Evening Update

Stocks See Relatively Rare Red Ink

Stocks finished the day in the red for only the second time in ten sessions as sentiment was relatively unnerved by Oracle and FedEx both matching earnings expectations but posting sales that disappointed, and after a smaller-than-expected increase in building permits. The run in commodity prices took a breather from their recent surge to take some of the wind out of the broad equity market’s sails. Treasuries were higher as equities moved lower, even after another increase in housing starts, an unexpected drop in weekly initial jobless claims—although the Labor Department cautioned that the holiday last week may have distorted the data—and a much larger-than-expected increase in the Philly Fed Index. In other equity news, Dress Barn provided a mixed profit report, Discover Financial Services turned in a surprising quarterly profit, AMR Corp reported that the parent of American Airlines obtained $2.9 billion in liquidity, while Eastman Kodak reiterated a loss, which overshadowed its $700 million capital raise.

The Dow Jones Industrial Average was down 8 points (0.1%) to close at 9,784, the S&P 500 Index decreased 3 points (0.3%) to finish at 1,065, and the Nasdaq Composite declined 6 points (0.3%) to 2,127. In moderate volume, 1.5 billion shares were traded on the NYSE and 2.6 billion shares were traded on the Nasdaq. Crude oil rose $0.02 to $72.53 per barrel, while wholesale gasoline was flat at $1.85 per gallon, and the Bloomberg gold spot price lost $4.10 to $1,013.20 per ounce.

Oracle (ORCL $22) matched the Street’s earnings target by announcing 1Q EPS ex-items of $0.30, although sales fell 5% to $5.1 billion, which disappointed analysts who had expected $5.3 billion. The company said sales would have fallen just 1% if not for currency fluctuations. ORCL also issued 2Q EPS guidance that matched analyst projections. Oracle noted that several factors hampered its results during the period, such as a tough comparison with strong results in the same period a year ago and weakness among companies such as SAP (SAP $50) that resell Oracle’s database software along with their own products. The company did not provide any new information as to when its pending acquisition of struggling computer server manufacturer Sun Microsystems (JAVA $9) will close, but did say that it expects a boost to its profits of $1.5 billion in the first full year after the merger is completed. The deal is currently being held up by European Union antitrust regulators. Oracle traded lower

FedEx (FDX $76) reported 1Q earnings down more than 50% at $0.58 per share, inline with estimates, as revenues shrank 20% to $8.0 billion – below the $8.2 billion that had been expected. The company said recession-dampened demand and a substantial decline in fuel surcharges negatively impacted the results, while strict cost control and one additional operating day offset that weakness somewhat. Following the earnings announcement, the company reiterated its earnings expectations for 2Q at $0.65-0.95, compared to the $0.83 that Wall Street is expecting. CEO Alan Graf said that while he sees “signs of improvement in the economy,” the company’s comparison basis will remain difficult next quarter. FDX came under pressure.

Discover Financial Services (DFS $16) reported 3Q EPS ex-items of $0.52, which handily topped the prediction of analysts that the company would lose $0.11 per share. Discover Card sales volume declined 7% during the period to $23 billion, while the net yield that DFS earned on its US card balances improved 95 bps to 9.90% as the firm charged higher interest rates on existing balances and offered fewer promotions. The lender also announced that it trimmed company-wide expenses by 14% during the period. DFS gave no firm guidance but did say that it is maintaining a “very cautious view of credit due to the mixed signals in the US economy.”

AMR Corp. (AMR $9) was up about 20% after the parent of American Airlines announced that it has obtained a total of $2.9 billion in additional liquidity and new aircraft financing and announced restructuring to its network in order to boost flying profitability. AMR’s $2.9 billion obtained consists of $1.3 billion in new liquidity, including $1 billion in cash from the advance sale of frequent flyer miles to Citigroup (C $4) and $280 million in cash under a loan facility from GE Capital Aviation Services secured by owned aircraft. The remaining $1.6 billion comes in the form of sale-leaseback financing commitments from GE Capital Aviation Services for Boeing (BA $53 ¹) 737s previously ordered by the company. Shares of Citigroup and Boeing were also higher on the day.

In terms of the network restructuring plans, AMR said it plans to refocus its network strategy by bolstering areas of strength, primarily aimed at eliminating unprofitable flights and reallocating resources to hubs in Dallas/Fort Worth, Chicago, Miami, and New York—the cornerstones of its network, including Los Angeles.

However, Eastman Kodak’s (EK $6) announcement that it will raise up to $700 million in fresh capital—including a $400 million investment from private equity firm KKR—was not met with as much enthusiasm as AMR Corp’s capital raise after the photography firm reiterated that it expects its net loss for the current year to be as much as $400 million, the high end of its previous forecast. Shares were down sharply.

Dress Barn (DBRN $17) announced adjusted 4Q EPS of $0.39, ahead of the average analyst estimate of $0.37, while revenues grew 4% to $399 million, coming in shy of the $401 million forecast. Same-store sales increased 1% during the period. DBRN made upbeat comments about recent operating trends, saying that early indications of sweater sales are off to a good start, which could set the tone for the fall season as sweaters form the largest category in that season. The retailer also gave an outlook that missed analysts’ estimates. DBRN shares were solidly lower.

Elsewhere, the FDIC announced that the first sale of “toxic assets” has taken place, with Texas-based mortgage servicer Residential Credit Solutions being the first to take advantage of the government’s Public-Private Investment Program (PPIP) by purchasing a stake in a portfolio of residential mortgage loans from Franklin Bank, a regional bank that failed last year. The portfolio has an unpaid principle balance of about $1.3 billion, and Residential Credit Solutions has agreed to pay $64 million in cash for a 50% stake in an entity that holds the loans and the company also issued a note of $728 million to the FDIC to help finance the sale. The FDIC estimated that the value of RCS's bid equates to approximately 70% of the outstanding balance on the loan portfolio. Meanwhile, RCS said it intends to actively manage the mortgage loans it purchased by contacting struggling borrowers to understand their financial situation and offer them alternative solutions. "We believe we can help more borrowers stay in their homes,” RCS said.

In other government reports, the Federal Reserve released its 2Q flow of funds summary, which showed household debt contracted at an annual rate of 1.75%, marking the fourth-consecutive quarter of contraction, led by consumer credit decreasing at an annual rate of 6.5%. Interestingly, the report also showed household net worth—the difference between the value of assets and liabilities—was estimated at $53.1 trillion at the end of 2Q, $2 trillion more than 1Q and the first increase since 3Q 2007.

Housing market shows more signs of firming, jobless claims drop

Housing starts (chart) for August were reported this morning, with starts showing a 1.5% month-over-month (m/m) increase to an annual rate of 598,000 units – inline with economist forecasts – while last month’s data was revised up from 581,000 to 589,000. Meanwhile, building permits, the more forward-looking indicator of homebuilding activity, came in 2.7% higher m/m to an annual rate of 579,000, compared to expectations of 583,000. All of the rise in both series can be attributed to a surge in multi-family construction, which can be quite volatile on a month-to-month basis. Housing starts for single-family homes fell 3.0% m/m to 479,000, and building permits for single-family homes decreased 0.2% m/m, but excluding the upward revision to July’s number, single-family building permits would have risen 0.9%. Building permits are one of the 10 leading economic indicators tracked by the Conference Board.

Sales of new and existing homes have been rising and price declines appear to be moderating, as housing affordability remains near 40-year highs and new homebuyers are taking advantage of the $8,000 tax credit. Homebuilders are starting to become cautious about expectations for future sales according to the National Association of Home Builders with the impending expiration of the credit, wherein transactions must be completed by November 30 to qualify. The increase in housing construction this year comes on the heels of a severe retrenchment, where builders increasingly used existing inventory to meet sales, and the level of sales relative to starts was nearly equal in January, an extremely unusual occurrence.

However, there is a sense that, despite ongoing foreclosures and the possible expiration of the new homebuyer tax credit, a bottom may be forming in the housing market. New homebuyers have constituted only 30% of sales since May and moderating price declines have boosted buyer confidence. Toll Brothers (TOL $22) CEO Robert Toll recently said in an interview on Bloomberg TV that in some markets, “people are now concerned with missing the market.” Stability in the housing market helps increase consumer confidence, as homes are the single biggest asset for most consumers and – together with the stock market – they constitute approximately two-thirds of consumer net worth.

Separately, weekly initial jobless claims (chart) showed improvement with just 545,000 people filing for unemployment benefits, well below the average forecast of 557,000. Meanwhile, last week’s data was revised up from 550,000 to 557,000. A Labor Department analyst cautioned that the Labor Day holiday may have influenced the larger-than-anticipated drop. Elsewhere in the report, the four-week moving average, considered a smoother look at the underlying trend in claims, declined by 8,750 to 563,000, and continuing claims increased by 129,000 to 6,230,000, higher than the forecast of 6,100,000.

Elsewhere, the Philadelphia Fed’s Business Activity Index (chart) jumped to 14.1 in September from 4.2 last month. The index was only expected to reach a level of 8.0. A reading of zero depicts conditions are neither expanding nor contracting so this is the latest in a series of manufacturing reports showing that the sector is returning to life as an uptick in sales and very lean inventories on hand have forced many companies to begin restocking – providing a nice boost to production demand.

Treasuries were higher following the slew of reports and as the equity markets moved lower. The yield on the 2-year note fell 4 bps to 0.94%, the yield on the 10-year note dropped 8 bps to 3.39%, and the yield on the 30-year bond decreased 9 bps to 4.17%. The economic calendar will be void of any major releases tomorrow.