Saturday Update

Markets End Week Higher, Treading Carefully Ahead of Stress Test Results

Stocks were higher yesterday and traders continue to weigh better-than-expected economic reports while treading carefully ahead of the release of the bank stress test results to the public, which have been postponed to next Thursday from Monday’s initially scheduled release. The ISM Manufacturing Index and the University of Michigan Consumer Sentiment Index for April both positively surprised, while March factory orders fell more than expected. The automakers reported mixed April vehicle sales and Citigroup sold its Japanese brokerage unit to raise capital. In earnings news, MasterCard, McAfee and Allergan beat earnings forecasts, while MetLife and Chevron missed estimates. Treasuries were lower.

The Dow Jones Industrial Average rose 44 points (0.5%) to close at 8,212, the S&P 500 Index gained 4 points (0.5%) to 878, and the Nasdaq Composite advanced 2 points (0.1%) to 1,719. In moderate volume, 1.3 billion shares were traded on the NYSE, and 2.1 billion shares were traded on the Nasdaq. Crude oil gained $2.08 to $53.20 per barrel, wholesale gasoline rose $0.05 to $1.52 per gallon, and gold lost $2.70 to $885.50 per ounce. For the week, the DJIA rose 1.7%, the S&P 500 Index gained 1.3%, and the Nasdaq Composite advanced 1.5%.

Carmakers reported April US auto sales that were mixed, with General Motors (GM $2) and Honda Motor (HMC $29) reporting sales that were not as bad as feared, and follow March’s better-than-expected sales for the industry. GM reported a 34% fall, Ford (F $6) reported a decline of 32%, and Chrysler announced a decrease of 48%. Foreign automaker Toyota Motor (TM $79) said sales fell 42% and Honda reported a decline of 25%. Shares of GM and Ford fell, while Honda and Toyota were higher.

Dow member Chevron (CVX $67) posted 1Q EPS of $0.72 excluding a gain of $0.20 per share on downstream asset sales, below the Reuters estimate of $0.81, as revenues fell 46% to $35 billion—reflecting lower prices for refined products and crude oil. The company said oil production and refinery inputs were both higher than a year ago and operating expenses came in lower, but upstream earnings declined sharply on lower prices for crude oil and natural gas. Shares were higher.

MasterCard (MA $173) reported 1Q EPS of $2.80, above analysts' forecast of $2.62, as revenues declined 2.2% to $1.2 billion. The credit card transaction processor said gross dollar and purchase volumes were up 0.3% versus last year and its "considerable cost reduction actions" allowed it to deliver a strong operating margin as it took important steps to align its operations with the challenging economic times. Management said it is too early to say that the future outlook is improving, however. Group CFO Martina Hund-Mejean was quoted as saying "When you look at what's happening in April, we're not yet seeing a stabilization. The data is mixed." MA shares fell.

Citigroup (C $3) announced that it has agreed to sell its Japanese brokerage business to Sumitomo Mitsui Financial Group (SMFJY $3) for 545 billion yen ($5.5 billion). The deal will boost Citigroup’s equity by $2 billion and comes as it and other major US banks are awaiting results from government stress tests to determine the financial strength of the sector. While selling this unit will result in an after-tax loss of approximately $200 million for Citigroup, it will free more than $2 billion in capital that was previously tied up in the business. Citigroup has already taken $45 billion in taxpayer funds through three government rescues and is trying to avoid further capital shortfalls. If the government decides to convert the Citigroup preferred shares that it already owns into common stock, existing shareholders could be diluted by as much as 74%. Shares were lower.

MetLife (MET $27) reported 1Q operating EPS of $0.20, short of the Street's expectation, which called for the company to post earnings of $0.34, as revenues fell 12% to $10.2 billion, also short of analysts' expectations. The company said it had strong premium, fees and other revenue in the challenging economic environment. But its operating earnings were negatively impacted by a decline in net investment income and lower equity markets, which pressured earnings in its annuity and variable life business. Shares were lower.

McAfee (MFE $40) announced 1Q EPS-ex items of $0.57, a growth of 31%, and above expectations for $0.48. Revenue during the quarter was $448 million, an increase of 21% compared with 1Q 2008. This marks the 13th consecutive quarter of double-digit revenue growth for MFE. Management gave an outlook for the second quarter which included earnings guidance of $0.54 to $0.58 per share, which compares favorably to the consensus estimate of $0.54 EPS for next quarter. Shares were higher.

Allergan (AGN $44) reported first quarter diluted EPS of $0.55 after adjusting for restructuring and other charges, up slightly from the $0.53 AGN reported in the first quarter last year. Analysts had been expecting flat EPS growth. Total product sales for the company were down 6% to $995 million, led by medical device sales that were down 18% and specialty pharmaceutical sales that were down 4%. Allergan, famous for medical products such as Botox, reaffirmed that the 2009 guidance it had provided in February is still achievable. Management is expecting full year profit of $2.71 per share on revenue of $4.3 billion. Shares fell.

Treasuries lower on better-than-expected economic data

Treasuries were lower. The yield on the 2-year note added 1 bp to 0.91%, the yield on the 10-year note rose 3 bps to 3.15% and the yield on the 30-year bond gained 4 bps to 4.07%.

The ISM Manufacturing Index (chart) improved to 40.1 in April from 36.3 in March, and was higher than the 38.4 forecast by a Bloomberg survey of economists. The separation point between contraction and expansion is 50, and an increasing level in the index indicates the economy is contracting at a slower pace, with April showing the fourth-straight monthly improvement. New orders improved significantly, to 47.2 from 41.2 in March, and the index is nearing the 48.8 level that is consistent with an increase in manufacturing orders. Employment increased to 34.4 from 28.1 in March and prices paid were 32.0 versus 31.0, indicating that prices continue to decline, but at a less rapid rate. The customer inventories index showed that distribution channels are paring inventories to levels now indicated as “too low,” after reporting eight consecutive months of being reported as “too high.” With the change in the customer inventory index, all components within the index are now showing an improvement in direction.

Manufacturers pared inventories by dramatically cutting back production after the economy came to a standstill in the fall. Now that inventories are at low levels, and credit markets have been somewhat unfrozen, manufacturers are slowly getting better access to capital and are starting to see an increase in confidence, and have started to move production back in line with demand.

When the crisis took another leg down following the Lehman Brothers bankruptcy last September, consumers went into hibernation and corporations began destocking inventory to align with falling sales. However, the fall was so dramatic that it simply could not be sustained and some pent-up demand built up. In 2009, consumers have benefitted from mortgage refinancing, a decrease in gasoline prices versus a year ago, and tax refunds now up 17% from 2008. While the economy is still contracting, the stock market’s move off the lows is reflecting optimism that the worst of the recession may be behind us.

Other economic data points released today include factory orders (chart), which fell 0.9% in March after rising a downwardly revised 0.7% in February. This was a sharper-than-expected fall as economists surveyed by Bloomberg were expecting a drop of 0.6%.

University of Michigan consumer sentiment (chart) data was also released, showing a reading of 65.1, well ahead of the expectation of 61.9 which would have been in-line with the March figure. This shows that US consumers now feel more confident about the economy than they have at any time since the credit crisis intensified last September.

UK flat as most European markets are closed

Due to the May Day holiday, most markets in Europe were closed, and stocks in the UK were down slightly. Financials were under pressure on uneasiness related to the US government delaying the release of its stress test results from Monday to Thursday of next week. There were also some reports from the economic front as the UK PMI Manufacturing Index rose more than expected, rising from 39.5 in March to 42.9 in April, compared to the 40.0 consensus of economists surveyed by Bloomberg. The reading still depicts contraction in manufacturing activity—as a reading above 50 signals expansion—but it suggests that the rate of contraction slowed, adding to the argument that we may be seeing the beginnings of a recovery in the global economy. However, a report from the Bank of England showed that mortgage approvals, although rising to a ten-month high, still fell short of economists' expectations.

Economic reports win battle of data calendars

With 1Q earnings season winding down, it was the economic calendar that stole the lion's share of the Street's attention as several key releases shaped the week's sentiment. Traders sounded more like groundskeepers than investors with all the chatter about the "green shoots" in the economy that may be emerging to suggest an economic recovery may be in the making. Helping spread optimism on Wall Street, even as the first reading of 1Q GDP—the preliminary and final figures are still to come—fell more than expected, a solid rise in personal consumption on a jump in durable goods orders stoked upbeat sentiment, overshadowing the disappointing output reading. The Federal Reserve also added to the favorable backdrop, after its monetary policy meeting yielded no change in its fed funds target range of 0.00-0.25%, while keeping its quantitative easing weapons—in the form of $1.75 trillion in asset purchases including $300 billion in Treasuries—aimed at the heart of the financial crisis. They also provided some relatively improved commentary, noting that its outlook "had improved modestly since the March meeting, partly reflecting some easing of financial market conditions." Other signs of roots of recovery in the economy came in the form of a much better-than-expected read on consumer confidence, a decline in weekly initial jobless claims, and the best reading of the Chicago PMI since September.

The economic data outweighed the continued flood of earnings reports, which aided the relatively improved sentiment, as the profit releases continued to promote optimism that corporate bottom lines faired better than most feared. Outside of earnings, the corporate news was highlighted by news out of the auto and financial sectors. Dow member General Motors reported that it has accelerated its restructuring and will phase out its Pontiac brand by the end of 2010 and will reduce its total number of plants in the US to 34 by the end of 2010, from 47 in 2008. Also, fellow automaker Chrysler filed for Chapter 11 bankruptcy protection after talks with the ailing privately-held firm's creditors fell through. Additionally, the financial sector was the worst performing group on fears—stoked by a Wall Street Journal report—that some of the nation's largest banks were told by US regulators that they may need more capital following the government's stress testing of the firms.

Labor report and stress test results will be next week’s highlights

The ISM Non-Manufacturing Index for April will be released Wednesday, and the expectation is a reading of 42.0, from March’s 40.8. The separation point between contraction and expansion is a reading of 50. The report will complement the 40.1 reading on the ISM Manufacturing Index released today, which showed the economy continues to decline, but the pace of decline has slowed.

Nonfarm payrolls will be released on Friday, and are expected to have fallen by 610,000 positions in April after falling 663,000 in March. The unemployment rate is expected to rise to 8.9% in April from 8.5% in March. The trends of initial jobless claims and the four-week average of initial jobless claims have been declining. Despite the improvements in initial claims, the number of people filing continuing claims continues to rise and is at a record high.

The final results of the U.S. government stress test of the 19 U.S. banks with assets greater than $100 billion will be released on Thursday, postponed from the an initial release date slated for Monday. Preliminary results were given to the banks privately on April 24, and the Fed released a white paper saying that most banks currently have capital levels well in excess of the amount required to be well capitalized. However, regulators said they believe “it is prudent for large bank holding companies to hold additional capital to provide a buffer against higher losses than generally expected, and still remain sufficiently capitalized” over the next two years and be able to lend if such losses materialize. It is unclear whether the Fed will release results on an individual or aggregate level for the banks, and buzz about the details have added volatility to markets in recent weeks.

Other releases on the economic calendar next week include construction spending, pending home sales, MBA Mortgage Applications, ADP Employment Change, initial jobless claims, consumer credit and wholesale inventories.