Evening Update

Volatile Day Leaves Stocks Unchanged

Markets bounced back and forth between gains and losses for most of the day before closing mixed and little-changed. Profit taking from the recent rally combined with another deluge of earnings reports as traders struggled to find direction. Corporate earnings continue to be largely better than expected, driven mainly by cost cutting to offset weak sales growth, and Boeing, Pfizer, Apple, Yahoo, PepsiCo, and Starbucks all positively surprised. The picture was less clear in the banking sector, however, as Morgan Stanley became the first of the nation’s largest banks to miss analyst expectations with its earnings report, while Wells Fargo, US Bancorp, SunTrust, and KeyCorp all reported results that included surging non-performing loans and credit losses. Meanwhile, Goldman Sachs announced that it has repurchased the warrants associated with its TARP loan, helping to offset the financial sector weakness somewhat. Elsewhere, Treasuries were lower as mortgage applications rose for a third-straight week and Fed Chairman Ben Bernanke completed his second day of testimony in Washington, reiterating his view that the Fed has the ability to implement a timely and effective exit strategy, although it doesn’t intend to begin that process for some time.

The Dow Jones Industrial Average fell 35 points (0.4%) to close at 8,881, the S&P 500 Index lost 1 point (0.05%) to finish at 954, and the Nasdaq Composite added 10 points (0.5%) to 1,926. In relatively light volume, 1.1 billion shares were traded on the NYSE and 2.3 billion shares were traded on the Nasdaq. Crude oil dropped $0.21 to $65.40 per barrel, wholesale gasoline increased $0.03 to $1.84 per gallon, and gold gained $2.38 to $950.88 per ounce.

Morgan Stanley (MS $28) was lower after reporting a 2Q loss of $1.37 per share, much larger than the Reuters forecast of a $0.53 per share loss. An $850 million charge related to repaying the government $10 billion in Troubled Assets Relief Program (TARP) funds weighed on results, as did the accounting impact of the tightening of its credit spreads on certain long-term debt. Net revenues for the quarter were down about 11.5% to $5.4 billion, which was slightly better than the Street's forecast. MS said it delivered strong results in investment grade and distressed debt trading and achieved solid performance in global wealth management, but its institutional securities unit revenues—which includes capital markets and investment banking—fell about 23%. CFO Colm Kelleher told Reuters television "it is clear that we are getting better signs of market stability," but this quarter had "a lot of accounting noise," and consumer deleveraging is still a concern for the economy. Responding to criticism of pay practices in the industry, Kelleher said “the war for talent seems to be as hot as ever, I’m not sure that’s sustainable.”

Wells Fargo (WFC $24) posted an 81% increase in 2Q EPS to $0.57, easily topping the Street's forecast of $0.34. Revenue rose 28% from 1Q on an annualized basis to $22.5 billion, with a 19% increase in legacy Wells Fargo revenue to $13.6 billion, while recently-acquired Wachovia contributed 39% of consolidated revenue. Shares were under pressure though amid credit loss concerns as the company reported net charge-offs rose 35% to $4.39 billion compared to last quarter, and nonperforming loans jumped 45% to $18.34 billion. WFC said it expects credit losses and nonperforming assets to increase and some analysts are expressing concern that the bank may not be adding enough to its credit loss reserves, after it added $700 million to its reserves during the quarter bringing it to $23.5 billion.

Meanwhile fellow TARP recipient US Bancorp (USB $19) was up after its 2Q adjusted EPS of $0.12 beat the average forecast of $0.10. That result is still down significantly from the earnings of $0.53 per share USB reported in 2Q 2008, mainly due to provisioning for loan losses and charges associated with repaying TARP funds. Average loan growth during the period was 13% year-over-year (y/y), driven by new credit card, home equity, and student loans. USB also increased its deposit base 20% y/y, and the increase in net charge-offs and non-performing loans both moderated to an 18% pace, on a quarter-over-quarter basis.

Regional lender KeyCorp (KEY $5) was higher despite a 2Q loss of $0.69 per share, which was worse than the expected loss of $0.40 per share. CEO Henry Meyer affirmed that “our results continue to reflect the weak economic environment and the aggressive steps we’ve taken to address credit quality.” Net loan charge-offs were $539 million, or 3% of the average loan balance during the quarter, with non-performing loans 26% higher than last quarter at 3.1% of all loans. CFO Jeff Weeden said the higher non-performing loans suggest charge-offs will “remain elevated” for the year.

SunTrust (STI $16), the nation’s seventh-largest bank by assets, was also higher after reporting a loss of $0.41 per share, better than the expected loss of $0.52 per share. STI provisioned for $962 million in future loan losses, more than double the amount it reserved in the same quarter last year. Management reported that net charge-offs increased across nearly all loan categories, with residential real estate being the biggest problem area. CEO James Wells noted that the environment remains difficult, but several positive trends, including deposit growth, increasing net interest margin, and lower early-stage delinquencies are encouraging.

In other bank news, Goldman Sachs (GS $160) revealed that it has repurchased the warrants awarded to the US Treasury as part of the TARP loan provided to Goldman last fall. Goldman had already repaid the government the $10 billion loan it received as part of the TARP program, and as part of that loan, the government also got these warrants giving it the ability to buy Goldman shares at a predetermined price in 10 years. GS paid $1.4 billion to buy back the warrants, including dividends, giving the government an annualized return on the investment of 23%. GS shares recovered from earlier weakness to finish higher following the announcement.

Apple (AAPL $157) traded higher after it reported fiscal 3Q EPS of $1.35, well above the Reuters estimate of $1.18, as revenues rose about 12% to $8.3 billion, which also topped the Street's estimate. The company sold 2.6 million Macintosh computers during the quarter, a 4% increase versus a year ago, quarterly iPhone sales surged 626% to 5.2 million units, while sales of iPods fell 7% to 10.2 million units. In typical AAPL fashion, the company issued conservative 4Q revenue and earnings guidance that came in below analysts' expectations.

Dow member Boeing (BA $42 ¹) announced 2Q EPS rose 22% to $1.41, topping the Street's forecast of $1.21, as revenues rose 1% to $17.2 billion, which was just shy of analysts' expectations. The aerospace firm said results were driven by growth in defense programs and strong performance in defense and commercial airplanes. BA reaffirmed its full-year EPS guidance and said it is still currently assessing schedule and financial implications from its most recent production snag related to the 787 Dreamliner, which led the company to again delay the first flight of the new plane. Shares were lower.

Fellow Dow component Pfizer (PFE $16) was higher after reporting 2Q EPS ex-items of $0.48, one penny ahead of analysts' estimates, but revenues of $11 billion came in short of the $11.3 billion, which had been forecast. The company said foreign exchange unfavorably impacted revenues by approximately $1.1 billion, as US revenues fell 5% and international revenues decreased 12% versus last year. PFE raised its full-year EPS guidance at the low end of its previous 2009 revenue outlook.

Yahoo (YHOO $17) reported 2Q EPS of $0.10, two cents above analysts' expectations, as revenues fell 13% to $1.6 billion. Shares were higher despite 3Q earnings guidance from the number-two internet search engine that came in below the Street's expectations. CEO Carol Bartz told analysts, “As far as the economy goes, it’s easy to assume it’s bumping along the bottom but in all honesty, there’s just so much conflicting information in the market that it’s just too early to call.” CFO Timothy Morse added “obviously it’s a tough time,” but “I think we did a good job of controlling what we can.”

PepsiCo (PEP $56) announced 2Q EPS ex-items of $1.02, two pennies higher than the Street's expectations, while revenues fell 3% to $10.6 billion. The company said its results reflect solid performances in its food and international businesses, while it continued the transformation of its North American beverage business. PEP reaffirmed its full-year revenue and earnings outlook. Shares were lower.

Starbucks (SBUX $17) gained nearly 20% after its 2Q earnings of $0.20 per share topped the average analyst projection of $0.19. Revenues declined almost 7% to $2.4 billion, inline with Street expectations, as same-store sales fell 5% globally and 6% in the US. CFO Troy Alstead, in an interview with Reuters Television, forecast 4Q earnings ex-items of $0.19-$0.20 per share, which was above analyst expectations. Alstead was cautious about forecasting a return to positive same store sales growth, however, stating "we're not prepared to make that projection yet ... it's still a very, very uncertain economy. Consumers are having a difficult time, unemployment continues to rise."

Mortgage applications rise for third-straight week, Bernanke back on the Hill

Treasuries were lower today in the absence of any major economic reports. The yield on the 2-year note added 2 bps to 0.94%, the yield on the 10-year note increased 6 bps to 3.54%, and the yield on the 30-year bond gained 6 bps to 4.45%.

The US MBA Mortgage Application Index rose for a third-straight week, increasing 2.8% for the week ended July 17, following the prior week's 4.3% growth, in an index that can be quite volatile on a week-to-week basis. The advance was attributed to the Refinance Index, which gained 4.0%, and a 1.3% advance in the Purchase Index. The rise in mortgage applications came despite the Mortgage Bankers Association (MBA) saying the average 30-year mortgage rate rose from 5.05% to 5.31%, still solidly above the record low of 4.61% that was reached at the end of March.

Federal Reserve Chairman Ben Bernanke completed his semi-annual monetary policy testimony on Capitol Hill as he spoke in front of the Senate Banking Committee today. Bernanke's testimony was inline with what he said yesterday in front of the House Financial Services Committee where he reiterated that the pace of the economic decline appears to have slowed significantly, and that the labor market has continued to weaken, with unemployment apt to stay uncomfortably high into 2011 and weigh on consumer confidence. The Fed Chief also discussed the exit strategy from the massive amount of stimulus efforts, reassuring traders that the Fed has the tools to successfully rein in the efforts in a timely manner to stave off a spark in inflation, but Bernanke quashed any rumors that the central bank will abandon its accommodative stance anytime soon.

Existing home sales are expected to have increased in June

Existing home sales for June will be released tomorrow, expected to rise 1.5% month-over-month (m/m) in June to an annual rate of 4.84 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.