Evening Update

Resiliency in the Face of Profit-Report Complacency

Stocks finished well off of the worst levels of the day, reaching positive territory in late-day action after showing resiliency in the face of a profit miss from Aetna and lowered guidance from Honeywell, coupled with cautious comments from Corning and lackluster non-wireless results from Verizon. Homebuilders and financials led the afternoon recovery, posting solid gains following a much larger-than-expected increase in new home sales, and Treasuries finished lower. In other equity news, RadioShack posted disappointing sales, while Agilent Technologies announced it will acquire medical device maker Varian. Elsewhere, Fed Chairman Ben Bernanke spoke again over the weekend, telling participants in a town hall style meeting that he expects the economy to grow around 1% in the second half of the year, although that will not be enough to stop unemployment from rising.

The Dow Jones Industrial Average rose 15 points (0.2%) to close at 9,109, the S&P 500 Index advanced 3 points (0.3%) to finish at 982, and the Nasdaq Composite added 2 points (0.1%) to 1,968. In moderate volume, 1.0 billion shares were traded on the NYSE and 2.1 billion shares were traded on the Nasdaq. Crude oil added $0.24 to $68.29 per barrel, wholesale gasoline increased $0.01 to $1.90 per gallon, and gold rose $3.28 to $954.63 per ounce.

Aetna (AET $26) announced adjusted 2Q EPS of $0.68, below the Reuters forecast of $0.78. Revenues increased 11% during the quarter to $8.7 billion, slightly above the $8.6 billion analyst estimate. The health insurer also reduced its full-year outlook for the second time in two months, and is now expecting to earn between $2.75-2.90 per share in 2009, after saying in June it would earn $3.55-3.70. Analysts are expecting earnings of $3.52 for 2009. The explanation for Aetna’s earnings slide continues to be higher commercial medical costs, which it has been unable to fully pass on to consumers during the recession. "We continue to see upward pressure on medical costs beyond what we projected in early June, which we believe is driven in part by changing provider behavior in the face of a deep recession," CEO Ronald Williams said, adding that the company is in the process of adjusting its pricing accordingly. AET shares came under pressure.

Corning (GLW $17) released its 2Q earnings report, showing EPS of $0.39, which beat analyst forecasts of $0.32. The world’s biggest maker of LCD glass saw sales fall 18% to $1.4 billion, inline with analyst estimates of $1.36 billion. CEO Wendell Weeks reported that customers began to restock their LCD inventory during the quarter, and the pickup in demand has allowed Corning to restart some of its idled production. CFO James Flaws noted that he expects overall glass demand to increase in 2010 and 2011 and “we are seeing signs that the impact of the global recession on our businesses may be moderating." But he cautioned that questions pertaining to the pace of economic recovery remain and that the company does not expect the global auto industry and U.S. truck market to rebound quickly. GLW's stock traded lower.

Dow component Verizon (VZ $31) reported adjusted 2Q earnings of $0.63 per share, in line with analysts' expectations. Sales rose 11% to $26.9 billion, driven by wireless growth of 28%, although mobile revenue growth would have been just 8% if not for the recent Alltel acquisition. In Verizon’s other divisions, the mass-market landline segment – which includes home phones and small businesses – saw sales increase 0.2%, while wholesale and enterprise business revenues fell again, as those areas have been particularly hard-hit by the recession. VZ’s overall retail customer churn rate at 1.37% remains the best in the industry. Management also reported that its integration of Alltel operations remains on schedule. According to the Dow Jones Newswires, VZ's CFO said the firm will slash an additional 8,000 jobs, or about 3.4% of its work force, in the second half of the year as part of an acceleration of its previous cost cutting program. Shares were lower.

Honeywell (HON $34) earned $0.60 per share in 2Q, a 38% drop year-over-year, which matched analyst expectations, while sales tumbled 22% to $7.6 billion, slightly below the analyst target of $7.7 billion. The diversified technology and manufacturing group lowered its EPS target to $2.85 for the full-year, which is at the low end of its previous outlook but still above the $2.83 average analyst forecast. CEO Dave Cote cautioned that economic conditions “remain challenging and we are not planning for any recovery in 2009." HON shares managed to eke out a gain after overcoming early pressure.

RadioShack (RSH $15) announced 2Q EPS of $0.39, above the analyst forecast of $0.29, but sales fell 3% to $966 million, which was below analyst expectations of $982 million. Same-store sales were 4% lower during the quarter, driven by weak sales of wireless accessories, digital-to-analog converter products, GPS products, music players, and digital cameras. The company said it is still experiencing an unfavorable economic environment and that it expects sales of converter boxes to decline in the second half of the year. RSH traded solidly lower.

Agilent Technologies (A $23) traded higher after announcing it will acquire medical device maker Varian (VARI $51) for $1.5 billion. The offer price of $52 per share represents a premium of approximately 35% to Varian’s previous closing price, and the boards of both firms have unanimously approved the all cash offer. Agilent CEO Bill Sullivan called the acquisition a “major step in Agilent’s transformation into a leading bio-analytical measurement company,” adding “while we continue to be a world leader in electronic measurement, our biggest opportunities for future growth are in bio-analytical measurement.” The transaction is expected to generate $75 million in annual cost synergies and achieve Agilent’s 20% return on invested capital (ROIC) target within four to five years, although shareholders still must approve the deal.

New home sales picking up

New home sales (chart) unexpectedly jumped 11.0% in June month-over-month (m/m) to an annual rate of 384,000 units, much better than the 3.0% gain expected by economists, and May sales were revised higher, to an increase of 2.4%, from the -0.6% initially reported. The median price of a new home fell at an accelerated pace, falling 12.0% year-over-year (y/y), to $206,200, after falling 4.5% y/y in May. Inventory of new homes for sale continued to fall in June, to 281,000 units, and combined with the jump in the pace of sales during the month, it represented 8.8 months of supply at the current sales rate, down from 10.2 months worth of sales in May. New home sales fell more significantly than existing home sales, struggling to compete with the steep discounts afforded by foreclosures. In response, homebuilders significantly cut back on new housing starts, allowing inventory levels of new homes to fall, and have been adjusting their models to fit changing consumer spending behaviors and credit conditions that have a bias toward smaller and more affordable homes. Treasuries finished lower amid the late-day recovery in the equity markets and following the housing report. The yield on the 2-year note added 4 bps to 1.03%, the yield on the 10-year note rose 6 bps to 3.72%, and the yield on the 30-year bond increased 8 bps to 4.62%.

Areas that have been hit the hardest going into the downturn will likely be sources of future growth. Even the housing market could positively contribute to gross domestic product in 2Q, as single-family housing starts and building permits have bounced approximately 30% off their respective bottoms. However, despite the improvement in the inventory data, home prices will likely continue to decline, as inventory levels remain above the 5-6 month level that is consistent with a normal market. Recovery has to start somewhere, and the stabilization in sales of homes is a good beginning.

Elsewhere, Fed Chairman Ben Bernanke held a town hall style meeting in Kansas City over the weekend, where he defended the government intervention in the economy over the past year. Responding to a question about government bailouts of private companies, Bernanke said "nothing made me more frustrated, more angry, than having to intervene," adding "I was not going to be the Federal Reserve chairman who presided over the second Great Depression." On the economy, Bernanke repeated the Fed view that the economy will start growing again in the second half of the year, with a growth rate of approximately 1% likely, although that will not be enough to stop unemployment from rising. When asked about the government’s $787 billion stimulus package, Bernanke pointed out that most of the money will be spent in 2010, so "it might be a little bit early" to judge the plan’s effectiveness, but politicians must not ignore the growing budget deficit. "It is very, very important for the Congress and the administration to develop a plan, to say, 'Here is how we're going to get back to fiscal sanity,'" Bernanke said.

In other Fedspeak, Federal Reserve Bank of Philadelphia President Charles Plosser—not a voting member of the Federal Open Market Committee—told the Dow Jones Newswires that the Fed will "probably have to begin raising rates sometime in the not-too-distant future." Plosser played off of Fed Chief Bernanke's aforementioned comments, saying "I also don't want to repeat the Great Inflation of the 1970's."

Home prices and consumer confidence on deck tomorrow

The S&P/Case-Shiller Home Price Index will be released tomorrow, with the expectation that prices fell 17.9% year-over-year (y/y) in May, after falling 18.1% in April (economic calendar). Although recent data shows that sales volumes in both existing and new home markets are picking up, home prices continue to fall. Even after the index has already dropped more than 30% from its 2006 peak, bringing home prices back to the 2003 level, the year-over-year pace of decline has so far only shown moderate signs of easing.

One of the factors weighing most heavily on housing prices is foreclosures, as foreclosed homes typically sell for 20% less than normal sales. RealtyTrac recently reported that foreclosures rose 20% year-over-year in 2Q, and 11% on a quarter-over-quarter basis. Going forward, foreclosures are expected to continue accelerating as foreclosure moratoriums and legislative mandated delays come to an end, and as unemployment levels continue to increase.

Also, the Consumer Confidence Index will be released and is forecast to decline slightly, falling to 49.0 in July from June's disappointing slide to 49.3, which followed back-to-back strong monthly gains. Moreover, the Richmond Fed Manufacturing Index will be released tomorrow.