Evening Update

Financials the Leader in the Clubhouse

Stocks finished out the holiday shortened week in high fashion, with financials surging following Wells Fargo's pre-announced 1Q earnings results that trounced the Street's estimates and after the New York Times report said all 19 banks will pass the stress tests being conducted by regulators. Reports of a $154 billion stimulus plan in Japan added to the bullish sentiment and sending commodity-related shares higher and the Dow Jones Industrials back above the 8,000 mark. Retail March same-store-sales came in mixed, but many consumer-related stocks were higher, as traders viewed the results as stabilizing. Additional positive news from banks included a sale of the iShares business by Barclays. Jobless claims fell and the trade deficit narrowed. Treasuries were lower and all US markets will be closed tomorrow in observance of Good Friday.

The Dow Jones Industrial Average jumped 246 points (3.1%) to close at 8,083, the S&P 500 Index gained 31 points (3.8%) to 857, and the Nasdaq Composite advanced 62 points (3.9%) to 1,653. In moderate volume, 1.8 billion shares were traded on the NYSE, and 2.2 billion shares were traded on the Nasdaq. Crude oil gained $2.75 to $52.13 per barrel, wholesale gasoline rose $0.04 to $1.48 per gallon, and gold fell $7.20 to $877.60 per ounce. For the week, the DJIA rose 0.9%, the S&P 500 Index gained 1.7%, and the Nasdaq Composite increased 1.9%.

The New York Times reported that regulators said all 19 banks will pass the stress tests, although some still may require more aid. Quoting officials involved in the examinations, they said this is a test a bank simply cannot fail, if the examiners determine that a bank needs “exceptional assistance,” the government will provide it. There is said to be a wide range of results among the institutions. Reuters, citing a person familiar with the matter, reported that President Barack Obama plans to meet with Treasury Secretary Timothy Geithner, Fed Chief Ben Bernanke and FDIC Chairman Sheila Bair on Friday to discuss the stress tests and talk about next steps. The White confirmed that a Friday meeting was scheduled but would not confirm who would attend.

Wells Fargo (WFC $20) surged after reporting preliminary 1Q EPS of $0.55, much higher than the Street estimate of $0.23. Expected total revenue of $20 billion includes another quarter of double-digit growth at legacy Wells Fargo, which is expected to be up 16%. They said the Wachovia acquisition is exceeding expectations. CEO Stumpf said they expect operating margins to be at the top of their peer group, noting a consolidated net interest margin of 4.1%. Combined net charge-offs are expected to be $3.3 billion, compared to 4Q of $2.8 billion at legacy WFC and $3.3 billion at legacy Wachovia. The company’s tangible common equity (TCE) ratio—a key measure of financial strength—is expected to rise to 3.1%, and the previously announced dividend cut will benefit retained earnings by $1.25 billion in additional common equity per quarter, which is 10 basis points of TCE per quarter, starting in 2Q. CFO Atkins noted business momentum in their traditional banking business, as well as “strong capital markets activities and exceptionally strong mortgage banking results - $100 billion in mortgage originations, with a 41% increase in the unclosed application pipeline to $100 billion at quarter-end.” While most of the mortgage business was from refinancing requests, Atkins said that 25% of the $190 billion in mortgage applications were for customers looking to purchase homes.

Retailers posted mixed February same-store-sales (SSS) that show the consumer is continuing to shop cautiously. According to a preliminary tally by the International Council of Shopping Centers, same-store-sales fell 2.1% in March, but that includes a 3% decline related to the Easter shift to April this year, versus March a year prior. A survey of economists by Bloomberg expected the figure to come in at -0.8% for the month.

Dow member Wal-Mart (WMT $51) reported February same-store sales rose 1.4% ex-fuel, lower than the Street estimate of 3.1%. The world's largest retailer said they expect their April ending quarter to post SSS at the high end of 1-3% and EPS at the high end of the $0.72-0.77 guidance given in February. Analysts are expecting $0.76 EPS for 1Q. The company noted the Easter shift lowered the average ticket during the month, but that given initial strength of sales this week, they expect strong performance in April. WMT said that they saw strength in health and wellness, and home and “do-it-yourself” segments. Shares were lower.

Discounters posted mixed results, with Costco (COST $47) reporting a 5% decline in same-store sales for March, including a 2% drop in U.S. outlets, lower than the analyst estimate of a 1.7% drop. Target (TGT $40) reported February SSS fell 6.3% versus an expected 7% decline and said April SSS would be flat versus a year ago. The company said that electronic sales were a source of strength and that sporting goods were weak. BJ’s Wholesale Club (BJ $32) said comp store sales fell 0.1%, worse than analyst estimates of an increase of 2.3%. Shares of COST and BJ were lower, while TGT was higher.

Department stores posted mixed same-store-sales results, but shares were generally higher. Kohl’s (KSS $45) reported a 4.3% decline in SSS versus expectations of -4.7% and JC Penney (JCP $25) said SSS fell 7.2% versus expectations of -10.5%. Luxury retailers Nordstrom (JWN $21) and Saks (SKS $3) reported SSS of -13.5% and -23.6% respectively. Shares of KSS, JCP, JWN and SKS were all higher.

Apparel stores also posted mixed same-store-sales results, but results were seen as better than feared, and most names were higher. Gap (GPS $15) reported SSS of -8.0% versus expectations of -9.9%, Limited Brands (LTD $11) reported SSS of -9.0% versus -12.0% expected, Abercrombie (ANF $25) said SSS fell 34% versus a 24% expected fall, American Eagle (AEO $14) reported SSS of -16.0% versus expectations of -10.4%. Shares of GPS, LTD and AEO closed higher, while shares of ANF were lower.

Barclays (BCS $11) traded higher after confirming that it has agreed to sell its iShares business to private equity firm CVC Capital Partners Group for $4.4 billion. Barclays will finance $3.1 billion of the sale and will be entitled to receive 20% of the equity return from iShares once CVC has achieved certain minimum returns. Barclays said the sale will boost its tier one ratio by 54 bps to 7.2% as of Dec. 31, 2008. The company said they expect to book a gain of $2.2 billion including $1.4 billion in goodwill.

Jobless claims fell and the trade deficit unexpectedly narrowed

Weekly initial jobless claims (chart) fell by 20,000 to 654,000, versus last week's figure that was upwardly revised by 5,000 to 674,000. The report was better than the Bloomberg consensus, which called for claims to come in at 660,000. The four-week moving average fell by 750 to 657,250, and continuing claims jumped to 5,840,000, versus the forecast of 5,800,000. The report marks the tenth straight week of claims above 600,000.

The U.S. February trade deficit (chart) unexpectedly decreased to $26.0 billion from January's revised $36.2 billion, and was the smallest trade gap in more than nine years. Economists surveyed by Bloomberg estimated a $36.0 billion shortfall. The deficit has shrunk a record seven straight months; it last rose in July 2008, and was marked by a 1.6% increase in exports and a 5.1% decrease in imports. Separately, the Import Price Index (chart) rose 0.5% in March, lower than the expected 0.9%. Import prices fell a revised 0.1% in February. Treasuries were lower. The yield on the 2-year note gained 2 bps to 0.95%, the yield on the 10-year note rose 6 bps to 2.92%, while the yield on the 30-year bond advanced 8 bps to 3.75%. All US markets will be closed Friday in observance of Good Friday.

Relative relief from limited earnings grief

In a Good Friday-shortened week, volume was relatively light as the first half of the week was spent by traders treading cautiously ahead of Dow component Alcoa's (AA $9) unofficial launch of 1Q corporate earnings season. Uncertainty whether the Street's expectations were in line with what impact the global recession actually had on the bottom lines and what type of commentary and guidance companies would divulge had traders playing their cards close to their vest. Alcoa missed forecasts on the bottom line but its slightly better-than-expected top line figures helped relatively calm nerves. Also, Bed Bath & Beyond (BBBY $31) surged after easily beating analysts' estimates on lower margin deterioration and better inventory levels, to help overcome early pressure and push the major indices into the green for the second half of the week.

Economic data was light, with the exception of the Federal Reserve's release of the minutes from its March monetary policy meeting detailing the discussion leading up to the historic move to expand its balance sheet by $1.15 trillion, through a combination of $300 billion in Treasury purchases and an additional $750 billion in mortgage-backed securities. The report revealed that the Fed revised down its economic outlook, to stoke some pessimism and threaten the aforementioned cautious earnings optimism, but a fifth-straight gain in mortgage applications and surprising M&A activity in the housing sector helped soothe the sting of the Fed's reduced economic outlook. Pulte Homes (PHM $10) announced an agreement to buy fellow homebuilder Centex (CTX $10) for $3.1 billion in stock. Pulte's CEO said he’s “cautiously optimistic about the housing market.”

However, that advance may have been overstated by the light volume and we have not begun to even scratch the surface of 1Q earnings season, so enthusiasm may be tempered heading into next week, in which we will get a plethora of key economic releases and as some major financial firms such as Goldman Sachs (GS $124) will report earnings, alongside Dow member Intel (INTC $16), which are likely to go a long way in shaping sentiment on the Street.

Markets will be digesting a slew of economic data in addition to earnings reports

Investors will be eyeing economic data to find out if recent “green shoots” showing improvement from the economic winter that followed the collapse of Lehman in the fall are simply blips or more sustainable trends. Starting off the week, advance retail sales will be released on Tuesday, and are expected to show a rise of 0.3% in March, following two months of better-than-expected results, with February falling a scant 0.1% and January showing a rise of 1.8%. After recovering from a state of paralysis during which consumers locked down, some pent-up demand built up. Consumers are also benefitting from refinancing from lower mortgage rates, a decrease in gas prices versus a year ago, and higher tax refund receipts to-date in 2009. However, as Liz Ann and Brad note, consumers are saving more to reduce debt, and private-sector deleveraging has only just begun.

The trend in prices will be measured by the Producer Price Index, which will also be released on Tuesday, and the headline rate is expected to be 0.0% in March. The core rate, which excludes food and energy, is expected to rise 0.1%. Year-over-year, the headline rate is expected to fall 2.0%, and the core is expected to rise 4.0%. Following the release of pricing at the wholesale level the Consumer Price Index (CPI) will be released on Wednesday, and it is expected that prices rose 0.2% in March, and ex-food and energy increased 0.1%. Year-over-year, the CPI is expected to be 0.0% and the core rate is expected to show a rise of 1.7%. As the Fed noted in the minutes from the last Federal Open Market Committee meeting, and Liz Ann Sonders writes about in her article “Deflation is Today’s Threat, Not Inflation,” for now, an environment of falling prices is the current concern. While the Fed has pumped massive amounts of liquidity into the system and the monetary base has increased, the money multiplier has plunged.

Industrial production will be released on Wednesday, and is expected to fall 0.9% in March after falling 1.4% in February. Capacity utilization is expected to have fallen to 69.7% in March from 70.9%, reinforcing the concerns about the prospects of deflation that can arise in an economy with excess slack.

Housing starts and building permits will be released on Thursday, and starts are expected to show a month-over-month decline of 5.7% to an annual rate of 550,000 in March, and building permits are expected to fall 2.5% to an annual rate of 550,000. February’s report fueled bullish sentiment regarding a turn in the housing market, as housing starts were up sharply versus an expected fall. However, the increase was led by a swing in the multi-family sector, and the impact of good weather during the month was noted. Permits were also better, and are seen as the more forward-looking indicator of the two data series. As noted in the bi-weekly Schwab Market Perspective, the housing market has shown signs of life recently, which can be attributed to increased affordability from falling prices and lower mortgage rates. While we expect prices to fall another 10-15% before finding stability due to elevated inventory levels, once home sales begin to rise, that could boost confidence and get others off the sidelines.