Evening Update

Traders Pocket a Weekly Gain

Stock averages ended nearly unchanged today, pausing after gaining roughly 7% this week, with markets lifted by strong earnings releases from JPMorgan and Intel earlier in the week as well as over 70% of companies reporting thus far announcing earnings ahead of estimates. Today’s action weighed results from General Electric and Google that beat bottom line estimates, but missed on revenues, as well as cautious commentary from both companies. In other earnings news, IBM, Bank of America, Citigroup and Mattel also issued earnings reports that were ahead of consensus estimates. The future of small- and medium-sized business lender CIT Group remains in the news, with reports of the possibility of short-term financing. Strength in housing starts and building permits pressured Treasuries.

The Dow Jones Industrial Average rose 32 points (0.4%) to close at 8,744, the S&P 500 Index was flat at 940, and the Nasdaq Composite gained 2 points (0.1%) to 1,887. In light volume, 1.3 billion shares were traded on the NYSE and 1.9 billion shares were traded on the Nasdaq. Crude oil rose $1.40 to $63.42 per barrel, wholesale gasoline increased $0.05 to $1.77 per gallon, and gold fell $0.80 to $936.55 per ounce. For the week, the DJIA advanced 7.3%, the S&P 500 Index rose 7.0%, and the Nasdaq Composite surged 7.4%.

CIT Group (CIT $0.70 ¹) rallied, but closed off session highs, after Reuters reported that the company is in talks with JPMorgan Chase (JPM $37) and Goldman Sachs (GS $157) regarding $2-3 billion in short-term financing. CIT did not comment on the Reuters report, and the banks either declined comment or didn’t return phone calls.

The company released a statement after markets closed yesterday that the bank is in discussions with potential lenders, and that its board of directors and management are evaluating alternatives to meet the company’s impending liquidity crisis. Separately, the Wall Street Journal reported that a group of CIT’s largest bondholders held a meeting yesterday where they discussed a potential plan to exchange $5 billion of bonds they hold for equity. Meanwhile, White House spokesman Bill Burton responded to questions about why the government had refused to inject capital into the bank, telling reporters that policymakers have decided to set the bar high for granting taxpayer aid to firms needing emergency bailouts. "A lot of that had to do with whether or not they could show themselves to be sustainable in the long term," Burton said. As has been widely reported, CIT could file for bankruptcy as soon as today if the bank cannot put an emergency plan in place to address its imminent liquidity crisis.

Schwab’s Director of Income Planning, Rob Williams, delves further into CIT’s issues in “CIT Bonds: Risks and Scenarios” and notes that ultimately, the outcome for bonds is often binary – either they continue to pay, or they don’t (after a default, or in bankruptcy). Rob offers advice for a range of bond investors.

Dow member General Electric (GE $12 ¹) reported 2Q earnings ex-items of $0.26 per share, down by nearly half from the level GE earned in 2Q last year, but still above analyst forecasts of $0.24. Sales fell 12% on a currency-adjusted basis to $39.1 billion, which was somewhat disappointing as most analysts had only expected revenues to decline by 10%. CEO Jeff Immelt noted that the environment remains “challenging,” but management continues to “position GE to win in a reset economy.” Earnings were lower in all business units except for the energy infrastructure unit, although GE noted that its global operations continue to contribute strong growth, with industrial sales up 31% in China, 46% in India, and 10% in the Middle East. As for the firm’s finance arm, GE Capital, Immelt announced that it “remains on track to be profitable for the full year.” The stock fell.

Fellow Dow member International Business Machines (IBM $115) released 2Q earnings, showing the technology bellwether earned $2.32 per share, compared to the Street forecast of $2.02. Sales fell 13% to $23.5 billion, roughly in line with analyst expectations. Services signings of $14.0 billion were down versus ’08, but within that, outsourcing signings were up 24% in constant currency. The company raised its cost and expense savings for 2009 from $3.0 billion to $3.5 billion, having achieved $1.5 billion year-to-date. Management is now guiding to full-year earnings per share of "at least $9.70," compared to its previous forecast of $9.20. "We are well ahead of pace for our 2010 roadmap of $10 to $11 per share," CEO Samuel Palmisano said. IBM shares rose.

Google (GOOG $430) earned $5.36 per share in 2Q, above the Reuters estimate of $5.09. Revenues increased 3% to $5.52 billion, slightly ahead of the $5.49 billion consensus forecast. General and administrative costs fell 23% compared to ’08 and headcount fell by 378. CEO Eric Schmidt remarked that business appears to have stabilized, but it is "too early to tell" if a full economic recovery is imminent. Management said YouTube could begin making a substantial profit sometime soon, noting that advertising, such as pre-roll ads on videos were gaining traction. The stock fell modestly.

Bank of America (BAC $13 ¹) said its 2Q EPS fell 25% to $0.33, ahead of analyst predictions of $0.29. Forecasts from analysts varied widely, ranging from a loss of $0.11 to a gain of $0.50, as the bank has undergone drastic changes in the past year. BAC announced that its credit card services division swung to a loss of $1.6 billion during the quarter, from a $582 million profit in the same period last year, as more borrowers fell behind on payments. Meanwhile, net charge-offs rose 25% to $8.7 billion, and nonperforming loans jumped 21% to $31.0 billion. CEO Ken Lewis warned that "Difficult challenges lie ahead from continued weakness in the global economy, rising unemployment and deteriorating credit quality that will affect our performance for the rest of the year and into 2010." Shares fell.

Citigroup (C $3) announced 2Q EPS of $4.3 billion, or $0.49 per share, although a gain of $6.7 billion from selling control of its Smith Barney brokerage business added to results. Citigroup did not provide comparable figures, but excluding that gain, Citi had an operating loss of approximately $0.27 per share, which was better than the loss of $0.33 per share that was the average analyst estimate. The operating loss from Citigroup contrasts with positive quarterly earnings reported from Bank of America, Goldman Sachs, and JPMorgan Chase, three of the other five largest banks in the country, as Citigroup continues to be particularly hard hit by the credit crisis. Citigroup aggressively cut costs during the quarter, resulting in operating expenses falling 21%, with CEO Vikram Pandit reassuring investors, "we remain optimistic that our turnaround of Citi will gain speed." Pandit, who took the company’s reigns in 2007 following the ousting of Chuck Prince, said in a speech earlier this week that he expects slow US economic growth in coming years as Americans are now saving more and borrowing less. Shares ended nearly unchanged, erasing an early gain.

Mattel (MAT $17), the world’s number one toymaker, announced that its earnings nearly doubled to $21.5 million, or $0.06 per share, much better than the average analyst forecast of $0.01. Sales slipped 19% to $898 million, with US sales off 12%, and international sales declining 26%, including unfavorable exchange rates that knocked 10 percentage points off of growth. CEO Robert Eckert noted that the results “met our expectations,” but added that “retailers are still very cautious on their inventory positions, as are we.” Mattel shares rose.

Surprising jump in housing starts gives investors hope the sector is stabilizing

Housing starts and building permits (chart) came in today stronger than expected, adding to investor hopes that the struggling sector may finally be stabilizing. Housing starts peaked at an annualized level of more than two million homes back in January 2006, and have since plummeted by almost 75% before starting to level off at last this spring. This morning’s report showed that builders broke ground at an annualized rate of 582,000 homes in June, which was higher than economists’ expectation of 530,000. At the same time, May figures were revised up to 562,000. Importantly, the single-family homes component of the index showed a 14% increase. Single-family homes constitute almost three-fourths of the index, but the smaller multi-family home market can oftentimes account for most of the fluctuations in the data, due to its more volatile nature. Both overall starts and single-family starts have now increased for two consecutive months, increasing the likelihood that demand has at last leveled-off, after starts hit a record low level of 479,000 in April, in one of the worst housing markets in US history. Take note though, that June’s better-than-expected figure is still almost 50% lower than the same period last year, so conditions in the industry remain severe.

At the same time, building permits, the more forward-looking indicator of future home construction, increased 9% to an annual rate of 563,000, again comfortably above the forecasted level of 524,000. The building permits index also appears to have stabilized, rising each of the past two months after reaching a record low level of 498,000 in April. That brings the index back to the level of December, but still almost 50% lower than the level seen in June 2008. Treasuries were lower today, with the yield on the 2-year note up 1 bp to 0.99%, the yield on the 10-year note rising 8 bps to 3.65%, and the yield on the 30-year bond increasing 10 bps to 4.54%.

Recharged bulls find more gas in the tank

After trending downwards for four-straight weeks as it appeared stocks could go no further based solely on the economy being “less bad” but still not good, stocks finally got some new ammunition to resume their upward trajectory. Earnings season in the US has kicked off with a bang, and many of the nation’s largest companies have reported better-than-expected results – putting to rest the skepticism from some bears that 2Q earnings would be full of negative surprises as the economy continues to shed jobs and housing prices have not yet stopped dropping.

Four of the nation’s five largest banks reported earnings this week, with Bank of America, JPMorgan, Citigroup, and Goldman Sachs all showing higher-than-expected results. Tech bellwethers IBM and Intel (INTC $19) also beat the Street’s earnings forecast, as did Johnson & Johnson (JNJ $59). Equity news this week was not entirely positive, as lowered outlooks from Dell (DELL $13) and Nokia (NOK $13) tempered enthusiasm somewhat, but by-and-large it was a positive start to earnings season, with 38 companies in the S&P 500 reporting results since July 8, and earnings beating estimates by 16% on average, according to Bloomberg. Corporate profits in total for 2Q are estimated to have fallen 35% from last year, according to Bloomberg data, with another 21% contraction expected on average for next quarter. Also acting as an anchor on further stock gains, small business lender CIT Group is still teetering on the edge of bankruptcy, and the uncertainty of how the economy would withstand another bank failure lingered over markets throughout the week.

Although earnings season overshadowed trading this week, there were also several economic reports for investors to consider. Two of the government’s primary measures of inflationary pressures in the economy – the Producer Price Index (PPI) (chart), and the Consumer Price Index (CPI) (chart) were both released, showing a relatively tame level of price increases and no immediate danger of runaway inflation or deflation. Meanwhile, industrial production (chart) data revealed that the decline in manufacturing activity slowed last month, while at the same time housing starts and building permits both posted their second-straight monthly increase, lending support to the theory that a tentative recovery in the economy is forming. Lastly, the minutes to the June 24 FOMC Meeting were released, showing that Fed members still view the economy as fragile, with the recovery still tenuous.

Existing home sales data will be next week’s major economic release

Existing home sales for June will be released on Thursday, expected to rise 0.6% month-over-month in June to an annual rate of 4.85 million, after rising 2.4% in May to 4.77 million units. The June sales data is expected to show the third-straight m/m rise. Pending home sales have increased for four months, and typically lead existing home sales by a month or two. However, contract closings have come in lower than would have been predicted by pending contracts, and the National Association of Realtors said that some contracts are falling through after appraisals are coming in at lower prices, as appraisers who aren’t familiar with the locale are using recent sales, which have been dominated by distressed sales, to model prices. The NAR believes that distressed sales typically sell for 20% less than the normal market price.

Other economic releases on the docket next week include the Conference Board’s Leading Economic Indicators Index, MBA Mortgage Applications, initial jobless claims, and the University of Michigan Consumer Sentiment Index. Traders will also be monitoring Fed Chair Ben Bernanke’s semi-annual testimony before Congress that begins on Tuesday.