Evening Market Update

Commodity Recovery Helps Stocks Get Back on Track

US equities finished nicely to the upside today, led by a rally in commodity prices and some better-than-expected reports from the earnings front. The domestic economic docket was highlighted by the release of the minutes from the April FOMC meeting, showing an intense discussion over the steps that should follow the end of QE2 in June. Treasuries moved lower, after showing little reaction to the third-straight weekly increase in mortgage applications. Crude oil prices spiked on a bullish inventory report from the US Department of Energy, while the US dollar finished flat after being down for most of the session. In equity news, shares of Dell surged after the company beat the Street’s earnings forecast and raised its guidance, while Target Corp and Deere & Co also bested the profit expectations of analysts. Elsewhere, Aflac Inc said it would take a $31 million loss in Q2, Allstate Corp agreed to acquire Esurance and Answer Financial for about $1 billion, and Staples lowered its full-year outlook.

The Dow Jones Industrial Average rose 81 points (0.6%) to 12,560, the S&P 500 Index increased 12 points (0.9%) to 1,341, and the Nasdaq Composite advanced 32 points (1.1%) to 2,815. In moderately light volume, 884 million shares were traded on the NYSE and 1.9 billion shares changed hands on the Nasdaq. WTI crude oil closed $2.77 higher at $99.68 per barrel, wholesale gasoline gained $0.02 to $2.94 per gallon, while the Bloomberg gold spot price increased $8.33 to $1,495.03 per ounce. Elsewhere, the Dollar Index—a comparison of the US dollar to six major world currencies—rose 0.2% to 75.40.

Dell Inc. (DELL $17) reported 1Q EPS ex-items of $0.55, well above the $0.44 consensus estimate of analysts surveyed by Reuters, but revenues, which rose 1% year-over-year (y/y) to $15.0 billion, came in below the $15.4 billion that the Street had forecasted. The computer maker said its results were aided by its enterprise solutions and services business, led by an 11% increase in server revenue. DELL increased its full-year operating profit outlook as it expects to benefit from stronger spending among state and local governments and education customers, a solid consumer back-to-school spending season, and above average seasonality from its small and medium business and consumer segments. Shares were nicely higher.

Additionally, Target Corp. (TGT $50) announced 1Q earnings of $0.99 per share, topping the $0.94 that the Street was expecting, with revenues increasing 2.2% y/y to $15.9 billion, but just below analysts’ expectations of $16.0 billion. The retailer posted a 2.0% y/y increase in 1Q same-store sales—sales at stores open at least a year. TGT said its 1Q results were the result of stronger-than-expected profitability in its credit card segment, which offset the impact of weaker-than-anticipated sales in its retail segment. TGT traded lower as the company’s same-store sales results and a decline in retail profit margins are weighing on its stock. Also, TGT said in a conference call with analysts that several pieces need to fall into place for it to meet analysts’ 2Q and full-year expectations, per Dow Jones Newswires.

Moreover, Deere & Co. (DE $86) posted fiscal 2Q profits of $2.12 per share, above the $2.06 that analysts had projected, with revenues increasing 25% y/y to $8.9 billion, exceeding the $8.1 billion that the Street was forecasting, led by sales of large farm equipment and an increase in prices. The company said construction equipment shipments are moving higher in spite of lingering weakness in the residential and commercial construction sectors. DE increased its full-year earnings outlook as markets for construction equipment in the US and farm machinery in Europe “are in the early stages of a recovery.” Shares of DE finished lower despite the report, amid concerns about whether the company can thwart higher raw-material costs with price increases.

Shares of Aflac Inc. (AFL $50) fell over 6% after the insurer said it will take a loss of about $31 million before taxes in Q2 as it sells off some investments that have been flagged as problematic. In related industry news, Allstate Corp. (ALL $32) announced an agreement to acquire auto insurer Esurance and insurance agency Answer Financial from White Mountains Insurance Group Ltd for approximately $1 billion in cash, in an effort to expand its online insurance presence. Shares of ALL were nearly unchanged on the day

Finally, Staples Inc. (SPLS $17) was down sharply after the office supply chain issued 2Q guidance that missed expectations and lowered its full-year outlook, after posting 1Q EPS of $0.28, which was below the $0.32 that analysts were expecting. SPLS said current expectations for the year “assume very little improvement in the economy,” continued investment in growth initiatives and competitive pricing in the contract market. The company’s 1Q revenues rose 2% y/y to $6.2 billion, roughly inline with the Street’s forecast.

With QE2 ending, Fed has intense discussion on next steps

The minutes from the April Federal Open Market Committee (FOMC) meeting were released midday, showing that with QE2 due to end by the end of June, and while “normalization” of monetary policy would not necessarily begin soon, the Fed felt it was appropriate to begin discussing next steps, which resulted in an intense discussion. Timing of a next step was somewhat outlined at the press conference following the meeting where Chairman Bernanke said that the “extended period” language for exceptionally low rates suggests a “couple of meetings” before action.

In the meeting, nearly all participants agreed that normalization would begin with halting reinvestment of payments on agency securities, and either simultaneously or soon after, ceasing to reinvest payments on Treasuries. As these moves were seen as a modest step toward tightening, these moves would be made in the context of the economic outlook and be accompanied by changes in the statement language. Further action was seen to be a mix between asset sales and rate hikes, with any asset sales to be announced in advance and tied to economic conditions.

Most participants saw changes in the target for the fed funds rate as the preferred active tool for tightening, but a number of participants noted it would be advisable to begin using the temporary reserves-draining tools in advance to improve effectiveness of rate changes. The Fed has the goal of first moving toward a Treasury-only portfolio before selling Treasuries, but expected that this could take five years, while a more rapid sales pace would take one to two years.

Like investors, the Fed lowered its economic growth forecast at the meeting, and this reduction has been a contributing factor to a decline in commodity prices. While lower commodity prices reduce the upside risk to headline inflation, wage inflation is typically the main thrust for broad-based price increases. As such, the impact of reduced global growth on the outlook for jobs has the market concerned. Additionally, the market may be transitioning toward a “risk-off” trade with increased uncertainty about the economy and a rise in the dollar due in part to the end of QE2, causing rough sledding for stocks.

In other economic news, the MBA Mortgage Application Index increased by 7.8% last week—the third-straight monthly gain—as the Refinance Index rose by 13.2%, to more than offset a 3.2% decline in the Purchase Index, while the average 30-year mortgage rate declined by 7 basis points (bps) to 4.60%.

Meanwhile, the jump in crude oil prices today was amplified by the weekly inventory report from the Department of Energy (DoE), which showed oil stockpiles unexpectedly fell, declining by 15,000 barrels compared to the increase of 1.7 million barrels that economists had forecasted.

Treasuries were lower, as the yield on the 2-year note was 4 bps higher at 0.56%, while the yields on the 10-year note and the 30-year bond gained 6 bps to 3.18% and 4.29%, respectively.

BoE minutes show split remains over monetary policy action

Sentiment in the European markets was buoyed by gains in basic materials and oil & gas issues as commodity prices rebounded following recent declines. The strength in resource-related issues helped offset a report that showed euro-zone construction output declined in March, and a separate release that revealed UK jobless claims unexpectedly increased in April, which added to the recent flare-up in concerns about a slowing global economy. In other economic news, the Bank of England (BoE) released the minutes from its early May monetary policy meeting, which showed policymakers remained split 6-3 on keeping the benchmark interest rate unchanged, with the three votes calling for an increase to the BoE’s interest rate.

In Asia/Pacific economic news, Australia issued a report that showed the nation’s consumer confidence deteriorated, while Moody’s Investors Service downgraded the long-term debt ratings of the nation’s largest banks.

Back in the Americas, Canada’s Index of Leading Indicators rose by 0.8% in April, above the 0.6% increase expected by economists, while a 0.1% rise in March wholesale sales was well short of expectations.

Existing home sales to highlight tomorrow’s economic docket

Tomorrow, the US economic calendar will bring the release of existing home sales, expected to rise 2.0% month-over-month (m/m) to an annual rate of 5.20 million units in April. Existing home sales reflect closing from contracts entered one to two months earlier and are the largest component of the housing sector. Sales are well below the more than 7 million annual unit pace that was reached before the housing bubble burst, as a flood of foreclosures and declining home values have arrested demand, sending sales to record lows of below 4 million units in July 2010. Foreclosures are likely to continue and recent data has been lackluster, with S&P CaseShiller showing home prices continue to decline, while this week we have seen housing starts and building permits drop sharply and homebuilder sentiment remains depressed.

Other releases on the domestic front tomorrow include weekly initial jobless claims, expected to fall to 420,000 from 434,000 last week, and the Conference Board’s Index of Leading Indicators, which economists are forecasting to increase 0.1% in April, after rising 0.4% in March. Finally, investors will get a look at manufacturing activity in the Mid-Atlantic region in the form of the Philadelphia Fed Manufacturing Index, forecasted to improve from 18.5 in April to 20.0 in May.

The international calendar will yield UK consumer confidence and retail sales, Japanese capacity utilization, industrial production, housing loans, department store sales, and the preliminary reading of Q1 GDP. Additionally, the Bank of Japan will begin its two-day monetary policy meeting.