Evening Market Update

Fed and Election Results Inline, Market Yawns

While the day yielded historic news, after the Federal Reserve announced an additional asset purchase program of $600 billion in longer-term Treasury securities and the mid-term elections resulted in one of the most one-sided outcomes in many years, the results of both were widely telegraphed and the small reaction in the stock market suggested the outcomes were already priced in. The Fed’s purchase program is in addition to the program to reinvest principal payments from its mortgage-backed security portfolio, and taken together, the program will total $850-900 billion by the end of 2Q 2011. In other economic news, the ISM Non-Manufacturing Index rose more than expected, ADP reported a larger increase in private sector jobs than forecast, and factory orders surprised to the upside, while mortgage applications fell. Treasuries were more volatile than the equity markets and ended mixed, with the yield curve steepening. Among sector movers, materials and utilities lagged, while financials led the advance. In equity news, Time Warner Inc, Aetna Inc, Hartford Financial Services Group, TRW Automotive Holdings and PulteGroup Inc beat estimates, and CVS Caremark Corp met forecasts, while Electronic Arts and EOG Resources issued disappointing guidance. Automakers reported better-than-expected October sales results and General Motors announced more details of its IPO.

The Dow Jones Industrial Average rose 26 points (0.2%) to 11,215, the S&P 500 Index gained 4 points (0.4%) to 1,198, and the Nasdaq Composite was 7 points (0.3%) higher to 2,540. In modest volume, 1.1 billion shares were traded on the NYSE and 2.0 billion shares were traded on the Nasdaq. Crude oil gained $0.79 to $84.69 per barrel, wholesale gasoline added $0.03 to $2.14 per gallon, while the Bloomberg gold spot price lost $9.50 to $1,347.95 per ounce. Elsewhere, the Dollar Index—a comparison of the US dollar to six major world currencies—was 0.4% lower at 76.41.

Time Warner Inc. (TWX $32) reported 3Q EPS ex-items of $0.62, compared to the consensus estimate of analysts surveyed by Reuters of $0.53 per share, with revenues increasing 2% year-over-year (y/y) to $6.4 billion, matching the Street’s forecast. The media company said its networks businesses delivered “robust growth” in advertising and subscription revenues. TWX raised its full-year EPS outlook. TWX traded to the downside.

Aetna Inc. (AET $31) achieved 3Q profits ex-items of $0.84 per share, well above the $0.67 that analysts had anticipated, with revenues declining 2% y/y to $8.5 billion, mostly inline with the Street’s forecast. The healthcare firm said its results were driven by a reduction in utilization of health care services after the surge it saw in 2009, combined with appropriate pricing and effective medical quality and cost management. The company’s total medical benefit ratio—a closely watched industry gauge of medical costs—declined from 85.6% a year ago to 81.8%. AET traded higher.

Hartford Financial Services Group (HIG $26 ¹) was nicely higher after handily beating Street forecasts of 3Q EPS of $0.97, reporting earnings of $1.43 per share in core earnings, which excluded some investment results. The CEO of the insurance company said in an interview reported by Dow Jones Newswires that “By any measure, we were well above expectations,” citing “really good underwriting performance” and significant improvement in the investment portfolio. HIG raised its full year core earnings to $2.60-2.70 per share, up from an earlier range of $2.10-2.30.

Electronic Arts Inc. (ERTS $16) reported fiscal 2Q EPS ex-items of $0.10, compared to the loss of $0.10 per share that analysts had expected, and although revenues fell 23% y/y to $884 million, the figure topped the $815 million that the Street had forecasted. The video game publisher said its “strong” quarter was driven by its FIFA 11 soccer game and digital offerings like the The Sims 3 Ambitions and Madden NFL 11. ERTS reaffirmed its full-year guidance, but issued 3Q EPS and 4Q guidance that was below analysts’ forecasts and shares fell.

CVS Caremark Corp. (CVS $31) announced 3Q adjusted earnings of $0.65 per share, inline with the Street’s forecast, with revenues dropping 3.1% y/y to $23.9 billion, roughly matching analysts’ expectations. The company said its pharmacy services segment revenue fell due to the previously announced termination of a few large client contracts and the decrease of covered lives under its Medicare Part D program. However its retail pharmacy segment revenues rose and same-store sales—sales at stores open at least a year—gained 2.5% y/y, reflecting a positive impact of its Maintenance Choice program. The company lowered the high end of its full-year EPS outlook. Shares rose.

PulteGroup Inc. (PHM $8) posted a 3Q loss excluding $2.60 in write-downs related to a goodwill impairment charge and other adjustments, of $0.03 per share, a narrower loss than the $0.05 expectation. The homebuilder said looking beyond the charges, its operations continued to demonstrate y/y progress, but industry conditions are expected to remain “challenging over the near term,” and it is continuing to reduce direct construction and overhead costs. Meanwhile, revenues declined 3.0% y/y to $1.1 billion, just above the $1.0 billion forecast, as home sales decreased due to softness in unit closing volumes, partially offset by an increase in average selling price. Shares were under solid pressure.

EOG Resources (EOG $89) was a laggard in trading, despite reporting 3Q EPS of $0.18 excluding hedging impacts and write-downs that was inline with the consensus estimate, as it reduced its forecast for production growth to 9% from 13%, citing decreases in North American natural-gas drilling activity.

TRW Automotive Holdings Corp (TRW $48) announced 3Q EPS of $1.47 excluding tax items, above the Street’s $0.78 per share estimate. The auto-parts maker said that while vehicle-production schedules have moderated in the second half of 2010 compared to the first half and earlier expectations, the overall recovery in the industry will support a strong year for the company. Shares continued their move higher.

Outside of earnings news, automakers reported US October sales of a 9.27 million annual run-rate, above the 8.9 million forecast reported by Bloomberg, with General Motors reporting an adjusted sales increase of 7.1% y/y for its core brands, above the 5.2% increase that analysts were anticipating per CNBC. Also, Ford Motor Co. (F $15) reported sales growth of 23.2% y/y, versus the 18.4% increase that analysts forecasted, Chrysler reported a 42.1% jump in sales, above the 32% increase that the Street was anticipating, Honda Motor Co (HMC $34) announced growth of 16%, and Hyundai Motor America said US sales rose 38%. However, Toyota Motor Corp (TM $71) lagged the increases posted in the industry, as sales fell 0.9%. Shares of the publicly-traded automakers were all higher. Additionally, GM announced more details in connection with its IPO.

Fed announces quantitative easing

The much anticipated statement from the Fed was released in afternoon trading, signaling the conclusion of the two-day Federal Open Market Committee (FOMC) meeting. As expected, the Fed deemed it necessary to begin a new program of asset purchases to “promote a stronger pace of economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate.” The Fed has a dual mandate of maximum employment and price stability, and today’s move is due to their judgment that the “pace of recovery in output and employment continues to be slow,” and that “progress toward its objectives has been disappointingly slow.”

Regarding the asset purchase program, the FOMC intends to purchase a further $600 billion of longer-term Treasuries by the end of 2Q 2011, a pace of about $75 billion per month. This is addition to the program to reinvest principal payments from its mortgage-backed security portfolio, which it anticipates to be $250-300 billion over the same time period, depending on the evolution of actual principal payments. Taken together, the purchases would equate to $850-950 billion of longer-term securities through the end of the second quarter, or an average of $110 billion per month, with the targeted maturities being in the 2.5-year to 10-year range, with an average duration of 5-6 years. The Committee will regularly review the pace of securities purchases and overall size of the program in light of incoming information and will adjust the program as needed to best “foster maximum employment and price stability.”

Regarding the components of the economy, most of the language in the statement was generally unchanged, as the Fed said that consumer spending remains constrained by high unemployment, modest income growth, lower housing wealth and tight credit and that while business spending is rising, employers remain reluctant to hire. The Fed dropped the reference to weak bank lending. The other changes consisted of their assessment of inflation, saying that while longer-term inflation expectations have remained stable, measures of underlying inflation have trended lower in recent quarters.

Thomas M. Hoenig was the lone dissenter for the seventh-straight meeting, believing that the risks of additional asset purchases outweighed the benefits, and was concerned that the high level of monetary accommodation increased the risk of future financial imbalances, and over time, would cause an “increase in long-term inflation expectations that could destabilize the economy.”

Treasuries were mixed and the yield curve steepened following the release. and the dollar fell. The yield on the two-year note fell 1 bp to 0.33%, and the yield on the 10-year note lost 2 bps to 2.57%, while the 30-year bond yield gained 12 bps to 4.05%.

Service sector activity and private sector payrolls top expectations

The ISM Non-Manufacturing Index rose more than expected in October to 54.3 from 53.2 in September, while the forecast was for a reading of 53.5. A reading of 50 separates expansion from contraction. The report is generally considered a measure of economic strength in the service sector and is the companion to the ISM Manufacturing Index, which posted an unexpected increase to 56.9 in October from 54.4.

Like Monday’s manufacturing reading, underlying components that contributed to the increase were business activity, which rose 5.6 points to 58.4, new orders, which gained 1.8 points to 56.7 and employment, which grew 0.7 points to 50.9. On the negative side of the ledger, a portion of the gain was due to an 8.2 point increase in prices to 68.3, and the manufacturing report also noted a 0.5 point rise in prices to 71.0. Additionally, supplier deliveries, a component in the leading indicator index, fell in both surveys, by 4 points to 51.0 in today’s report, but strength in new orders could be a positive indicator for future deliveries.

Meanwhile, the ADP Employment Change Report showed private sector payrolls rose by 43,000 jobs in October, compared to the forecast of economists surveyed by Bloomberg, which called for a 20,000 increase, and September’s 39,000 job decrease was favorably revised to a 2,000 loss. The release does not include government hiring and firing and comes ahead of Friday’s broader nonfarm payrolls report, where economists expect an increase of 60,000 jobs in October, after falling 95,000 in September. Excluding government hiring, October private sector payrolls are expected to increase 80,000, after expanding by a smaller-than-forecasted 64,000 in September.

Elsewhere, factory orders rose more than expected, growing 2.1% month-over-month (m/m) in September, compared to the increase of 1.6% that economists had expected, and August’s 0.5% decrease was favorably revised to an unchanged reading. September durable goods orders—reported last week—were upwardly revised from a 3.3% increase to a 3.5% gain. Nondefense capital goods ex-aircraft, considered a good proxy for business spending, slipped 0.2%, following the 5.1% jump that was seen in August, and last week’s report of a 0.6% drop.

In other economic news, the MBA Mortgage Application Index fell 5.0% last week, after the index that can be quite volatile on a week-to-week basis, increased 3.2% in the previous week. The decline came as the Refinance Index dropped 6.4%, more than offsetting a 1.4% rise in the Purchase Index. The downward move in the overall index came amid a 3 basis point increase in the average 30-year mortgage rate to 4.28%, just above the record low of 4.21% on October 8.

International economic news light, Hong Kong strong

Economic news was mixed amid a light calendar in Europe, with a reading of UK services activity unexpectedly improving and Spain’s unemployment increasing by a smaller-than-expected amount, while a separate report showed Spanish consumer confidence deteriorated.

However an improvement in Hong Kong’s PMI and upgrade by Goldman Sachs prompted a surge in the Hang Seng Index, rising 2.0%. Elsewhere, China’s service sector had mixed results, and Australian building approvals unexpectedly dropped.

Jobs in the US and central bank action in England due out tomorrow

The US economic calendar is set to yield the weekly initial jobless claims, expected to increase to 442,000, while the prior week’s decline to 434,000 benefitted from a seasonal adjustment from the Columbus Day holiday. Additional announcements include the preliminary estimate of 3Q non-farm productivity, expected to increase 1.0% after declining 1.8% in the second quarter, and retailers will be announcing same-store sales – sales at stores open at least a year - for October.

Central bank action continues tomorrow, with the meeting du jour coming from the Bank of England, where policy makers have leaned toward additional asset purchases in prior meetings, and will now also have the Fed’s announcement to weigh in their decision.

Other international economic releases will include UK housing prices, euro-zone and Canadian services PMI reports, and Australia’s trade balance and retail sales.