Evening Market Update

Traders Look to Holiday and Book Yesterday’s Profits

Markets closed decisively lower on Friday headed into a holiday weekend. Losses were pared midday despite a downgrade of Spain's credit rating by Fitch that was seen as lagging to action already taken by S&P, but stocks fell anew in the last hour of trading. Treasuries were higher as equities erased some of yesterday’s gains, and as personal spending fell short of estimates and the Chicago Purchasing Managers Index fell more than expected, while consumer sentiment was revised upward. In light equity news, Apple Inc's iPad went on sale internationally to long lines in Japan, J. Crew Group Inc and Guess? Inc reported better-than-expected earnings, while Lowe's Companies Inc increased its quarterly dividend.

The Dow Jones Industrial Average lost 122 points (1.2%) to close at 10,137, the S&P 500 Index fell 14 points (1.2%) to finish at 1,089, and the Nasdaq Composite decreased 21 points (0.9%) to 2,257. In moderate volume, 1.5 billion shares were traded on the NYSE and 2.1 billion shares were traded on the Nasdaq. Crude oil lost $0.58 to $73.97 per barrel, wholesale gasoline fell $0.01 to $2.03 per gallon, and the Bloomberg gold spot price gained $1.60 to $1,214.25 per ounce. Elsewhere, the Dollar Index-a comparison of the US dollar to six major world currencies-rose 0.6% to 86.71. For the week, the DJIA lost 0.6%, while the S&P 500 Index rose 0.2%, and the Nasdaq Composite advanced 1.3%.

Apple Inc. (AAPL $257) was higher in afternoon action as its iPad went on sale in nine countries, including Australia, Canada, Japan, and the UK, as well as other major countries in Europe. The Wall Street Journal reported that analysts estimate AAPL will sell about 1.7 million iPads in the April to June quarter and 5.0 million units worldwide for the year.

J. Crew Group Inc. (JCG $46) reported 1Q EPS of $0.68, above the $0.57 consensus estimate of Wall Street analysts, with revenues increasing 20% year-over-year (y/y) to $414 million, besting the $395 million that the Street was looking for. US same-store sales-sales at stores open at least a year-rose 15% y/y and the retailer’s gross margin rose on decreased markdowns and promotional selling. JCG was nicely higher after the results, which also revealed an increased full-year EPS outlook by the company.

Guess? Inc. (GES $38) announced 1Q EPS of $0.54, compared to the $0.49 that analysts were expecting, with revenues increasing 22% y/y to $539 million, above the $507 million that the Street was forecasting. US same-store sales rose 9.7% y/y, and the company said all its business segments delivered double-digit revenue and operating earnings growth. However, the company lowered its full-year EPS outlook, based on the continued strengthening of the US dollar against the euro, which is expected to have a further negative translation and margin impact on EPS. Shares gave up an early gain and were lower.

Lowe's Companies Inc. (LOW $25) reported that it will increase its quarterly cash dividend by 22% to $0.11 per share, which will be payable August 4, 2010. Shares were lower.

Personal spending disappoints, Chicago business activity drops, and sentiment rises

Personal income was 0.4% higher in April, inline with the Bloomberg estimate, while March's 0.3% increase was revised to a 0.4% gain. Personal spending was unchanged in April, compared to expectations of a 0.3% rise, and March's 0.6% increase was left unrevised. The savings rate increased to 3.6% in April, after an upwardly revised 3.1% reading for March.

Also, the PCE Price Index, which is released with the income and spending data, was up 2.0% y/y in April, the same increase as the previous month, and slightly above the consensus forecast of a 1.9% increase. The core PCE Price Index, which excludes food and energy, was 0.1% higher month-over-month (m/m), matching expectations. Year-over-year, core prices moved 1.2% higher, above the consensus of economists surveyed, which called for a 1.1% gain.

Elsewhere, the University of Michigan's Consumer Sentiment Index increased by a larger amount than initially reported in the preliminary release, rising from 73.3 to 73.6 in May, compared to the expectation of economists, who forecasted an unchanged reading. The 73.6 level is above the April level of 72.2, but matches the readings that were posted in March and February. The upward revision came as the economic outlook component of the report increased to 68.8 from 68.3 in the preliminary report, and from 66.5 in April.

In other economic news, Chicago PMI fell more than expected, falling from 63.8 in April to 59.7 in May, compared to the decline to 61.0 that was forecasted by economists. The index of business activity in the midwest continued to expand as a reading of 50 is the demarcation point between expansion and contraction, but key components of the report such as production, new orders, and order backlogs all deteriorated in May. Also, the employment component fell out of expansion territory, dropping from 57.2 in April to 49.2 in May.

Treasuries were higher, extending early gains that followed the mixed bag of economic data, after Fitch cut Spain’s credit rating, causing some euro-area fears to resurface and prompt some flight-to-safety buying. The yield curve steepened, as the yield on the 2-year note fell 11 bps to 0.77%, the yield on the 10-year note lost 8 bps to 3.29%, and the 30-year bond yield decreased 5 bps to 4.20%. Please note all US markets will be closed on Monday in observance of Memorial Day.

Spain rating downgrade after trading in Europe closes

Following the European market close, Fitch Ratings lowered Spain's credit rating to AA+ from AAA, citing a reduction in growth of the economy due to the process of adjusting to a lower level of private sector and external indebtedness, while recognizing that "it’s still a high rating" as public finances are strong and the government is committed to fiscal reform. Spain's debt-to-GDP in 2009 at 53% is lower than many other European nations, while its deficit is elevated at 11.2% last year. The reaction to the move was somewhat muted, as Standard & Poor's lowered Spain's rating to AA on April 28.

In European economic news, UK consumer confidence unexpectedly deteriorated in May, Sweden's 1Q GDP expanded more than forecast, while a separate report showed Swedish retail sales unexpectedly fell in April. Also, German import prices rose more than anticipated, Switzerland's trade surplus widened, and Italy’s producer prices increased.

Asia/Pacific economic news was dominated by a mixed bag of economic reports from Japan, headlined by an unexpected modest increase in Japan’s jobless rate to 5.1% in April, and a larger-than-expected drop in the nation's Consumer Price Index for April. Other reports included an unexpected increase in Japanese retail trade and a smaller-than-forecasted decline in the nation’s large retailers' sales for April.

Stocks remain at the mercy of the international front

Bulls may be suffering from some motion sickness as volatility continued this week, with the equity markets continuing to hang on the headlines coming out Europe and Asia. Spain contributed to the lion’s share of the euro-area news, while geopolitical concerns as tensions rose between North and South Korea and China’s comments on the euro added to the swings in the markets.

Equity markets came under pressure in the first half of the week on the news that North Korea ordered its military to be on alert and Spain bailed out a regional bank over the weekend. Moreover, a separate report suggested that Spain is pushing four regional savings banks to merge with stronger partners, overshadowing the narrowly approved-it passed by one vote-15 billion euro austerity plan by the Spanish Parliament. The uneasiness toward the euro-area and geopolitical concerns in Korea were exacerbated by reports that China was reconsidering its foreign exchange holdings of the euro, which led to a late-day slide in the US and the week appeared to be poised for another finish below the flatline. However, China's denial of the report the following day, helped spark a steep rally and US stocks overcame the week's losses and post modest gains ahead of the Memorial Day Holiday weekend. But, the gains in the equity markets were threatened by Friday afternoon’s downgrade of Spain's credit ratings.

A mixed bag of US economic data did little to help traders find conviction, adding to the week's volatility, with steep gains in existing and new home sales being tempered by skepticism about whether the housing market will prosper after the effect of the homebuyer tax credit wears off. Also, an unexpected downward revision to US 1Q GDP and a smaller-than-expected drop in weekly initial jobless claims took the shine off a greater-than-expected increase in durable goods orders.

Shortened week to be highlighted by employment report

After coming back from a three-day holiday weekend, traders will be digesting the ISM Manufacturing Index on Tuesday, which is expected to show a decrease to 59.4 in May from 60.4 in April, with 50 being the level that separates contraction versus expansion in the economy. Meanwhile, the ISM Non-Manufacturing Index, which has been more volatile on a month-to-month basis, is expected to increase to 55.8 from 55.4, and will be released on Wednesday. The manufacturing sector expanded for the ninth-consecutive month in April and was the fastest since June 2004, while the services index came in flat, posting only six readings in expansion territory over the past eight months, suggesting manufacturing activity continues to lead the economic recovery. Manufacturing has been stronger on export strength and as factories ramped up after businesses allowed inventories to plunge by unsustainable amounts, however manufacturing strength could be hampered later in the year as a stronger dollar could weigh on the price competitiveness of US exports.

Nonfarm payrolls will headline the week on Friday, with the Bloomberg survey of economists forecasting payrolls grew by 500,000 in May after increasing 290,000 in April, while excluding government hiring, private sector payrolls are expected to increase 175,000, after expanding by 231,000 in April. Temporary hiring for the Census is distorting the headline number, as it added 66,000 in April, while the government has said that Census hiring could peak in May at nearly 500,000, while state and local and postal service jobs have continued to decline. The unemployment rate is estimated to decline to 9.8% from 9.9%, after the rate increased in April from 9.7% as workers re-enter the workforce as job openings increase.

Other releases on next week’s busy US economic calendar include construction spending, factory orders, pending home sales, MBA Mortgage Applications, ADP Employment Change Report, nonfarm productivity, initial jobless claims, and consumer credit.

Elsewhere in the Americas, Canada releases 1Q GDP, industrial product prices, building permits and employment, while Brazil announces manufacturing PMI and industrial production.

In Europe, releases include euro-zone business and consumer confidence, CPI, PPI, retail sales, 1Q GDP, UK and euro-zone manufacturing and services PMI reports, and UK mortgage approvals, housing prices, consumer credit, as well as and German retail sales and unemployment.

In the Asia/Pacific region, announcements include Japan's manufacturing PMI, vehicle sales, industrial production, housing starts, construction orders, vehicle sales, monetary base, capital spending, China and India's manufacturing PMI indexes, and Australian new home sales, retail sales, 1Q GDP, housing prices and building approvals.

Several central banks meet to discuss monetary policy, including the Bank of Canada and Reserve Bank of Australia.