Evening Update

Lack of Confidence Leads to Weak Trading

Stocks were under pressure today, leading to the fourth-straight down week for stocks as investors fear the economy may not be recovering as rapidly as originally thought. A larger-than-expected drop in consumer confidence, combined with a profit warning from Dow member Chevron were the main factors weighing on sentiment today. Meanwhile, energy stocks remained one of the weakest portions of the market as crude oil continued its sharp sell-off that has seen prices fall from over $70 per barrel to below $60 per barrel in the span of just two weeks. Treasuries were higher on the general risk-aversion trading and after it was reported that import prices jumped and the nation’s trade deficit unexpectedly fell. In other equity news, General Motors has officially emerged from bankruptcy, completing the process much sooner than had been expected, and Shaw Group’s earnings report fell short of analyst projections.

The Dow Jones Industrial Average fell 37 points (0.5%) to close at 8,147, the S&P 500 Index lost 4 points (0.4%) to 879, while the Nasdaq Composite rose 3 points (0.2%) to 1,756. In light volume, 922 million shares were traded on the NYSE, and 1.7 billion shares were traded on the Nasdaq. Crude oil fell $0.52 to $59.89 per barrel, wholesale gasoline lost $0.01 to $1.65 per gallon, and gold gained $0.25 to $912.60 per ounce. For the week, the DJIA slipped 1.6%, the S&P 500 Index slumped 1.9%, and the Nasdaq Composite sagged 2.3%.

Chevron (CVX $61) suffered moderate losses after the company said its 2Q refining results are expected to be "significantly lower than the first quarter." CVX reported that US refining margins were down sharply and although its 2Q exploration and production earnings are expected to benefit from an increase in crude oil prices, it will be largely offset by "substantial unfavorable foreign currency effects” stemming from a weaker dollar. The nation’s second-largest energy producer reported that the falling dollar reduced its profit by almost $7 million per day during April and May, more than double the impact of currency movements during 2Q 2008.

General Motors (GMGMQ $1) announced that it has emerged from bankruptcy, completing the process in just 39 days, which was three days faster than rival Chrysler’s proceedings, and three weeks earlier than expected. GM signed a deal today to sell key assets to a newly formed company which will be 61% owned by the US government, with the rest being owned by the Canadian and Ontario governments, GM union workers, and bondholders of the old GM. . The new General Motors Company will have just four brands—Chevrolet, Cadillac, Buick and GMC—as Pontiac is being dropped, and Hummer, Saturn, and Saab are being sold. An emphasis will be placed on fewer vehicle models, and the dealership network in the US will be consolidated, from 6,000 to 3,600 by the end of next year. In a press conference, GM's CEO Fritz Henderson pledged to repay loans to the US government "much sooner" than the 2015 deadline, while noting that the company expects to “take the company public again as soon as practical, starting next year.“

Shaw Group (SGR $24) reported fiscal 3Q EPS ex-items of $0.57, three cents short of the Reuters estimate, as revenues were flat versus last year at $1.8 billion. The power plant builder said, while its performance was relatively strong across most segments, it is disappointed with two underperforming projects that impacted results of its fossil and nuclear segment. SGR lowered its full-year profit forecast, which came in below the Street's forecast. Shares were down almost 10%.

Treasury Secretary Tim Geithner testified before two congressional panels that will play a role in writing regulatory legislation on derivatives today. Geithner laid out a proposal that would place large dealers such as JPMorgan Chase (JPM $32) and Goldman Sachs (GS $142) under much stricter supervision than they previously faced. "We propose to require all OTC (over-the-counter) derivatives dealers ... to be subject to substantial supervision and regulation, including conservative capital requirements, conservative margin requirements and strong business conduct standards," Geithner said. This is the latest step in a process that the Obama administration hopes will bring about the most sweeping overhaul of the US financial regulatory system since the Great Depression. Four large banks, including Citigroup (C$3) and Bank of America (BAC $12 ¹) in addition to JPM and GS, control more than 90% of the derivatives market. Shares of all four banks were down today.

Consumer sentiment drops, import prices jump, trade gap unexpectedly narrows

The preliminary University of Michigan's Consumer Sentiment Index (chart) dropped much more than expected, falling from 70.8 in June to 64.6 in July, versus the Bloomberg forecast, which called for a slight decline to just 70.0. The index is now back to the lowest level since March—when the equity markets posted their lows of the recession. The University of Michigan said in a statement that consumers concluded that the economic downturn would last longer and their personal finances would not recover as quickly as they had previously expected. Survey results showed consumer expectations for six months from now fell sharply, plunging from 69.2 to 60.9, marking the largest drop since last October.

The report exemplifies the recently resurfaced concern on the Street that has pared gains from the mid-March rally in equity markets. As Schwab’s Chief Investment Strategist Liz Ann Sonders, and Director of Sector and Market Analysis, Brad Sorensen, CFA, note in their bi-weekly Schwab Market Perspective, consumers constitute 70% of our nation’s economy and weakness in the consumer sector could be a significant hurdle to rapid economic growth. Stocks rebounded on the potential for the first leg up of the economy, and investors are now looking for actual signs of growth to push the market higher.

Treasuries added to gains following the report as risk-taking in the market was put on hold. The yield on the 2-year note fell 3 bps to 0.89%, the yield on the 10-year note dropped 11 bps to 3.29%, and the yield on the 30-year bond gave back 11 bps to 4.19%.

The Import Price Index (chart) rose 3.2% in June, well above the expected increase of 2.0% of economists surveyed by Bloomberg. Import prices increased an upwardly revised 1.4% in May. Year-over-year, import prices are down 17.4%. Imported petroleum prices jumped 20.3% in June to contribute to the lion's share of the rise in import prices, while non-petroleum import prices rose 0.2% in June.

The trade deficit (chart) was also released this morning, and unexpectedly narrowed to $26.0 billion in May, versus the Bloomberg estimate that called for the gap to increase to $30.0 billion. At the same time, April's deficit of $29.2 billion was revised to a smaller gap of $28.8 billion. Imports have now plunged for a 10th-straight month, and exports posted a small gain. As a result, the US trade deficit now sits at the lowest level since November 1999.

Given that the trade deficit forms part of the GDP calculation, today’s better-than-expected reading means the 2Q GDP figure could come in better than economists had been expecting. The average forecast of 72 economists surveyed by Bloomberg is for a 2% quarter-over-quarter contraction in US GDP in 2Q, which would be a marked improvement from the -5.5% reading in 1Q, and the 6.3% drop in 4Q 2008. Leading economic indicators have now improved for two consecutive months – the best two-month improvement since November/December 2001, which was just after the last recession ended in October 2001. This indicator has had a strong track record in identifying the end of other previous recessions as well.

Economic optimism hits wall to keep bulls in the stall

With corporate and economic data relatively light this week, the Street had little tangible news to act on, leaving uncertainty as a main ingredient for sentiment. Unfortunately, uncertainty has not proven to be friendly to the bulls and this week they paid the price. The major equity markets finished in the red as traders continued to grapple with growing concerns that the rally in equities since mid-March may have blinded the Street from seeing the true health of the global economy. Mixed reported data did not help lift the blindfold from the bulls' eyes and only fueled the unfriendly uncertainty. Dow member Alcoa (AA $9) unofficially kicked off 2Q earnings season and posted a smaller-than-expected loss and revenue that topped analysts' expectations. But growing rhetoric on the Street suggesting the possible need for a second stimulus package to ward off a "double-dip" recession sapped any enthusiasm that may have been stirred up by Alcoa's report. The mixed picture that stymied stocks this week may have been best illustrated by murky same-store sales reports from the nation's retailers, which saw Target (TGT $38) miss expectations but offer upbeat comments on 2Q EPS. Moreover, weekly initial jobless claims finally dipped below the 600,000 level, only to be discounted by seasonal factors and an accompanying jump in continuing jobless claims, which posted another record high above 6.8 million. The Street was left looking for signs suggesting where the economy stands but that won’t be the case next week as a jammed-packed economic calendar will be joined be a plethora of major earnings reports.

Next week's earnings calendar has the potential to grab the lion's share of attention and steer the direction of the markets. Financials will be in focus as Goldman Sachs (GS $142) and Dow member JPMorgan Chase (JPM $32) are set to headline several reports in the sector. Technology will also be in focus with Dow members IBM (IBM $101) and Intel (INTC $16), as well as Google (GOOG $415) on the docket for next week. Traders may be looking for signs in the banking sector on the group's capital strength after the government's stress tests of the industry, how lending activity—the lifeblood of the economy—is being affected by interest rate movements, and any comments regarding the credit card business, which may be the next hurdle for the group to scale. In the technology sector, comments about demand will likely be at the forefront of the Street's mind as it may signal the health of business spending, potentially helping clear up the uncertainty surrounding the sustainability of the global economic recovery.

Next week’s economic calendar will bring investors much to consider

A full economic calendar awaits investors next week, starting with Tuesday’s release of the Producer Price Index, an important measure of inflation at the wholesale level. The index is expected to show prices increased 0.9% month-over-month in June. Meanwhile, the core rate, which excludes food and energy, is estimated to have increased 0.1%, which would indicate that outside of volatile energy prices, pricing pressure in the economy remains low.

Then on Wednesday, the other major inflation reading – the Consumer Price Index – will be announced. It is expected that prices at the consumer level rose 0.6% in June, after rising just 0.1% in May. Similarly, when excluding food and energy, it is expected that consumer prices rose just 0.1%. Future inflation expectations remain anchored below 2%. Given the nearly perfect inverse correlation historically between inflation rates and stock market valuation, continued low and stable inflation would be a positive development for stocks.

Later in the week, industrial production data will be released, and is forecasted to have fallen 0.6% in June, after dropping 1.1% in May. That is expected to push capacity utilization to another record low level of 67.8%. This is what the Fed referred to in its last policy meeting when it said "substantial resource slack is likely to dampen cost pressures,” clearing the way for a continued easy money policy from the Fed.

The advance retail sales report will also draw investor attention next week. Ex-autos, sales are expected to have increased 0.5%, which would be inline with the May level. Although recent data shows retail sales may be stabilizing at a low level, consumer spending over the next several years will likely be lower than we’ve seen the past decade. Consumers have begun changing their behavior though, as seen by the consumer savings rate, which was almost 0% just a year ago and has since risen to the highest level in over a decade. Although we continue to be of the view that the recession is likely ending, and may already be over, the economy is unlikely to return to rapid growth before the consumer sector has healed.

Housing starts and building permits will be announced on Friday to round out the week. Housing starts are expected to show builders broke ground at an annualized rate of 530,000 homes in June, inline with the May level, while building permits are expected to have increased 1.4% to an annual rate of 525,000. The numbers have been unpredictable in recent months due to erratic changes in weather and the volatile multi-family home market. However, when focusing on single-family homes, it becomes clear that home sales are starting to stabilize at a low level. Prices will likely continue to fall though, because of the elevated inventory of existing homes available for sale, combined with the aforementioned pressures weighing on American consumers. Foreclosed homes typically sell for 20% less than normal market prices, which is contributing to home affordability at a 40-year high and helping to continue to push prices down.

Other releases on next week’s calendar include the Empire Manufacturing Index, the National Association of Home Builders Index of builder confidence, the Philadelphia Fed’s Business Activity Index, MBA Mortgage Applications, initial jobless claims, and the June 24 FOMC meeting minutes will be released.