Evening Update

Stocks Extend Sharp Rally

Wall Street continued its winning streak today, adding to last week’s strong rally that saw stocks gain over 7%. More estimate-beating 2Q earnings reports and another rise in leading economic indicators explained most of today’s strength, with reports of a bondholder-led rescue of CIT Group also giving traders some relief that the bank has narrowly avoided bankruptcy. Today’s earnings calendar was relatively light, highlighted by better-than-expected results from Johnson Control, Halliburton, and Hasbro, while reports from Caterpillar, Coca-Cola, and Texas Instruments will all be released before trading begins tomorrow. The bond market was also strong, with Treasuries ending today higher following the bullish economic data, and as traders await tomorrow’s semi-annual testimony from Fed Chairman Ben Bernanke before the House Financial Services Committee, which could give markets some insight into potential exit strategies the Fed has been planning.

The Dow Jones Industrial Average rose 104 points (1.2%) to close at 8,848, the S&P 500 Index gained 11 points (1.1%) to finish at 951, and the Nasdaq Composite added 23 points (1.2%) to 1,909. In light volume, 1.1 billion shares were traded on the NYSE and 2.0 billion shares were traded on the Nasdaq. Crude oil rose $0.42 to $63.98 per barrel, wholesale gasoline increased $0.02 to $1.79 per gallon, and gold gained $13.35 to $950.85 per ounce.

Multiple media outlets reported that CIT Group (CIT $1 ¹) reached an agreement with bondholders on Sunday night for $3 billion in rescue financing, citing sources familiar with the talks—helping the firm stave off having to file for Chapter 11 bankruptcy protection. The report said the liquidity facility carries a 2.5 year term and portions will be available immediately. Shares were sharply higher although CIT did not confirm the report.

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.

Johnson Controls (JCI $23) was higher after reporting fiscal 3Q EPS ex-items of $0.25, above the Reuters estimate of $0.19, as revenues fell almost 30% to $7.0 billion. The company noted that cost-saving initiatives helped it return to profitability despite very challenging conditions in most of its global markets, and management expects to further increase profitability in 4Q and into 2010. JCI gets over half of its revenues from auto products, where sales were down nearly 40%, while the rest of the business comes from building services, which declined just 14% during 2Q. The company is bidding on projects totaling almost $800 million related to the government’s stimulus package, which management said it expects to have a “meaningful positive impact” on 2010 results.

Halliburton (HAL $22) reported 2Q EPS ex-items of $0.30, four cents above the Street's forecast, as revenues declined about 10% to $3.5 billion. The world’s second-largest oilfield services provider said revenue for most of its product service lines fell, primarily based on a reduction in North American rig count leading to lower pricing and demand for products and services. “Weak global demand and volatility in the commodity markets continue to weigh on the oilfield services industry,” the company said, while CEO David Lesar noted that the industry’s “long-term economic fundamentals” are bright, but the “depth and duration of the cycle remains uncertain.” Shares were higher.

Hasbro (HAS $26) reported 2Q EPS of $0.26, three pennies ahead of analysts' estimates, and revenues rose 1% to $792 million. The world’s second-biggest toymaker said it performed well in what continues to be a challenging global environment, as US and Canada sales were boosted by growth in toys related to the summer movies Transformers and G.I. Joe, while a negative foreign exchange impact weighed on sales in its international segment. Shares of HAS finished higher.

Industrial-parts manufacturer Eaton Corp (ETN $49) gained almost 10% after reporting 2Q EPS ex-items of $0.23, down almost 90% year-over-year, but above the average analyst estimate of $0.17. Sales were down 32% to $2.9 billion during the quarter. The company also lowered its outlook for the full year, stating “as we survey our end markets, the year is shaping up to be considerably weaker than we had forecast in April.” ETN is now predicting full-year operating earnings of $2.00-2.20 per share, from an earlier estimate of $3.60-4.20. The average analyst estimate was just $1.90, showing that investors already expected a downgrade to full-year guidance.

Shares of Human Genome Sciences (HGSI $13) were up almost 300% after the company said its experimental lupus drug—Benlysta—met its primary efficacy endpoint in the first of two pivotal Phase 3 trials by achieving a statistically significant improvement in patient response rate versus a placebo. GlaxoSmithKline (GSK $38) was also moderately higher as it has a co-marketer and co-developer agreement with HGSI for the drug.

Leading Index posts third-straight month in the green

The Index of Leading Economic Indicators (chart) rose 0.7% in June, above the 0.5% increase that economists surveyed by Bloomberg expected, and May's advance was revised from 1.2% to 1.3%. The largest negative contributor was the money supply but it was more than offset by benefits from an increase in building permits and a favorable interest rate spread. This was the third-straight gain in the index, the first time the index has climbed three months in a row since 2004, and the Conference Board noted that the recession has been losing steam since spring, but the economy is still suffering very large job losses and "if these trends continue, expect a slow recovery this autumn," according to a Conference Board economist.

The recent increases in the Conference Board's Index of Leading Economic Indicators (LEI) index are one reason to believe that a tentative recovery in the economy is underway. This index is comprised of 10 individual components (all of which are now either stable or improving), and the indicator has had a strong track record in identifying ends of previous recessions. However, the combination of the worst financial crisis since the Great Depression and bruised consumers will likely keep a lid on growth in the long term, and could imply the risk of a W-shaped recovery (back-to-back recessions like in the early-1980s).

Treasuries were higher following the bullish data, with the yield on the 2-year note down 2 bps to 0.97%, the yield on the 10-year note falling 4 bps to 3.61%, and the yield on the 30-year bond decreasing 2 bps to 4.51%.