Evening Update

Search for Diamonds in the Rough

A late-day rally followed the succession of economic releases throughout the day, and while economic data continues to show an economy in decline, traders continue to search for nuggets of good news. This morning’s releases of a larger-than-expected fall in industrial production and capacity utilization and falling headline prices at the consumer level were offset by strong improvements in Empire Manufacturing, a jump in homebuilder sentiment and a bullish mid-day release of the Fed Beige Book, which showed five of twelve districts noting a moderation in the rate of economic decline. In equity news, Intel announced higher-than-expected EPS but gave less-than-optimistic guidance, Procter & Gamble raised its dividend, AMR Corp. and CSX Corp. both beat estimates, while Burger King missed and Capital One Financial reported an increase in its charge-off rate. Mortgage applications fell and Treasuries were mixed.

The Dow Jones Industrial Average rose 109 points (1.4%) to close at 8,030, the S&P 500 Index gained 11 points (1.3%) to 852, and the Nasdaq Composite advanced 1 point (0.1%) to 1,627. In moderate volume, 1.5 billion shares were traded on the NYSE, and 2.1 billion shares were traded on the Nasdaq. Crude oil lost $0.16 to $49.25 per barrel, wholesale gasoline fell $0.01 to $1.45 per gallon, and gold rose $1.38 to $892.11 per ounce.

Dow member Intel (INTC $16) reported 1Q EPS fell 56% versus a year ago to $0.11, but well above the $0.03 that analysts surveyed by Reuters expected, as revenues fell 26% to $7.1 billion. The company said its gross margin fell seven percentage points due to higher factory underutilization charges and startup costs. Also, INTC said average selling price for all microprocessors was flat compared to last quarter, and microprocessor units were lower versus 4Q. However, the company's CEO said, "We believe PC sales bottomed out during the first quarter and that the industry is returning to normal seasonal patterns." Looking ahead, the company said due to continued economic uncertainty and limited visibility, it is not providing 2Q revenue guidance, but for internal purposes, it is currently planning for revenue approximately flat versus 1Q. Shares were lower.

Dow Component Procter & Gamble (PG $49) rose after announcing that its Board of Directors declared an increase in its quarterly dividend from $0.40 per common share to $0.44, representing a 10% increase.

AMR Corp. (AMR $5) surged after reporting a 1Q loss of $1.30 per share, which came in narrower than the Street's estimate of a loss of $1.62, as total operating revenues fell 15.1% to $4.8 billion. The parent of American Airlines said it was able to obtain nearly $100 million from a loan secured by aircraft, reduce planned capital expenditures by about $100 million, and identify ways to help control unit costs. The company said, "While lower fuel prices have provided a significant buffer against falling demand in 2009, the struggling economy and capital markets remain significant challenges for American and the rest of the industry." Looking ahead, AMR said it expects consolidated capacity in 2Q and for 2009 to decline by 8% and more than 6.5%, respectively.

CSX Corp. (CSX $31) rallied after the transportation company reported 1Q EPS of $0.62, easily topping analysts' estimates of $0.51, as revenues fell 17% to $2.2 billion. CSX said its decline in revenue was primarily due to a 17% drop in volume, driven by "significant weakness in industrial production, housing starts, and consumer spending, as well as in agriculture and energy sectors."

Capital One Financial (COF $17) erased early losses and closed higher after the credit card firm said its March annualized net US charge-off rate—rate of loans it does not expect to collect—increased from 8.38% in February to 9.00%, after adjusting for the lower amount of days in February. However, COF said its 30 days+ delinquency rate remained for March.

Burger King Holdings (BKC $19) fell sharply after the fast-food franchise said 3Q revenues were $600 million, shy of the Street's forecast of $630 million, as total worldwide same-store sales were up 1%. BKC added that its 3Q EPS were negatively impacted by "significant traffic declines" in March, which resulted in lower-than-expected company restaurant margins for the quarter. The company expects 3Q EPS to come in the range of $0.33-0.35, versus the $0.33 the Street is expecting.

Deluge of data, with nuggets of stability

Treasuries ended mixed in a volatile session, and tended to follow the movements in equities, with early bond market gains erasing as stocks rallied in late session trading. The yield on the 2-year note gained 1 bp to 0.85%, the yield on the 10-year note fell 1 bp to 2.77%, and the yield on the 30-year bond rose 2 bps to 3.67%.

Industrial production (chart) fell 1.5% in March, worse than the estimated decline of 0.9% after falling a revised 1.5% in February. Capacity utilization continued to decline, and was a record low 69.3% for this series, which began in 1967, and was lower than the expected 69.7%, and February’s revised 70.3%. For the first quarter as a whole, output fell at an annual rate of 20.0%, and output has fallen 13% from a year ago. Declines in production were broad-based, with the exception of motor vehicles and parts, which rose 2% in March. Manufacturing, a sub-set of the report, posted 65.8% utilization, a historical low not seen since the start of this series in 1948. Manufacturing output fell 1.7%, falling 22.5% when annualizing the first quarter, after declining 18% in the fourth quarter.

After a 3% drop in energy prices, the Consumer Price Index(chart) fell 0.1% in March, compared to the Bloomberg forecast that called for a 0.1% gain. The core rate, which strips out food and energy, was up 0.2%, topping the forecast of 0.1%. Year-over-year (y/y), the headline rate fell to -0.4% from 0.2%, marking the first annual decline since August 1955, and core inflation remained at 1.8%. Energy prices fell 23% from a year earlier, accounting for the decline in the headline rate. In response to excess slack in the economy, as measured by a low 69.3% 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, stifling economic growth.

On the positive side of the ledger, and while regionally specific, the first reading on activity in the month of April improved, as the Empire Manufacturing Index, a measure of manufacturing in New York, increased to -14.65 from -38.23, much better than the estimate of -35.00, indicating economic activity is contracting at a slower pace. The index of new orders, while still negative, shot up 41 points to -3.9.

In other economic news, the US MBA Mortgage Application Index fell 11% to 1113.2 for the week ended April 10, failing to gain ground for a sixth-straight week. The Refinance Index dropped 10.9% to 6071.7, and the Purchase Index also declined, falling 11.3% to 264.1. The Mortgage Bankers Association (MBA) said the average 30-year fixed loan dipped from 4.73% the week before to 4.70%, and the MBA noted that the lack of an adjustment for the Easter/Passover weekend may have contributed to the decline in applications.

Elsewhere, the National Association of Home Builders Index of builder confidence jumped from 9 in March to 14 in April—but a reading below 50 means most respondents still view conditions as poor. Improvements were seen in sales, traffic and expectations for sales over the next six months. New homebuyer tax credits, low mortgage rates, falling prices and seasonal trends have increased buyer interest and traffic and were attributed to the rise in sentiment.

The Federal Reserve Beige Book was released mid-day, which includes anecdotal information on monthly regional economic conditions through April 6. Five of the twelve district banks noted a moderation in the rate of decline, an improvement from the last report where weaker conditions or declines were noted in ten of twelve districts. A slight improvement in retail sales was reported in some districts, and better-than-expected homebuyer traffic led to a scattered pickup in home sales in a number of districts. However, manufacturing weakened with only a few exceptions, and non-residential real estate conditions continued to deteriorate. Bankers reported tight credit conditions, rising delinquencies and some deterioration in loan quality. Employment continued to decline, with only scattered reports of hiring. The data is gathered in preparation for the next Federal Open Market Committee meeting, which will be held on April 28-29.

Home builder sentiment rose, but housing starts are expected to fall

Housing starts and building permits will be released tomorrow, and starts are expected to show a month-over-month decline of 7.4% to an annual rate of 540,000 in March, and building permits are expected to fall 2.7% to an annual rate of 549,000. February’s report fueled bullish discussions by market participants 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. 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.