and may use less conventional policies, such as buying Treasuries, Chairman Ben S. Bernanke said on Dec. 1.

The difference in yield, or spread, between 10-year Treasuries and similar-maturity Japanese government debt narrowed to 1.10 percentage points today, the least since June 1993. The dollar-yen’s correlation with the 10-year yield spread is 0.8 this month, according to Bloomberg calculations. A reading of 1 would mean the two variables move in lockstep.

‘Dollar’s Downtrend’

“The dollar’s downtrend against the yen will continue,” said Masafumi Yamamoto, head of foreign-exchange strategy for Japan at Royal Bank of Scotland Group Plc in Tokyo and a former Bank of Japan currency trader. “The Fed will have to say something about quantitative easing to show how they will move policy forward. This depresses Treasury yields and makes dollar assets unattractive.”

The dollar may decline to 88 yen by March 31, he said.

The U.S. housing slump that triggered the credit crisis and the ensuing recession shows no signs of abating. New-home starts in November dropped to a 736,000 annual pace, the lowest level since records began in 1959, the Commerce Department is forecast by economists to report today before the Fed’s decision.

The Bush administration is moving with “deliberative speed” in considering possible financing for U.S. automakers, Treasury Secretary Henry Paulson said yesterday in an interview with Fox News and Fox Business Network, according to an e-mailed transcript. General Motors Corp. and Chrysler LLC may be only weeks from insolvency, the companies said in congressional hearings on Dec. 4 and Dec. 5.

Bad News

“Bad U.S. economic news is now hurting the dollar rather than helping it,” Nizam Idris, a strategist at UBS AG in Singapore, wrote in a report today. “Investors are increasingly nervous about another Fed rate cut and increasing government debt issuance. The Bush administration is attempting to figure out how much aid they can provide.”

The U.S. Treasury reported yesterday that international demand for long-term U.S. financial assets weakened in October as foreign investors bought fewer American stocks, corporate bonds and agency debt.

Total net purchases of long-term equities, notes and bonds fell to a net $1.5 billion in October from $65.4 billion the previous month, the Treasury said in Washington. Including short-term securities such as stock swaps, foreigners bought a net $286.3 billion, compared with net buying of $142.6 billion the previous month.

To contact the reporter on this story: Stanley White in Tokyo at swhite28@bloomberg.net.

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Crude Oil Rises After OPEC Chief Calls for Sizable Output Cuts

By Mark Shenk

Dec. 16 (Bloomberg) -- Crude oil rose for the first time in three days after OPEC Secretary-General Abdalla El-Badri said the group needs to make a “sizable” output cut at this week’s meeting in Algeria.

The Organization of Petroleum Exporting Countries will probably lower production targets by at least 2 million barrels a day, or 7.3 percent, at a meeting tomorrow in Oran, according to 18 of 33 analysts surveyed by Bloomberg News. Global stockpile levels are at 57 days of forward cover, higher than their five- year average, Kuwait’s Oil Minister Mohammed al-Olaim said.

“It looks like OPEC will come out with a strong statement at this week’s meeting and make significant cuts, with the assistance of Russia,” said Michael Lynch, president of Strategic Energy & Economic Research, in Winchester, Massachusetts. “The prospect of the cuts is causing people to rethink the market balance for next year.”

Crude oil for January delivery rose as much as 51 cents, or 1.2 percent, to $45.02 a barrel and was trading at $44.65 at 7:56 a.m. Singapore time on the New York Mercantile Exchange. The price has tumbled 70 percent from a record $147.27 on July 11. Yesterday, oil fell $1.77, or 3.8 percent, to $44.51 a barrel.

U.S. industrial production declined 0.6 percent in November, the third drop in four months, the Federal Reserve said yesterday in Washington.

U.S. fuel demand may drop further as manufacturing in the country declines. Chinese crude processing tumbled to the lowest in 15 months, a report showed.

Lower Demand

China’s refineries processed 27.27 million tons of crude last month, or 6.64 million barrels a day, as an economic slowdown cut demand, the China Mainland Marketing Research Co. said in a statement yesterday. That’s down 8.5 percent from 29.8 million tons in October. China is the second-biggest oil- consuming country, after the U.S.

“The demand side of the oil picture is looking gloomier after the release of the latest Chinese consumption numbers,” said Addison Armstrong, director of market research for Tradition Energy in Stamford, Connecticut.

The International Energy Agency, which coordinates energy policy in 28 developed countries, said in a Dec. 11 report that global oil demand will contract this year for the first time since 1983 and cut its outlook for 2009.

Consumption worldwide will shrink by 200,000 barrels a day, or 0.2 percent, to 85.8 million barrels a day in 2008, the IEA said in the monthly report. Next year consumption worldwide will increase by 400,000 barrels a day, or 0.5 percent, to 86.3 million barrels a day, the report showed. That was down 200,000 barrels a day from November’s forecast.

4 Million Barrels

“OPEC will have to cut 4 million barrels a day at a minimum, given the drop in demand and because of non-OPEC production, to stop the fall in prices,” said economist Philip Verleger, president of PKVerleger LLC in Aspen, Colorado.

Global stockpiles can meet 57 days of world demand, five days more than the five-year average, OPEC President Chakib Khelil said.

“Stocks are very high, we need to take action at this time,” El-Badri told reporters when he arrived at his hotel in Oran yesterday. The oil market has 100 million barrels in excess stockpiles, he said.

The group, which agreed in October to reduce production by 1.5 million barrels a day starting Nov. 1, has implemented 75 percent of the cut, Khelil, who is also Algeria’s oil minister, told reporters in Oran.

“Everybody supports the cuts, I don’t have any doubts about it,” Khelil said. “The Saudis have reduced their supply to the market by 8 percent, which has had an effect on the market.”

Russian Request

OPEC is asking Russia, the second-largest producer after Saudi Arabia, to reduce oil output by 200,000 to 300,000 barrels a day to help revive prices, OAO Lukoil Chief Executive Officer Vagit Alekperov said in Moscow yesterday. Alekperov and Russia’s Deputy Prime Minister Igor Sechin are attending the meeting.

“In addition to an OPEC cut of 4 million barrels, Russia will have to cut by 400,000 barrels to support prices, and I don’t think either of these will happen,” Verleger, said.

Oil options volatility jumped to a record yesterday ahead of today’s expiration, as January futures traded above $50 a barrel and then collapsed to below $45 amid speculation on the impact of an OPEC production cut.

Brent crude oil for January settlement declined $1.81, or 3.9 percent, to settle at $44.60 a barrel on London’s ICE Futures Europe exchange.

To contact the reporter on this story: Mark Shenk in New York at mshenk1@bloomberg.net.

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Australia Stocks: Macarthur Coal, Santos, Telstra, Woodside

By Shani Raja

Dec. 16 (Bloomberg) -- The following companies are having unusual price changes in Australian trading today. Stock symbols are in parentheses.

The S&P/ASX 200 Index fell 70.20 points, or 2 percent, to 3,521.20 at 11:02 a.m. in Sydney.

Oil companies: Woodside Petroleum Ltd. (WPL AU) dropped 1.33 cents, or 3.75 percent, to A$34.16, the most since Dec. 2. Santos Ltd. (STO AU) fell 29 cents, or 1.9 percent, to A$14.71.

Crude oil fell on speculation OPEC production cuts may be insufficient to bolster prices as the global recession curbs fuel consumption. Crude for January delivery fell 3.8 percent to $44.52 a barrel at the close of floor trading on the New York Mercantile Exchange.

Macarthur Coal Ltd. (MCC AU), the world’s biggest exporter of pulverized coal, tumbled 64 cents, or a record 18 percent, to A$2.84, the lowest in four years and the index’s biggest loser. Macarthur cut its first-half profit forecast as much as 53 percent and reduced its sales estimate after customers sought to defer shipments on slumping steel demand.

Macquarie DDR Trust (MDT AU), an Australian real estate investment trust, dropped 1 cent, or 14 percent, to 3.9 cents, a record low. Macquarie Group Ltd. (MQG AU) said it ceased to be a substantial holder of the company’s shares.

Telstra Corp. (TLS AU) slumped 24 cents, or 6.6 percent, to A$3.41, a record low. Australia’s largest telephone company had its rating cut to “hold” from “buy” at ABN Amro Holding NV. Telstra tumbled 48 cents, or 12 percent, to A$3.65 yesterday after being disqualified from the government’s plans to build a nationwide high-speed Internet network.

To contact the reporter on this story: Shani Raja in Sydney at sraja4@bloomberg.net.

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Japan Stocks Fall on U.S. Manufacturing; Inpex Drops on Oil

By Masaki Kondo

Dec. 16 (Bloomberg) -- Japan stocks slumped as a drop in U.S. manufacturing and Isuzu Motors Ltd.’s cutbacks in developing markets pointed to a deepening of the global economic recession.

Honda Motor Co., which gets more than half its sales from North America, slid 6.6 percent. Isuzu, Japan’s largest truckmaker, tumbled 5 percent after putting expansion plans in Thailand and Russia on hold. Sony Corp., the world’s second- biggest maker of consumer electronics, dived 5 percent after Credit Suisse Group more than halved its price estimate. Inpex Corp., Japan’s largest oil and gas explorer, sank 5.4 percent after crude fell for a second day.

The Nikkei 225 Stock Average declined 190.61, or 2.2 percent, to 8,474.05 as of 9:39 a.m. in Tokyo. The broader Topix index fell 21.03, or 2.5 percent, to 825.90, with almost five stocks slumping for each that advanced.

The current price level of Japanese equities “is based on the assumption the global economy will recover from the second half of next year,” Mamoru Shimode, chief equity strategist at Deutsche Bank AG, said in an interview with Bloomberg Television. “There is no evidence for that, and investors are reluctant to make a move until they see the evidence.”

Manufacturing in the U.S. fell 0.6 percent last month, the Federal Reserve said today, while the New York Fed’s regional economic index slipped to minus 25.8, the lowest level since the tally began in 2001, from 25.4 in November. Readings below zero signal manufacturing is shrinking.

Fundamental Changes

Honda, Japan’s second-biggest automaker, sank 6.6 percent to 1,947 yen, while closest rival Nissan Motor Co. slid 5.7 percent to 312 yen. Isuzu fell 5 percent to 113 yen after President Susumu Hosoi said in an interview with Bloomberg News the company scrapped expansion of pick-up truck production in Thailand and delayed a plan to manufacture trucks in Russia next year.

Sony sagged 5 percent to 1,843 yen. Credit Suisse cut its investment rating on the stock to “underperform” from “neutral” and slashed its 12-month price estimate on the stock by 59 percent to 1,000 yen, saying Sony needs fundamental changes in its business to catch up with Apple Inc. and Nintendo Co.

Inpex fell 5.4 percent to 616,000 yen, while rival Japan Petroleum Exploration Co. lost 3.2 percent to 3,680 yen. Crude oil for January delivery extended its drop to a second session yesterday, falling 3.8 percent to settle at $44.51 a barrel in New York. The contract rebounded as much as 1.2 percent today.

Nikkei futures expiring in March retreated 1.7 percent to 8,480 in Osaka and slumped 2 percent to 8,480 in Singapore.

To contact the reporter for this story: Masaki Kondo in Tokyo at mkondo3@bloomberg.net.

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Asian Stocks Slump on Recession Concern; Macarthur Coal Falls

By Patrick Rial

Dec. 16 (Bloomberg) -- Asian stocks fell as signs of a deepening world recession raised concern profits will shrink at companies from coal producers to electronics makers.

Macarthur Coal Ltd., the world’s biggest exporter of pulverized coal, plunged 20 percent after slashing its profit forecast and announcing job cuts amid lower demand. Posco, Asia’s third-largest steelmaker, lost 2.7 percent after the Nikkei newspaper said Toyota Motor Corp. will ask for cheaper steel prices. Sony Corp. slid 3.6 percent after Credit Suisse Group reduced its rating.

The MSCI Asia Pacific Index declined 1.6 percent to 86.67 as of 10 a.m. in Tokyo. Shares in the gauge carry an estimated dividend yield of 3.8 percent, compared with 3.3 percent for the Standard & Poor’s 500 Index in the U.S.

Japan’s Nikkei 225 Stock Average dropped 1.7 percent to 8,521.14. Shares in Australia and South Korea also retreated, with New Zealand equities rising.

The collapse of the American mortgage market triggered a global recession that’s dragged the MSCI Asia gauge down 45 percent this year. Japan, the U.S. and Europe have entered the first simultaneous recession since World War II.

The S&P 500 Index declined 1.3 percent yesterday after the New York Federal Reserve’s regional manufacturing index contracted the most on record.

Macarthur fell 20 percent to A$2.79 after saying profit in the six months ending Dec. 31 may be between A$75 million ($50 million) and A$125 million. That compares with a Nov. 13 forecast of between A$150 million and A$160 million.

Toyota, the world’s second-largest automaker, will ask for a 30 percent reduction in steel sheet prices for the year starting in April, on slumping demand for cars, the Nikkei newspaper said.

Posco dropped 2.7 percent to 380,000 won.

Sony had its investment rating cut by Credit Suisse Group to “underperform” from “neutral.” The brokerage slashed its 12- month price estimate on the stock by 59 percent to 1,000 yen.

To contact the reporter for this story: Patrick Rial in Tokyo at prial@bloomberg.net;

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Bank of Montreal, Smith & Wesson, STEC: U.S. Equity Preview

By Lynn Thomasson

Dec. 15 (Bloomberg) -- The following companies may have unusual price changes in U.S. trading tomorrow. Stock symbols are in parentheses, and share prices are as of 6:30 p.m. in New York, unless otherwise specified.

Standard & Poor’s 500 Index futures expiring in March 2009 fell 1.1, or 0.1 percent, to 871.2. Dow Jones Industrial Average futures fell 7 points to 8,574. Nasdaq-100 Index futures dropped 0.2 percent to 1,193.

Bank of America Corp. (BAC US) added 2 cents to $14.13 after the close of regular trading. The biggest seller of U.S.- backed bank debt raised $1.5 billion issuing more of its government-backed 3.125 percent notes due in June 2012, according to data compiled by Bloomberg. The company sold the debt, guaranteed by the Federal Deposit Insurance Corp., at 102.04 cents on the dollar to yield about 2.51 percent, Bloomberg data show.

Bank of Montreal (BMO US) slumped 7 percent to $24.54. Canada’s fourth-biggest bank plans to sell as much as C$1.1 billion ($890 million) in stock to bolster its balance sheet. The sale of more stock can dilute a company’s earnings per share.

ConocoPhillips (COP US): The second-largest U.S. refiner said it won’t announce its capital spending budget for 2009 until January. The company said it’s still evaluating plans in light of “significant uncertainties” regarding the outlook for oil, natural gas and refined product prices. ConocoPhillips shares added 1 percent to $51.90 in regular trading.

Harley-Davidson Inc. (HOG US): Chief Executive Officer Jim Ziemer will retire in 2009 after 40 years at the biggest U.S. motorcycle maker. Ziemer will stay on the job until his successor is in place, the company said. Harley-Davidson shares slipped 0.7 percent to $16.20 in regular trading.

Papa John’s International Inc. (PZZA US): The pizza chain said earnings in 2009 could be could be as low as $1.32 a share. Analysts polled by Bloomberg estimated $1.61 on average. The stock dropped 1.9 percent to $16.26 in regular trading.

Smith & Wesson Holding Corp. (SWHC US) plunged 18 percent to $2.19. The 156-year-old gunmaker reported second-quarter profit of 1 cent a share. Analysts polled by Bloomberg estimated 4 cents on average.

STEC Inc. (STEC US) tumbled 17 percent to $3.89. The maker of memory chips lowered its fourth-quarter sales forecast to a range between $55 million and $59 million because of canceled orders. The company earlier predicted revenue as high as $72 million.

To contact the reporter on this story: Lynn Thomasson in New York at lthomasson@bloomberg.net.

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Canada Stocks Fall on Economy Reports, Oil; Gold Miners Gain

By John Kipphoff

Dec. 15 (Bloomberg) -- Canadian stocks fell, led by financial companies and energy producers, after a U.S. manufacturing report fanned speculation that a deepening North American recession will cut profits.

Manulife Financial Corp. led insurers and banks lower, after manufacturing in New York contracted at the fastest pace on record. Husky Energy Inc. paced a drop in energy shares as crude oil prices dropped. Research In Motion Ltd. declined after rival Apple Inc. was downgraded at Goldman Sachs Group Inc.

“Confidence is still lacking in the financial sector,” said Ian Nakamoto, director of research at MacDougall MacDougall & MacTier Inc. in Toronto, which manages about C$3.5 billion.

The Standard & Poor’s/TSX Composite Index fell 53.62, or 0.6 percent, to 8,461.83 in Toronto. Losses were limited as mining shares including Barrick Gold Corp. advanced as prices for the precious metal climbed to the highest in two months.

The main Canadian equity benchmark has fallen 39 percent in 2008, poised for its worst-ever annual drop, after slumping commodity prices and global credit losses of almost $1 trillion dragged down the energy, mining and finance shares that account for three-quarters of the index’s value.

Manufacturing in the U.S., Canada’s biggest export market, slumped further in November as exports tumbled and automakers slashed their assembly rate to the lowest level in more than 18 years, the Federal Reserve said today in Washington.

The New York Fed reported the weakest factory performance in its region this month since its survey began in 2001. Canada sends about three-quarters of its exports to the U.S. and it the biggest supplier of oil and gas to the neighboring country.

Target Lowered

Manulife Financial slipped 3.2 percent to C$20.31. Canada’s biggest insurance company has its share-price target lowered by at least two analysts today after it completed a C$2.275 billion share sale last week to shore up capital.

Toronto-Dominion Bank, Canada’s second-largest lender, declined 2.9 percent to C$40.45. Royal Bank of Canada, the country’s biggest bank, retreated 1.6 percent to C$34.25.

National Bank of Canada, the nation’s sixth-largest lender, fell 7.1 percent to C$28.32 amid concern that there will be further delays to a plan to restructure C$32 billion in frozen asset-backed commercial paper. National Bank held about C$2.2 billion of the insolvent debt as of Oct. 31.

Canaccord Capital Inc., a Vancouver-based brokerage that agreed to buy back about C$58 million of the insolvent paper from clients after a successful restructuring, jumped a record 17 percent to C$3.80.

“It seems that things keep getting worse in terms of credit markets and the overall macroeconomic picture,” said Ralph Lindenblatt, a portfolio manager with Bissett Investment Management in Calgary, which has the equivalent of about $9.7 billion under management.

“That just makes it that much more challenging to come up with resolution” for the frozen ABCP market, he said.

Oil Retreats

Crude oil fell 3.8 percent to $44.51 a barrel, retreating from an earlier gain to above $50 a barrel in New York, on speculation that OPEC production cuts may be insufficient to bolster prices as the global recession curbs fuel consumption.

Husky Energy, the oil and gas producer controlled by Hong Kong billionaire Li Ka-shing, slid 5.8 percent to C$29.99. TransCanada Corp., the owner of the nation’s largest pipeline system, fell 2.4 percent to C$32.10.

Research In Motion, maker of the BlackBerry e-mail phone, declined 6.1 percent to C$45.52. Apple, the maker of the iPhone and Macintosh computers, was cut to “neutral” from “buy” by Goldman, Sachs analyst David Bailey, on concern that consumer spending is slowing. RIM, whose earnings report is scheduled for Dec. 18, said earlier this month that subscriber gains fell short of its forecasts in the third quarter.

Gold mining companies gained as gold prices rose to the highest in two months as the slumping dollar boosted the appeal of the precious metal as an alternative investment.

Barrick Gold Corp., the world’s biggest gold producer, added 4.5 percent to C$40.64. Goldcorp Inc., the second-largest gold miner by market value, gained 4.6 percent to C$36.38. Agnico-Eagle Mines Ltd., owner of Canada’s biggest gold deposit, jumped 7.6 percent to C$52.20.

To contact the reporter on this story: John Kipphoff in Toronto at jkipphoff@bloomberg.net.

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Brazil Stocks Fall Most in 2 Weeks, Led by Tim, B2W; Bolsa Dips

By Alexander Ragir and William Freebairn

Dec. 15 (Bloomberg) -- Brazilian stocks fell the most in two weeks as analysts said retail sales may decline and telephone subscriber growth will slow as the economy weakens next year.

Retailers B2W Cia. Global do Varejo and Lojas Americanas SA dropped more than 8 percent after Credit Suisse AG said same- sales may contract 3 percent in 2009. Tim Participacoes SA fell the most in seven weeks after an executive transfer from the mobile-phone company’s Italian parent raised speculation Tim won’t be sold.

“There are a lot of uncertainties about the economy and how companies will be affected by the global crisis,” said Mirela Rappaport, who helps manage the equivalent of $48 million at Investport in Sao Paulo.

The Bovespa slid 1,053.67, or 2.7 percent, to 38,320.19. The gauge surged 11 percent last week. Mexico’s Bolsa slid 1.7 percent, while Chile’s Ipsa fell 0.9 percent. The MSCI Emerging Markets Index gained 2 percent.

Brazilian same-store sales may contract next year because of the slowing economy and tighter credit, Credit Suisse said, lowering its earnings estimates for companies including B2W. The brokerage had previously predicted growth of 3 percent.

B2W Drops

“Companies are already indicating some slowdown in consumption, starting especially in November, which should negatively impact fourth-quarter results,” analysts Marcel Moraes, Tufic Salem and Antonio Gonzalez wrote in a note.

Internet retailer B2W sank 9.2 percent to 25.60 reais after it had its share-price forecast cut to 33 reais from 54 reais.

Lojas Americanas, which controls B2W, plunged 8.7 percent to 6.50 reais, its steepest decline since Oct. 24.

Brazil economic growth will probably slow by more than half to 2.5 percent next year, according to the median estimate of about 100 economists in a central bank survey published Dec. 8.

Latin American phone companies will likely see narrower margins in 2009 as the global credit crisis leads to slower subscriber growth, Deutsche Bank AG said.

The “economic downturn in Latin America in 2009 should slow down telecom subscriber additions across the region, decrease ARPUs and pressure margins of telecom operators,” analyst Rizwan Ali wrote in a note. ARPU is average revenue per user.

Vivo Participacoes SA, the largest-mobile operator, fell 1.2 percent to 35.56 reais.

Tim Retreats

Tim tumbled 13 percent to 3.93 reais. Luca Luciani, the head of domestic mobile services for Tim parent Telecom Italia SpA, is moving to the Brazilian unit, according to a Tim spokesman who declined to be identified. Management changes will be announced this week, the spokesman said.

The move “throws water on the idea of a sale,” said Peter Lyons, analyst at Oscar Gruss & Son Inc. in New York. “If Telecom Italia is putting their best guys into the company, that means Telecom Italia sees Tim as very valuable.”

The BM&FBovespa Small Cap index fell 2 percent. The BM&FBovespa MidLarge Cap index dropped 2.2 percent.

Brazilian stocks have tumbled 40 percent this year as slowing global growth and tighter credit curbed demand for raw materials, leading to a selloff in commodity producers.

Mexico’s Bolsa index fell for a second day, led by mobile- phone operator America Movil SAB and cement-maker Cemex SAB.

America Movil

America Movil fell with other Latin American phone operators. Its Claro unit is Brazil’s second-biggest wireless company by market share.

Cemex, the biggest cement producer in the Americas, dropped to the lowest in a week after Deutsche Bank AG said the company may report later today fourth-quarter revenue and cashflow dropped more than 19 percent.

America Movil fell 4.8 percent to 21.05 pesos. Cemex dropped 6.2 percent to 10.71 pesos.

Banco Santander Chile, the nation’s biggest lender, fell 3.7 percent to 20.23 pesos on concern the global economic slowdown will reduce earnings.

“Banco Santander is the most liquid of Chile’s banks,” said Juan Partida, an analyst at UBS. “U.S. banks are falling sharply today and when there is a problem or increase in aversion towards the global financial sector, normally the one that gets hit the hardest in Chile is Banco Santander.”

Argentina’s Merval rose 1.5 percent, Colombia’s IGBC gained 1.1 percent and Peru’s IGBVL slipped 1.1 percent.

To contact the reporter on this story: Alexander Ragir in Rio de Janeiro at aragir@bloomberg.net;



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S&P 500’s Worst Writedowns Signal Rally as Gap Widens

By Elizabeth Stanton

Dec. 15 (Bloomberg) -- Just when U.S. companies are about to report their biggest writedowns, the losses may be the strongest signal yet that it’s time to buy stocks.

Companies in the Standard & Poor’s 500 Index are marking down assets at the fastest rate in six years, leaving operating profits 46 percent higher than net income in the third quarter, a level last seen in 2003 when the previous bull market began. Starbucks Corp., Johnson Controls Inc. and Washington Post Co. reported profits before restructuring and layoff expenses for the period ended in September that were twice their bottom line.

Earnings at U.S. companies have dropped for five straight quarters, matching the longest streak on record, as the deepest financial crisis since the Great Depression turned 2008 into the worst year for the S&P 500 since 1931, according to data compiled by Bloomberg. The ballooning gap between net income and operating profit suggests companies are getting rid of their weakest businesses, setting the stage for a recovery in stocks next year.

“Trough earnings tend to coincide with a maximum level of writedowns,” said William Knapp, New York-based investment strategist at MainStay Investments, which manages $25 billion. “You will start to see profitability return once the economy turns, which will probably be in the second half of next year. The market is going to recognize that through price and activity six-plus months ahead of time.”

Frozen Credit

Frozen credit markets and concern Detroit-based General Motors Corp., the biggest U.S. automaker, will file for bankruptcy protection sent the S&P 500 down 1.8 percent this month. Shares may plunge another 20 percent before recovering late next year, New York University finance professor Nouriel Roubini, who predicted the global financial crisis, said on Bloomberg Television on Dec. 12.

The U.S. economy may shrink 0.8 percent next year, according to the average estimate of gross domestic product by economists surveyed by Bloomberg.

The S&P 500 tumbled 44 percent since its October 2007 record as almost $1 trillion of losses and writedowns at the biggest financial companies triggered a global recession and raised the possibility of deflation, when falling prices squeeze corporate earnings.

This decline is worse than in 2001 when the bursting of the technology bubble brought on the last recession, said Stephen Wood, New York-based senior portfolio strategist at Russell Investments, which manages $180 billion.

‘Systemic Implications’

U.S. stocks fell today, wiping out last week’s gains, after manufacturing showed a worsening economy that analysts said will hurt earnings at companies from JPMorgan Chase & Co. to Apple Inc. The S&P 500 retreated 1.3 percent to 868.57.

The last bear market “was large, but it didn’t have systemic implications,” Wood said. “We will be led out of this by credit. If credit doesn’t improve materially, then stock isn’t going to matter.”

Companies are paying an average 10.8 percent to borrow, up from 6.53 percent in January, according to Merrill Lynch & Co.’s Corporate & High Yield Master Index on Dec. 12. The premium investors demand for lending to companies instead of the government has risen to 8.85 percentage points, compared with 2.96 at the start of the year, the index shows.

The growing difference between operating income, which measures a company’s surviving businesses and strips out one- time costs, and net income, which includes all expenses, may mean the profit slump will end, says MainStay’s Knapp.

Setting the Stage

A widening gap heralded the end of the dot-com crash. S&P 500 operating earnings exceeded net profit by 67 percent in the final three months of 2002, a period when stocks dropped to the lowest level since 1997. The index then doubled through October of last year.

Texas Instruments Inc. reported operating profit of $67 million and a net loss of $589 million in the fourth quarter of 2002 after the second-largest U.S. chipmaker wrote down an investment in Micron Technology Inc. That set the stage for per- share profit growth from continuing operations of 186 percent in 2003 and a 96 percent rally in the Dallas-based company’s stock that year.

Companies report bigger differences between profit and operating income when profits are falling the fastest, “and that often happens near market lows,” said Robert Arnott, the founder of Pasadena, California-based Research Affiliates LLC, which manages $30 billion.

‘Significant Jump’

The gap will expand in the fourth quarter as companies write down acquisitions and take charges for job cuts and plant closures, said Chris Senyek, head of accounting and tax policy at ISI Group Inc., an economic and market-research firm in New York. The number of Americans filing claims for unemployment benefits has surged to the highest level since 1982, according to a government report last week.

“You’re going to see a significant jump in the fourth quarter and into next year,” Senyek said.

Steeper writedowns may be inevitable because falling stock prices diminish the value of completed takeovers. Thirty-eight companies in the S&P 500 have a lower market capitalization than the value of their goodwill, the balance-sheet asset left when companies pay a premium in an acquisition.

New York-based Time Warner Inc., the world’s largest media company, and Macy’s Inc., the department-store operator, as well as Los Angeles-based Northrop Grumman Corp., the third-biggest defense contractor, may be forced to write down acquisitions to match the decline in their shares after the S&P 500 dropped 40 percent this year, according to data compiled by Bloomberg.

‘Ultimately Improve’

The writedowns “will ultimately improve reported earnings when the economic downturn ends and we come out of it,” Senyek said. A rebound may take longer than it did in 2003 because the current economic contraction is more severe, he added.

Starbucks, Johnson Controls and Washington Post are among S&P 500 companies that are coping with the recession by getting rid of weaker units, which may help them rebound once the economy exits the yearlong recession.

While Starbucks reported operating income of $76.9 million for the quarter that ended in September, the Seattle-based coffee retailer’s net profit was $5.4 million because of charges taken to close 600 U.S. stores and cut 13,000 jobs.

The company this month doubled its forecast for 2009 expense reductions to $400 million. Chief Financial Officer Troy Alstead told analysts during a conference on Dec. 4 the savings will come mostly through firings and lower product costs.

Johnson Controls

Johnson Controls, the largest maker of automotive seats, reported net income for the September quarter of $16 million. Excluding a $495 million charge for job cuts, earnings at the Milwaukee-based company were $439 million.

In October, the company said it would pare production and workers as U.S. auto sales slumped. The retrenchment included the shutdown this month of a plant in Ohio and the mid-2009 closing of a Kentucky plant that makes metal parts for seats.

Washington Post, publisher of the newspaper in the nation’s capital, earned $10.3 million under generally accepted accounting principles. Operating income, excluding writedowns from cutting the value of its community newspapers, was $40.3 million.

Sales rose 10 percent last quarter thanks to gains in its education and cable-television units, helping the company maintain its $2.15-a-share quarterly dividend in November. The New York Times Co., publisher of the namesake newspaper, reduced its payout by 74 percent last month.

For S&P 500 companies, both net income and operating profits are likely to decline through the first half of next year, said Nicholas Sargen, chief investment officer at Fort Washington Investment Advisors, which manages $30 billion in Cincinnati.

At that point, he said, “I’m going to start to pay more attention to the operating profits because I think we’ve seen most of the write-offs and operating is going to be giving me a better gauge as to the true earnings power of these companies going forward, and we’re doing it from very depressed levels.”

To contact the reporter on this story: Elizabeth Stanton in New York at estanton@bloomberg.net.

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U.S. Stocks Drop as Reports Show Worsening Manufacturing Slump

By Whitney Kisling

Dec. 15 (Bloomberg) -- U.S. stocks fell, wiping out last week’s gains, after manufacturing showed a worsening economy that analysts said will hurt earnings at companies from JPMorgan Chase & Co. to Apple Inc.

JPMorgan tumbled 7.5 percent on Merrill Lynch & Co.’s prediction that the biggest U.S. bank by assets may post a quarterly loss, while Apple slid 3.6 percent after the maker of iPods was downgraded to “neutral” at Goldman Sachs Group Inc. Ingersoll-Rand Co. and Textron Inc. lost more than 3.1 percent as industrial production decreased for the third time in four months and the New York Federal Reserve’s regional economic index contracted the most on record.

“There’s a lot of uncertainty right now as we start the week,” said John Wilson, co-director of equity strategy at Memphis, Tennessee-based Morgan Keegan, which manages $120 billion. “Right now the concern is the depth and duration of the recession that we’re in.”

The Standard & Poor’s 500 Index slipped 1.3 percent to 868.57 as financial and technology shares were the biggest drags on the gauge. The Dow Jones Industrial Average declined 65.15 points, or 0.8 percent, to 8,564.53. The Russell 2000 Index of small U.S. companies decreased 3.4 percent.

The first simultaneous recessions in the U.S., Europe and Japan since World War II have dragged the S&P 500 down almost 45 percent since its October 2007 record. The benchmark index rose 0.4 percent last week on speculation President-elect Barack Obama’s spending proposals will restore growth and the Bush administration may save General Motors Corp. and Chrysler LLC.

About 1.2 billion shares changed hands on the New York Stock Exchange, 25 percent less than the three-month average.

Apple, JPMorgan Downgraded

Apple slid $3.52 to $94.75 after being cut from “buy” at Goldman Sachs on concern that consumer spending will weaken further. David Bailey reduced his 12-month share-price estimate to $115 from $125.

JPMorgan fell $2.31 to $28.63. The stock was cut to “underperform” from “neutral” at Merrill Lynch, which said “it is increasingly clear that credit costs in the U.S. will get much worse.” Merrill also slashed JPMorgan’s share-price target by 39 percent to $27. Merrill’s Guy Moszkowski is the only analyst tracked by Bloomberg to rate JPMorgan the equivalent of “sell.”

Financial companies in the S&P 500 lost 4 percent as a group, while computer-related shares retreated 1.7 percent.

Morgan Stanley, Goldman Sachs

Morgan Stanley and Goldman Sachs, which report earnings this week, both retreated. The firms, which have each lost more than 69 percent this year, probably will report fourth-quarter losses on shrinking asset values and a decline in fees for businesses such as merger advice, trading and money management, according to the average estimate of analysts surveyed by Bloomberg.

Morgan Stanley declined 1.5 percent to $13.64 after Deutsche Bank AG analyst Michael Mayo said earnings per share will drop 59 percent in 2009 as revenue declines to the same level as 2005.

Goldman Sachs fell 1.9 percent to $66.46. Bank of America Corp. slid 5.5 percent to $14.11, and Wachovia Corp. lost 3.4 percent to $5.11.

Telephone companies in the S&P 500 slid 3.1 percent as a group after AT&T Inc., the biggest U.S. phone company, was downgraded to “neutral” from “buy” at Goldman Sachs, which noted that the economic slowdown led to a drop in its employee pension fund. AT&T shares lost 3.7 percent to $27.13.

Verizon Communications Inc., the second-largest U.S. wireless company, slipped 1.5 percent to $32.30. Sprint Nextel Corp., the nation’s third-biggest wireless company, lost 7.1 percent to $1.82. Qwest Communications International Inc. dropped 12 percent to $2.77.

Manufacturing Slump

Ingersoll-Rand, the maker of Thermo King refrigeration equipment, slid 49 cents to $15.14, while Textron, producer of Cessna planes and Bell helicopters, retreated 76 cents to $14.57.

The Fed Bank of New York’s general economic index fell to minus 25.8, the lowest level since records began in 2001, from minus 25.4 in November. Readings below zero for the Empire State index signal manufacturing businesses are shrinking. U.S. industrial production decreased 0.6 percent in November, the third drop in four months, according to a separate report from the Fed in Washington.

‘Weakness and Concern’

“It comes on top of weak employment data, weak earnings data and expectations that earnings are going to continue to be weak,” said Dean Gulis, part of a group that manages $2.5 billion for Loomis Sayles & Co. in Bloomfield Hills, Michigan. “The general tone of the market is still one of weakness and concern.”

Fed policy makers will announce a decision on interest rates tomorrow. Fed funds futures show traders are pricing in 64 percent odds that the central bank will reduce its benchmark rate by three-quarters of a percentage point to 0.25 percent. The rest of the bets are for a 50 basis-point cut to 0.5 percent.

Construction companies retreated after a survey showed confidence among homebuilders remained at a record low, while Fitch Ratings downgraded nine companies’ credit ratings and said the builders will see more challenges from the housing downturn.

Lennar Corp. was cut one level to non-investment grade, while Centex Corp. and D.R. Horton Inc. were lowered one step deeper into junk-bond territory. Lennar fell 9 percent to $8.80. Centex dropped 7.2 percent to $10.54, and D.R. Horton tumbled 9.8 percent to $7.02.

‘Pressures Will Persist’

“As weak as housing has been, it can deteriorate further,” Fitch said. “Operational and financial pressures will persist and, probably, intensify for the public homebuilders during 2009.”

Developers Diversified Realty Corp. led a decline in real estate companies, dropping 17 percent to $4.70. The owner and manager of more than 700 shopping centers won’t complete the sale of 13 assets this month as expected and said it doesn’t have an agreement with the buyer yet.

The S&P 500 is poised for its worst year since the Great Depression after losses and writedowns at the biggest global financial companies reached almost $1 trillion and earnings at U.S. companies dropped for five straight quarters, matching the longest streak on record.

Companies in the S&P 500 are marking down assets at the fastest rate in six years, leaving operating profits 46 percent higher than net income in the third quarter, a level last seen in 2003 when the previous bull market began. The ballooning gap between net income and operating profit suggests companies are getting rid of their weakest businesses, setting the stage for a recovery in stocks next year.

GM Rallies

General Motors Corp. rallied the most in the Dow as President George W. Bush said deliberations by his administration on whether to use bank bailout money for GM and Chrysler LLC “won’t be a long process” because of the “fragility” of U.S. automakers. The shares, which have declined 84 percent this year, added 3.6 percent to $4.08.

Benchmark indexes also retreated as the list of investors burned by Bernard Madoff’s alleged $50 billion Ponzi scheme grew.

Madoff clients facing losses range from New York Mets owner Fred Wilpon’s Sterling Equities Inc. to hedge funds such as Fairfield Sentry Ltd. The alleged scam has ensnared more than 25 companies around the world, including financial-services firms BNP Paribas SA in Paris and Nomura Holdings Inc. in Tokyo, which said they may lose money because of trading or lending tied to Madoff’s firm.

In all, companies, individuals and foundations have disclosed about $24 billion of investments with Madoff, according to data compiled Bloomberg and media reports.

The MSCI Asia Pacific Index climbed 4.4 percent today as Toyota Motor Corp. rallied 9.8 percent and Hyundai Motor Co. jumped 7.1 percent. Europe’s Dow Jones Stoxx 600 Index fell 0.4 percent.

To contact the reporter on this story: Whitney Kisling in New York at wkisling@bloomberg.net.

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