Evening Update

Bulls Retreat After Disappointing Retail Report

Markets lost ground today after an economic report showed a surprising drop in April retail sales. Every sector finished in the red as investors questioned the sustainability of the recent rally now that the bank stress tests are in the rearview mirror and a reminder came that the American consumer is still struggling. On the equity front, the EU levied a record $1.5 billion antitrust fine on Dow member Intel Corp. Corporate earnings were also in focus and Macy's, BMC Software and Dr. Pepper Snapple all beat expectations, while Applied Materials missed. Elsewhere, Verizon Communications announced that it will sell its wireline business to Frontier Communications, AIG proclaimed that it intends to fully repay taxpayer aid within three to five years, and Treasury Secretary Tim Geithner spoke about potential bank reform. Other economic data released today showed that import prices increased, business inventories fell, and mortgage applications decreased. Along with the fall in the stock market, Treasuries were higher today as traders retreated to safe havens.

The Dow Jones Industrial Average lost 184 points (2.2%) to close at 8,285, the S&P 500 Index fell 24 points (2.7%) to 884, and the Nasdaq Composite decreased 52 points (3.0%) to 1,664. In moderate volume, 1.7 billion shares were traded on the NYSE, and 2.4 billion shares were traded on the Nasdaq. Crude oil fell $0.83 to $58.02 per barrel, wholesale gasoline increased $0.02 to $1.69 per gallon, and gold increased $2.95 to $926.30 per ounce.

Dow member Intel Corp. (INTC $15) was fined 1.1 billion euros ($1.5 billion) by the European Union (EU) for antitrust violations asserting that the company abused its dominant market position and offered illegal rebates to computer manufacturers, shutting rival Advanced Micro Devices (AMD $4) out of the market. The EU said INTC's practices hurt "millions of European consumers," and ordered the chipmaker to immediately halt these illegal practices. This is the largest antitrust fine in the EU’s history, more than double the 497 million euro fine that was imposed on fellow Dow component Microsoft (MSFT $20) in 2004. INTC said it takes "strong exception to this decision," and it believes the decision ignores the reality of a highly competitive microprocessor marketplace. INTC added that there has been "absolutely zero harm to consumers," and will appeal the decision. AMD said the ruling is an important step toward establishing a truly competitive market. Shares in AMD rose 1%.

The fine comes after management gave investors reason for optimism about 2Q results. INTC's CEO told an investor conference that 2Q order and billing patterns are a little better than expected and the quarter is "so far, so good," but results for the period are dependent on the month of June. In addition, INTC's sales chief said that PC prices are under pressure, but price segmentation of its chips and brands have not collapsed and it is seeing increased supply chain confidence. INTC’s shares finished close to unchanged today.

Fellow Dow member Verizon Communications (VZ $30) announced plans to divest its local wireline operations serving residential and small-business customers in predominantly rural areas in 14 states and that Frontier Communications (FTR $8) will acquire the operations. FTR will purchase the operations for $5.3 billion in stock and will assume $3.3 billion of VZ's debt. Shares of VZ and FTR were both moderately lower today.

Macy's (M $12) posted a 1Q net loss ex-items of $0.16 per share, narrower than the $0.20 per share loss analysts surveyed by Reuters estimated. Revenues fell 9.5% to $5.2 billion and same-store sales for the quarter fell 9%. The department store said given the continued uncertainty in the macro-economic environment, it believes that it is prudent to maintain its previous annual guidance of sales to decline between 6-8% and EPS to be between $0.40-0.55. Shares were lower.

Applied Materials (AMAT $11) reported an adjusted fiscal 2Q net loss of $0.12 per share, two cents larger than the loss the Street was expecting, but revenues were $1.0 billion, which topped analysts' expectations. New orders fell almost 40% to $649 million versus last quarter, and the backlog of orders also declined, falling to $3.2 billion from $4.1 billion in 1Q, reflecting what the company called a period of "exceptionally weak demand." AMAT said it expects to report a 3Q loss between $0.06-0.14 per share and revenues to be flat to down 15% versus last quarter. Analysts are expecting AMAT to report a loss of $0.08 per share and revenue of $950 million for 3Q. On the bright side, the company's CEO said it believes demand is improving in China where the stimulus for consumer buying is having an impact. AMAT finished down today.

BMC Software (BMC $32) was down nearly 8% after the company’s 4Q profit ex-items of $0.64 slightly beat analyst forecasts for $0.62, but management made disappointing comments about the company’s outlook. BMC reported that it expects growth in bookings and revenue to slow to the “low single digits” in fiscal year 2010. The company also reported it did not expect a material benefit during the first year from its new relationship with Cisco Systems (CSCO $18). The shares had risen 30% this year before today.

Dr. Pepper Snapple (DPS $22) posted 1Q EPS ex-items of $0.37, ahead of the $0.29 that analysts had been expecting. Revenue fell 3% to $1.3 billion. DPS President and CEO Larry Young reported that the company is still seeing pressure at the premium end of its product portfolio, especially with Snapple, but he is optimistic about the company’s prospects, stating that “consumer sentiment appears to be improving.” Management also raised its 2009 EPS guidance to $1.70-1.78, up 11 cents from its previous guidance. The average estimate among analysts had been for full year earnings of $1.67 per share. DPS shares were higher today.

AIG (AIG $2) CEO Edward Liddy told congress today that the bailed out insurer expects to repay all of the taxpayer aid it has received within the next three to five years. Liddy informed the congressional committee that "If the marketplace holds the way it is right now, we think that the American taxpayer will be fully repaid," Liddy also defended the secrecy surrounding the company’s restructuring program – termed “Project Destiny” – although he did agree to cooperate with Congress and provide “everything that we possibly can." The stock was down a further 10% today. The shares have lost over 90% of their value since last fall.

Elsewhere, Treasury Secretary Tim Geithner spoke before the Independent Community Bankers of America and gave investors some clues on future regulatory reform in the banking sector. In response to a question on the thorny issue of “too big to fail” that has plagued the government since the banking crisis began, Geithner proposed a framework wherein large, systemically important firms would pay into a fund that would cover the costs should one of them become in danger of failing. "Our judgment is that it needs to be a separate solution where the burden of funding ... (is) borne by the large institutions in a level proportionate to their size," he said. He made clear the administration’s goal to limit the extent to which taxpayers and smaller banks would be responsible for bearing the burden of these large banks that took "irresponsible risk."

Retail sales and business inventories fall, but import prices stand tall

Advance retail sales (chart) fell 0.4% in April, below a forecasted unchanged reading, while March's decline was again unfavorably revised from -1.2% to -1.3%. Ex-autos, sales declined 0.5%, versus a projected reading of a 0.2% increase. March's decline was also unfavorably revised further from -1.0% to -1.2%. Removing gasoline, autos, and building materials from the index, the group the government uses to calculate Gross Domestic Product (GDP), sales at retailers fell 0.3%. As consumers represent 70% of US GDP, the health of the consumer is critical to the economy. It appears that the rebound in consumer spending seen back in January and February may have been spurred by pent-up demand, mortgage refinancing, and tax refunds. Today’s report illustrates the uncertain environment retailers are still faced with as the economy bounces off the bottom, but continues to be in recession. Consumers are still hurting— their debt levels remain elevated and the long process of deleveraging has only just begun. As such, the economy’s path to recovery is unlikely to be in a straight line.

Treasuries were higher along with the economic uncertainty. The yield on the 2-year note lost 2 bps to 0.86%, while the yield on the 10-year note fell 7 bps to 3.11%, and the yield on the 30-year bond also declined 7 bps to 4.09%.

In other economic news, business inventories (chart) fell 1.0% in March, slightly less than the forecast of a 1.1% decline, while February was revised lower from -1.3% to -1.4%. Sales dropped by 1.6%, but the inventory-to-sales ratio came in unchanged from an upwardly revised 1.44 in February, suggesting the drop in sales was offset by further reductions in stockpiles of goods companies are keeping on their shelves. The inventory-to-sales ratio, which measures how long it will take to deplete current inventory levels at the current sales pace, remains elevated, as it reached the 1.28 level in the same period a year ago.

In other economic news, the US MBA Mortgage Application Index fell 8.6% to 895.6 for the week ended May 8. The Refinance Index dropped 11.2% to 4588.6, while the Purchase Index advanced slightly, rising 0.5% to 265.7. The Mortgage Bankers Association (MBA) said the average 30-year mortgage rate declined 3 basis points to 4.76%. The report may be welcome news for the housing front as the Purchase Index managed to gain modest ground, suggesting some homebuyers are warming up to the near record low mortgage rates and increasing housing affordability.

Elsewhere, crude oil inventories unexpectedly dropped, falling by 4.7 million barrels, versus the Reuters forecast of a 1.4 million barrel increase, gasoline stockpiles also unexpectedly fell, declining by 4.1 million barrels, compared to the 200,000 barrel increase that was expected, and distillate inventories rose 1.0 million, slightly below the 1.3 million barrel increase that was forecast. Crude oil and gasoline prices initially jumped after the report but later pared gains as souring sentiment over the economy weighed on the market.

Led by a 15.4% surge in oil prices—the sharpest jump in more than seven years per Reuters— Import Price Index (chart) increased 1.6% in April, more than the expected increase of 0.6%. However, nonpetroleum prices decreased for the ninth consecutive month, falling 0.4% in April, led by industrial supplies and materials prices. Import prices gained a downwardly revised 0.2% in March.

Another inflation data point on deck for tomorrow

The Producer Price Index will be released tomorrow and is expected to show a month-over-month increase of 0.2% in April. In March, prices dropped by an unexpectedly large 1.2% amid falling energy prices, which have since stabilized as seen by today’s reading on the import price index. The core rate, which removes food and energy, is estimated to have increased 0.1% in April after being flat in March. Year-over-year (y/y), the headline rate is projected to show a fall of 3.7%, after falling 3.5% in March. Core prices are forecast to increase 3.4% y/y, slightly slower than the 3.8% increase seen in March.

Up to now, inflationary pressures in the economy have been low, helped by falling energy and food prices. But with the drop in energy prices slowing recently and many central banks worldwide still aggressively running their printing presses in an attempt to fight off a more severe recession, the market is watching closely to make sure that inflation does not take hold. The threat of deflation is that it creates an environment where declining demand leads to falling prices, which in turn leads to still lower demand in a negative spiral that can be hard to stop once it has started. Although the Fed has recently pumped massive amounts of liquidity into the system and the money supply is increasing, at the same time the money multiplier has plunged as a result of reduced lending, making the risk of inflation at this time low.

Also scheduled to be released tomorrow are weekly initial jobless claims, and continuing claims, with both forecast to have risen. Jobless claims are expected to have risen to 610,000 from 601, 000. Similarly, continuing claims are projected to have risen from 6,351,000 to 6,400,000.