Evening Update

Markets Can’t Hold Early Gains

A variety of economic data points came in better than expected today but stocks were unable to sustain early gains. Stocks sold off this morning after it was confirmed that several major US insurance companies will receive government aid from TARP funds, and markets never recovered. Also weighing on sentiment, FDIC Chairman Sheila Bair revealed that some bank CEOs will likely be replaced, triggering a sell off in the financial sector as investors considered the potential for more government involvement in that sector. In other news, GM announced dealership closings, J C Penney released an inline earnings report, fellow department store retailer Nordstrom’s earnings release beat analyst expectations, and Fed Chairman Ben Bernanke hinted that participation in the Fed’s TALF program is increasing. Treasuries were lower following the flood of data.

The Dow Jones Industrial Average dropped 62 points (0.7%) to close at 8,269, the S&P 500 Index lost 10 points (1.1%) to 883, and the Nasdaq Composite fell 9 points (0.5%) to 1,680. In moderate volume, 1.2 billion shares were traded on the NYSE, and 2.0 billion shares were traded on the Nasdaq. Crude oil decreased $2.28 to $56.34 per barrel, wholesale gasoline decreased $0.04 to $1.68 per gallon, and gold rose $5.70 to $932.20 per ounce. For the week, the DJIA fell 3.6%, the S&P 500 Index lost 5.0%, and the Nasdaq Composite slipped 3.4%.

The US Treasury Department is planning to inject up to $22 billion into insurance companies from its Troubled Asset Relief Program (TARP). A Treasury spokesman said Hartford Financial Group (HIG $15 ¹), Prudential Financial (PRU $39 ¹), Principal Financial Group(PFG $19), Lincoln National(LNC $16), Allstate (ALL $25), and Ameriprise Financial (AMP $25) have all applied for, and been granted, access to emergency taxpayer funding. Insurance companies own 18% of all corporate bonds so supporting them is consistent with the program’s goal of restoring struggling credit markets. To be eligible for the program, insurers had to also be a savings bank, prompting Lincoln National and Hartford to recently buy small banks in order to qualify – following the lead of firms as diverse as GMAC LLC, American Express (AXP $24), Morgan Stanley (MS $26), and Goldman Sachs (GS $134) that have all transformed themselves into bank holding companies since the financial crisis began last fall.

Hartford announced that it had won preliminary approval for $3.4 billion in TARP funds while Lincoln National said it may receive $2.5 billion. Allstate, and Principal Financial Group both confirmed that they have qualified for the program without stating a dollar amount they expect to receive. Meanwhile, Ameriprise announced it will turn down the government’s offer, stating: “While we appreciate Treasury’s approval of our application, we have elected not to accept funding”. Prudential is still undecided if it will participate, releasing a statement saying it is considering “all options.” Shares of the insurers were mixed following the announcement.

Bloomberg is reporting that the government plans to replace some bank CEOs that were part of the recent US Government Bank Stress Tests, quoting FDIC Chairman Sheila Bair. Bair was speaking today in an interview for Bloomberg’s “Political Capital with Al Hunt” program, which will air this weekend. Responding to a question about whether any managers would be replaced, Bair responded: “There will be an evaluation process. We’re requesting it as part of the capital plan. And yes.” The Obama administration has already asked GM’s former CEO Rick Wagoner to step down in March after the company failed to come up with a satisfactory restructuring plan. The CEOs at AIG (AIG $2), Fannie Mae (FNM $1), and Freddie Mac (FRE $1 ¹) have all already been replaced after being taken over by the government.

Meanwhile, Federal Reserve Chairman Ben Bernanke indicated that demand for the Fed’s Term Asset-Backed Securities Loan Facility (TALF) continues to increase. After what Bernanke referred to as “lower than expected” results in March and April, Bernanke remarked that “In the past several weeks, investors appear to have become more willing to participate in the program. Early indications are that demand for TALF loans in June will be even higher.” The TALF program is intended to improve conditions in the securitized lending market for consumer and business loans. Bernanke’s comments come from a May 12 letter to US Representative Keith Ellison from Minnesota. Ellison’s office published the letter today.

As the June 1st restructuring deadline approaches, Dow member General Motors (GM $1) announced that it has sent notices to 1,100 dealerships that will be closed, The terminations by GM follow Chrysler's announcement yesterday that it will terminate about 25% of its dealerships.

J C Penney (JCP $27) reported 1Q EPS of $0.11, inline with the Reuters estimate, with revenues falling 5.9% to $3.9 billion, and same-store sales down 7.5%. Looking ahead, the company expects consumer spending and mall traffic to remain weak and management issued 2Q and full-year EPS guidance below analyst expectations.

Fellow department store Nordstrom (JWN $23) reported 1Q EPS ex-items of $0.31, five cents above the Street's forecast, as revenues fell 9.2% to $1.7 billion, while same-store sales fell 13.2%. JWN also raised its full-year EPS guidance.

Treasuries fall amid flood of economic data

Treasuries were lower as the market digested several economic reports that came in mostly better than economists had been expecting. The yield on the 2-year note added 1 bp to 0.85%, the yield on the 10-year note rose 4 bps to 3.13% and the yield on the 30-year bond gained 3 bps to 4.08%.

Industrial production (chart) fell 0.5% in April, better than the estimated decline of 0.6%, and much better than the revised 1.7% drop witnessed in March. Output has fallen 12.5% from the level of last April and is now 16% below its peak in December 2007. Declines were broad based across industries, with motor vehicles and parts the only area posting gains – rising 1.4% from last quarter’s level. Capacity utilization continued to decline from March’s revised 69.4% to a still further record low of 69.1% for this series, which began in 1967, although this figure was better than the 68.8% level economists had been predicting. Manufacturing, a sub-set of the report, declined further from an already record low of 65.8% to a still lower 65.7%. Manufacturing output fell 0.3% quarter-on-quarter and is now 14.5% lower than last April.

Led by a 2.4% drop in energy prices, the Consumer Price Index (chart) was flat in March and inline with the Bloomberg forecast. The core rate, which strips out food and energy, was up 0.3%, higher than the forecast of 0.1%. Year-over-year (y/y), the headline rate fell to -0.7%, accelerating from the -0.4% in March which marked the first annual decline since August 1955. Core inflation accelerated slightly to 1.9% from 1.8% last month. Energy prices are now 25.2% lower than they were a year earlier, accounting for much of the decline in the headline rate.

The first reading on activity in the month of May, the Empire Manufacturing Index – a measure of manufacturing in New York State – improved from -14.65 to -4.55. This was much better than the estimate of -12.00. A level of zero suggests conditions are neither contracting nor expanding so this index does indicate activity is still contracting, but at a slower pace than was expected.

Preliminary University of Michigan consumer sentiment (chart) improved more than expected again, rising from 65.1 in April to 67.9 in May. This was above the forecast of an increase to 67.0. The index now sits at a level not seen since September—before the collapse of Lehman Brothers that led to November's lowest reading since 1980. In addition to the overall sentiment improvement, survey results showed consumer expectations rose as well. The report suggests consumers are becoming more optimistic amid the recent run up in financial markets.

Week in review: the rally rests

After sharply rallying off of the 12-year lows reached in March, stocks finished the week in the red as traders took a breather, looking for the next progression of the potential end to the recession in the form of data going from being "less bad" to actual signs of growth. The health of the retail sector was one of the main focal points of the equity markets, but offered mixed results as Dow member Wal-Mart (WMT $49) matched 1Q earnings expectations, April retail sales unexpectedly fell, while some major department stores posted profit reports that were mostly better-than-expected. The reports underscored continued apprehension from the consumer—which accounts for the lion's share of the economy—adding to the uncertainty regarding the sustainability of the recent momentum in the stock markets. An unexpected jump in weekly initial jobless claims added to the uneasy sentiment this week, but the data was not all bad as both wholesale and consumer inflation readings came in benign, and the increase in the trade deficit was smaller than expected, joining Friday's favorable manufacturing and consumer sentiment data.

The reprieve in the economic enthusiasm weighed on the sectors that had benefitted from the recent optimism surrounding the potential end to the global recession. Industrials, commodity-related issues, and consumer discretionary stocks were among the biggest losers as traders took the opportunity to book profits. Financials were the worst performers, falling more than 10% as several firms announced stock offerings aimed at either paying back the government TARP money or satisfying the capital requirements as a result of last week's stress tests of the banking industry.

Housing market and Fed meeting minutes will be the economic focus next week

Housing starts and building permits will be released on Tuesday, with starts in April expected to rise nearly 3.0% to an annual rate of 523,000. Building permits, the more forward-looking indicator, are expected to rise 2.7% to an annual rate of 530,000. The two data series have been somewhat volatile on a month-to-month basis, influenced by large swings in multi-family starts and weather. While March housing starts fell 10.8%, the more relevant single-family start number rose 0.6% in February and was flat in March.

The minutes from the April Federal Open Market Committee (FOMC) meeting will be released on Wednesday. There were few changes made in the statement at the April 29 meeting, with the Fed keeping rates unchanged and maintaining prior programs to purchase up to $1.25 trillion of agency mortgage-backed securities, up to $200 billion of agency debt and up to $300 billion of Treasury securities. The Committee said that while the economic outlook had improved modestly since the March meeting, they remain concerned about deflation and expect economic activity to remain weak for a time, despite an eventual gradual resumption economic growth.

The timing and amount of Treasury purchases has been under close scrutiny, and some market participants believed the “line in the sand” for purchases was 3.0% on the 10-year Treasury. However, Fed Chair Ben Bernanke later clarified the Fed’s stance, saying "We're not trying to target a particular interest rate," adding "Our objective is to provide more liquidity into the system and to help private credit markets,” and credit spreads have been declining. Bernanke also has noted that the housing market has shown some signs of bottoming. Any additional insight on the Fed’s outlook for the economy and asset purchase programs will be scrutinized by the market.

Other economic releases for the week include the National Association of Home Builders Index of builder confidence, MBA Mortgage Applications, initial jobless claims, the Philly Fed’s Business Activity Index, and the Leading Indicators Index.