Evening Update

Summer Rally Pauses Amid Profit Taking

Stocks retreated for the third time in four days as traders booked profits and bulls searched for the next positive signal that could send stocks higher. Markets did enjoy some late day support however as midday losses were pared and stocks finished off of their session lows. News from both the corporate and economic arenas was relatively light today, giving markets time to reflect on recent events and prepare for key reports later in the week. Investors did get a stronger-than-expected sales report from McDonald’s, a reassurance from Freddie Mac that it won’t need additional cash injections, estimate-beating profits from both Priceline.com and Sysco Corp, and improved guidance from Hormel to boost the bull case for stocks, although this was offset by profit misses from Berkshire Hathaway and Dish Network. Elsewhere, Southwest Airlines upped its offer to buy Frontier out of bankruptcy proceedings, while State Street announced that its legal costs could exceed the level it had reserved for. Meanwhile, Treasuries moved higher in the absence of economic data.

The Dow Jones Industrial Average fell 32 points (0.3%) to close at 9,338, the S&P 500 Index lost 3 points (0.3%) to finish at 1,007, while the Nasdaq Composite declined 8 points (0.4%) to 1,992. In relatively light volume, 1.1 billion shares were traded on the NYSE and 1.9 billion shares were traded on the Nasdaq. Crude oil lost $0.33 to $70.60 per barrel, while wholesale gasoline rose $0.02 to $2.03 per gallon, and gold fell $8.80 to $946.15 per ounce.

Dow member McDonald's Corp. (MCD $56) was higher after posting global same-store sales that increased 4.3% in July, topping analysts' estimates that called for the company to report a roughly 3% gain. The fast-food chain said US same-store sales last month increased 2.6%, compared to the Street's forecast of a 2% increase. MCD said its US sales rose on top of strong prior-year growth due to new products, including its McCafe espresso-based coffees, and continued strength of its core menu. Internationally, sales rose 7.2% in Europe, led by its tiered-menu approach complemented by popular local summertime offerings, while sales in Asia/Pacific, Middle East and Africa increased 2.1% due to Australia's ongoing momentum, partially offset by China.

Freddie Mac (FRE $2) was up over 100% after the second-largest US home mortgage funding firm posted a quarterly profit of $768 million—the first profit in two years—and said that it does not need to request additional funding from the US Treasury. But one-time accounting adjustments and marked-to-market gains contributed to the results and the company noted that these are subject to change in future periods. After paying the government $1.1 billion in dividends on preferred shares it owns of the company, FRE posted a 2Q net loss of $0.11 per share, much smaller than the $3.86 per share loss that the Street had forecast. The government has pledged up to $200 billion for the company and FRE has used over $51 billion thus far. FRE said, "While we are seeing some early signs pointing to a housing recovery—including a modest uptick in house prices in some markets—our outlook remains cautious due to rising foreclosures, growing unemployment, tight lending standards and buyers' reluctance to re-enter the market."

Priceline.com (PCLN $150) was up over 10% after posting adjusted 2Q EPS of $2.02, above the Reuters estimate of $1.79, as revenues jumped approximately 18% to $604 million, topping the Street's forecast of $574 million. Gross bookings—total dollar value, inclusive of all taxes and fees—increased 13% to about $2.4 billion. CEO Jeffery Boyd noted that leisure travel demand for the peak summer season was “stronger than expected,” driven in part by discounts. The online travel firm noted that its international revenues grew 20% compared to a year ago, and it continued to gain market share globally in 2Q, reflecting solid performance in the US, Europe, and Asia. The company also offered 3Q guidance above the Street's forecast.

Berkshire Hathaway (BRKA $104,000) reported 2Q operating earnings excluding investments of $1,147 per share, missing the $1,285 per share that the Reuters estimate called for. Revenues fell 2% to $29.6 billion and shares were lower. But including investment gains in its equity investments and derivatives, BRKA posted the first increase in its net earnings in seven quarters, per Reuters.

Hormel Foods (HRL $38) was solidly higher after the meat and food company, which makes Spam, raised its full-year profit outlook from a range of $2.15-2.25 per share to between $2.36-2.42 per share, a level that exceeds the Reuters estimate of $2.29 per share. The company said a strong performance from its refrigerated foods segment, an improved performance by its Jennie-O Turkey store segment, and continued solid results from its grocery business allowed it to deliver a stronger than expected 3Q.

Dish Network Corp (DISH $19) was strongly ahead despite reporting 2Q EPS of $0.14, well below the average analyst estimate of $0.67. Management noted that results were impacted by almost $200 million in expenses related to a legal battle with Tivo (TIVO $10), although comparable EPS figures were not provided. Contributing to the positive sentiment today is news that the country’s second-largest satellite-TV provider was able to grow its subscriber base for the first time in over a year. DISH reported 26,000 net new customers, aided in part by the industry-wide switch from analog to digital broadcast signals in June. Meanwhile, sales were roughly flat at $2.9 billion, which was approximately inline with analyst expectations.

Food distributor Sysco Corp (SYY $25) was up after its 4Q EPS ex-items of $0.50 beat the average Wall Street estimate of $0.49. Sales dipped 7% to $9.1 billion, roughly inline with the $9.2 billion that had been expected. Management noted that market conditions remain “difficult,” but strong focus on cost management helped it deliver the better-than-expected results.

Southwest Airlines (LUV $9) raised its offer to buy Frontier Airlines Holdings (FRNTQ $0.32) in bankruptcy court by 50% to approximately $170 million, compared to its previous offer of $114 million. Southwest is competing with Republic Airways Holdings (RJET $6) as it seeks to acquire the struggling airline. If LUV’s bid is successful, it would boost its network in the Rocky Mountain region, give it access to Atlanta – the world’s busiest airport – and allow it to operate international flights for the first time. Frontier filed for bankruptcy in April 2008 and has already agreed to be acquired by Republic for $109 million, although that agreement contains a provision allowing Frontier the freedom to accept a higher bid. “Our bid ultimately should be seen as the strongest offer by all interested parties,” Southwest CEO Gary Kelly said. Both LUV and RJET finished lower following the announcement.

State Street Corp (STT $52) shares were under moderate pressure after the firm revealed that it may not have set aside enough funds to cover losses from lawsuits and probes by regulators into its operations. "Depending upon the resolution of these governmental proceedings, the remainder of the reserve established in 2007 may not be sufficient to address ongoing litigation," STT said in a regulatory filing today. The company had originally set aside approximately $625 million to cover potential legal costs and as of the end of June, there was $193 million remaining in the fund. State Street said on June 25 that it could be sued by the SEC over its disclosures about and management of fixed income investments through 2007, while the firm has already been sued by investors claiming its funds took too much risk by investing in subprime mortgages.

Weekly economic docket led by FOMC meeting

Treasuries were higher today, as the yield on the 2-year note fell 4 bps to 1.21%, the yield on the 10-year note dropped 2 bps to 3.76%, and the yield on the 30-year bond lost 3 bps to 4.54%.

Although today's economic calendar was void of any major releases, this week is full of important reports – led by the FOMC meeting – which could go a long way in helping traders determine if the recent rally on economic optimism has more fuel to continue. The two-day Federal Open Market Committee meeting, which begins tomorrow, will be closely watched. The meeting concludes with the release of a policy 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 banks' 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.

Also on the docket for tomorrow are the nonfarm productivity report and a reading of wholesale inventories. Nonfarm productivity is expected to have risen 5.5% in 2Q, following a 1.6% gain in 1Q. Productivity has improved during the recession as companies have slashed payrolls even faster than output fell. Meanwhile, economists are forecasting a 0.9% decline in inventories for the month of June, following a 0.8% drop in May, as companies have been cautious about restocking in the face of weak demand.