Evening Update

Markets Cheer Improved Jobs Picture

Stocks moved solidly higher today as bullish sentiment prevailed after the labor report showed the smallest job loss since August 2008 and an unexpected decline in the unemployment rate, which benefitted from fewer people listing themselves as part of the workforce. Strength was broad-based, with the largest gains posted in the consumer discretionary and financials sectors, which are both directly impacted by the outlook for employment on the health of the consumer. In equity news, AIG extended its advance on the week after reporting blowout earnings, while Fannie Mae announced a worse-than-expected loss. CBS Corp and Computer Sciences both beat analyst estimates and Nvidia posted an unexpected profit. Elsewhere, consumer credit fell more than expected and the “cash for clunkers” program received an additional $2 billion in funding. Treasuries were under heavy pressure on the better labor data. The dollar uncharacteristically rose on the improved economic data, reversing the usual response of declining when traders placed risk-seeking bets.

The Dow Jones Industrial Average rose 114 points (1.2%) to close at 9,370, the S&P 500 Index gained 13 points (1.3%) to finish at 1,010, and the Nasdaq Composite advanced 27 points (1.4%) to 2,000. In moderate volume, 1.5 billion shares were traded on the NYSE and 2.3 billion shares were traded on the Nasdaq. Crude oil lost $1.01 to $70.93 per barrel, while wholesale gasoline fell $0.05 to $2.01 per gallon, and gold gained $0.15 to $963.60 per ounce. For the week, the DJIA advanced 2.2%, the S&P 500 Index rose 2.3%, and the Nasdaq Composite gained 1.1%.

American International Group (AIG $27) reported adjusted 2Q EPS of $2.57, much more than the Reuters estimate of $1.33, and net premiums earned by the maligned insurance firm—majority owned by the US government—fell 17% to $8 billion. The company's CEO Edward Liddy—who will retire on Monday—said its results reflect stabilization in certain businesses, with the primary drivers of its positive 2Q results including reductions in net realized capital losses and continued reductions in the risk profile of its financial products portfolio. AIG added that while its insurance companies' operating results remain challenged, largely driven by weak economic conditions and the lingering effect of negative AIG events earlier in the year, performance trends stabilized from 1Q. Shares were higher by over 20%.

Federal National Mortgage Association (FNM $0.66), also known as Fannie Mae, reported a 2Q net loss of $2.67 per share, wider than the Street's forecast of a $2.14 per share. The mortgage financer said delinquencies continued to surge, and it said it will be required to obtain an additional $10.7 billion in funding from the Treasury, as part of the $200 billion package extended to FNM, of which $34.2 billion has been received so far. Shares were lower.

CBS Corp. (CBS $11) announced 2Q EPS of $0.08, one penny ahead of the Street's forecast, as revenues of $3.0 billion were down 11%, in line with analysts' estimates. The media firm said, "early signs of a recovery took hold in the second quarter, and our revenue, profit and EPS trends were all better than in the first quarter." CBS' television revenue fell about 10%, due to lower advertising sales, as softness in the advertising marketplace continued during 2Q, the company said. CBS reaffirmed its full-year operating earnings guidance. Shares were up over 25%.

Nvidia (NVDA $14) reported 2Q EPS ex-items of $0.07, compared to the Street's forecast, which called for the graphic chip maker to record a $0.02 per share loss. Revenue fell 13% to $777 million for the quarter, also better than the $712 million analyst forecast. The company said business is recovering as product demand is improving and its strategic investments are leading to new growth. NVDA issued 3Q revenue guidance above analysts' estimates. NVDA shares were higher.

Computer Sciences Corp. (CSC $49) rose after posting fiscal 1Q EPS ex-items of $0.74, much higher than the $0.51 that the Street had expected, as revenues fell 12% to $3.9 billion, also topping analysts' estimates. CSC said it anticipates modest improvement in the economy, which should drive an increase in short-term projects during the second half of its fiscal year. CSC raised its full-year EPS guidance.

Labor report surprises on the upside

Nonfarm payrolls (chart) fell 247,000 in July, much less than the Bloomberg estimate that called for a 325,000 decline. June was favorably revised to -443,000 from -467,000, and May was also revised from -322,000 to -303,000. The job loss in July was the smallest since August 2008. The unemployment rate unexpectedly fell from 9.5% to 9.4%, versus the consensus forecast calling for the jobless rate to rise to 9.6%. Average hourly earnings rose 0.2%, versus the Street's forecast of 0.1%. The average workweek rose to 33.1 hours from 33.0. The unemployment rate improved as people decided to leave the labor force, either because they were discouraged over job prospects or other reasons such as returning to school, and therefore the number of unemployed artificially improved, down to 14.5 million from 14.7 million in June - however, the number of people employed still fell. Treasuries were solidly lower, falling sharply following the labor data. The yield on the 2-year note surged 10 bps to 1.30%, the yield on the 10-year note rose 10 bps to 3.85%, and the yield on the 30-year bond increased 8 bps to 4.61%.

The number of people who are working part-time for economic reasons, those who would like to work full-time but are unable to, fell to 8.8 million from 9.0 million. Productivity has remained high (rather than falling during a recession), as employers saw the white’s of the eyes of the recession in the fall and didn’t wait to reduce jobs – cut payrolls faster than normal, as well as shifted people to part-time from full-time. With productivity high, it is likely that in response to any increase in demand employers will either have to increase the hourly workweek and/or employees, with July showing a potential step in this process, with the workweek increasing and the number of involuntary part-time workers improving.

Weekly initial jobless claims have been improving, and while they have been somewhat distorted by fewer layoffs in the auto sector than seen typically during summer production shutdowns and retooling, yesterday’s release did not have any auto sector adjustment, and still showed a 104,000 decline in the four-week average of claims from the peak. According to today’s labor report, employment in the auto sector improved by 28,000 during July.

Late yesterday, the Senate voted to approve a $2 billion extension for the “cash for clunkers” program, and was signed into law this morning by President Barack Obama. The program has been credited with a strong surge in auto sales in late July.

Consumer credit was reported by the Federal Reserve late in the session, and showed a contraction of $10.3 billion in credit in June, more than the forecasted decline of $5.0 billion in June. The series of declines is the longest since 1991 according to Bloomberg. Revolving debt fell $5.25 billion, while non-revolving debt, including auto loans, declined $5.0 billion.

New yearly highs as economic enthusiasm rides

Even with traders debating whether the recent rally in the equity markets in the past month and since early March has outpaced the economic reality, stocks managed to keep chugging higher. The major equity market posted fresh yearly highs, with the S&P 500 Index topping the 1,000 mark and finishing at the highest closing level since October. Economic data continued to show burgeoning signs of recovery that gave the bulls the edge in the momentum sustainability argument, highlighted by Friday's relatively favorable labor report. A better-than-expected ISM Manufacturing Index reading complimented upbeat manufacturing reports in China and the eurozone, and along with more favorable housing data, helped stoke economic optimism.

Stocks showed some resiliency during the week, overcoming an unexpected drop in the ISM Non-Manufacturing Index, continued concerns that China may begin to rein its stimulus measures, and surprisingly sobering commentary from the Bank of England and the European Central Bank. Both eurozone central banks left their respective interest rates unchanged as expected, but the BoE unexpectedly increased its bond purchasing program, saying the UK recession is deeper than policymakers expected, while the ECB noted that recent reports suggest that economic activity over the remainder of this year is likely to remain weak, although the pace of contraction is "clearly slowing down.”

The equity front provided some of the sustenance for the bulls' resiliency, starting with Ford (F $8) after it posted an increase in monthly sales on a year-over-year basis for the first time since 2007. Additionally, the automakers cheered the rapid success of the government's "cash for clunkers" sales incentive program, which received an additional $2 billion in funding on Friday. Elsewhere, Dow member Caterpillar (CAT $48 ¹) supported sentiment after it reaffirmed its 2009 outlook and its Chairman Jim Owens told analysts, "We feel like we've found bottom. We are beginning to see some stabilization in sales volumes. It just feels a little better inside and out." Even a vast majority of the nation's retailers posting solid declines in July same-store sales could not derail sentiment as traders decided to focus on some relatively upbeat guidance and positive comments on gross margin improvements in the group.

Busy week of economic releases, Fed meeting is the main event

The two-day Federal Open Market Committee meeting next week will be closely watched. The meeting concludes with the release of its statement mid-day Wednesday. The Federal Reserve is not expected to change its fed funds target rate or its asset purchase programs, but traders will be scrutinizing how the Fed weighs the signs of economic improvement with the still lagging recovery in bank’s willingness to lend, exemplified by elevated levels of cash held by banks in the form of reserves at the Fed.

Recent Fed discussion has been centered on the exit strategies the Fed would employ to unwind the accommodative actions taken to stave off a sustained decline in the economy. It is likely that the Fed will work in reverse order to unwind, first allowing the Fed’s balance sheet to contract by allowing asset purchase programs to expire. The Fed’s short-term credit extensions have already declined to less than $600 billion as of mid-July from about $1.5 trillion at the end of 2008, falling automatically as credit market conditions improved.

The expectation for the Fed to raise interest rates went up slightly with the better-than-expected labor report today, as an economic recovery would imply banks begin to accelerate lending, which has the potential to stoke inflation as the money multiplier kicks in, with each additional dollar lent out creating approximately ten dollars of demand.

Advance retail sales for July will be reported on Thursday, expected to show sales rose 0.6%, after posting a 0.6% increase in June. Excluding the more-volatile auto sector, sales are expected to rise 0.1%, after registering a 0.3% rise in June. Excluding autos, gasoline and building materials, the figure the government uses to calculate the consumer spending component of GDP, sales have been anemic, falling 0.1% in June and were unchanged in May.

Industrial production will be reported on Friday, and the forecast is that production rose 0.3% in July, an improvement from the 0.4% decline in June, and capacity utilization is expected to improve to 68.4% from the record low 68.0% posted in June. Businesses have been allowing inventories to fall to record low levels, falling $283.4 billion in the first half of 2009, in an effort to conserve cash and lower costs.

The Consumer Price Index will also be reported Friday, and the Bloomberg survey of economists expects that prices were unchanged in July, after rising 0.7% in June on higher energy prices. The core rate, which strips out food and energy, is forecasted to have increased 0.1% in July, and increased 0.2% in June.

Other releases on the economic docket include nonfarm productivity, wholesale inventories, MBA mortgage applications, the trade balance, initial jobless claims, business inventories and University of Michigan consumer sentiment.