Stocks suffered an across-the-board decline on Monday as investors questioned whether banks can continue to post strong results amid signs that borrowers are still falling behind on their debts.
The Dow Jones Industrial Average fell 289.60 points, or 3.6%, to 7841.73. It was the blue-chip measure's steepest one-day point loss since March 2 and its worst percentage decline since March 5. The slide broke a three-day winning streak for blue chips.
The Dow was hurt by a 24% slide in Bank of America. The bank said that its first-quarter net income more than tripled, with the company's recent Merrill Lynch acquisition contributing more than $3 billion to its bottom line, but net charge-offs rose and losses in its credit-card business ballooned.
The bank is still facing "extremely difficult challenges primarily from deteriorating credit quality driven by weakness in the economy and growing unemployment," said Chief Executive Ken Lewis.
Major bank stocks had rallied over the last month but fundamental questions linger for the sector. The industry's ability to extend credit is still constrained, according to a Wall Street Journal analysis of Treasury Department data. The Obama administration may also convert some of the preferred shares that it's obtained via bank bailouts into common stock once a round of stress testing is done next month, according to reports.
Such a move would give the administration added flexibility to provide further aid to the banks without allocating additional money, but would dilute existing shareholders of the firms' common stock.
The S&P 500 dropped 37.21 points, or 4.3%, to 832.39, led by an 11% slide in its financial sector. Goldman Sachs Group fell 4.6% and J.P. Morgan Chase fell 11%. Citigroup tumbled 19% after being cut to a "sell" rating from a "hold" by Argus Research. All three lenders posted better-than-expected first-quarter results last week.
"The bank earnings so far just seem to be smoke and mirrors and the other companies aren't reporting quality earnings. It's just reducing expenses and dipping into reserves," said Harry Rady, chief executive officer of Rady Asset Management.
The Chicago Board Options Exchange Volatility Index jumped more than 16%, a sign that nervousness among investors is again on the rise, though it remained below the 40 mark, well short of its peak near 80 last fall.
The technology-focused Nasdaq Composite Index slid 64.86 points, or 3.9%, to 1608.21. Oracle said that it plans to acquire Sun Microsystems for $7.4 billion. The deal followed the unraveling of Sun's talks to sell itself to International Business Machines. Sun's shares rose 37% while Oracle fell 1.3%. IBM, which reports earnings after the close on Monday, declined 0.8%.
Last week's sunny outlook at the start of earning season has since clouded over, as trepidation over the health of the banking sector crept into the market. Although Bank of America reported solid first-quarter profits, many traders say banks are enjoying a one-time bonanza thanks to the government's bailout package, says Peter McKay.
Some of the unease weighing on stocks rippled into the commodities markets as well. Crude oil for May delivery sank $4.45 per barrel, or 8.84%, to $45.88, the lowest settlement for a front-month contract since March 11.
Jack Ablin, chief investment officer at Harris Private Bank in Chicago warned clients on Monday that stock and bond markets are sending conflicting signals about the prospects for an economic recovery and stabilization of the financial system.
Mr. Ablin said he's concerned that the spread between yields on BBB-rated corporate debt and 10-year Treasurys has remained above five full percentage points since November, not budging even as the stock market posted a furious rally from its March lows.
That means bond investors are still charging companies a hefty premium to borrow, reflecting deep skepticism that risk has dissipated enough to justify lower borrowing costs. That message is at odds with that of the most bullish stock investors, who believe the crisis that struck last fall is now waning.
"Unfortunately, history tells us that it's the bond investors who are usually right in situations like this," said Mr. Ablin, who's maintaining a hold-steady approach on stocks for now.
Regarding the recent spate of first-quarter profits at banks, he said: "There's a lot of cynicism out there about these income statements. They're one-time gains, clearly."