Evening Market Update

Late-Day Weakness Erases Gains, Dow Drops Below 10,000

Stocks ended the day in the red, after early gains on the heels of strong housing data were washed away in the final hour of trading, reminding investors of the risk and volatility that have emerged in the markets. On the economic front, durable goods orders and mortgage applications both saw greater-than-expected increases, while new home sales rose to the highest level in two years. Treasuries finished the day lower, but off the day’s lows, after the auction of $40 billion in five-year notes. In equity news, Vertex Pharmaceuticals announced promising results in a late-stage clinical drug trial, while the New York Times is reporting that Apple Inc is the subject of an informal inquiry into its business practices in the music business. Elsewhere, Toll Brothers reported a 2Q loss, but topped analysts’ expectations, Fidelity National Information Services announced a Dutch tender offer for $2.5 billion of its shares, AIG’s CEO said the company is “on a clear path to repaying taxpayers” and the SEC is charging an ex-employee of Walt Disney Corp with trying to sell insider information.

The Dow Jones Industrial Average fell 69 points (0.7%) to close at 9,974, the S&P 500 Index declined 6 points (0.6%) to finish at 1,068, and the Nasdaq Composite lost 15 points (0.7%) to 2,196. In heavy volume, 1.9 billion shares were traded on the NYSE and 3.0 billion shares were traded on the Nasdaq. Crude oil gained $2.22 to $70.97 per barrel, wholesale gasoline rose $0.03 to $1.96 per gallon, and the Bloomberg gold spot price jumped $8.60 to $1,212.85 per ounce. Elsewhere, the Dollar Index—a comparison of the US dollar to six major world currencies—was up 0.9% to 87.19.

Vertex Pharmaceuticals (VRTX $35) were higher after a late-stage clinical trial showed its experimental hepatitis-C drug made treatment more effective when added to a standard therapy The data showed that three-quarters of patients who had not previously been treated had a sustained viral response, or viral cure, after using the drug for 12 weeks in combination with the standard therapy. The company will report the data from two other large trials in the third quarter and will file for approval in the second half of 2010.

Luxury homebuilder Toll Brothers (TOL $21) reported a 2Q net loss of $0.24 a share, a penny above Street forecasts, after revenue fell 22% to $311.3 million. TOL said it believes a recovery is underway in the housing market and is adding land for the first time since 2006. The CEO said that activity in May suggests that “for us the tax credit wasn’t the determinative factor – rather, we believe, the past few months’ activity has been driven by an increase in confidence among our buyers in their job security, their ability to sell their existing homes, and general trends in home prices.” Net signed contracts rose 41% and the cancellation rate fell to 5.3% from 21.7% a year earlier. Backlog increased to $993.5 million as of April 30, the first quarter-over-quarter increase in three years. Shares were higher.

Apple Inc’s (AAPL $244) music-business practices are the subject of an informal inquiry by the US Justice Department according to The New York Times, citing people familiar with the matter. The agency is looking at whether Apple pressured music publishers to not give Amazon.com Inc (AMZN $123) one day of exclusive access to music that is about to be released so that Apple could create marketing promotions around the music. A spokesman for the Justice Department declined to comment, as did a spokesman for Apple. Amazon representatives could not be reached. Shares of both companies traded lower.

Payments processor Fidelity National Information Services (FIS $27) said its board has authorized a $2.5 billion stock repurchase plan in a modified Dutch tender offer, with the price to be between $29-31 per share, depending on demand. This “leveraged recap,” where the company expects to incur about $2.5 billion in debt to pay for the offer, is in addition to the 13.6 million shares remaining in an existing three-year buyback program. The announcement comes shortly after a rumored deal in which FIS would be acquired by a consortium of private-equity firms collapsed due to a disagreement on price. Shares finished higher.

Walt Disney Co (DIS $33) traded higher after an ex-Disney corporate communications employee was charged with conspiracy and wire fraud, allegedly offering to sell information to hedge funds. CNBC is reporting that the compliant noted CEO Iger was in negotiations with private equity firms to sell the ABC television network. Disney commented that “the reference in the complaint to conversations regarding ABC Network were and are false.” The advance in the stock was already underway along with the broader market, and shares showed little reaction to the news.

American International Group (AIG $34) CEO Robert Benmosche, in an appearance before the congressional oversight panel overseeing the government’s response to the financial crisis, said “AIG is now on a clear path to repaying taxpayers”, adding “in recent months, we have become less reliant on government aid.” The insurance giant has received $132 billion in taxpayer aid since the financial crisis began, including $49 billion from the Troubled Asset Relief Program (TARP), which gave the US Treasury a nearly 80% stake in the company. AIG is in the process of selling two international life insurance subsidiaries, AIA and AILCO, for a total of about $51 billion, and Benmosche added that AIG is “working hard” to complete the sales by the close of this year. Shares of AIG were lower.

Durable goods orders rise and mortgage apps jump, new home sales surge

Durable goods orders rose 2.9% month-over-month (m/m) in April, higher than the forecast of a 1.3% increase, while ex-transportation, orders fell 1.0%, while the expectation was for a 0.5% increase. Prior months were revised higher for both measures, with the headline figure coming in unchanged in March versus the initially reported 1.3% decline, and the ex-transportation figure was adjusted higher to 4.8% in March versus the previously reported 2.8% increase. Non-defense capital goods excluding aircraft, considered a good proxy for business spending, fell 2.4% in April after jumping 6.5% in March, and are up at a 22% annual pace over the past three months, up from 15% in March. The durable goods data is volatile on a month-to-month basis as the large size of orders for items such as airplanes and military equipment can have a tendency to distort the data.

New home sales rose 14.8% m/m in April to an annual rate of 504,000 units, much higher than the increase to 425,000 units that was anticipated, and are considered a more timely indicator of conditions in the housing market than existing home sales, as they reflect contract signings. Existing home sales data was released Monday, and showed a 7.6% m/m increase to an annual rate of 5.77 million units. Prior month’s sales figures were revised higher. The average price for a new home fell 9.5% year-over-year to $198,400 and declined 9.7% m/m. Inventory of new homes for sale fell to 211,000 units, representing 5.0 months of supply at the current sales rate, and represented the fewest number of new homes for sale since 1968, according to Bloomberg. Treasuries moved lower on the rise in equities, even after the auction of $40 billion in five-year notes drew a yield of 2.13%, the lowest yield in more than a year. The yield on the 2-year note was up 2 bps to 0.81%, while the yield on the 10-year note gained 3 bps to 3.18%, and the 30-year bond yield increased 3 bps to 4.09%.

Purchases of new homes rose to the highest level in two years as buyers rushed to qualify for the tax credit, as contracts needed to be entered by the end of April to close before the June expiration. Real estate professionals are reporting that while the housing market could see a temporary fallback after the expiration of the tax credit, buyer confidence has returned amid high affordability with mortgage rates low and the prior steep declines in prices.

In other economic news, the US MBA Mortgage Application Index jumped 11.3% last week, after the index, that can be quite volatile on a week-to-week basis, fell 1.5% in the previous week. The increase came amid a 3.3% increase in the Purchase Index, which tumbled 27.1% the week before, and a 17% surge in the Refinance Index, which rose 14.5% the prior week. The share of applications filed to refinance rose to 72% of total applications from 68% the previous week. The increase in the overall index came after a 3 basis-point decrease in the average 30-year mortgage rate, which declined to 4.80%, closer to the record low of 4.61% that was reached at the end of March 2009.

Focus in Europe turns to banks

Concerns about the problems swirling around the euro-area debt crisis spilling over to the region’s banking sector have been exacerbated within the last two days as the markets saw four regional savings banks in Spain “pushed” to merge with stronger partners in the region, and one regional bank taken over by the Bank of Spain. Today, Ireland’s central bank said that some of the country’s banks “are not moving with purpose” and a Polish newspaper is reporting that Poland is considering putting together a consortium of local companies to bid for a 70% stake in Bank Zachodni WBK that is being sold by Allied Irish Banks Plc (AIB $3), citing unnamed sources. Meanwhile, European Union Financial Services Commissioner Barnier said that banks should be taxed to pay for future crises and CNBC is reporting that US Treasury Secretary Geithner is urging Europeans to conduct a bank stress test. Elsewhere, Italy’s government approved 24 billion euros ($30 billion) in budget cuts that include a three-year wage freeze for civil servants and a crackdown on tax evasion to address a deficit of 5.3% in 2009 and a debt-to-GDP ratio of 115.8%.

In European economic news, mortgage applications in the UK rose m/m and 15% year-over-year, consumer confidence in Germany fell, and French consumer spending declined worse than forecast at 1.2% m/m, versus the expectation of a 0.5% decrease.

In Asia/Pacific news, minutes from the last Bank of Japan (BoJ) monetary policy meeting implied that some members believed there were few options left to further stimulate the economy. Several BoJ members said that the bank should “devise ways to avoid excessive involvement in resource allocation among individual firms.” Elsewhere, the Shanghai Securities News reported China will allow domestic insurers to invest in shares listed on the Hong Kong exchange, while current regulations allow investments only in Hong Kong H-shares and red chips.

Second reading on 1Q GDP growth in the US due out tomorrow

Tomorrow provides the second look at 1Q Gross Domestic Product (GDP), expected to show growth of 3.4% quarter-over-quarter annualized, an upward revision to the originally reported 3.4% growth, while 4Q GDP was 5.6%. Additionally, personal consumption is expected to be upwardly revised to 3.8% from 3.6%, an acceleration from the 4Q pace of 1.6%. Since the first GDP report, we have seen strong factory orders and construction spending reports for March, as well as increases in consumer spending and both wholesale and business inventories for the final month of 1Q, which may help explain the forecast for an upward revision.

In the first release of 1Q GDP, contributions to growth were more evenly distributed during the first quarter relative to the fourth quarter, as inventory building added 1.6% to 1Q GDP, while last quarter’s 3.8% contribution was a disproportional percentage of growth, consumer spending added 2.6% this quarter and capital spending on equipment and software contributed 0.8%. Meanwhile, net exports subtracted 0.6%, as imports (a subtraction from GDP) outpaced exports, and while federal government spending contributed 0.1%, state and local government deducted 0.5%. Residential construction subtracted 0.3% and commercial real estate investment deducted 0.4%.

The other releases on the US economic calendar tomorrow is weekly initial jobless claims, which economists are expecting to fall to 455,000 from a previous reading of 471,000.

International economic releases tomorrow include Japan’s trade balance, German CPI, French consumer confidence, Italian business confidence, Brazilian unemployment, as well as Australian leading indicators and capital expenditures.