Evening Update

Weak Retail Sales Break the Better-Than-Expected Trend

Stocks moved lower today as weaker-than-expected retail sales and an unexpected decline in the Producer Price Index spooked traders who saw the data as being somewhat contradictory to a string of economic news that showed a slowing pace of decline in the economy. Even a strong earnings report from Goldman Sachs failed to propel financial services stocks higher, and the sector led to the downside. In other equity news, Dow member Johnson and Johnson reported upside earnings and Dendreon reported favorable results for its prostate cancer treatment. President Barack Obama and Fed Chair Bernanke delivered speeches on the economy. In other economic data, business inventories fell. Treasuries rose on the weak wholesale price data and decline in retail sales.

The Dow Jones Industrial Average lost 138 points (1.7%) to close at 7,920, the S&P 500 Index fell 17 points (2.0%) to 842, and the Nasdaq Composite declined 28 points (1.7%) to 1,626. In moderate volume, 1.7 billion shares were traded on the NYSE, and 2.2 billion shares were traded on the Nasdaq. Crude oil lost $0.64 to $49.41 per barrel, wholesale gasoline fell $0.01 to $1.46 per gallon, and gold fell $4.67 to $889.18 per ounce.

Goldman Sachs (GS $115) reported 1Q EPS of $3.39, easily beating the Reuters estimate of $1.49, as revenues gained about 13% to $9.4 billion. The company benefitted from strength in its trading and principal investments unit, led by a record jump in its fixed income, currency, and commodities group revenues to $6.6 billion—more than double the amount in 1Q last year. On a conference call with analysts, the company's chief financial officer said the company continues to reduce its risky positions, pointing out that its residential real estate securities total an amount that he called "now just a trading position." Also, he noted that its leveraged loan exposure has fallen to about $2.3 billion from $53 billion of legacy loans the firm held at the end of last year's 3Q. The company’s tier 1 ratio under Basel I (guidelines applicable to bank holding companies) was 13.7%.

Separately, shares came under pressure despite the better-than-expected results after Goldman announced a $5 billion public offering of its common stock, which priced at $123 before the market open. The company said it would like to use the capital raised plus additional resources to repay all of the $10 billion in Troubled Asset Relief Program (TARP) capital it has received from the government, “after the completion of the stress assessment, if permitted by our supervisors and if supported by the results of the stress assessment.” GS's financial chief said given the strong quarterly results, the repayment of TARP funds is a "duty," but warned that early repayment of the capital doesn't mean the company has somehow surmounted the deep problems facing the global marketplace. "There are headwinds still and that's what makes us cautious," he said, also adding that "We are still in a difficult market environment."

Dow member Johnson & Johnson (JNJ $51) reported 1Q EPS of $1.26, four cents above the Street's profit estimate, and revenues declined 7.2% to $15.0 billion. Worldwide consumer sales fell 8.7%, pharmaceutical sales declined 10.1%, while medical devices and diagnostic sales declined 2.9%. The company also confirmed its full-year earnings guidance of between $4.45-4.55 per share, excluding special items. Shares were close to unchanged on the day.

Shares of Dendreon Corp. (DNDN $17) rose well over 100% after the biotech firm said that the pivotal phase-3 impact study of its prostate cancer treatment, Provenge, significantly prolongs survival in men with advanced prostate cancer. The company said that because the data meet the criteria and specifications outlined by the FDA, it intends to file an amendment to its existing Biologic License Application in the fourth quarter of this year to gain licensure of Provenge.

Retail sales fall, PPI drops

Advance retail sales (chart) unexpectedly fell 1.1% in March, below a forecasted gain of 0.3%, while February's number was upwardly revised from -0.1% to 0.3%. Ex-autos, sales fell 0.9%, versus a projected reading of 0.0%. February was revised higher from 0.7% to 1.0%. If gasoline, autos, and building materials are removed, the group the government uses to calculate GDP, sales at retailers dropped 0.9%. Consumers had locked down spending during late 2008, and relieved some pent-up demand by spending on the margin in early 2009. Complicating the analysis of March sales is the shift of Easter from March to April this year and also demonstrates the hazard in reading too much into any one month’s data. Some economic data has shown signs that activity is declining at a less rapid rate – the first step in a potential recovery. While we are encouraged by the progress being made, improvements remain tenuous for now. Consumers are repairing their balance sheets by spending less and saving more and the process of private-sector deleveraging has only just begun.

The Producer Price Index (chart) dropped 1.2% in March, much lower than an expected reading of 0.0%, according to Bloomberg. The core rate, which removes food and energy, was flat, shy of the 0.1% estimate. Energy prices fell 5.5%, with gasoline falling 13.1%, and food was 0.7% less expensive. Year-over-year (y/y), the headline rate is down 3.5%, and the core rate edged down from 4.0% y/y to 3.8%.

The threat of deflation is an environment where declining demand precipitates downward prices. The Fed has pumped massive amounts of liquidity into the system and the monetary base has increased, which has unleashed the growing fear of inflation. However, the money multiplier has plunged, which is not inflationary.

Business inventories (chart) fell 1.3% in February, slightly more than the forecast of a 1.2% decline, while January was revised lower from -1.1% to -1.3%. Sales rose 0.2%, helping decrease the inventory-to-sales ratio from an upwardly revised 1.45 in January to 1.43, suggesting a slight easing of the handcuffs—due to the persistent production and spending cuts companies are deploying in the face of the global economy. But the inventory-to-sales ratio, which measures how long it will take to deplete current levels at the current sales pace, remains elevated, as it reached the 1.29 level in the same period a year ago.

Treasuries were higher in reaction to the retail and inflation data. The yield on the 2-year note lost 2 bps to 0.84%, the yield on the 10-year note fell 7 bps to 2.78%, while the yield on the 30-year bond decreased 6 bps to 3.65%.

Obama and Bernanke offer speeches about the economy

President Barack Obama gave a speech in front of Georgetown University, in which he discussed the state of the economy when he took office in January, steps his administration has taken in its first three months, and what still needs to be done to stabilize the economy. Obama said the steps to recapitalize banks, strengthen the housing market, and rescue the auto sector were necessary pieces of the recovery puzzle. He added that these actions are "starting to generate signs of economic progress." Although he said this is welcome and encouraging news, Obama said it does not mean that the hard times are over and "2009 will continue to be a difficult year for America's economy."

Federal Reserve Chairman Ben Bernanke gave a speech at Morehouse College on "Four Questions about the Financial Crisis." In his prepared remarks, Bernanke noted that "Recently we have seen tentative signs that the sharp decline in economic activity may be slowing, for example, in data on home sales, homebuilding, and consumer spending, including sales of new motor vehicles." Bernanke added that a leveling out of economic activity is the first step toward recovery and we will not have a sustainable recovery without a stabilization of our financial system and credit markets. He noted that it is making progress on that front as well, and the Federal Reserve is committed to working to restore financial stability as a necessary step toward full economic recovery.

Addressing some concerns about how the Fed will unwind its aggressive actions to stave off a jump in inflation, the Fed Chief said that it has a number of effective tools that will allow them to drain excess liquidity and begin to raise rates at the appropriate time. Bernanke also said that unwinding or scaling down some of its special lending programs will almost certainly have to be part of its strategy for reducing policy stimulus once the recovery is under way. He added that, "I can assure you that monetary policy makers are fully committed to acting as needed to withdraw on a timely basis the extraordinary support now being provided to the economy, and we are confident in our ability to do so. To be sure, decisions about when and how quickly to proceed will require a careful balancing of the risk of withdrawing support before the recovery is firmly established versus the risk of allowing inflation to rise above its preferred level in the medium term."

Economic news will be plentiful tomorrow

Industrial production will be released tomorrow, and is expected to fall 0.9% in March after falling a revised 1.5% in February. Capacity utilization is expected to have fallen to 69.6% in March from a revised 70.2%.

Traders will be watching tomorrow’s release of the Consumer Price Index (CPI), which is expected to show that prices rose 0.1% in March, and ex-food and energy also increased 0.1%. Year-over-year, the CPI is expected to be -0.1% and the core rate is expected to show a rise of 1.7%. As shown in today’s Producer Price Index, the economy is at risk of experiencing an environment of falling prices, or deflation. Given the excess slack in the economy, demonstrated by low levels of capacity utilization, and low demand, businesses slash prices to stimulate demand. While it’s natural to cheer falling prices, an era of deflation can have a destructive impact if it enters a negative spiral, where consumers hold off on purchases in the hope of lower prices in the future.

Other items on tomorrow’s economic calendar include the Fed’s Beige Book, the Empire Manufacturing Index, and the National Association of Home Builders sentiment index.