Evening Update

Financials Lead Market to the Downside

Stocks posted modest declines as financial services companies continue to dilute current shareholders by raising capital and economic data showed higher than expected prices at the wholesale level while manufacturing activity plunged in the New York region. Volume was modest, as traders await the conclusion of the Fed meeting on monetary policy, marked by the mid-day statement to be issued tomorrow. The dollar strengthened as concerns about the banking sector in Europe mount on top of apprehension about government debt in some European countries, and materials shares joined financials to lead on the downside. In financials, Wells Fargo became the latest bank planning on paying back TARP money, aided by an equity offering and major credit card firms reported mixed card metrics. Mid-day, General Electric held a webcast of its annual outlook meeting where it forecast revenue to be flat in 2010. Elsewhere, Best Buy posted better-than-expected earnings but gave disappointing guidance and Dow member Boeing conducted its first flight of its 787 Dreamliner after two years of delay. Treasuries were lower after a stronger-than-expected increase in industrial production was reported and the inflation data, while homebuilder confidence unexpectedly waned.

The Dow Jones Industrial Average fell 49 points (0.5%) to close at 10,452, the S&P 500 Index lost 6 points (0.6%) to 1,108, and the Nasdaq Composite declined 11 points (0.5%) to 2,201. In modest volume, 1.2 billion shares were traded on the NYSE and 2.0 billion shares were traded on the Nasdaq. Crude oil rose $1.18 to $70.69 per barrel, wholesale gasoline gained $0.02 to $1.85 per gallon, and the Bloomberg gold spot price decreased $2.60 to $1,124.10 per ounce. Elsewhere, the Dollar Index—a comparison of the US dollar to six major world currencies—was higher by 0.8% to 76.94.

General Electric (GE $16 ¹) held its annual outlook meeting, forecasting that revenue and margin growth would be flat in 2010, while expecting cash flow of $26 billion. Analysts are expecting revenue to decline to $151.2 billion in 2010 from an estimate of $155 billion in 2009. CEO Jeff Immelt said that the global economic environment was improving, although recovery was expected to be “gradual.” Immelt said that the “worst is over” for the firm’s financial services unit GE Capital, and noted that the division was allowed to get “too big” and from now on, “we’re going to be very disciplined about where the business is and where it’s going.” He went on to say that GE is “back on offense” after entering 2009 in a defensive manner. Immelt said he wants to go back to its historical dividend payback and would look opportunistically at share buybacks. Shares spiked above the unchanged line, but ended the day lower.

Wells Fargo & Co. (WFC $26) is the latest major financial firm to announce intentions to exit the Treasury’s Troubled Asset Relief Program (TARP), reporting that it will redeem the $25 billion in preferred stock issued to the government, as it sold $10.65 billion in common stock priced at $25 per share. WFC added that it will also raise $1.35 billion through the issuance of common stock to the company’s benefit plans in lieu of a portion of 2009 incentive cash and other compensation to certain WFC team members. The company said it also intends to increase equity by $1.5 billion through asset sales and that repaying the TARP will eliminate $1.25 billion in annual preferred stock dividends, and will be “slightly accretive” to EPS in 2010. Shares were higher.

Best Buy (BBY $42) reported 3Q EPS of $0.53, ten cents above the consensus estimate of Wall Street analysts, with revenues increasing 4.5% versus last year to $12.02 billion, slightly above the $11.98 billion that the Street forecasted. BBY’s same-store sales for the quarter increased by 1.7%, led by a 4.6% increase in sales from its domestic segment on increased traffic and an improvement in the average sales ticket, as a result of growth in sales of notebook computers, flat panel TVs, mobile phones, and appliances, partially offset by decreases in gaming, movies and music. The electronics retailer said that November saw an 8.4% jump in same-store sales, on low double-digit sales growth during the “Black Friday” shopping weekend. BBY raised its full-year revenue and EPS guidance, but shares were under pressure in afternoon action, as the company forecasted that the gross margin will decline by 80-100 basis points, on increased sales of discounted products such as notebook computers and flat-panel TVs.

Headlining a plethora of reports of key credit card metrics, JPMorgan Chase (JPM $41) reported that its US credit-card net charge-off rate—loans the company does not anticipate being repaid—increased from 8.02% in October to 8.81% in November, while Bank of America (BAC $15 ¹) said its charge-off rate declined from 13.22% to 13.00% and American Express (AXP $41) said it’s charge-off rate declined to 3.9% from 4.1% in October. Other card companies such as Capital One Financial (COF $41) and Discover Financial Services (DFS $16) both reported increases in charge-off rates. However, DFS, JPM and AXP noted that accounts that are at least 30 days delinquent—a gauge used to forecast future loan losses—declined. Shares of all of the firms were under pressure.

Dow member Boeing (BA $56 ¹) made its first test flight of its 787 Dreamliner, over two years after the initial voyage was set to kick off. Delays for the flight have come courtesy of a two-month strike and costly design and manufacturing delays. The company will now proceed with hundreds of additional test flights before the first plane is set to be delivered sometime in 4Q 2010. Shares were modestly lower.

Wholesale prices jump, production gains, but NY manufacturing activity disappoints

Treasuries were lower as inflation gained and industrial production rose. The yield on the 2-year note rose 5 bps to 0.86%, the yield on the 10-year note gained 4 bps at 3.59%, while the yield on the 30-year bond advanced 4 bps to 4.53%.

The Producer Price Index showed prices at the wholesale level jumped month-over-month (m/m) in November, rising 1.8% after advancing 0.3% in October. The average economist forecast was for prices to increase by 0.8%. Energy prices rose by 6.9%, led by a 14.2% surge in gasoline prices, which accounted for the majority of the inflation gauge’s rise as food prices rose a moderate 0.5%. Even after stripping out the more volatile components of food and energy, the core rate also topped analysts’ forecasts after rising by 0.5% compared to the expectation for a 0.2% increase. A 4.2% jump in prices for light motor trucks and higher cigarette prices also contributed to the rise in the core rate. On a year-over-year basis, headline producer prices were 2.4% higher—the first 12-month increase since November 2008—and the core rate was 1.2% higher.

Meanwhile, industrial production was also released this morning, and showed a 0.8% increase, compared to the 0.5% gain that had been expected. Last month’s previously reported 0.1% gain was revised down to a flat reading. The auto sector continues to be the source of much of the volatility in this report, as car and parts output gained 1.8%. However, manufacturing ex-autos rose by 1.1%, following last month’s 0.2% decrease. Production of consumer goods moved 0.3% higher, reflecting an increase of durable goods, but home electronics fell for the 10th month in a row. The report also showed that capacity utilization improved from a slight downwardly revised 70.6% to 71.3%, above the 71.1% forecast. Capacity utilization remains about 10 percentage points below its long-term average, illustrating the impact of the global recession and helping to explain why inflation concerns remain subdued and the unemployment rate sits at an uncomfortably high 10.0%.

Elsewhere, the Empire Manufacturing Index, a measure of manufacturing in the New York region, deteriorated much more than expected in December to a level of 2.55, but remains above the level of zero that suggests conditions are neither contracting nor expanding. Economists surveyed by Bloomberg expected a slight improvement to 24.00, from 23.51 in the previous month. The report is the first major piece of data looking at manufacturing conditions in December. The indexes for new orders and shipments fell close to zero, and current and expected employment indexes slipped back into negative territory. Respondents said that while input prices had picked up a bit, the prices received index moved further into negative territory, suggesting that price increases are not being passed along.

In other economic news, the NAHB Housing Market Index, a gauge of homebuilder confidence, unexpectedly slipped in December to 16, compared to expectations of a rise to 18. Last month’s reading was left unrevised at 17. A reading below 50 means most respondents still view conditions as poor. Within the report, the current sales condition fell one point, while sales expectations for the next six months declined by 2 points, with a gauge of traffic being unchanged. The NAHB Chief Economist noted that the expanded tax credit was starting to factor into buying plans, but that the poor economy and tight lending conditions for consumers and builders remained an obstacle to recovery.

Anxiety about European banks, strength in natural resource economies

Worries about credit problems continued to dominate European news, after euro member Austria nationalized its sixth-largest bank, and announced it was injecting as much as 450 million euros ($655 million) into the lender and the central bank said the country’s banks may need to strengthen their capital in the medium-term, citing stress-test results. Reassurances from the Austrian central bank that it isn't running a watch list on other banks did little to calm nerves.

Fears about the health of the banking sector in the eurozone were exacerbated by Moody’s Investor Services reiteration that its outlook for the Irish banking sector remains negative, and comes on the heels of Fitch’s credit rating downgrade last week of the government debt of Greece. Greece Prime Minister George Papandreou yesterday said “In the next there months we will take those decisions that weren’t taken for decades” to cut the country’s deficit. Papandreou said he would cut the deficit, currently at 12.7% of GDP per Bloomberg, below the EU’s 3% limit by 2013, and begin reducing debt. Measures considered include an overhaul of the tax system, asset sales, and cuts to military spending, while attempting to avoid measures such as public-sector wage cuts, which were announced last week in Ireland.

In European economic news, the German ZEW Survey declined from 51.1 in November to 50.4 in December—the third-consecutive monthly deterioration—but a slightly smaller drop than the decline to 50.0, which was forecasted by economists surveyed by Bloomberg. The survey is a measure of investor and analyst’s six-month expectations, likely hampered by Fitch’s credit rating downgrade on Greece. Elsewhere, consumer prices in France and Spain both rose by a smaller amount than anticipated, while prices at the consumer level in the UK rose more than forecast for November.

In Asia/Pacific, the Reserve Bank of Australia’s released minutes from its December monetary policy meeting, where it raised its main lending rate for a third-consecutive month. The RBA’s release dampened expectations that the central bank will increase rates again at its next meeting in February after the report revealed that the “question for members was whether it was more appropriate to take a further step at this meeting or to hold the cash rate steady pending a further evaluation of developments at the February meeting.”

In the Americas, Canada’s index of leading indicators rose 1.3%, much higher than the 0.7% expected by the Bloomberg survey of economists. Nine of the index’s ten components increased and one was unchanged, the broadest increase in more than two years.

Elsewhere, Brazil real retail sales rose 8.4% in October from a year earlier, better than the 6.4% forecast and the advance was the fastest pace in a year. September sales were revised to a 5.1% increase, while October sales rose 1.4% month-over-month on a seasonally-adjusted basis. Despite posting two quarters of positive GDP growth, Brazil has yet to initiate interest rate hikes, with the central bank last week citing excess slack and a non-inflationary recovery “at the moment.”

Another inflation reading, housing data and conclusion of Fed meeting on tap

Tomorrow the Consumer Price Index (CPI) will be released, anticipated to have risen 0.4% month-over-month in November, after increasing 0.3% October. Ex-food and energy, the core CPI rate is forecasted to have risen 0.1%, after a 0.2% increase in the prior month.

Housing starts for November will also be reported, expected to show a jump of 8.7% m/m in November to an annual rate of 575,000 units, after dropping 10.6% in October, while building permits, one of the leading indicators tracked by the Conference Board, are forecasted to increase 3.4% m/m after declining 4.2% m/m in October. This report has been distorted by the initial November 30 expiration of the buyer tax credit, which has been extended to April 30, 2010. As with the “cash for clunkers” program, the concern is that government incentives simply pulled forward demand, leaving a gap in the future. While auto sales have resumed growth, the overhang of foreclosures in process due to rising unemployment and steep prior price declines places the housing market in a more fragile position. Housing affordability is near 40-year highs, but the scheduled March conclusion of the Fed’s mortgage-backed security purchase program could put mortgage rates at risk of moving higher.

The two-day Federal Open Market Committee (FOMC) meeting concludes with the release of the statement mid-day Wednesday. While no changes are expected to interest rate policy, market participants continue to watch for any clues that indicate the timing of when the Fed expects to contemplate tightening, focusing on the language used by the Fed with regard to the “extended period” for keeping rates at an exceptionally low rate.

Fed Chair Bernanke last week said that “we’re still looking at the extended period,” and despite rising commodity prices, indicated that “inflation could move lower from here.” The Fed has given a trio of reasons for keeping rates low, namely “low rates of resource utilization (the unemployment rate), subdued inflation trends and stable inflation expectations.” While inflation and employment are expected to be restrained due to excess slack, inflation expectations are more fickle, and the Fed has the tough job of walking a tightrope between boosting investor risk appetites and asset prices, while avoiding inflationary pressures. The Fed has started to publicly address the role of the dollar, as a disorderly decline in the dollar could send inflation expectations higher.

Other economic news on tomorrow’s US calendar is the release of the MBA Mortgage Applications Index. Internationally, Japan announces a final reading on machinery tool orders, Europe releases PMI readings in several countries, and Australia reports 3Q GDP and the October reading on leading economic indicators.