Evening Update

Another Late-Day Recovery Despite Disappointing Data

Stocks looked poised for a solid day in the red after the second-straight drop in the Consumer Confidence Index on uneasiness regarding the unemployment picture. But the equity markets managed to show more late-day resiliency, paring a good majority of losses to finish modestly lower. Earnings reports continued to paint a positive picture as Amgen easily topped expectations—helping propel the Nasdaq Composite to a gain—while Viacom, Coach, Masco and Coventry Health Care all managed to beat or match estimates. There was also some M&A activity for traders to analyze, as IBM and SprintNextel both announced acquisitions of smaller rivals. But energy shares weighed on Wall Street, exacerbated by a gloomy outlook by BP, and Office Depot posted a wider-than-expected loss as consumers continued to quell spending. Other reports on the economic calendar helped soothe some of the sting as the S&P/Case-Shiller Index showed improvement relative to the prior month, and a Fed regional manufacturing survey came in better than anticipated. Treasuries were mixed following a disappointing two-year note auction.

The Dow Jones Industrial Average dipped 12 points (0.1%) to close at 9,097, the S&P 500 Index declined 3 points (0.3%) to finish at 980, while the Nasdaq Composite rose 8 points (0.4%) to 1,976. In moderate volume, 1.2 billion shares were traded on the NYSE and 2.2 billion shares were traded on the Nasdaq. Crude oil fell $1.08 to $67.30 per barrel, wholesale gasoline decreased $0.02 to $1.88 per gallon, and gold fell $16.80 to $937.05 per ounce.

Amgen (AMGN $62) reported 2Q EPS ex-items of $1.29, well above the average analyst estimate of $1.16, while sales at the world’s largest biotech company fell 1% to $3.7 billion. AMGN also announced a deal with GlaxoSmithKline (GSK $39) to sell its bone drug to osteoporosis patients in overseas markets, and raised its full-year guidance to $4.80-4.95, from the previous level of $4.55-4.75. CEO Kevin Sharer reported that “concerns we had about the pressure of the recession on health care have moderated.” AMGN shares were higher.

Office Depot (ODP $4) was down over 15% after the company posted a 2Q adjusted loss of $0.22 per share, which came in wider than the $0.12 per share loss that analysts surveyed by Reuters had expected. The office supply firm said sales fell 22% to $2.8 billion, also missing expectations, and same-store sales in North America dropped 18% during the quarter, driven by macroeconomic factors as consumers and small business customers continued to rein in their spending, especially in large ticket items like furniture and computers.

BP PLC (BP $50), Europe’s second-largest oil company, traded lower after the company warned that the outlook is still negative. CEO Tony Hayward told investors "we see little evidence of any growth in demand and expect the recovery to be long and drawn out." Hayward added, "we are in turbulent times, volatile and uncertain.” BP also reported 2Q earnings fell 53% to $4.4 billion.

Viacom (VIAB $24) announced 2Q adjusted earnings of $0.49 per share, one penny better than the Reuters estimate. Sales at the media conglomerate were down 14% to $3.3 billion, slightly below the $3.5 billion forecast, due to a weak advertising market, video game sales, and box office results. CEO Philippe Dauman said that the economy continues to be a “challenge” for the company, but Viacom hopes to temper the impact of the recession on its results through diversified revenue streams and operational discipline. The stock finished in negative territory after relinquishing early gains.

Coach (COH $28) said it earned $0.43 per share in 4Q after adjusting for unusual items, inline with the level analysts had been expecting. Revenues at the luxury goods maker slumped 1% to $778 million, just shy of the $783 million forecast, as same-store sales at the firm’s North American locations dipped 6.1%. Management pointed out the significant improvement in its inventory levels during the quarter, and highlighted the fact that it avoided discounting its items in spite of the recessionary pressures it faced. In terms of the future outlook, CEO Lew Frankfort said the company will “plan cautiously until we see concrete evidence of a change in consumer behavior.” COH shares were lower following the report.

Masco (MAS $13) released 2Q earnings of $0.15 per share, compared to a loss of $0.03 that had been predicted by analysts. Meanwhile, revenues at the building product manufacturer declined 23% to $2.0 billion as weak sales of new home construction products weighed on results, although that was partially offset by better sales of paints and stains. Masco also raised its full-year outlook to a loss of $0.05-0.25 per share, compared to its prior guidance of $0.15-0.35, although management still expects housing starts to decline 40% this year. MAS was up over 10% today.

Coventry Health Care (CVH $23) rose sharply after reporting 2Q EPS ex-items of $0.50, ten cents above the Street's forecast, as sales increased 19% versus last year to $3.5 billion, which slightly exceeded analysts' forecasts. CVH said it had Medicare membership growth of 39% compared to last year, and continued growth in individual risk membership. The company raised its full-year EPS guidance.

International Business Machines (IBM $117) came under moderate pressure after revealing a $1.2 billion acquisition of SPSS Inc (SPSS $49), a business analytics software company. The deal represents a 42% premium to the prior close for SPSS shares. IBM expects the deal to help expand its Information on Demand software portfolio and business analytics capabilities. Separately, IBM said it has also acquired privately-held Ounce Labs, another business analytics software company, although financial terms of that deal were not disclosed.

In other M&A news, Sprint Nextel (S $5) announced that it will acquire Virgin Mobile USA (VM $5) for $483 million. Sprint already owns 13% of VM, which uses Sprint’s network to offer its service. The offer price is a 31% premium to yesterday’s closing price. The deal is expected to improve Sprint’s prepaid business, as competition for the more lucrative postpaid customers has intensified. Sprint said it intends to keep the Virgin Mobile brand name. Sprint shares traded higher amid the afternoon recovery in the equity markets..

Fall in home prices moderates and consumer confidence posts second-straight decline

The S&P/Case-Shiller Home Price Index showed that US home prices fell 17.1% year-over-year in May – better than the 17.9% forecast and better than the 18.1% fall seen in April. This marks the fourth-consecutive month that the pace of decline has moderated, following 16 straight months of record declines beginning in October 2007. Although seasonal factors are making comparisons difficult as we are now entering the seasonally strong period for the housing market, S&P reported that this could be an inflection point as 13 of the 20 cities in the index saw prices improve relative to April. “To put it in perspective, these are the first time we have seen broad increases in home prices in 34 months. This could be an indication that home price declines are finally stabilizing,” S&P said, although still stressing that “we likely do have a way to go before we see sustained home price appreciation.”

Home prices will likely continue to decline as inventory levels remain elevated and home foreclosures are still accelerating. Having said that, we think it is possible that the housing market could start to be a positive contributor to the economy again even if prices continue to decline. Recent data has shown that sales volumes are picking up as buyers are being lured off of the sidelines due to record affordability levels and government support for the industry. Housing construction activity also looks to be picking up with housing starts and building permits both up approximately 30% from their respective bottoms. This is one of the burgeoning signs of economic recovery we see, although we believe that the road ahead will remain bumpy.

Meanwhile, the Consumer Confidence Index fell more than forecast in July to a level of 46.6. Economists had only been expecting a slight decrease to 49.0, from the June reading of 49.3. The strong rally in the stock market had led the index to back-to-back strong monthly gains in April and May, before falling again the past two months as rising unemployment has weighed on the mood of the nation’s consumers. The University of Michigan Consumer Sentiment Index data released last Friday also showed consumers have become less confident in July. Also included in today’s report, consumer expectations for the next six months fell from 65.5 to 62.0, while the percentage of respondents who felt jobs are plentiful dropped to just 3.6% - the lowest level since 1983. Treasuries were mostly higher following the disappointing read on consumer confidence, but two-year notes came under pressure following a $42 billion note auction that was characterized as weak, drawing a higher-than-expected yield to entice demand. The yield on the 2-year note added 4 bps to 1.08%, the yield on the 10-year note decreased 4 bps to 3.68%, and the yield on the 30-year bond dropped 8 bps to 4.54%.

Separately, the Richmond Fed Manufacturing Index revealed that manufacturing conditions in the central Atlantic region improved in July, sending the index to a level of 14 from 6 in June. Economists had only been expecting a reading of 8, with numbers above 0 indicating expanding activity.

The Federal Reserve Beige Book will be released tomorrow, in anticipation of the next FOMC policy meeting in two weeks (economic calendar). The report is a summary of anecdotal economic information from all 12 Federal Reserve Districts and the market pays attention to it not just because it will be used by the Fed as it sets monetary policy, but also because it provides a more timely reading of current economic conditions than most other reports. In the last Beige Book, which was released in June, five of the twelve District Banks reported a moderation in the rate of economic decline, although the report noted that credit conditions remain tight and employment conditions are difficult, with wages generally flat or falling. The expectation is that this Beige Book will confirm the view that the economy is gradually recovering although pockets of weakness remain.

In spite of all of the progress that has been made, much of the recent stabilization has been a direct result of the enormous government stimulus of the economy, and any anti-growth policies at this point could lead to a double-dip recession as seen in the early 1980s.

Durable goods orders will also be reported on Wednesday, and are expected to have decreased 0.6% month-over-month (m/m) in July, after rising 1.8% in June. Ex-transportation, orders are forecasted to be flat m/m, after rising 1.1% in June. The monthly orders data can be very volatile as large orders for items such as airplanes and military equipment have a tendency to skew the data. When examining the trend in this report though, it appears that new orders – although still weak – have recovered from the severe downturn earlier in the year. Although consumers have dramatically reduced discretionary spending and businesses have curtailed all unnecessary expenses, inventory levels are now at such a low level that some restocking is necessary.

New orders for nondefense capital goods are one of the best leading indicators of future economic activity and the strong upward trend in the Conference Board’s Index of Leading Economic Indicators – that has now persisted for three months – has a strong track record in identifying the end of recessions historically. Weekly MBA mortgage applications will also be released tomorrow.