Evening Market Update

Persistent Debt Woes Keep Markets on Edge

In a volatile session, the debt ceiling impasse, coupled with disappointing economic data out of the US, kept stocks in the red to close out the month of July. Optimism regarding a weekend deal in Washington helped to bring markets off their lows, but a larger-than-expected deceleration in 2Q GDP, a steep downward revision to 1Q’s output, and lackluster reads on consumer sentiment and regional manufacturing soured the mood. Treasuries finished solidly higher following the economic data, continuing to show little reaction to the looming August 2 deadline to raise the debt ceiling. Meanwhile, earnings remained in focus on the equity front, with Dow member Merck & Co posting profits that matched estimates, fellow Dow member Chevron topping the Street's forecasts but slipping on its revenues, while Starbucks and Expedia exceeded the Street’s forecasts for both earnings and revenues. 

On Friday, the Dow Jones Industrial Average was down 0.5%, the S&P 500 Index was 0.4% lower, and the Nasdaq Composite was declining 0.2%. WTI crude oil is declining $1.82 at $95.62 per barrel, wholesale gasoline is off $0.03 at $3.04 per gallon, and the Bloomberg gold spot price is advancing $7.70 to $1,623.65 per ounce. Elsewhere, the Dollar Index-a comparison of the US dollar to six major world currencies-is down 0.5% to 73.80. 

Dow member Merck & Co. Inc. (MRK $34) announced 2Q profits ex-items of $0.95 per share, inline with the consensus estimate of analysts surveyed by Reuters, with revenues rising 7.1% year-over-year (y/y) to $12.2 billion, exceeding the $11.8 billion that the Street had anticipated. The drugmaker said it benefitted from double-digit growth from key products and successful new product launches, while emerging markets accounted for 18% of sales during the quarter. MRK raised the lower end of its full-year EPS forecast, while reiterating its revenue outlook. Shares were lower.

Fellow Dow component Chevron Corp. (CVX $105) reported 2Q EPS of $3.85, above the $3.56 that analysts had projected, but revenues rose 31.4% y/y to $69 billion, below the $71.6 billion that the Street was expecting. The company said earnings grew y/y, primarily driven by gains in its oil and gas exploration and production business, resulting from higher crude oil prices. CVX traded lower.

Starbucks Corp. (SBUX $41) announced fiscal 3Q EPS of $0.36, two cents above the estimate of analysts, with revenues increasing 12% y/y to $2.9 billion, topping the $2.8 billion that the Street had expected. The coffee retailer said its 3Q same-store sales-sales at stores open at least a year-rose 8% y/y, driven by strong traffic, and a higher average ticket price. The company raised its full-year EPS guidance. SBUX was nicely higher.

Expedia Inc. (EXPE $33) posted 2Q earnings ex-items of $0.55 per share, above the $0.49 estimate on the Street, with revenues growing 23% y/y to $1.0 billion, topping the $962 million that analysts were anticipating. The online travel agent said its gross bookings rose 19% y/y, while advertising and media revenues rose 27% compared to last year. Shares were sharply higher.

First read on 2Q GDP, consumer sentiment and regional manufacturing data disappoint

The first look-of three-at 2Q Gross Domestic Product, the broadest measure of economic output, showed a smaller rate of expansion than expected, rising at a 1.3% quarter-over-quarter (q/q) annualized rate of growth, compared to the sharp downwardly revised 0.4% increase in 1Q, and the 1.8% growth that was forecasted by a Bloomberg survey of economists. Also, personal consumption was well below expectations, gaining 0.1%, down from the 2.1% that was posted in 1Q, and compared to the 0.8% growth that was forecasted. 1Q's growth was revised from a 1.9% rate of expansion as consumer and government spending were negatively revised, and inventories rose at a smaller rate than previously forecasted, while imports-a subtraction from GDP-increased more than estimated.

The GDP Price Index rose 2.3%, compared to the 2.0% increase that economists anticipated, and the core PCE Index, which excludes food and energy, increased 2.1%, versus the 2.3% rise that was expected.

The biggest driver of today's GDP report was the sharp deceleration in personal consumption, which accounts for nearly 70% of total output, as it only contributed 0.07 percentage points (pps) in 2Q, down from 1.47 pps in 1Q, as durable goods purchases fell 4.4% after rising 11.7% in 1Q. Consumer outlays were hampered by the frustratingly high unemployment rate and higher food and energy prices that cut into discretionary income, while the sharp drop in durable goods was also impacted by auto sales, which were stymied by the parts supply and production disruptions from the Japanese earthquake and tsunami.

Meanwhile, there were some positives in the report as fixed investment, led by business equipment and software and commercial structures, contributed 0.69 pps to GDP. Also, inventories rose to add 0.18 pps too output, federal government spending-although offset by a drop in state and local spending-increased GDP by 0.18 pps, and exports added 0.81pps to the calculation, partially offset by an increase in imports.

Elsewhere, the final University of Michigan's Consumer Sentiment Index was unexpectedly revised lower to 63.7 from the preliminary reading of 63.8 for the month of July, compared to the increase to 64.0 that economists expected. The downward revision reflected a decrease in current economic conditions, which offset an improvement in consumer expectations. Additionally, consumers’ outlook on short-term inflation was unrevised, while long-term inflation expectations ticked higher.

Moreover, the Chicago Purchasing Managers Index fell more than expected, declining from 61.1 in June to 58.8 in July, led by decelerations in production and new orders, as well as a steep decline in employment. A reading above 50 depicts expansion.

In other economic news, the  2Q Employment Cost Index rose 0.7%, above the 0.5% increase that economists had expected, after rising by 0.6% in 1Q.

Treasuries finished solidly higher following the data, as the yield on the 2-year note was down 5 bps to 0.37%, the yield on the 10-year note dropped 16 bps to 2.79%, and the 30-year bond rate fell 12 bps to 4.14%.

Global debt concerns beget global uneasiness

Continued concerns about the ability of US lawmakers to come to an agreement on raising the debt ceiling by the August 2 deadline and disappointing US economic data set the tone across the pond, while the region’s own debt concerns also continued to hamper sentiment. Eurozone debt contagion worries were fostered by Moody's Investors Service placing Spain, a key nation at the center of the contagion uneasiness, on review for a possible downgrade. Moody’s cited long-term budget-balancing challenges, along with subdued economic growth and fiscal slippage within parts of its regional and local government sector. Meanwhile, there were some major economic reports that were released in Europe, with German retail sales surging 6.3% month-over-month (m/m) in June, above the 1.7% increase that economists expected, and eurozone consumer prices for July coming in cooler than expected. Also, the UK released a plethora of data including: consumer confidence falling more than expected, while home prices improved and mortgage approvals rose more than expected. Finally, France released reports showing consumer spending increased more than expected and producer prices declined inline with expectations.

In the Asia/Pacific region the atmosphere wasn't any better, as sentiment was pressured by the standoff in Washington, while some earnings reports out of the region contributed to the dour mood. Meanwhile, on the Japanese economic front, June data showed household spending fell more than expected, industrial production rose less than forecasted, consumer prices rose roughly inline with expectations, while July manufacturing activity accelerated. Elsewhere, South Korea's industrial production rose more than economists' expectations in June, but at a reading showing a solid deceleration from May, China's Leading Index dipped slightly in June from May, and Taiwan reported that its 2Q GDP expanded at the slowest pace since 2009, per Bloomberg, but slightly stronger than what economists had anticipated.

In news out of the US' neighbor to the north, Canada's Gross Domestic Product for the month of May-the nation measures its output on a monthly basis-showed a contraction of 0.3%, well short of the 0.1% expansion expected by economists surveyed by Bloomberg. The drop was the largest decline on two years and followed an unchanged reading in April, as output suffered amid temporary disruptions in the mining and oil and gas sector.

Global debt concerns continue to pressure stocks

After posting solid gains last week, the US equity markets responded this week by registering a sizeable move below the flatline as US lawmakers failed to reach a debt ceiling deal. Meanwhile, although earnings season continued to mostly exceed analysts' expectations, commentary from some companies fostered uncertainty regarding an economic rebound in the second half of the year that most economists have forecasted. Elsewhere, the economic front offered little inspiration for the bulls, culminating with Friday’s disappointing read on 2Q GDP. Although pending home sales unexpectedly rose and weekly initial jobless claims fell below the 400,000 level for the first time since the week ending April 1, new home sales surprisingly fell, durable goods orders surprised to the downside, and regional manufacturing reports showed lackluster activity. Moreover, the Federal Reserve's Beige Book noted that the pace of economic expansion moderated and housing and employment remained weak.

Labor report and ISM's to likely shed some light on a possible second-half recovery

With concerns growing that a second-half recovery in the economy may be threatened, next week's US economic calendar will likely help determine if a rebound is in the cards. The Institute for Supply Management (ISM) will report its July figures for activity in the manufacturing and non-manufacturing sectors. The ISM Manufacturing Index will get the ball rolling on Monday, expected to dip slightly from 55.3 in June to 55.0 for July, with a reading above 50 depicting expansion, while Wednesday’s ISM Non-Manufacturing Index is anticipated to improve from 53.3 in June to 53.7 in July. The changes in new orders and inventories of these reports will be analyzed for signs of demand, while the employment components will be scrutinized for signs that the labor market is rebounding from recent weakness.

The employment picture will likely garner the most attention during the week as the jobs components of the ISM reports will be joined by releases of the ADP Employment Change and weekly initial jobless claims on Wednesday and Thursday, respectively, leading up to Friday's labor report.

July nonfarm payrolls are expected to grow by 90,000 jobs, after rising a disappointing 18,000 in June, and private-sector payrolls are projected to increase 118,000, after advancing by 57,000 in June. The unemployment rate is forecasted to remain at 9.2% and average hourly earnings are anticipated to rise 0.2% month-over-month (m/m), after being flat in June.

Other reports on the US economic calendar for next week include: construction spending, personal income and spending, MBA mortgage applications, factory orders, and consumer credit. In other economic news in the Americas: Canada will release its July employment statistics, along with building permits and its PMI Index, Mexico will report its manufacturing and non-manufacturing data for July, as well as consumer confidence, and Brazil will announce its July PMI Manufacturing Index and industrial production for June.

Economic data due out elsewhere on the international front include: eurozone and UK PMI Indices, the eurozone unemployment rate, PPI, and retail sales, German factory orders, Italian GDP and industrial production, French trade balance, UK PPI, the Japanese Leading Index, China's services PMI, Australian building approvals, home prices, trade balance, and retail sales. However, the highlight of the international economic front will likely be the plethora of central bank meetings from the Bank of Japan, the Bank of England, the European Central Bank, and the Reserve Bank of Australia.