Dow up 40 as crude falls below $119

By Charley Blaine and Elizabeth Strott

Falling prices for crude oil today turned around a stock market that was worried yet again about the health of financial companies.

Crude finished at $118.58 a barrel, down 59 cents from Tuesday and down 19.5% from its intraday high of $147.22 on July 11.

Crude's fall has pulled down retail gasoline prices. AAA's daily Fuel Gauge survey showed the retail gasoline prices averaging $3.862 a gallon, down 6.1% from the survey's July 17 high of $4.114 a gallon.

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The Dow Jones industrials, meanwhile, closed up 40 points to 11,656, its highest close since June 25. The blue chips had been down as many as 94 points before a government report showed larger-than-expected domestic oil supplies.

The Standard & Poor's 500 Index was up 4 points to 1,289. And the Nasdaq Composite Index was up 29 points to 2,378.

Late today, American International Group (AIG, news, msgs), the world's largest insurer, posted its third consecutive quarterly net loss, hurt again by the write-down of derivatives linked to bad mortgage investments.

The report could lead to a weak open on Thursday.

AIG said its second-quarter net loss was $5.36 billion, or $2.06. a share, compared with net income of $4.28 billion, or $1.64 a share in the year-earlier quarter.

Shares fell 8.2% to $26.70 in after-hours trading after falling 2.7% to $29.09 in regular trading.

Market looks beyond Freddie Mac

Today's rally came despite a much larger-than-expected loss for mortgage capital supplier Freddie Mac (FRE, news, msgs) and deepening concerns about the prospects of Freddie Mac and rival Fannie Mae (FNM, news, msgs) as stockholder-owned companies.

Freddie Mac's loss was three times larger than expected, and it cut its dividend 80% to 5 cents a share. The stock fell 19.3% to $6.49, the worst performance among S&P 500 stocks. Fannie Mae, down 14.7% to $11.60, was the second-worst S&P performer.

Pimco's Bill Gross told Bloomberg Television today the Treasury will probably be forced to buy as much as $30 billion of preferred shares in both Fannie Mae and Freddie Mac to help shore up their capital. He predicted the purchases could come as soon as the end of the third quarter.

Despite the decline in oil, energy stocks were the strongest sector of the market, followed by materials and metals stocks and technology stocks. The best performers among Nasdaq-100 stocks were Research In Motion (RIMM, news, msgs), Cisco Systems (CSCO, news, msgs), Microsoft (MSFT, news, msgs) and Apple (AAPL, news, msgs). All were up 2.2% or more.

Cisco's third-quarter earnings and outlook cheered investors, and Microsoft moved higher on a note from UBS analyst Heather Bellini saying she expected the software giant to buy back as much as $20 billion of its shares over the next three months. The move might placate shareholders angered when the company's failed bid for Yahoo (YHOO, news, msgs) pushed Microsoft shares down as much as 20%.

The buyback would be done quietly, she told Bloomberg News. "They won't announce it until it's done." (Microsoft is the publisher of MSN Money.)

Stocks rallied on Tuesday, with the Dow up 332 points, as the Federal Reserve kept interest rates on hold at 2% and the cost of crude oil fell. Few analysts expect the Fed to raise rates any time soon. "Rates are probably on hold until 2009," Michael Darda of MKM partners wrote in a note to clients today.

Caterpillar (CAT, news, msgs) was the Dow leader with a 3.4% gain to $70.51, followed by Microsoft, up 3.1% to $27.02. General Motors (GM, news, msgs), down 4.1% to $10.25, was the Dow loser.

Credit card processor Fidelity National (FIS, news, msgs) was the S&P 500 leader, up 18.6% to $22.50. Whole Foods Markets (WFMI, news, msgs) was the third-worst performer in the S&P 500, after Freddie Mac and Fannie Mae, falling 12.6% to $20.04. Late Tuesday, Whole Foods cut its dividend after its third-quarter earnings missed analyst estimates.

Fifteen of the Dow stocks were higher, along with 283 S&P 500 stocks and 63 stocks in the Nasdaq-100 Index ($NDX.X). The Nasdaq-100 was up 26 points, or 1.4%, to 1,896.

Energy prices -- New York close

	Wed.	Thur.	Chg.	Month chg.	YTD chg.
Crude oil (NYMEX) (per barrel)	$118.58	$119.17	-$0.59	-4.43%	23.55%
Heating oil (per gallon)	$3.2379	$3.2820	-$0.0441	-5.84%	22.21%
Natural gas (per million BTU)	$8.7730	$8.7260	$0.0470	-3.79%	17.24%
Unleaded gasoline (per gallon)	$2.9493	$2.9564	-$0.0071	-3.24%	18.41%

Freddie Mac worse than expected

Freddie Mac reported its fourth consecutive quarterly loss, losing $821 million, or $1.63 per share, in the second quarter, down from a gain of $729 million, or 96 cents per share, a year earlier. The results missed analysts' expectations for a 54-cent-a-share loss.

Second-quarter revenue fell 28% to $1.69 billion, and credit-related expenses jumped to $2.5 billion, more than double the $1.2 billion Freddie set aside for the first quarter.

Freddie Mac today reiterated its plans to raise $5.5 billion in capital.

The company, along with Fannie Mae, has been slammed in recent weeks as questions about capital levels and economic health of both companies have forced the White House, Treasury Secretary Hank Paulson and Fed chief Ben Bernanke to craft plans to help bolster confidence in the government-chartered mortgage giants. Freddie Mac shares are down 86% over the past year, and Fannie Mae shares have shed 76% of their value in that period.

Over the past four quarters, Freddie Mac has lost more than $4.6 billion.

CEO Richard Syron said the company still needs to raise $5.5 billion and may slow purchases of mortgages to avoid breaching regulatory capital requirements. He also said the company would wait for its stock to improve before starting the capital raising.

"Neither we nor anyone else can predict when the housing market will recover and it would be folly for anyone to try to do so," Syron said on a conference call with analysts today. "There's still a large amount of inventory to work through the system and record foreclosures continue to be the problem, pushing results down further."

The results were so bad that a number of observers were skeptical that Freddie Mac could avoid being taken over by the federal government.

Freddie Mac and Fannie Mae are in a race to see if the housing market will turn around before they run out of capital, Armondo Falcon, the former head of the Office of Federal Housing Enterprise Oversight, Freddie Mac's regulator, told CNBC this afternoon.

"This correction is more severe than what we've seen in the recent past," Christopher Whalen, co-founder of independent research firm Institutional Risk Analytics, told Bloomberg News. "Both Fannie and Freddie are going to be profoundly insolvent by the time we're done with this."

The earnings report "significantly shortens the timeline for Treasury intervention," Ajay Rajadhyaksha, head of fixed-income research for Barclays Capital in New York, told Bloomberg. With the value of Freddie's outstanding stock now at $4.3 billion, Rajadhyaksha said, "I don't see how they can raise capital by themselves without a capital infusion from Treasury."

Freddie and Fannie own or guarantee more than $5 trillion in U.S. mortgages, about half of all mortgages in the country. The number of U.S. foreclosure filings surged by 53% in June from last year; nearly 1 in every 171 U.S. households is in some stage of foreclosure, according to RealtyTrac.

Treasury hires Morgan Stanley

Meanwhile, the Treasury Department is taking its concerns about Freddie and Fannie one step further.

The Treasury this morning announced that it has hired Morgan Stanley to provide "a sensitivity analysis on the financial profile of selected financial services firms, and assessment of appropriate capital structures."

The Treasury reiterated its position that it has no plans to use its new authority to backstop Fannie and Freddie but that hiring Morgan Stanley will help the agency "analyze and understand these authorities, should circumstances ever warrant their use."

Legg Mason fired by Massachusetts pension fund

Massachusetts' $50.6 billion pension fund on Wednesday fired Legg Mason Capital Management, the Legg Mason (LM, news, msgs) subsidiary run by fund manager Bill Miller, and four other fund firms from managing a $1.8 billion U.S. stocks portfolio. Miller's Legg Mason Value Trust is down nearly 33% this year and has struggled with poor returns since the end of 2006.

The pension fund's board approved transferring about $1.4 billion of the $1.8 billion portfolio to asset manager State Street Global Advisors. State Street (STT, news, msgs) will manage the assets as an index mandate linked to the Russell 3000 index portfolio, the fund said.

The remaining assets will be put into a new fund-of-hedge-funds portfolio that will seek returns in excess of market returns, the pension fund's officials said.

They said the reshuffling of the asset managers was also part of its long-term goal of moving away from actively managed portfolios for large-capitalization U.S. stocks.

Legg Mason closed down 1.2% to $42.33.

In addition, the fund fired Ariel Investments, NWQ, Mazama Capital Management and Gardner Lewis.

Analyst: Lehman could cut dividend

With Freddie Mac's loss already deflating the financials today, comments about Lehman Bros. (LEH, news, msgs) didn't help that stock this morning.

Ladenburg Thalmann analyst Dick Bove said Lehman could cut its quarterly dividend by 90% and could sell between $30 billion and $50 billion in high-risk securities. Bove lowered his price target on Lehman to $23 from $27.

"My sense is that Lehman feels a need to take action now to stop, for once and, hopefully, for all, the constant stories and rumors swirling around the company," Bove wrote in a note to clients.

Worries about Lehman's liquidity level and its exposure to risky mortgage-backed securities has made the company a constant in the rumor mill in recent weeks. Reports yesterday speculated that the company may sell all or part of its investment management business.

Lehman shares finished up 1.1% to $20.46.

Cisco's sales jump

Cisco Systems shares jumped 5.7% to $23.93, fifth-best among Nasdaq-100 stocks and 11th among S&P 500 stocks.

Late Tuesday, the networking company reported better-than-expected earnings and strong sales in its fiscal fourth quarter.

The tech bellwether earned $2 billion, or 33 cents per share, up from $1.9 billion, or 31 cents per share, in the same quarter last year. Adjusted income was 40 cents per share, a penny better than Wall Street's consensus estimate.

Sales rose 10% to $10.4 billion, also ahead of analysts' expectations.

On a conference call with analysts, Chief Executive John Chambers said the maker of networking and communications equipment will likely face several quarters of difficulty. Many analysts had expected the company to struggle for a longer period. Chambers reaffirmed the company's long-term revenue growth guidance of between 12% and 17% per year.

One analyst was optimistic about Cisco. "I think the company is in reasonably good shape to weather the coming storm," Rob Enderle of the Enderle Group told MarketWatch.com.

News Corp., Time Warner report results

In other earnings news, News Corp. (NWS, news, msgs) said late Tuesday that fiscal-fourth-quarter profit rose 27% to $1.13 billion, or 43 cents per share, from $890 million, or 28 cents per share, a year earlier.

Analysts had been expecting earnings of 34 cents per share.

The international media company said sales at its newspaper group, which includes The Wall Street Journal, rose 54% to $1.48 billion. Cable network sales rose 26% to $1.39 billion, and its film entertainment division saw operating income more than double in the quarter to $220 million.

But the stock was down 5% to $14.49, after CEO Rupert Murdoch said the company faces "more challenging macro-economic conditions" in fiscal 2009.

Meanwhile Time Warner (TWX, news, msgs) reported a 26% drop in second-quarter profit.

Time Warner said weakness at its AOL unit weighed on results. The company earned $792 million, or 22 cents per share, in the quarter -- down from $1.07 billion, or 28 cents per share, in the second quarter of last year. Excluding items, Time Warner earned 24 cents, a penny ahead of expectations.

But AOL has been a drag on the overall company. AOL's revenue fell 16% in the quarter, and the service lost 604,000 subscribers, a 29% decline. Online advertising revenue at AOL rose a meager 2%.

The company also said it will split AOL's dial-up Internet business from the advertising business by early 2009. "A separation of AOL would eliminate what's been a drag on growth and a management distraction," Christopher Marangi, associate portfolio manager at Gabelli & Co, told Reuters. "We look forward to hearing more about structural alternatives there."

Time Warner reiterated its 2008 profit target of between $1.07 and $1.11 per share.

The stock fell 0.3% to $14.83.

Short hits from the markets -- 4 p.m.

	Wed.	Thur.	Chg.	Month chg.	YTD chg.
Treasurys
13-week Treasury bill	1.600%	1.710%	-0.110	-2.14%	-49.04%
5-year Treasury note yield	3.315%	3.281%	0.034	1.50%	-4.05%
10-year Treasury note yield	4.048%	4.007%	0.041	1.73%	0.32%
30-year Treasury bond yield	4.690%	4.629%	0.061	1.89%	5.18%
Currencies
U.S. Dollar Index	74.410	74.055	0.355	1.35%	-2.98%
British pound in dollars	$1.9474	$1.9535	-0.0061	-1.79%	-2.10%
Dollar in British pounds	£0.5135	£0.5119	0.0016	1.82%	2.15%
Euro in dollars	$1.5430	$1.5466	-0.0036	-1.10%	5.57%
Dollar in euros	€ 0.6481	€ 0.6466	0.0015	1.11%	-5.28%
Dollar in yen	109.76	108.28	1.48	1.74%	-1.87%
Canadian dollar in U.S. dollars	$0.954	$0.959	-$0.0054	-2.39%	-3.92%
U.S. dollar in Canadian dollars	$1.049	$1.042	$0.0068	2.54%	4.10%
Commodities
Gold	$883.00	$886.10	-$3.10	-4.30%	5.37%
Copper	$3.4235	$3.4170	$0.01	-6.50%	12.58%
Silver	$16.5050	$16.5720	-$0.07	-7.22%	10.62%
Corn	$5.0800	$5.2525	-$0.17	-13.53%	11.53%
Crude oil (NYMEX) (per barrel)	$118.58	$119.17	-$0.59	-4.43%	23.55%