Morning Update

Stocks Down as Tarp Repayment Gets Harder

Stocks are lower in early action after a report that several of the nation's banks will find it harder than initially thought to repay the TARP funds they had borrowed. JPMorgan Chase, American Express, and Morgan Stanley were mentioned in the report as banks that will need to raise more capital than was originally reported if they want to repay the government funds this year. Goldman Sachs was named as a firm with adequate capital already. In other equity news, managed care company Aetna lowered its full-year guidance, while two homebuilders, Toll Brothers and Hovnanian, both reported a greater-than-expected loss. Treasuries are mixed after mortgage applications fell 16% and May's ADP employment report showed companies cut more than half a million jobs during the month. Later today, Fed Chairman Ben Bernanke is set to address the House Budget Committee and investors will be watching closely for any clues that the Chairman thinks the recession is easing. Overseas, markets were mixed with Asia mostly higher but Europe under pressure.

As of 8:49 a.m. ET, the June S&P 500 Index Globex futures contract is 6 points below fair value, the Nasdaq 100 Index is 5 points below fair value, and the DJIA is 45 points below fair value. Crude oil is down $0.57 at $67.98 per barrel, and gold is down $4.87 at $976.99 per ounce.

Bloomberg is reporting that the Federal Reserve has surprised the nation's banks, many of whom thought they were well on their way to fulfilling requirements to repay the government funds they had borrowed, by making the requirements more rigorous. Citing an unnamed source, the report asserts that JPMorgan Chase (JPM $35) and American Express (AXP $25 ¹) were told they need to boost common equity, just a few weeks after being told by the government that they had enough capital to withstand a deeper recession. Also being told to raise additional capital was Morgan Stanley (MS $30), who was already in the process of repairing the capital hole found in the government stress tests. Goldman Sachs (GS $143) was mentioned in the report as a firm not needing additional funds. None of the firms has yet commented on the report.

Managed care company Aetna (AET $27) 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.

Toll Brothers (TOL $20) 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.

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 that had been expected. Sales were down by nearly half to $398 million.

Mortgage applications drop, more jobs lost

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.

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 drop in mortgage applications and continued job losses are in line with what Schwab's Chief Investment Strategist Liz Ann Sonders, and Director of Market and Sector Analysis, Brad Sorensen, CFA, have mentioned for some time in their latest Schwab Market Perspective: Not the Time for Summer Complacency. The road to recovery is paved, but potholes remain. Many economic indicators are showing that activity is declining at a slower rate, and in some cases even improving, an essential first step in a potential recovery. This does not mean that investors should become complacent, however, as the aftermath of the great debt experiment of the past quarter-century and the resultant necessity of private sector deleveraging will be with us for some time. This could keep a lid on economic growth even in recovery. To learn more, please visit www.schwab.com/marketinsight.

The ISM Non-Manufacturing Index for May will be reported at 10:00 a.m. ET and is expected to rise to 45.0 from 43.7 in April. The separation point between contraction and expansion is a reading of 50. This report is expected to complement the 42.8 reading on the ISM Manufacturing Index, which was released on Monday and showed manufacturing continues to decline, but the pace of decline has slowed.

Also on tap for today is a report on factory orders, expected out at 10:00 ET.

European GDP as expected, shares sag

Europe is lower in afternoon trading after today's GDP report confirmed an earlier reading on the eurozone region's output. GDP contracted at 2.5% from last quarter and 4.6% from the same period a year ago, in line with analyst expectations. Meanwhile, household consumption continued to fall, dropping 0.5% from the level of the fourth quarter. This was slightly worse than had been previously reported and was also worse than economists had predicted. Equity news is also weighing on trading, with Bouygues (BOUYF $44), the French road builder and mobile phone operator, down after its profit fell 29%. Amlin (APLCF $5), the British insurer, is also down after announcing intentions to purchase Fortis Corporate Insurance for approximately $500 million in an attempt to expand in Europe. Amlin will need to raise around 80 million pounds ($133 million) to finance the deal.

Australian GDP lifts Asia

Investors in Asia were greeted with a surprising report showing that GDP in Australia rose 0.4% year-over-year in the first quarter, compared to the contraction of 0.4% that had been expected by economists surveyed by Bloomberg. This surprising announcement sent Australia's S&P/ASX 200 Index up over 1.5%, with financial and technology stocks particularly strong. The Australia GDP report combined with a better-than-expected housing report in the US yesterday to aid positive sentiment throughout the region. Elsewhere, South Korea's KOSPI Index managed a gain of 0.1% in spite of pressure on KB Financial Group (KB $35) and Woori Finance Holdings (WF $28). The two Seoul-based banks announced that they are exploring plans to raise capital, concerning existing stockholders that they may see their shares diluted. Japan's TOPIX Index gained 0.1% on the back of positive sentiment from Mitsubishi Heavy Industries (MHVYF $4) after Japan's largest heavy machinery maker announced that it expects to boost revenues from its nuclear and clean-energy businesses by approximately 50% by 2012.