Evening Update

Broadened Recovery and Earnings Upside Soothe Bulls

Stocks were higher, despite starting the day in a gloomy mood after another move by China intended to slow growth, this time by increasing reserve requirements for Chinese banks, which was digested in US trading yesterday, bulls took solace after mortgage applications increased and the Fed released its Beige Book, which showed improvement in US economic activity broadened. In equity news, Google threatened to leave China after censorship and a “highly sophisticated” attack on its infrastructure in mid-December, while Dow member Kraft Foods, as well as a string of technology companies, including QLogic, Linear Technology, and TriQuint Semiconductor said profits would be higher than Street estimates. Additionally, McAfee and Facebook agreed to a security solutions collaboration. Treasuries were lower.

The Dow Jones Industrial Average rose 54 points (0.5%) to close at 10,681, while the S&P 500 Index added 9 points (0.8%) to 1,146, and the Nasdaq Composite rose 26 points (1.1%) to 2,308. In moderately light volume, 970 million shares were traded on the NYSE and 2.3 billion shares were traded on the Nasdaq. Crude oil fell $1.14 to $79.65 per barrel, wholesale gasoline lost $0.04 to $2.06 per gallon, while the Bloomberg gold spot price rose $9.83 to $1,138.33 per ounce. Elsewhere, the Dollar Index—a comparison of the US dollar to six major world currencies—was down 0.1% to 76.85.

Google (GOOG $587) said it is considering shutting down its Chinese search site and facilities as it said it cannot tolerate strict censorship and after it discovered a “highly sophisticated” attack in mid-December on the world’s largest internet search firm’s corporate infrastructure originating from China that resulted in the theft of intellectual property from GOOG. The company added that at least twenty other companies from a wide range of businesses have been similarly targeted, and it has evidence to suggest that a primary goal of the attackers was accessing the Gmail accounts of Chinese human rights activists, and while only two Gmail accounts were accessed, activity was limited to subject line and account information, rather than the content of the e-mails, and enhanced security measures have been implemented since the attack. A spokeswoman at Yahoo (YHOO $17) said the company is “aligned with Google” and strongly believes that the violation of user privacy is something that “we as internet pioneers must all oppose,” per the Wall Street Journal, while Microsoft (MSFT $30) said that they had no indication that any of their mail properties had been compromised. GOOG was lower, while Chinese search engine Baidu Inc. (BIDU $438) rose sharply and YHOO and MSFT also rose.

Dow member Kraft Foods (KFT $29) increased its full-year EPS guidance from at least $1.97 to at least $2.00, reflecting strong operating gains as well as a significant increase in marketing investments versus the prior year. KFT said it is delivering high-quality earnings growth despite the difficult economic environment, and it is well positioned to deliver sustainable top-tier performance, “with or without Cadbury.” Analysts are expecting the company to report $2.00 per share in earnings for 2009. Shares closed fractionally lower.

QLogic Corp (QLGC $20) reported preliminary 3Q results, in which it expects to post EPS ex-items of between $0.29-0.30, versus its previously forecasted range of $0.22-0.24, with revenues rising 12-13% sequentially to $147-149 million, exceeding the previously forecasted range of $134-140 million. Analysts are calling for the technology infrastructure firm to report 3Q EPS of $0.25 and revenues of $140 million. QLGC said its revenue performance was driven by strong sequential growth for its host products compared to 2Q. However, shares of QLGC were under pressure, after rising yesterday on competitor Emulex Corp’s (ELX $13) bullish results, wherein revenues rose 26% sequentially, while ELX shares rose for a second-straight day.

Elsewhere in technology earnings, semiconductor company Linear Technology Corp (LLTC $30) reported 2Q EPS ex-items and stock-based compensation of $0.41, higher than the Street’s forecast of $0.31 on revenues of $256.4 million, and gave guidance for 3Q revenues to rise 7-10% quarter-over-quarter to $274.3-282 million, above analysts estimates for revenue of $257.6 million. In commenting on the results, the CEO said that the company experienced stronger than expected bookings, with particular strength in the industrial, communications and computer end-markets, and given a higher book-to-bill ratio than the past several quarters, “leads us to be optimistic as we enter our third quarter.” Despite the report, shares were lower.

Shares of TriQuint Semiconductor (TQNT $6) bucked the trend in technology stock reactions to earnings today, ending higher after the firm announced preliminary results of 4Q revenues of $190 million and EPS of $0.12-0.13, higher than the analyst estimate of $181 million and $0.11, after the company cited strong holiday demand for its RF solutions for communication products including mobile phones. Guidance for 1Q is for a “normal seasonal decline” in revenue of 10-15%.

In other technology news, McAfee Inc. (MFE $41) and privately-held social networking site Facebook announced an “unprecedented” security solutions collaboration that will make MFE’s security software available to more that 350 million Facebook users. MFE will be Facebook’s exclusive provider of consumer security software and Facebook users will be eligible for a complimentary six-month subscription of and will then be eligible for special discount subscription pricing. Shares of MFE were higher.

Mortgage apps jump, Fed Beige Book showed economic improvement

Treasuries were lower with the yield on the 2-year note up 4 bps to 0.95%, the yield on the 10-year note 6 bps higher at 3.77%, and the yield on the 30-year bond rose 9 bps to 4.70%.

The US MBA Mortgage Application Index rose 14.3% last week, after the index, which can be quite volatile on a week-to-week basis, gained a slight 0.5% in the previous week. The increase came amid a 5 basis-point drop in the average 30-year mortgage rate to 5.13% versus the previous week, and as the Refinance Index jumped 21.8%, supporting the rise in the overall application gauge. Meanwhile, the Purchase Index rose 0.8%. The average 30-year mortgage rate remains above the record low of 4.61% that was reached at the end of March. Treasuries remain lower.

The Federal Reserve released its Beige Book report, which depicts economic activity in all twelve Fed Districts across the nation and is one of many tools used by the Federal Open Market Committee (FOMC) when determining its monetary policy. The report indicated that while economic activity remains at a low level, conditions have improved modestly further, and those improvements are broader geographically than in the last report. Ten districts—compared to eight in the last report—reported some increased activity or improvement in conditions, while the remaining two reported mixed conditions—versus four reporting little change and/or mixed conditions in the last report.

Positive aspects of the release included most districts reporting that consumer spending in the recent 2009 holiday season was slightly greater than in 2008, but still far below 2007 levels. Also, manufacturing activity increased or held steady since the last report in most areas and the release also noted that the manufacturing outlook was optimistic, but spending plans remain cautious. Moreover, the Fed reported that toward the end of 2009, home sales increased in most districts, especially for lower-priced homes, but home prices appeared little changed since the last release and residential construction remained at low levels in most districts. On the inflation front, the report said that price pressures remained subdued in nearly all districts.

On the negative side, commercial real estate was still weak in nearly all districts with rising vacancy rates and falling rents. Additionally, since the last report, loan demand continued to decline or remained weak in most districts, while credit quality continued to deteriorate. On labor conditions, the Fed did note that some hiring was reported in a few districts, but labor market conditions remained generally weak with modest wage increases appearing in just a few districts. All in all, the report offered few major differences from the last report that would suggest a change in the Fed’s impression that “exceptionally low” levels of the fed funds rate are warranted for an “extended period.” We will have to see how the Fed views conditions in the economy at its next monetary policy meeting, which begins on January 26th, and the FOMC is expected leave the fed funds rate unchanged at a range of 0-0.25%.

Meanwhile, crude oil prices, already under some pressure amid the uneasy global economic recovery concerns, moved to session lows following the Energy Information Administration’s oil inventory report, which showed crude oil stockpiles rose by 3.7 million barrels, versus the Dow Jones estimate, which called for oil stockpiles to grow by 1 million barrels. Additionally, the report showed gasoline stocks increased by 3.8 million barrels, versus a 1 million barrel increase forecast, and distillate inventories rose by 1.4 million barrels, compared to the 1.8 million barrel decline that was forecasted. However, crude oil prices have pared losses in afternoon action.

Chinese moves to tighten dominate international economic news

The People’s Bank of China’s (PBOC) late-day announcement yesterday that it will increase the reserve requirements of banks—the amount these firms must set aside in reserve—by 50 basis points effective January 18th took markets and economists by surprise and increased speculation that the PBOC could raise its benchmark lending rate sooner than anticipated, and was the latest in a string of moves by the central bank this year, which included guiding rates higher on a three-month bill auction and a one-year bill auction, as well as remove 200 billion yuan through the execution of a 28-day bond repurchase agreement, to curtail excess liquidity.

After extending a record 9.2 trillion yuan ($1.3 trillion) in new loans during the first eleven months of 2009, markets are concerned that the economy could overheat, and that loans may have been used for speculative purposes, including investment in property. Lending in China should decrease in 2010, and while it’s difficult to determine the likelihood of a Chinese property-bubble burst, banks appear to be well positioned to absorb losses, and funding for projects started in 2009 will likely continue in 2010. However, given the strong gains in emerging market stocks in 2009, risks are elevated and valuations are stretched in some cases. As stimulus exits near, markets could become more volatile, testing the resolve and conviction of investors.

Elsewhere in economic news, the German government reported that 4Q GDP for Europe’s largest economy contracted at a 5.0% annual growth rate in 2009, worse than the 4.8% contraction expected by economists. "At the moment, we are assuming stagnation in quarter-on-quarter terms in the final quarter," said a government spokesman, after the economy grew 0.4% in 2Q and 0.7% 3Q, as stimulus from the expiration of “cash-for-clunkers” ended. In other economic news, Italian industrial production rose by a smaller amount than expected, France’s consumer prices increased slightly more than forecast, and UK industrial production gained more than anticipated.

Measure of US consumer spending on tap for tomorrow

Advance retail sales will likely be the marquee economic report on tomorrow’s economic calendar, and possibly the week for that matter, with the release covering the month of December—one of the most crucial periods for the year in the retailer sector, as it covers a large portion of the holiday shopping season. Headline sales are expected to increase 0.5%, following November’s strong 1.3% increase, while stripping out autos, sales are forecast to increase 0.3%, versus the previous month’s relatively strong 1.2% advance. Traders pay closer attention to the figure excluding the more volatile component of autos as it gives a smoother look at the health of the consumer, which account for about 70% of all economic activity. Sales for December were foreshadowed as being relatively better-than-expected last week as major retailers posted same-store sales—sales at stores open at least a year—that exceeded analysts’ estimates.

Other US economic releases include weekly initial jobless claims, expected to rise to 437,000 from 434,000 the week prior, and business inventories, slated to increase 0.3% in November.

On the international economic calendar, tomorrow brings Japanese machine orders, German CPI, Eurozone industrial production, Chinese new loans, and Australian employment change. Additionally, the European Central Bank meets to discuss monetary policy.