Evening Market Update

Stocks Rise on Economic Optimism

Optimism over the economic recovery was given a boost today after a string of manufacturing reports came in generally better than expected, with highlights coming from an increase in August over July from the two largest economies in the world, the US and China, prompting stocks to end higher and Treasuries suffering in a flight to more risky assets. In other US economic news, mortgage applications rose, while private sector payrolls declined and construction spending fell more than expected. In equity news, Apple Inc unveiled a refresh to its iPod and AppleTV products and a new social networking feature to iTunes, and Burger King Holdings Inc was reported to be the subject of a takeover. Earnings were reported from Heinz Co that were generally inline with forecasts and yesterday’s preannouncement, while Brown-Forman Corp missed estimates. Elsewhere, auto makers reported year-over-year declines in August sales, as last year’s figures included the cash-for-clunkers boost.

The Dow Jones Industrial Average surged 255 points (2.5%) higher to 10,269, the S&P 500 Index gained 31 points (3.0%) to 1,080, while the Nasdaq Composite advanced 63 points (3.0%) to 2,177. In moderate volume, 1.2 billion shares were traded on the NYSE and 2.1 billion shares were traded on the Nasdaq. Crude oil added $1.99 to $73.91 per barrel, wholesale gasoline gained $0.03 to $1.89 per gallon, and the Bloomberg gold spot price lost $2.95 to $1,244.50 per ounce. Elsewhere, the Dollar Index—a comparison of the US dollar to six major world currencies—fell 0.7% to 82.48.

Apple Inc (AAPL $250) released a refreshed product line, in a much-heralded event. A new lineup of iPods updated features to the nano, shuffle and iPod touch. Additionally, an updated version of iTunes was released with a social networking feature called Ping, with CEO Steve Jobs saying it is “Facebook and Twitter meets iTunes.” Another highlight of the event was a revamped strategy to AppleTV, where a new $99 price point for the device and $4.99 movie and $0.99 TV shows rentals will allow customers the ability to stream content from either the internet or Apple mobile devices. Shares rose, but were off the highs of the day.

Burger King Holdings Inc. (BKC $19) was nearly 15% higher after the Wall Street Journal reported that the fast food chain has been in talks with private equity firms in recent weeks regarding a possible sale of the company, citing people familiar with the matter. A spokeswoman for the company declined to comment on the report.

The major automakers are reporting August US auto sales, with General Motors posting a 7% year-over-year (y/y) drop in sales, and Ford Motor Co’s (F $12) sales fell 7.1% y/y, while Chrysler achieved a 7% increase in sales compared to last year, per figures provided by CNBC. However, these figures are being compared to last year’s results that benefitted from the government’s cash for clunkers program, and traders may be discounting the soft y/y sales performance, and shares of F are nicely higher. Other major automakers are set to report sales later today. Elsewhere, Toyota Motor Corp (TM $69) said sales plunged 31.4% as the automaker was an outsized beneficiary of the clunkers program.

H.J. Heinz Co. (HNZ $46) reported that fiscal 1Q revenues rose 1.6% y/y to $2.5 billion, roughly matching the Reuters estimate, and the condiment company confirmed yesterday’s preannounced 1Q EPS of $0.75, which exceeded the Street’s forecast of $0.72. HNZ said organic sales—sales excluding the impact of foreign exchange as well as divestitures and acquisitions—rose 3.6% y/y, as North American gained 4.8% led by ketchup, while emerging markets grew 22% on an organic basis. Shares were near the unchanged mark.

Brown-Forman Corp. (BF/B $59) was solidly lower after the company reported fiscal 1Q EPS of $0.76, below the $0.83 consensus estimate, with revenues increasing 1% y/y to $745 million, also below the $758 million that was forecasted on the Street. The maker of Jack Daniel’s whiskey said that while the environment remains “sluggish,” it posted good underlying growth in sales and gross profit, driven by strong net sales performance internationally.

ISM surprisingly improves, but ADP report shows jobs unexpectedly declined

The ISM Manufacturing Index surprisingly improved to 56.3 in August from 55.5 in July, compared to the expected fall to 52.8 that was expected by economists surveyed by Bloomberg. The reading marks the thirteenth-consecutive month the manufacturing sector has been above the 50 level that separates contraction versus expansion, and indicates the overall economy grew for the sixteenth-straight month.

Within the report, production posted solid growth of 2.9 percentage points to 59.9 and has shown expansion for fifteen-straight months, and employment increased from 58.6 in July to 60.4 in August, recording the ninth-consecutive monthly expansion, which could help curb some of the uneasiness regarding the employment picture and what Friday’s labor report may reveal (economic calendar). However, there were some areas that may garner some negative attention if the trends continue. New orders, a solid gauge of demand, although remaining in growth territory for over a year, has decelerated for three-straight months, and export orders declined by 1.0 percentage point to 55.5. Exports, as noted by the Federal Reserve Chairman Ben Bernanke last week in Jackson Hole, Wyoming, are a third source of domestic demand and export markets are an important reason that manufacturing has been a leading sector in the recovery. The complement ISM Non-Manufacturing index will be released on Friday and is expected to decline from 54.3 in July to 53.2 in August, making the eighth-straight monthly expansion.

Meanwhile, the ADP Employment Change Report showed private sector payrolls declined by 10,000 jobs in August, compared to the forecast of economists surveyed by Bloomberg, which called for a 15,000 increase, and July’s 42,000 job increase was downwardly revised to a 37,000 gain. The release does not include government hiring and firing and comes ahead of Friday’s broader nonfarm payrolls report, where economists expect a decrease of 100,000 in August, after falling 131,000 in July (economic calendar). Excluding government hiring, August private sector payrolls are expected to increase 42,000, after expanding by a disappointing 71,000 in July.

Elsewhere, construction spending fell more than expected, dropping 1.0% in July, compared to the 0.5% decline that was expected, and June’s 0.1% increase was revised to a 0.8% drop. Residential and nonresidential spending both posted declines.

In other economic news, the US MBA Mortgage Application Index rose 2.7% last week, after the index that can be quite volatile on a week-to-week basis, gained 4.9% in the previous week. The gain came as the Refinance Index increased 2.8%, teaming up with 1.8% growth in the Purchase Index. The increase in the overall index came amid a 12 basis-point decline in the average 30-year mortgage rate to 4.43%, a new record low.

The aforementioned favorable US ISM Manufacturing report had Treasuries extending early losses that came from improved sentiment regarding the economic recovery in the wake of strong manufacturing data out of China and a much better-than-expected 2Q GDP report out Australia. The yield on the two-year note was 4 bps higher at 0.51%, the yield on the 10-year note rose 11 bps to 2.58%, and the 30-year bond yield advanced 13 bps to 3.65%.

China and Australia economic news lifts recovery spirits

Markets globally cheered the rebound in the Chinese PMI Manufacturing indexes, which unexpectedly increased in August over July. The CFLP PMI Index, which the Chinese government issues and is primarily a reading on state-owned enterprises, rose from 51.2 in July to 51.7 in August, above the 51.5 that economists had expected. Also, the HSBC Markit report, which includes private enterprises, showed Chinese Manufacturing PMI rebounding from a level depicting contraction to a reading of growth, as the index increased from 49.4 in July to 51.9 in August. Within the CFLP index, production and orders both accelerated in August, while export orders in the broader index fell to 49.5 in August from 49.8 in July.

Aiding the bullish sentiment, Australia reported much better-than-forecasted domestic output, as its 2Q GDP increased 1.2% quarter-over-quarter (q/q), after increasing 0.7% in 1Q, above the 0.9% growth that was expected. Also, on a y/y basis, 2Q GDP down under rose 3.3%, after posting 2.6% growth in 1Q, and well above the 2.8% increase in output that had been forecasted.

Purchasing manager reports for the manufacturing sector were released across the globe, with the majority showing a deceleration, but were generally better than expected. Highlights include the euro-zone PMI, which at 55.1 rose 0.1%, and was better than the forecast of 55.0, as France bested estimates, and Germany remained at a strong 58.2. Disappointing results were seen in the UK, which fell to 54.3 from 56.9 in the month, while the expectation was 57.0, Brazil fell to 49.5 from 51.8, and export powerhouse South Korea fell to 50.9 from 53.2. Elsewhere, decelerating manufacturing PMI reports were issued in India, Taiwan, Switzerland, Spain, and Italy. Outside the manufacturing sector, retail sales in Germany—Europe’s largest economy—unexpectedly fell month-over-month (m/m) in July.

Tomorrow brings yet another reading on both jobs and housing

Tomorrow’s US economic calendar will be highlighted by weekly initial jobless claims, forecast to increase slightly to 475,000 from 473,000 the week prior. Additionally, factory orders are expected to increase 0.2% in July after falling 1.2% in June and pending home sales are anticipated to decline 1.0% in July after falling 2.6% in June. Elsewhere, final 2Q nonfarm productivity will be released, expected to decline by 1.9% while unit labor costs rose 1.2%.

In international economics, the second reading on euro-zone 2Q GDP, as well as PPI for the euro-zone, UK housing prices, French unemployment, and Swiss 2Q GDP will be released. Additionally, the European Central Bank and Bank of Brazil will meet to discuss monetary policy, where no changes are expected from either central bank.

Senior Market Analyst, Michelle Gibley, CFA, offers analysis of the South American nation in her latest article, Country Focus: Time to Consider Brazil?, noting that Brazil’s long-term outlook remains positive, while near-term risks, such as election uncertainty and Petrobras’ capital raising, have the potential to subside in coming months, and rate hikes could be easing. Read the rest of her analysis at www.schwab.com/oninternational.