Evening Market Update

Corporate News Wins Tug-of-War

Stocks ended the day in the green, weighing weak economic data against better news coming from earnings and the M&A front. The lowest reading of consumer sentiment since March 2009 was reported by the University of Michigan, which joined June industrial production that was weaker-than-expected, July regional manufacturing activity that unexpectedly remained in negative territory, and a higher core inflation rate, and Treasuries were mixed. However, better news from the corporate front kept a bid under stocks, led by strength in technology stocks, after Google Inc released blowout results. Elsewhere, Citigroup Inc beat the Street, but there were questions about the quality of earnings, BHP Billiton Ltd announced a $12.1 billion acquisition of Petrohawk Energy Corp, and Carl Ichan announced a nearly $10.2 billion bid for Clorox Co. Elsewhere, Standard & Poor’s said a downgrade was possible if the US did not tackle fiscal spending and the European bank stress tests were released showing eight banks failed.

The Dow Jones Industrial Average gained 43 points (0.3%) to 12,480, the S&P 500 Index rose 7 points (0.6%) to 1,316, while the Nasdaq Composite advanced 27 points (1.0%) to 2,790. In moderate volume, 1.1 billion shares were traded on the NYSE and 1.8 billion shares changed hands on the Nasdaq. WTI crude oil was $1.55 higher at $97.24 per barrel, wholesale gasoline gained $0.01 to $3.13 per gallon, and the Bloomberg gold spot price rose $6.10 to $1,593.33 per ounce. Elsewhere, the Dollar Index—a comparison of the US dollar to six major world currencies—fell 0.1% at 75.15. For the week, including dividends, the DJIA lost 1.4%, the S&P 500 Index fell 2.1%, and the Nasdaq Composite decreased 2.5%.

Citigroup Inc. (C $39) posted 2Q EPS of $1.09, topping the $0.96 consensus estimate of analysts surveyed by Reuters, with revenues, although falling 7% year-over-year (y/y) to $20.6 billion, exceeding the $19.9 billion that the Street had projected. The company said it produced growth in both loans and deposits and improved its financial strength. The company also said its net credit losses fell 35% y/y. Shares were lower amid concerns about the strength of the company’s core earnings, as 2Q results benefited from a $2 billion release of funds that were held in reserve to cover loan losses.

Google Inc. (GOOG $597) reported 2Q earnings ex-items of $8.74 per share, above the $7.85 that the Street had anticipated, with revenues excluding traffic acquisition costs (TAC) of $6.92 billion, compared to the $6.55 billion that analysts had forecasted. The world’s largest internet search engine said its Google-owned site revenues jumped 39% y/y, while its partner sites generated revenue growth of 20%. GOOG was up over 10%.

In M&A news, BHP Billiton Ltd. (BHP $91) announced that it has reached a definitive agreement to acquire US-based gas producer Petrohawk Energy Corp. (HK $38) for $38.75 per share in cash, or about $12.1 billion. BHP said the deal is expected to provide it with greater exposure to the world’s largest energy market. Shares of HK were up over 60%, while BHP traded lower

Elsewhere, activist investor Carl Icahn announced that his company has offered to acquire consumer products maker Clorox Co. (CLX $75) for $76.50 per share, valued at about $10.2 billion. CLX confirmed it has received an unsolicited proposal from Icahn Enterprises LP (IEP $46), which already has more than a 9% stake in the company, and will review the offer in due course. However, in a letter to CLX’s CEO, Icahn pushed for the company to seek other offers, particularly from “strategic buyers,” noting that there would be “numerous superior bids” to acquire the company, per Bloomberg. CLX was nicely higher. 

CPI mixed, production rises, while sentiment falls and NY manufacturing contracts

The Consumer Price Index showed prices at the consumer level were down 0.2% month-over-month (m/m) in June, a larger drop than the forecasts of economists surveyed by Bloomberg, calling for a 0.1% decrease, with May’s 0.2% increase unrevised. However, the core rate, which strips out food and energy, was 0.3% higher m/m in June, exceeding estimates of a 0.2% increase, with May’s 0.3% increase unadjusted. On a y/y basis, consumer prices were 3.6% higher in June, matching the level seen in May and economists’ forecasts, and the core CPI was 1.6% higher y/y, as expected, after rising by 1.5% in May.
 Elsewhere, industrial production in June rose 0.2% m/m, slightly below the expectation for a rise of 0.3%, while May’s reading was downwardly adjusted to a decline of 0.1% from a previously reported gain of 0.1%. Manufacturing was flat during the month, as supply chain disruptions from the quake in Japan curtailed the production of automobiles and related industries, while business equipment fell 0.7% m/m after jumping 1.2% in May. Capacity utilization remained unchanged at 76.7%, while the expectation was for an increase to 76.9%. Utilization remains 3.7% below its average rate from 1972 to 2010.

In other economic news, the preliminary University of Michigan’s Consumer Sentiment Index showed consumers were unexpectedly pessimistic in July, as it fell from 71.5 in June to 63.8—the lowest level since March 2009, compared to the slight increase to 72.2 that economists had projected. The steep drop came as the economic outlook and current economic conditions components of the report both fell solidly. However, the 1-year inflation outlook declined from 3.8% to 3.4%, while the 5-year expectation decreased from 3.0% to 2.8%.

Finally, the Empire Manufacturing Index, a measure of manufacturing in the New York region, continued to show contraction in July, as it remained in negative territory after modestly rising to -3.76 from June’s level of -7.79, compared to the estimates of economists, which called for an improvement to 5.00. A reading below zero denotes a contraction in activity. The report is the first major piece of data looking at manufacturing conditions in July.

Treasuries were mixed following the data, with the yield on the 2-year note down 1 bp at 0.36% and the yield on the 10-year note was 4 bps lower at 2.91%, while the 30-year bond rate was unchanged at 4.25%.

Europe the focus overseas: bank stress test results and Italian austerity vote

Eurozone debt concerns continued despite the passage of Italy’s austerity plan and the release of the results from a second bank stress test. Italy’s austerity plan, which was expedited to try to calm the recent flare-up in contagion fears, won a final confidence vote in the lower house Chamber of Deputies today, paving the way for final passage of the plan but Italian stocks and bonds shares remained under pressure. Yesterday, the proposal won a confidence vote in the nation’s Senate.

Meanwhile, the results of the second round of stress tests of 91 European financial institutions by the European Banking Authority (EBA) were released and showed 8 banks failed the test, with a capital shortfall of 2.5 billion euros ($3.5 billion). The breakdown of the failures included: five banks in Spain, 2 in Greece, and 1 Austrian institution. According to Bloomberg, to pass the test, banks needed to maintain tier-1 capital ratios of more than 5% under a scenario including a 0.5% economic contraction in the eurozone this year, a 15% drop in European equity markets, and trading losses on sovereign debt not held to maturity. However, the reaction in the markets was subdued as skepticism remained regarding how stringent the EBA’s tests were, as the tests did not test debt held on “banking books,” as it is expected to be held to maturity and is not marked-to-market, and the estimate of a 25% writedown in the value of Greek 10-year government debt is small relative to where the bonds are currently trading. The EBA said that about 20 banks would have failed and needed a total of 26.8 billion euros if the tests were performed in April but didn’t because banks as a group had raised 50 billion euros of capital from January to April.

Economic news in the Asia/Pacific region was light, headlined by an announcement from China that it will deploy further measures to try to contain real-estate prices by extending limits on purchases to smaller, second- and third-tier cities and curbing gains in rents.

Global debt concerns trump upbeat beginning of 2Q earnings season

Despite favorable 2Q earnings reports from Dow member JPMorgan Chase & Co. (JPM $40) and Google Inc, the equity markets finished solidly south of the flatline for the week, as concerns regarding the global debt crisis hamstrung sentiment. With the deadline for raising the debt ceiling looming on the horizon, the fiscal issues facing the US gained attention to curb conviction among traders, exacerbated by Moody’s Investors Service and Standard & Poor’s warning that a failure to lift the debt limit could warrant a downgrade of the world’s largest economy’s top-notch triple-A rating. Meanwhile, sovereign debt contagion concerns in the eurozone carried over from late last week, with key euro-area countries Italy and Spain in the crosshairs, despite successful debt auctions and the Italian government passing its austerity plan. However, stocks chipped away at the declines mid-week as the minutes from the US Federal Reserve’s June monetary policy meeting suggested that additional monetary policy stimulus, or QE3, could be on the way, with Fed Chairman Ben Bernanke’s first day of testimony in front of Congress reiterating the possibility. However, expectations of imminent stimulus were cooled during the following day of testimony as Bernanke told the Senate that at this point the Fed is not prepared to take further action on monetary policy. Also, the Fed Chairman questioned the efficacy of further easing in the current economic environment.

The minutes and Bernanke’s testimony showed that the Central Bank is uncertain with regard to policy as every mention of the possibility of QE3 was met with an immediate response of “on the other hand, the economy could evolve in a way that would warrant a move toward less-accommodative policy.” This week’s data from the US economic front did little to provide clarity for the Fed, as inflation readings were mixed, jobless claims fell, and retail sales grew modestly, while small business optimism came in below forecasts, and the first look at manufacturing activity depicted contraction.

Housing market likely takes a back seat to earnings and government debt

Earnings season will heat up in earnest next week, and government debt both in the US and overseas is likely to dominate market action, while the US economic calendar will include housing data, starting with homebuilder sentiment in Monday’s NAHB Housing Market Index, while Tuesday brings housing starts, expected to rise 2.7% m/m in June to an annual rate of 575,000 units, while building permits, one of the leading indicators tracked by the Conference Board as it is a gauge of future construction, are forecasted to fall 2.3% m/m to 595,000 units. Lastly, Wednesday brings existing home sales, forecasted to rise 2.6% m/m to an annual rate of 4.94 million units in June.

Other releases scheduled next week include the MBA Mortgage Applications Index, weekly initial jobless claims, the Conference Board’s Index of Leading Indicators, and the Philadelphia Fed’s Business Activity Index. Other reports in the Americas include: Canada’s leading index, wholesale sales, CPI, and retail sales, Brazil’s unemployment rate, as well as Mexico’s retail sales, unemployment rate, and CPI.

Other international reports include eurozone consumer confidence, manufacturing and services PMIs, and industrial new orders, the German ZEW Survey of Economic Sentiment Index, Ifo Business Climate Index, and producer prices, UK home prices and retail sales, Japanese department store sales and leading index, and the leading index from Australia and China, as well as the preliminary manufacturing PMI for China released by HSBC. The central banks of Hong Kong, Canada, and Brazil meet to discuss monetary policy, and the minutes from the last Bank of England meeting will be released.