Morning Market Update

Tensions in Middle East Spoil the Bulls’ Feast

Even after the ISM’s read on the service sector posted the highest level of expansion since August 2005, retail same store sales were mostly better than forecasted, and jobless claims dropped more than anticipated, US equity markets are under pressure in late-morning action. Exacerbated tensions in the Middle East are dampening the mood, along with a lack of urgency by the European Central Bank after its monetary policy meeting, are dampening the mood in the global stock markets. Treasuries are mostly lower amid the aforementioned data, which also included an improvement in 4Q productivity and an unexpected increase in factory orders. Traders are also awaiting a speech by Fed Chairman Ben Bernanke in afternoon action. Meanwhile, the equity front is garnering attention, with disappointing results Target Corp and some department stores being offset by mostly better-than-estimated January same-store sales. Moreover, Visa Inc, MasterCard Inc and YUM! Brands Inc all posted better-than-expected profits, but Dow member Merck & Co Inc offered a disappointing outlook. Overseas, Asia finished mixed in holiday-lightened action, while Europe is under pressure after the ECB’s policy meeting and reports showing euro-zone retail sales unexpectedly fell and Royal Dutch Shell missed analysts’ earnings expectations.

At 11:04 a.m. ET, the Dow Jones Industrial Average is down 0.2%, while the S&P 500 Index and the Nasdaq Composite are declining 0.4%. Crude oil is down $0.58 at $90.28 per barrel, wholesale gasoline is increasing $0.01 to $2.51 per gallon, and the Bloomberg gold spot price is decreasing $3.05 to $1,332.28 per ounce. Elsewhere, the Dollar Index—a comparison of the US dollar to six major world currencies—is up 0.9% at 77.84.

Dow member Merck & Co. Inc. (MRK $33) posted 4Q EPS ex-items of $0.88, topping the $0.83 consensus estimate of analysts surveyed by Reuters, with revenues decreasing 1% year-over-year (y/y) to $12.1 billion, exceeding the $11.5 billion that was anticipated. The company withdrew its long-term EPS outlook, while issuing full-year 2011 EPS guidance that came in below analysts’ forecasts. MRK is trading solidly lower.

Visa Inc. (V $72) reported fiscal 1Q EPS of $1.23, two cents north of the consensus estimate, with revenues growing 14% y/y to $2.2 billion, roughly inline with expectations. The credit card transaction firm said it saw growth in payments volume, cross border volume and processed transactions globally. The company reaffirmed its full-year 2011 outlook. Meanwhile, fellow credit card transaction firm MasterCard Inc. (MA $239) achieved 4Q EPS of $3.16, above the $3.04 that the Street had anticipated, with revenues increasing 10.7% y/y to $1.4 billion, matching the consensus estimate. Nonetheless, shares of both companies are lower.

Yum! Brands Inc. (YUM $50) announced 4Q EPS ex-items of $0.63, above the $0.60 that was expected, as revenues increased 6% to $3.6 billion, exceeding the $3.5 billion forecast on the Street. The operator of KFC, Pizza Hut, and Taco Bell said same-store sales—sales at stores open at least a year—grew 5% y/y in the US, while international sales ticked 1% higher, led growth of 8% in China. YUM is trading nicely higher.

Meanwhile, the nation’s retailers are reporting January same-store sales results, headlined by Target Corp. (TGT $54), which announced a 1.7% y/y increase, compared to the 1.9% gain that analysts surveyed by Reuters had anticipated. TGT said January sales were below expectations, particularly in portions of the South and the Northeast, but its remodel program continues to drive incremental traffic and sales, while its REDcard rewards 5% savings program continues to perform as expected. Shares are modestly higher.

Moreover, Costco Wholesale Corp. (COST $71) reported its January same-store sales grew 9.0% y/y, including gasoline sales and foreign exchange, well above the 6.1% that the Street had forecasted, and excluding fuel and currency, sales rose 6.0%. Shares are higher.

BJ’s Wholesale Club Inc. (BJ $43) announced that its January same-store sales rose 2.7% y/y, but its announcement that it will explore strategic alternatives, including the possible sale of the company is garnering the most attention, and its shares are surging.

Department store chain, Macy’s Inc. (M $22), achieved 2.6% y/y growth in same-store sales for January, above the 2.1% gain that analysts had anticipated. The company said January represented a successful conclusion to a great year of sales growth, while sales during the month were restrained by the series of snowstorms that caused widespread store closings along the East Coast and in the Southeast US. However, other department stores such as Kohl’s Corp. (KSS $51) and J.C. Penney Co. Inc. (JCP $32) reported disappointing sales results for the month, noting adverse weather conditions, but JCP did increase its 4Q earnings outlook. Shares M are higher, while JCP and KSS are lower.

Elsewhere, Gap Inc. (GPS $20) reported an unexpected increase in sales and Limited Brands Inc’s (LTD $31) sales surged past analysts’ forecasts, while American Eagle Outfitters Inc. (AEO $15) recorded a smaller-than-forecasted decline in sales. All three retailers are solidly higher. 

Service sector activity jumps, jobless claims fall, while productivity and factory orders rise

The ISM Non-Manufacturing Index unexpectedly rose in January to 59.4 from 57.1, where economists surveyed by Bloomberg forecasted the reading to remain. A reading of 50 separates expansion from contraction. The measure of economic strength in the service sector jumped to the highest level since August 2005, complimenting the companion to the ISM Manufacturing Index, which posted the highest rate of expansion since May 2004 on Tuesday. The index suggested that activity in the service sector expanded for the fourteenth-straight month as new orders rose to 64.9 from 61.4—the highest since January 2004—and business activity/production increased from 62.9 to 64.6, the highest since 2005. Also, the employment rose from 52.6 to 54.5, the largest level of expansion since May 2006, polishing the luster from today’s release and ahead of Friday’s Labor Report. However, the prices paid component moved above the 70 mark for the first time since September 2008, rising to 72.1, which may be fueling inflationary concerns that threaten corporate profits and the purchasing power of consumers—the heartbeat of the economy.

There are numerous concerns that could derail the recovery, as housing continues to stagnate and foreclosures remain on the rise, while rising commodity costs warrant attention for signs that increased prices could be passed along to the consumer, though this is presently not a problem. The concern is what higher prices may do to both profit margins and consumers as companies continue to have trouble passing along rising costs, thereby squeezing profit margins, while where they can pass those costs on, consumers take the ultimate hit, especially in food, heat and gasoline prices, leaving less money for discretionary purchases.

Meanwhile, weekly initial jobless claims fell by 42,000 to 415,000, versus last week's figure which was upwardly revised by 3,000 to 457,000, and below the 420,000 level that economists had expected. The four-week moving average, considered a smoother look at the trend in claims, increased by 1,000 to 430,500, while continuing claims dropped by 84,000 to 3,925,000, below the forecast of economists, which called for continuing claims to come in at 3,950,000.

Elsewhere, the preliminary reading on 4Q nonfarm productivity showed a 2.6% increase on an annual basis, compared to the 2.0% gain that economists expected. Unit labor costs were 0.6% lower, versus a gain of 0.2% that was estimated. Moreover, factory orders unexpectedly rose, increasing 0.2% month-over-month (m/m) in December, compared to the decline of 0.5% that economists surveyed by Bloomberg had expected, and November’s 0.7% increase was favorably revised to a 1.3% gain. December durable goods orders—reported last week—were favorably revised from a 2.5% drop to a 2.3% decline.

Treasuries are mostly lower following the plethora of data, with the yield on the two-year note up 4 bps to 0.69% and the yield on the 10-year note 2 bps higher at 3.50%, while the 30-year bond is flat at 4.62%.

Finally, Federal Reserve Chairman Ben Bernanke is expected to speak at the National Press Club on the topic of “The Economic Outlook and Macroeconomic Policies,” at about 12:30 p.m. ET. Following the Fed Chief’s speech, there will be a Q&A session.

Europe finds pressure on energy earnings and data, while ECB reports on its policy

The equity markets in Europe remain lower in late-day action, with oil & gas issues leading the way on the heels of a disappointing earnings report out of the sector, continued uneasiness toward the Middle East political unrest, and a disappointing euro-zone economic report. Meanwhile, stocks extended losses as traders digested the European Central Bank’s monetary policy announcement, in which it expectedly kept its benchmark interest rate unchanged at 1.0% and offered no new additions to its asset purchase program. However, traders closely scrutinized the customary press conference by ECB President Jean-Claude Trichet that followed the monetary policy announcement, as the central bank faces the difficult task of maintaining price stability as inflationary pressures mount in key parts of the euro-area, while trying to foster the continued economic recovery.

Trichet softened his tone regarding inflation, noting that “very close monitoring” of price developments is “warranted,” but also saying inflation expectations remain “firmly anchored.” The ECB head also pointed out that the balance sheets of euro-area banks are contracting again and it was “important” that banks meet expanding credit demand, per Dow Jones Newswires. The euro fell solidly versus the US dollar following Trichet’s remarks, as expectations have ramped up that the ECB may be nearing some tightening of monetary policy sooner than some had expected, and some are noting that they expected Trichet to project a slightly more hawkish tone at the press conference.

Elsewhere, shares of Royal Dutch Shell (RDS/B $71) are under pressure to weigh on the markets, after the company posted 4Q earnings ex-items that missed expectations and it said profits from its refining division remained “under pressure,” per Bloomberg. Moreover, sentiment was stymied by a report that showed euro-zone retail sales unexpectedly fell in December, offsetting stronger-than-expected PMI Services reports from France, the UK, euro-zone, and Germany—Europe’s largest economy.

The UK FTSE 100 Index is down 0.4%, France’s CAC-40 Index is 1.0% lower, and Germany’s DAX Index is unchanged.

Asia mixed as earnings, weather, and tensions in Middle East remain in focus

With activity light due to the Lunar New Year, which had several markets including China, South Korea, and Taiwan closed, stocks in Asia finished mixed as Japanese stocks moved lower on the flare-up in political tensions in the Middle East and a disappointing earnings report in the region. Japan’s Nikkei 225 Index declined 0.3%, bogged down by a solid drop in shares of Panasonic Corp. (PC $14) after the world’s largest maker of plasma TVs, per Bloomberg, posted earnings that missed analysts’ forecasts, due to losses out of its television business, while keeping its outlook unchanged. However, after the closing bell Sony Corp. (SNE $35) reported better-than-forecasted profits, aided by growth in earnings of its PlayStation games division. Elsewhere, Australia’s S&P/ASX 200 Index rose 0.5%, after a cyclone hit the nation’s northeast coast today, but the damage was less than some had expected, per Reuters. Also, shares of Qantas Airways (QUBSF $2) rose solidly to help the advance after the airline increased its international fuel surcharge and noted that it has hedged over 60% of its remaining fuel requirements. Meanwhile, Australian building permits jumped well above economists’ expectations to help support sentiment. Finally, India’s BSE Sensex 30 Index rose 2.0% after a report showed the nation’s service sector activity expanded further in January.