Evening Update

Markets Continue to Price in Recovery

The US dollar weakened to nearly a 12-month low, as traders continue to add to risk-based trades, pushing commodity prices and related stocks higher. Financials also led to the upside, after analysts increased price targets and estimates for several names in the group. With the economy continuing to recover from the credit crisis, as evidenced by capital raising via a half dozen IPOs slated for this week and filings by AMR Corp. and Louisiana-Pacific Corp. today, attention has turned to tomorrow’s Federal Reserve meeting, where the Fed may indicate the curtailment of its asset purchase programs. In other equity news, Lowe’s gave disappointing guidance, packaged-food company ConAgra beat EPS estimates but missed revenue projections after a rally in the stock, while Carnival, CarMax and China Mobile were all higher after announcing positive results. Treasuries were higher on a weaker-than-expected Richmond Fed Manufacturing Index and a strong auction for $43 billion in 2-year notes.

The Dow Jones Industrial Average gained 51 points (0.5%) to close at 9,830, the S&P 500 Index rose 7 points (0.7%) to 1,072, and the Nasdaq Composite advanced 8 points (0.4%) to 2,146. In moderate volume, 1.3 billion shares were traded on the NYSE and 2.5 billion shares were traded on the Nasdaq. Crude oil rose $1.79 to $71.50 per barrel, wholesale gasoline added $0.03 to $1.78 per gallon, and the Bloomberg gold spot price increased $10.90 to $1,015.80 per ounce.

Lowe’s Companies (LOW $21) reiterated its full-year sales and earnings guidance for 2009 that accompanied its 2Q earnings report in August, and said it expected 2010 EPS to be between $1.24-1.34. The consensus estimate of Wall Street analysts called for the home improvement retailer to post earnings of $1.34 per share for fiscal year 2010. Sales for next year were projected to increase 3-4%, while analysts are forecasting a 3% increase in sales to $48.5 billion, the company said, adding that same-store sales are expected to increase 1% in 2010, after falling between 7-9% this year. LOW said the economic environment remains challenging and it continues to drive operating efficiencies. The company added that although prices have declined in recent years, the home remains many consumers’ largest asset, and they are shifting to more do-it-yourself projects as they balance convenience with the cost of outsourcing. Shares fell.

Carnival Corp. (CCL $34) reported fiscal 3Q EPS of $1.33, beating the $1.18 that analysts had expected, with revenues of $4.1 billion roughly inline with the Street’s forecast. The cruise vacation firm said its net income of $1.1 billion exceeded its previous guidance, as a result of better-than-expected pricing on close-in bookings worldwide during the seasonally strong summer period. Looking ahead, the company said, “While the environment for travel remains challenging, we are encouraged by the strength we have had in booking volumes throughout the year.” CCL raised its previous full-year EPS guidance that is above Wall Street estimates, but offered a 4Q earnings forecast that missed expectations. Shares were higher.

CarMax (KMX $21) reported 2Q EPS ex-items of $0.36, double what Wall Street analysts had anticipated, as revenues rose 13% to $2.08 billion compared to last year, also topping the $1.8 billion that analysts had forecasted. The nation’s largest retailer of used cars said it had healthy increases in both used and wholesale vehicle sales and the growth was the result of easier year-over-year comparisons, but it also reflected improving customer traffic trends and an improvement in sales execution. KMX said the government’s “cash for clunkers” program resulted in a spike in traffic in late July and August, and it believes this program had a beneficial effect on its sales. Shares were higher by nearly 10%.

The combination of the successful “cash for clunkers” program and extremely low inventories has led to increased production by carmakers, and General Motors announced today that it will add a third shift to three plants, restoring nearly 2,400 jobs in its second move since August to ramp up production.

ConAgra Foods (CAG $22) announced that its fiscal 1Q EPS ex-items rose 41% versus last year to $0.38, four cents above the Street’s expectation, but revenues fell 3.1% to $2.96 billion, missing the $3.09 billion that had been expected by analysts. Brands that posted strong sales growth and market share gains included Healthy Choice, Hunt’s, Marie Callender’s, Orville Redenbacher’s and Snack Pack. The packaged-food company said it is off to a strong start in fiscal 2010, with profit at its consumer foods segment jumping 43% and it expects the balance of the year to show strong profits for this segment due to “manageable inflation, good cost savings,” sales growth, and favorable product mix. The company raised its EPS guidance from continuing operations for the full-year to $1.70, ex-items. Shares were lower.

China Mobile (CHL $52) was higher after the world’s largest cell phone firm by users said it added 5.26 million subscribers in August, topping the 4.55 million that were added in July.

Dollar continued to weaken, regional business activity report unexpectedly unchanged

Treasuries closed higher after a weaker-than-expected reading from the Richmond Fed Manufacturing Index and strong demand for today’s $43 billion 2-year auction, the first in a record week of $112 billion in Treasury issuance for the combination of 2-year, 5-year and 7-year maturities. The yield on the 2-year note lost 3 bps to 0.95%, the yield on the 10-year note fell 3 bps to 3.45%, and the yield on the 30-year bond declined by 3 bps to 4.20%.

The Richmond Fed Manufacturing Index unexpectedly came in unchanged at 14, versus the forecast of economists surveyed by Bloomberg that called for the index to improve to 16 in September, matching last week’s Empire Manufacturing Index and the Philadelphia Fed’s Business Activity Index reports, which both showed continued expansion of business activity. A reading of zero is the demarcation point between expansion and contraction. New orders declined from 18 in August to 13 for September, and shipments ticked up slightly from 21 the previous month to 22.

Is the economic recovery strong enough for the Fed to begin its “exit?”

The two-day Federal Open Market Committee (FOMC) meeting concludes tomorrow with the mid-day statement release. No changes are expected to interest rate policy at the meeting, but market participants are closing scrutinizing the timing of a possible “exit strategy” from the massive stimulus deployed to combat the credit crisis. The only change made at the August meeting was that the Fed extended the timing of the Treasury purchase program to the end of October. Traders will also be watching for any hints of changes to the mortgage-backed security purchase program, slated to expire at the end of the year. After this week, the next FOMC meeting is scheduled for November 3-4. The Fed is expected to update its economic forecast, last given at the June meeting.

Demand for Treasuries has remained strong, amid buying from foreigners, bank investments (at the expense of lending reserves), and rising savings from US consumers, keeping yields low. The Fed has been a smaller buyer of Treasuries, at 30% of new issues, relative to purchasing nearly 80% of new agency mortgage-backed securities, so the conclusion of this program could drive mortgage rates higher, at a time when the housing market is still undergoing a tenuous recovery. The sudden end of asset purchases could be disruptive to markets, and is seen as the reason the Fed extended the timing of its Treasury purchase program, thus giving the Fed time to shrink the size of its purchases over time, in a slow withdrawal.

Fed Chair Ben Bernanke penned an op-ed article in the Wall Street Journal in July that listed tools at the Fed’s disposal to withdraw liquidity from the system. One option listed was using reverse repurchase (repo) agreements, basically issuing collateralized short-term debt that third parties could purchase. Bloomberg reported today that the Fed started talks with bond dealers to discuss the mechanics of such a program, trying to gauge demand, and cited people involved with the discussions. A spokeswoman for the Federal Reserve Bank of New York, through which open market operations are typically conducted, declined to comment.

The other release on tomorrow’s economic calendar is the weekly release from the Mortgage Banker’s Association of the Mortgage Application Index, which is comprised of both refinances and new purchases.