Evening Update

Bulls Find Energy and Yield Relief

Stocks were met with early sluggishness as traders grappled with sharp downward revisions to March durable goods orders, another surge in continuing jobless claims and a disappointing new home sales report. But a good auction in the bond market pressured yields, which have moved to uneasily high levels, providing some relative relief to fears that increasing yields may hamper a recovery in the equity markets, and stocks finished solidly higher. Commodity-related issues also gained ground to help the advance, led by strength in energy shares after a much larger-than-expected drop in crude oil stockpiles. Equity news was dominated by the auto sector as Visteon – Ford’s largest auto parts supplier – has filed for bankruptcy, while General Motors gained bondholder support for a sweetened debt-for-equity swap. In other equity news, Costco reported a drop in its quarterly sales and profits, Proctor & Gamble gave guidance for 2010 that was below analyst expectations, and Heinz reported in-line earnings but gave a disappointing outlook. Treasuries were higher after the good auction in $26 billion 7-year notes.

The Dow Jones Industrial Average rose 104 points (1.3%) to close at 8,404, the S&P 500 Index advanced 14 points (1.5%) to 907, and the Nasdaq Composite gained 21 points (1.2%) to 1,752. In moderate volume, 1.4 billion shares were traded on the NYSE, and 2.2 billion shares were traded on the Nasdaq. Crude oil rose $1.39 to $64.84 per barrel, wholesale gasoline increased $0.02 to $1.91 per gallon, and gold advanced $8.73 to $958.62 per ounce.

Visteon (VSTN $0.07), the US auto parts supplier that was once a part of Ford (F $6), has filed for Chapter 11 bankruptcy protection, adding to recent fears over what an unsupported liquidation of one of the industry’s large auto makers could mean for the rest of the industry. The Chapter 11 filing yesterday listed $4.6 billion in assets and $5.3 billion in liabilities. Visteon has not reported an annual profit since 2000, the year it was spun off from Ford, while the firm lost $328 million in the fourth quarter.

Elsewhere, General Motors(GM $1) has convinced a group of its bondholders to accept a sweetened debt-for-equity deal. A regulatory filing showed this arrangement through which the firm’s $27 billion in unsecured debt would be exchanged for an initial 10% equity stake in a reorganized GM, along with warrants granting the option to buy 15% more of the company once it hits certain market cap levels. An ad hoc committee of GM bondholders released a statement on their website today stating that they support the deal. Bondholders have until 5 p.m. ET on Saturday to indicate that they would oppose the deal and the Treasury has not yet said what level of acceptance the deal needs from bondholders for the plan to be approved. A senior Obama administration, speaking on the condition of anonymity, said the government expects at least 35% of bondholders to accept the new offer, according to Reuters. The official estimated that any GM bankruptcy would take at least 60 to 90 days and perhaps longer, and said that potential new aid to GM could total $40 billion, including $9 billion from Canada. Shares of GM gave up early gains and were lower.

Additionally, talks overseas hit a snag between German government officials regarding providing GM's European subsidiary, Opel, with a bridge loan in the event GM files for bankruptcy to help it try to find a buyer, shielding it from the damaging impact of a bankruptcy filing by its US parent.

Costco Wholesale Corp (COST $48) announced 3Q earnings of $209.6 million, or $0.48 per share, a drop of 29% relative to last year. Analysts polled by Reuters had been expecting a profit of $0.53 per share for 3Q. Management cautioned that these results included $34 million on a pretax basis in mostly non-cash charges related to a lawsuit settlement over membership renewal policy. Sales were down 5% to $15.8 billion as same-store-sales fell 7%. Costco CFO Richard Galanti commented that results were hampered by “ongoing weakness in sales, particularly sales of higher-ticket, discretionary items.” COST was lower.

Proctor & Gamble (PG $53) estimated its 2010 sales growth would be between positive 1% and negative 2%, while EPS will be in a range of $3.65-3.80, representing earnings growth of 0-4%. That is below the average analyst estimate of $3.91 per share earnings in 2010. Shares were higher in choppy action.

H.J. Heinz (HNZ $36) 4Q EPS fell 10% to $0.55, which was in line with analyst predictions. Revenues fell 6% to $2.5 billion, with adverse currency moves attributing for much of the weakness. On an organic basis, sales actually grew 5% during the quarter. For 2010, Heinz announced that it expects EPS to be in a range of $2.60-2.70, below the $2.90 that analysts had forecast. Shares finished modestly lower.

Disappointing new home sales report overshadows positive durable goods orders

Durable goods orders (chart) increased 1.9% in April, much better than the expected improvement of just 0.5% month-over month (m/m). However, March data was revised significantly lower, from a previously announced decline of 0.8% to a 2.1% drop. Ex-transportation, orders were also better than expected – rising 0.8% compared to a forecasted decline of 0.3%. March data was negatively revised from a fall of 0.6% to a 2.7% plunge. Nondefense capital goods orders ex-aircraft, considered a good indicator of business spending, fell 1.5%, on top of falling 1.4% in March. Rising defense orders offset declines in business equipment. The monthly orders data have been very volatile, making it difficult to draw a conclusion on a trend.

With capacity utilization at record lows, hitting 69.1% in April, manufacturers have cut orders for machinery, while businesses and consumers have delayed purchases of computers and appliances, as these investment are highly discretionary and may require access to capital to finance. Inventories fell another 0.8%, following a 1.7% drop in March, and have fallen for four consecutive months.

New home sales (chart) rose 0.3% for April month-over-month (m/m) to an annual rate of 352,000 units, smaller than the 1.1% gain expected by economists. March sales were revised significantly lower, to a drop of 3.0%, from the fall of 0.6% initially reported. The median price of a new home fell 15% year-over-year, to $209,700, but rose 3.7% m/m, in typical seasonal fashion. Inventory of new homes for sale fell to 297,000, comprising 10.1 months worth of sales, higher than the 5 to 6 months that is considered a stable market. New home sales have struggled to compete with the steep discounts afforded by foreclosures. In response, homebuilders have significantly cut back on new housing starts, allowing inventory levels of new homes to fall.

A quarterly release by the Mortgage Bankers Association today showed that the combined percentage of loans in foreclosure and at least one payment past due, or non-current loans, was 12.1% non-seasonally adjusted in 1Q, the highest in the history of survey, which dates back to 1972. Delinquencies on mortgage loans were 9.1% seasonally adjusted, and foreclosures were 3.9%. The pace of foreclosures has picked up now that foreclosure moratoriums and legislative mandated delays have ended. In a shift, prime mortgages now represent the largest share of new foreclosures, reflecting the impact of rising unemployment. Four states, CA, FL, AZ and NV, continue to drive the figures, accounting for 46% of foreclosure starts.

Elsewhere, weekly initial jobless claims (chart) fell by 13,000 to 623,000, versus last week's figure that was upwardly revised by 5,000 to 636,000. The Bloomberg consensus called for claims to reach 628,000. The four-week moving average fell by 3,000 to 626,750, and continuing claims surged again to another record, rising 110,000 to 6,788,000, versus the forecast of 6,745,000.

Crude oil prices moved higher in after the US Energy Information Administration released its weekly inventory report, which showed stockpiles dropped much more than expected, falling 5.4 million barrels versus the forecast that called for a 700,000 barrel decline. In related news, the Organization of the Petroleum Exporting Countries (OPEC) left its crude oil output unchanged at 24.85 million barrels per day. OPEC's decision was widely expected.

Treasuries finished higher, with the majority of gains coming on the mid-to-long end of the curve after a good auction of $26 billion in 7-year Treasury notes, which helped the yield on the 10-year note come off of 3.71%—a new high for the year that it posted following yesterday's sharp sell off after a 5-year auction that also showed solid demand. Equities took their cue from the bond market, rallying as a result of the pullback in yields, which have moved higher recently and stoked concerns that the elevated yields may hamper a recovery in the equity markets. The yield on the 2-year note lost 1 bp to 0.97%, the yield on the 10-year note fell 10 bps to 3.64%, and the yield on the 30-year bond dropped 13 bps to 4.50%.

Another look at 1Q output on tap

A revised reading on the nation’s economic output will be released tomorrow, with economists expecting 1Q GDP growth to be revised up to -5.5% quarter-on-quarter (q/q) from the -6.1% that was originally reported. Although this still represents a significant contraction in the economy, it is slightly better than the 6.3% annualized decline suffered in 4Q. At the same time, Personal consumption is expected to be downwardly revised slightly from 2.2% to 2.0%, while the GDP Price Index and Core PCE Index are expected to remain in line with previously reported figures.

In spite of the sharp drop in GDP, investors are taking some solace in recent readings on the economy as two factors weighing heavily on first quarter output – falling inventory and reduced government spending – are likely to improve in coming quarters. As Schwab's Liz Ann Sonders discusses in her article Characteristics of Economic Recovery, the recession may in fact already be coming to an end, although the process is likely to be bumpy. Record-lean inventory levels suggest an imminent ramping-up of production and the impact of many of the announced government stimulus measures is still to come, although the effects of consumers paying down debt and saving more will likely keep a lid on economic growth and could even result in a W-shaped cycle (a "double-dip").

The Chicago Purchasing Manager Index for May and the final read on the University of Michigan's Consumer Sentiment Index for May, will also grace tomorrow's economic calendar.