Evening Update

Economic and Deficit Worries Knock Stocks

Stocks fell today, after the ISM Non-Manufacturing Index and factory orders reports failed to provide enough fuel to sustain the high expectations about the rate of economic recovery. Also, the MBA Mortgage Applications Index had a steep falloff in the rate of refinancing and new purchase activity, due in part to a rise in the average 30-year fixed mortgage rate. As if to confirm the move in Treasury yields in recent weeks, Fed Chair Bernanke said that while rising rates reflect optimism about an economic recovery, long-term government deficits threaten financial stability. In concert with the hit to optimism today, the U.S. dollar and Treasuries rose in a flight to safety, knocking down commodities and related stocks, which were the day’s losers to the downside. In equity news, two homebuilders – Toll Brothers and Hovnanian – reported larger–than-expected quarterly losses, Aetna lowered its full-year outlook, Williams-Sonoma beat the Street’s earnings expectations, oil refiner Valero predicted a 2Q loss and announced a capital raising, NetApp sweetened its take-over bid for Data Domain, and TiVo garnered a positive patent ruling award. In other economic news today, the May ADP employment report showed continued job losses.

The Dow Jones Industrial Average fell 65 points (0.7%) to close at 8,676, the S&P 500 Index lost 13 points (1.4%) to 932, and the Nasdaq Composite declined 11 points (0.6%) to 1,826. In average volume, 1.3 billion shares were traded on the NYSE, and 2.3 billion shares were traded on the Nasdaq. Crude oil fell $2.43 to $66.12 per barrel, wholesale gasoline lost $0.02 to $1.90 per gallon, and gold declined $19.40 to $962.45 per ounce.

Toll Brothers (TOL $18) announced a loss in 2Q of $0.52 per share as revenues fell by more than 50%. This loss is slightly better than the $0.59 per share loss suffered in 2Q last year, but analysts had been expecting a greater improvement and a loss of just $0.50. Management noted that there are signs buyers are re-entering the new home market, although they declined to give any guidance for the rest of the year and cautioned that the uncertain job market and shaky economy continue to impact buyer sentiment in the homebuilder industry. The company noted that while existing distressed home sales dominate purchase data, there are local markets where foreclosures are limited and available supply is less abundant. TOL shares were under moderate pressure.

Fellow homebuilder Hovnanian Enterprises(HOV $3) reported its 11th straight quarterly loss, losing $1.50 per share in 2Q. This was wider than the loss of $1.26 per share that had been expected. Sales were down by nearly half to $398 million. HOV was lower today.

Managed care company Aetna (AET $26) has announced that higher-than-expected commercial medical costs and lower revenue from Medicare are dragging on its business, forcing it to cut its earnings guidance for 2009. The new guidance is $3.55-$3.70 per share, down from $3.85-3.95. Analysts surveyed by Reuters had been forecasting a profit of $3.80 per share. AET traded down nearly 5% on this news.

Williams-Sonoma(WSM $14) lost $0.18 per share in the first quarter, better than the loss of $0.21 per share that had been expected. Revenues fell 22% to $612 million, with same-store sales down 21%. CEO Howard Lester noted he is “continuing to gain confidence” in the company’s ability to meet its sales guidance that was given at the beginning of the year, although as the industry reduces inventory levels, promotional pricing pressure is a risk. The stock fell nearly 10%.

Valero (VLO $18) shares fell sharply after the oil refiner predicted a loss of approximately $0.50 per share in the second quarter as results have been impacted by downtime at two of its refineries, lower diesel margins, and sour crude oil discounts. Valero also announced that it will offer 40 million shares of common stock in an attempt to boost capital after recently purchasing a stake in a Netherlands-based refiner for $600 million.

NetApp (NTAP $19) sweetened its offer to acquire Data Domain(DDUP $33). The move was prompted by yesterday’s counter offer coming from EMC Corp(EMC $12). The two bids are now both at $30 per share, although NetApp management noted that “the complementary nature of the Data Domain and NetApp product lines will result in higher aggregate growth compared to the redundancies that would result with the EMC product line.” Neither DDUP nor EMC responded to the announcement. Shares of NTAP and EMC were lower, while DDUP shares were higher.

Shares of TiVo Inc (TIVO $11) surged over 50% today, after a judge ordered satellite service provider Dish Network Corp (DISH $16) and related company Echostar (SATS $16) to pay $103 million in addition to the $105 million already paid to TiVo in a patent infringement suit, and ordered the companies to cease selling the service. Dish lost a patent infringement case initially filed by TiVo in 2004, and had modified its software while the case was appealed, but the judge determined the company still infringed. Analysts note that the move could allow TIVO to negotiate license agreements, and could receive additional payments in the form of damages. Dish and Echostar have said they plan to appeal the ruling. Shares of DISH and SATS were lower.

Services economy still contracting, more jobs lost, Bernanke warns on rising fiscal deficits

Federal Reserve Chairman Ben Bernanke spoke to the House Budget Committee today on the current economic and financial conditions. Addressing concerns regarding rising Treasury rates, he stated that “in recent weeks, yields on longer-term Treasury securities and fixed-rate mortgages have risen” due to concerns about large federal deficits, although Bernanke noted that other factors such as greater optimism about the economic outlook are also at play. However, Bernanke noted that “Unless we demonstrate a strong commitment to fiscal sustainability in the longer term, we will have neither financial stability nor healthy economic growth.” During the Q&A session, Bernanke said that either cuts in spending or increases in taxes will be necessary, and that the Fed will not monetize, or buy the debt, from the U.S. government. He said that even after completing the $300 billion Treasury purchase, “we will still hold less Treasuries, a smaller volume of Treasuries, than before the crisis began.” He concluded by saying “we need to begin now to plan how we’re going to get the fiscal situation into a balance in the medium term.”

The ISM Non-Manufacturing Index (chart) for May rose to 44.0 from 43.7 in April, smaller than the 45.0 expected by economists. The separation point between contraction and expansion is a reading of 50. The index for new orders unexpectedly fell to 44.4 from 47.0. Employment improved to 39.0 from 37.0, demonstrating a smaller rate of contraction in employment. Prices paid moved to 46.9 from 40.0, indicating a slower rate of price declines during the month, following a similar path to the ISM Manufacturing Index prices component, which rose to 43.5 from 32.0. The report complements the 42.8 overall reading on the ISM Manufacturing Index released on Monday, which showed manufacturing continues to decline, but the pace of decline has slowed. While manufacturing continues to decline, the level of the ISM Manufacturing Index is consistent with growth in the overall economy, the first time in seven months, and while non-manufacturing orders fell, manufacturing orders improved to 51.1 in May, now at a level indicating growth, after 17 months of contraction. Treasuries were higher. The yield on the 2-year note lost 4 bps to 0.91%, the yield on the 10-year note declined 7 bps to 3.54%, and the yield on the 30-year bond fell 4 bps to 4.44%.

The ADP Employment Change Report was released today, showing that large private sector employers shed 532,000 jobs in May, more than the 525,000 that economists had expected. At the same time, April’s figure was revised from the previously-reported 491,000 jobs lost to 545,000. This report has gained in market importance, as another read on the employment situation, despite somewhat volatile results that have not been a particularly accurate predictor on the labor report, due out Friday.

The US MBA Mortgage Application Index fell 16.1% for the week ended May 29. This follows a drop of 14.2% for the prior week, in an index that can be quite volatile on a week-to-week basis. The Refinance Index plummeted 24%, while the Purchase Index fell 4%. The Mortgage Bankers Association (MBA) said the average 30-year mortgage rate increased to 5.25%, a significant jump from last week’s 4.81% rate. This is the highest level for mortgage interest rates since January, after the record low of 4.61% was reached at the end of March.

Also released today was a factory orders (chart) report showing an improvement to 0.7% in April, smaller than the expectation of a 0.9% rise. Also, March’s reading was revised significantly lower, to -1.9% from an initially reported drop of 0.9%.

Tomorrow’s economic calendar includes the final reading on 1Q nonfarm productivity, expected to rise 1.2% and 1Q unit labor costs forecasted to have increased 2.9%. Weekly initial jobless claims are expected to be 620,000, down from the prior week’s reading of 623,000. In equity news, monthly same-store sales will be reported by retailers.