Evening Update

Stocks Falter on Banking and Credit Cost Concerns

In the final day of trading before a three-day holiday weekend, markets were led lower by weakness in the financial sector as JPMorgan Chase missed analysts’ revenue target and added $1.9 billion to its loan loss reserves. In related financial news, all the major credit card issuers issued charge-off and delinquency results for December, with Capital One Financial and Bank of America reporting increases in change offs. In other equity news, Intel announced earnings that beat top and bottom line expectations for Q4, Verizon Wireless lowered prices on multiple calling plans, and US-based cosmetics firm Bare Escentuals agreed to be acquired by Japanese firm Shiseido Co. Treasuries finished the day higher on multiple economic reports, including the industrial production report that matched expectations, New York manufacturing activity rising more than anticipated, and consumer sentiment failing to match expectations. All US markets will be closed on Monday, in observance of Martin Luther King Jr. Day.

The Dow Jones Industrial Average fell 101 points (0.9%) to close at 10,610, the S&P 500 Index dropped 12 points (1.1%) to 1,136, while the Nasdaq Composite lost 29 points (1.2%) to 2,288. In moderate volume, 1.4 billion shares were traded on the NYSE and 2.6 billion shares were traded on the Nasdaq. Crude oil was $1.39 lower at $78.00 per barrel, wholesale gasoline decreased $0.02 to $2.05 per gallon, and the Bloomberg gold spot price fell $11.40 to $1,131.45 per ounce. Elsewhere, the Dollar Index—a comparison of the US dollar to six major world currencies—was down 0.66% to 77.24. For the week, the DJIA lost 0.1%, while the S&P 500 Index fell 0.8%, and the Nasdaq Composite declined by 1.3%.

Dow component JPMorgan Chase (JPM $44) reported 4Q EPS of $0.74, compared to the estimate of Wall Street analysts, which called for the company to post EPS of $0.61, while net revenues were $25.2 billion, which missed the Street’s forecast of $26.8 billion. JPM said it benefitted from the diversity of its leading franchises, as it had continued earnings strength in its investment bank, commercial banking, asset management, and its retail banking franchises. The company’s investment banking unit saw its fees jump 38%, on sharp increases in debt and equity underwriting. However, JPM’s consumer lending unit weighed on results on credit costs, leading to the addition of $1.9 billion to its loan loss reserves. The company’s CEO James Dimon said, “While we are seeing some stability in delinquencies, consumer-credit costs remain high, and weak employment and home prices persist. Accordingly, we remain cautious.” The company’s Chief Financial Officer said it would boost its dividend this year, “if we’re lucky,” in a conference call with analysts, per Reuters. Shares finished lower. Traders will anxiously await earnings reports from the other major banks next week, including Citigroup (C $3), Goldman Sachs (GS $166), Wells Fargo (WFC $28) and Morgan Stanley (MS $31).

Adding to the backdrop of credit-cost uneasiness, Capital One Financial (COF $41) announced that US credit-card charge offs—balances that the company does not think will be paid off—increased from 9.6% in November to 10.14% in December. However, COF said card delinquencies—accounts at least 30 days past due and an indicator of possible future charge offs—dropped from 5.87% in November to 5.78% for December. Elsewhere, Dow member American Express (AXP $42) announced that its US delinquency rate dipped from 3.9% in November to 3.7% in December, and its charge off rate decreased from 7.6% to 7.1%. Discover Financial (DFS $15) reported a December delinquency rate of 5.49%, down from 5.65% in November and a decrease in charge-offs from 8.98% to 8.68%. Rounding out the credit-card issuers is Bank of America (BAC $16), whose 13.53% charge-off rate in December was the highest among issuers who have reported so far and rose from 13% in November, reversing a three month trend of decline. All four credit-card issuers traded lower.

Fellow Dow member Intel (INTC $21) reported 4Q EPS of $0.40, ten cents above the Street’s forecast, with revenues jumping 28% versus last year to $10.6 billion, also besting forecasts of analysts, which called for the company to post $10.1 billion in revenues. Compared to 3Q, INTC’s PC client group revenues rose 10%, while its data center group sales grew by 21%. The company added that its Atom microprocessor and chipset revenues were up 6% versus last quarter. The Dow member said its gross profit margin during the quarter was a record 65%—up 12 percentage points versus last year—as the average selling price for microprocessors was up sequentially. The company said it expects 1Q revenue of $9.7 billion, versus analysts’ estimates of $9.3 billion, and it expects the gross margin is expected to be 61%, plus or minus 2 percentage points. Despite the results, INTC was lower.

Verizon Wireless—jointly owned by Dow member Verizon (VZ $31) and Vodafone (VOD $22)—announced that it will lower its unlimited talk plan from $99 per month to $69.99 and cut its baseline voice plan to $40 per month, with unlimited texting costing an additional $20 per month. The move is expected by some analysts to be followed by a similar action from Dow component AT&T (T $26). AT&T has not commented on the announcement. Verizon Wireless also announced that it will charge a monthly fee for certain phones that have the capability to browse the web and to run applications, and new options for its family share plans. In an interview last week, Verizon’s Chief Technology Officer said that wireless firms will eventually have to change their billing methods to charge customers for data used, instead of a flat fee for unlimited use, in order to prevent networks from being overloaded. Shares of all three firms mentioned were lower.

Shiseido Co, (SSDOY $22) Japan’s largest cosmetics maker, per Bloomberg, agreed to acquire California-based Bare Escentuals (BARE $18) for about $1.7 billion in cash. A US subsidiary of Shiseido will offer to purchase all outstanding shares of BARE fro $18.20 per share, representing a 40.8% premium to BARE’s average closing price over the last three months. The deal is expected to expand Shiseido reach into the mineral-based cosmetics market. BARE was up over 40%, and Shiseido was also higher in US trading.

Consumer inflation remains subdued, New York manufacturing expands above forecasts

The Consumer Price Index showed prices at the consumer level rose 0.1% month-over-month (m/m) in December, below the forecast of economists surveyed by Bloomberg, which called for the index to rise 0.2%. The core rate, which strips out food and energy, also increased by 0.1% m/m for December, inline with what the Street had expected. While food and energy is the smallest component in the CPI basket, it tends to be the most volatile and often explains a majority of changes in the index at the headline level. On a year-over-year basis, consumer prices were up 2.7% in December, compared to the forecast of 2.8%, and the core CPI was 1.8% higher year-over-year, matching expectations.

Meanwhile, industrial production was also released this morning, and showed a 0.6% m/m increase in December, inline with estimates, while November was revised down and October was revised up. December’s gain primarily resulted from a 5.9% increase in utilities due to unseasonably cold weather, while manufacturing edged down 0.1%, business equipment was up 0.9%, and the output of mines rose 0.2%. For the 4Q as a whole, production rose at an annual rate of 7.0%, with consumer goods increasing at an 8.0% annual rate, business equipment up at a 2.2% annual rate, and the production of materials increasing at a 9.3% annual rate.

Despite the increase in capacity utilization to 72.0%, above the 71.8% forecast, and revisions higher to November and October, utilization remains 8.9% below its long-term average, and combined with high unemployment and an excess in housing, explains why the increase in the year-over-year CPI headline rate - due to lapsing easy comparisons due to changes in energy prices – is less important than changes in the core CPI, with the ability for businesses to pass along price increases subdued.

In other economic news, the Empire Manufacturing Index, a measure of manufacturing in the New York region, rose in January to a level of 15.92, and remains above the level of zero that suggests conditions are neither contracting nor expanding. Economists surveyed by Bloomberg expected an improvement to 12.00, following the previous month’s upwardly revised level of 4.50. The report is the first major piece of data looking at manufacturing conditions in January, and next week, the Philly Fed Manufacturing Index will be released, expected to decrease from 20.4 in December to 18.0 in the current month, providing further insight into the health of the sector.

Elsewhere, the preliminary University of Michigan Consumer Sentiment improved by a smaller amount than expected, increasing from 72.5 in December to 72.8 in January, versus the Bloomberg forecast, which called for an increase to 74.0. The current conditions component of the report advanced from 78.0 in December to 81.0, but the expectations component deteriorated from 68.9 to 67.5. Inflation expectations moved higher with the one-year outlook increasing from 2.5% to 2.8%, and the five-year expectation rose slightly from 2.7% to 2.8%.

Treasuries were higher as the yield on the 2-year note fell 5 bps to 0.87%, the yield on the 10-year note decreased by 6 bps to 3.67%, while the yield on the 30-year bond lost 4 bps to 4.58%.

Chinese housing prices continue sharp increase

In international economic news, Germany’s wholesale prices rose by a smaller-than-expected amount month-over-month (m/m) in December, Eurozone consumer prices rose m/m in December, in line with the forecast of economists surveyed by Bloomberg, while the trade balance in the Euro area fell to 4.8 billion euros in November, compared to the estimate, which called for the trade balance to come in at 7.0 billion euros. In China, housing prices continued to soar in December, climbing 7.8% y/y in December, which is the fastest increase in 18 months and an acceleration from November, when price rose by 5.7% y/y. China is attempting to slow price increases by enforcing policies to limit speculative investments and requiring a minimum down-payment ratio of 40% for everyone except first-time homebuyers. Approximately 20% of all loans issued by Chinese banks go to the property sector and these banks made nearly four times more mortgage loans in the first 3 quarters of last year than were extended in all of 2008.

Sentiment has negative reaction to earnings season and China’s actions

The bulls faced some adversity this week and stocks came under pressure as 4Q earnings season got underway, financials found some resistance and China made multiple moves to prevent asset bubbles from forming. Dow member Alcoa (AA $16) unofficially kicked off the earnings season in lackluster fashion, posting a smaller-than-expected profit excluding items, and pressuring sentiment as traders have ramped up expectations for profits in 4Q. Financials also came under pressure this week to weigh on stocks, amid the aforementioned credit-cost concerns, which exacerbated the proposal by the Obama Administration unveiled his plan for a new tax on large financial firms, which was dubbed the “Financial Crisis Responsibility Fee,” aimed at recouping taxpayer funds from the Treasury’s Troubled Asset Relief Program (TARP), which were used to bailout the banking and auto industries.

Uneasiness in the US equity markets also came from abroad, as China announced some effort to help prevent excessive speculation and follow through on recent pledges to keep excess liquidity in check. The People’s Bank of China (PBOC) announced that it will increase the reserve requirements—funds that banks must set aside—by 50 basis points. Moreover, the PBOC increased interest rates on a 20 billion yuan one-year bill auction, the second time in a week the bank has increased interest rates on an auction, and said the PBOC will remove 200 billion yuan through the execution of a 28-day bond repurchase agreement, to curtail excess liquidity. The moves by China elevated concerns about the continuation of the global economic recovery as the Asian nation led the world economy out of the recession.

The US economic front offered little to help the resurfacing concerns about the economic recovery as retail sales unexpectedly declined—but November’s figure was upwardly revised to an even stronger gain—weekly initial jobless claims increased more than anticipated, and the trade deficit widened more than expected, which suggested the potential of a larger drag of net exports on GDP. However, not all the data was bad as the Beige Book showed economic conditions have improved modestly further, and those improvements were broader geographically than in the last report.

Holiday shortened week light on economic data despite heavy earnings calendar

The earnings calendar will lead the marquee next week, as trading is shortened due to Monday’s market closure in observation of the Martin Luther King holiday, and there is a light schedule for economic data. The first major economic release is expected on Wednesday, with the Producer Price Index (PPI) for the month of December, which is forecast to be flat m/m, after jumping 1.8% in November on a surge in energy prices. Excluding food and energy, the core rate is expected to rise 0.1% in December, after November’s hotter-than-expected reading of 0.5% was influenced by a 4.2% increase in prices for light motor trucks and rise in cigarette prices. On a y/y basis, the headline price is expected to jump 4.4%, while the core rate is forecasted to increase a more subdued 1.0%.

Housing starts for December will also be reported on Wednesday, expected to be up a mere 0.2% m/m in December to an annual rate of 575,000, experiencing volatility around the initial expiration of the tax credit, which influenced a 10.1% drop in October and 8.9% jump in November. Building permits, one of the leading indicators tracked by the Conference Board, are forecasted to decrease 1.5% m/m after declining 4.2% m/m in October and increasing 6.9% in November. Despite new home sales falling in three of the past four months, and still low homebuilder sentiment, builders have been slowly constructing fresh supply, as inventory levels fell to very low levels in early 2009, and builders have had to transition to smaller and more affordable homes to meet consumer preferences and buying power.

Other releases on the US economic calendar include the NAHB Housing Market Index, MBA Mortgage Applications, initial jobless claims, the Index of Leading Economic Indicators, and the Philadelphia Fed’s Business Activity Index.

International economic releases include Japanese consumer sentiment, industrial production, machinery orders, leading indicators and department sales, the Bank of Canada’s monetary policy meeting, UK CPI, employment and retail sales, as well as PPI and the Zew survey of investor sentiment in Germany. Due to the focus on global growth driven by China, there will be plenty of focus on the country’s slew of data due out on Wednesday night which includes 4Q GDP, PPI, CPI, retail sales, industrial production and fixed asset investment.