Evening Update

Stocks Waiver but Manage to Hold Weekly Gains

Markets opened lower but managed to steadily recover lost gains throughout the day, with the Dow and S&P 500 both edging back above the flatline just before the close of trading, capping off a sharp rally that has seen the Dow gain more than 900 points in just 10 days. The Nasdaq also saw a late rally but came up short, snapping an incredible winning streak that saw the index finish higher for 12 straight days. Earnings season continued to hold the Street’s attention today, with revenue shortfalls from Microsoft and Amazon.com weighing on tech shares, although overall, earnings continued to come in ahead of analyst forecasts. Schlumberger, Black & Decker, and American Express all either matched or beat Street forecasts with their earnings reports today, adding to the long list of companies to do so this earnings season. Elsewhere, CIT Group amended its offer to buy back its bonds and reported that if the offer is accepted, it believes it will avoid bankruptcy, while Guaranty Financial Group revealed that it will likely not be able to avoid bankruptcy, which would be the largest bank failure thus far in 2009. Meanwhile, Treasuries were mixed after the University of Michigan Consumer Sentiment Index was revised up slightly, but still showed a drop in consumer confidence to the lowest level since April.

The Dow Jones Industrial Average rose 24 points (0.3%) to close at 9093, the S&P 500 Index was up 3 points (0.3%) at 979, and the Nasdaq Composite gained lost 8 points (0.4%) to 1,966. In light volume, 1.0 billion shares were traded on the NYSE and 2.2 billion shares were traded on the Nasdaq. Crude oil rose $0.89 to $68.05 per barrel, wholesale gasoline increased less than $0.01 to $1.92 per gallon, and gold rose $2.45 to $951.60 per ounce. For the week, the DJIA advanced 4.0%, the S&P 500 Index rose 4.1%, and the Nasdaq Composite gained 4.2%.

Dow member Microsoft (MSFT $23) reported fiscal 4Q EPS ex-items of $0.36, in line with the Reuters estimate, as revenues fell 17% versus the same period last year to $13.1 billion, more than $1 billion short of the Street's estimate of $14.5 billion. The software giant said its business continued to be negatively impacted by weakness in the global PC and server markets. Sales of its Windows operating system—the firm's most important business—fell for the first time on record. Microsoft’s revenue shortfall is raising some doubts among investors, who had thought a tech recovery could be taking hold after tech bellwethers Intel (INTC $19), International Business Machines (IBM $118), and Texas Instruments (TXN $24) all announced better-than-expected results recently. Microsoft shares were under heavy pressure, down almost 10% today.

Fellow Dow component American Express (AXP $29 ¹) announced 2Q EPS ex-items of $0.27, matching the Street's estimates, with revenues of $6.1 billion, which was $300 million short of analysts' estimates. The credit card firm said provisions for loan losses totaled $1.6 billion versus $1.8 billion a year ago, primarily reflecting lower average cardmember receivables and loans, offset by higher write-offs and past due loans. AXP added, "Although it is still too early to point to any sure signs of an economic recovery, the number of cardmembers who are falling behind in their payments, the volume of bankruptcy filings and the level of loan write-offs were better than we had expected." Shares were modestly lower.

Amazon.com (AMZN $86) posted 2Q EPS of $0.32, one cent above analysts' forecasts, as revenues grew 14% to $4.7 billion, which was slightly below estimates. Sales in the US rose 13%, and its international unit increased 16%. The online retailer issued 3Q revenue guidance that matched the Street's expectations. AMZN traded solidly lower.

Broadcom (BRCM $27) was down solidly after the chip maker announced that it earned $0.03 per share in 2Q, well below the average analyst prediction of $0.24. Sales were down 13% to $1.04 billion, which was better than the $984.4 million analyst forecast. Broadcom noted that its patent dispute with rival Qualcomm (QCOM $47) impacted its results during the quarter, but did not detail specifically the impact that settlement had on its EPS figure. CEO Scott McGregor reported that the results "reflected a return to a more stable ordering pattern" despite uncertainties in the economy, and the firm guided to sales of $1.12-1.19 billion in 3Q, which is above the average analyst expectation of $1.02 billion.

Jointly held Verizon Wireless—a partnership of Dow component Verizon Communications (VZ $) and Vodafone (VOD $20)—announced that it added 1.1 million customers in 2Q, below the 1.4 million posted by rival and Dow member AT&T (T $25). Verizon Wireless CEO Lowell McAdam sought to quell any rumors that an immediate pickup in demand is imminent, stating “the third quarter is going to be tough. I don’t think it’s going to get a lot worse, but I don’t see the third quarter being some big pickup,” adding “I have not seen trends that would indicate we’ve left the bottom.” VZ shares were moderately higher.

Schlumberger (SLB $57) announced 2Q EPS of $0.68, four pennies above the Street's forecasts, with revenues falling 8% versus last quarter to $5.5 billion, which slightly exceeded analyst projections. The oil and gas firm said its oilfield services revenue was 9% lower sequentially to $4.96 billion, while North American gas drilling reached a five-year low as demand remained weak and storage is still at levels way above seasonal averages, which means a substantial increase in demand is needed to stimulate and sustain higher levels of drilling. "We do not anticipate this will happen before 2010,” the company said. Shares were lower.

Black & Decker (BDK $37) was sharply higher after the power tool maker posted 2Q EPS of $0.63, easily topping the Street's forecast of $0.37, as the company met "extremely weak" demand with active costs cuts. BDK said a favorable insurance settlement enabled it to report higher EPS than it anticipated. Revenues dropped 27% to $1.2 billion, matching analysts' forecasts. The company issued 3Q EPS guidance below the Street's expectations but offered full-year EPS that came in above expectations.

CIT Group (CIT $1 ¹) said that it has amended some of the terms in its existing cash tender offer to buy back some of its outstanding bonds, and if the offer is successful the company does not intend to seek relief under the US Bankruptcy Code but rather to pursue restructuring efforts through other means. CIT announced today that it will offer bondholders an additional $50 per $1,000 principal if they tender their bonds by July 31, giving bondholders an incentive to act early to accept CIT’s offer. Creditors accepting the offer will receive a total of 82.5 cents on the dollar for the bonds, as CIT’s credit crunch has left the bank unable to fully repay its debt. Those who tender bonds after July 31 will receive just 75.5 cents on the dollar. Shares were higher.

Meanwhile, Guaranty Financial Group (GFG $2), the second-largest bank in Texas, has said that “it is probable that it will not be able to continue as a going concern” as credit losses and write-downs have left it “critically undercapitalized,” with negative capital ratios. If it does fail, Guaranty will be the largest US bank to do so in 2009. Guaranty is approximately half the size of IndyMac Bancorp (IDMCQ $0.03), which failed last July. Chief Marketing Officer John Wessman said Guaranty is still working with regulators, and the bank believes it can avoid major disruptions to its customers.

Treasuries nearly unchanged ahead of consumer sentiment report

The University of Michigan's Consumer Sentiment Index (chart) for July was revised to a higher level than the preliminary report, rising from 64.6 earlier this month to 66.0, and slightly higher than the forecast of economists surveyed by Bloomberg, which called for a 65.0 reading. However, this is still the first drop for the sentiment index in five months after climbing back to the 70.8 level in June. The index is now back to the lowest level since April when recent equity market lows from March were still weighing heavily on the minds of consumers. The University of Michigan said in a statement that lower income and less favorable job prospects in the next year are key factors making consumers remain anxious about their financial position, and while consumers feel that the economic free-fall is now over, they still see little reason to believe the stimulus policies will improve their financial condition any time soon. The report also noted that inflation expectations for the 1-year time horizon moved slightly lower and the 5-year outlook remained unchanged, while survey results showed consumer expectations for six months from now fell solidly.

Treasuries were mixed following the report, with the yield on the 2-year note down 1 bp to 1.0%, the yield on the 10-year note up 1 bp to 3.66%, and the yield on the 30-year bond unchanged at 4.55%.

Rally Continues for Second Week

Last week’s sharp rally was maintained again this week, with stocks now over 10% higher in just 10 days. A better-than-expected 2Q earnings season continues to be the main source of strength in equity markets. According to Bloomberg, 74% of the 200 S&P 500 Index companies to report 2Q earnings beat analyst forecasts. That would be the highest rate ever, with data going back to 1993, if the trend is sustained. Caterpillar (CAT $39 ¹), Coca-Cola (KO $50), Wells Fargo (WFC $24), Ford (F $7), and AT&T were just some of the companies to positively surprise this week, reassuring investors that corporate earnings have not suffered as much as feared during the recession.

Some bears have pointed out though that revenues are still plummeting, and most of the earnings surprise has come from steep cost-cutting rather than improving business trends, which has tempered enthusiasm somewhat. Also moderating some of the otherwise positive sentiment, loan losses in the banking sector are still climbing. Regional lenders KeyCorp (KEY $5), and SunTrust (STI $16) were among the financial institutions reporting surges in problem loans, making investors somewhat cautious regarding the future outlook for that sector.

The earnings calendar was light this week, but investors got another reassuring report on the housing sector to add to the general sense of economic relief permeating markets for the past two weeks. Existing home sales for the month of June were reported to have increased 3.6% month-over-month, which was above expectations and marked the third-straight month of improvement. The data combined with last week’s reports on housing starts and building permits to indicate that the precipitous drop in the housing market is losing steam.

Slew of economic data next week, capped by the first reading on 2Q GDP

New home sales will be released Monday, and are expected to have increased 2.9% in June to an annual rate of 360,000 units, after falling 0.6% in May. Homebuilder confidence and housing starts both increased in June, as consumer traffic improved. New home sales have failed to keep up with the pace of existing home sales, due to the discounts afforded by foreclosures. Pricing continues to decline, and Tuesday’s release of the S&P/Case-Shiller Home Price Index is forecasted to have fallen 17.9% year-over-year (y/y) in May, a slight improvement over April’s 18.1% decline. The index is a three-month rolling average representing 20 major cities and had plunged 32.6% from its peak in 2006 through April.

Durable goods orders will be reported on Wednesday, and are expected to have decreased 0.6% month-over-month (m/m) in June, after rising 1.8% in April. Ex-transportation, orders are forecasted to be flat m/m, after rising 1.1% in May. The monthly orders data have been very volatile. Consumers are increasingly saving more and spending less, slashing highly discretionary large purchases. Businesses are also cutting unnecessary expenses, and with utilization levels at a record low 68.0% in June, have cut orders for new machinery.

The Federal Reserve Beige Book will be released mid-day Wednesday, and includes anecdotal information on monthly regional economic conditions. Meanwhile, Advance Gross Domestic Product, the first reading on the broadest measure of economic output, for 2Q will be released on Thursday, and is expected to have fallen an annualized 1.5%, after dropping 5.5% in 1Q. Personal consumption is expected to have fallen 0.5% after rising 1.4% in 1Q and the GDP Price Index is expected to rise 1.0%, with the core PCE Index, which excludes food and energy, increasing 2.4%. It appears consumers are continuing, either by force or by choice, to restructure their balance sheets and deleverage or save, instead of spend. However, not all is gloomy, as government stimulus and Americans propensity to spend leads us to believe that a sustained severe retrenchment in consumer spending is unlikely at this point.