Evening Update

Rally Maintained as Fed Decision Contains Few Surprises

Stocks were up strongly before the Fed decision and the rally was sustained as the Fed did little to surprise investors. As widely expected, the Fed kept its extraordinary easing policy in place, although it did acknowledge a further slight improvement in economic conditions since its last meeting. Treasuries turned mixed after the statement, which did not enlarge the Fed’s Treasury purchase program, although the Fed noted that it will slow the pace of its transactions so that the program runs out in October, instead of September as previously expected. In other economic news, the trade deficit expanded as crude oil imports jumped in June. Although the economy stole center stage today, corporate news was largely positive and helped add to the bullish sentiment. A string of companies including Applied Materials, Macy’s, and Sara Lee all beat Street expectations with their earnings reports. Elsewhere, Microsoft and Nokia announced that they will team up on smart phones targeting business users and Toll Brothers traded sharply higher after announcing strong preliminary 3Q results and giving an upbeat outlook for the housing market.

The Dow Jones Industrial Average gained 120 points (1.3%) to close at 9,362, the S&P 500 Index increased 11 points (1.2%) to finish at 1,006, while the Nasdaq Composite advanced 29 points (1.5%) to 1,999. In moderate volume, 1.2 billion shares were traded on the NYSE and 2.2 billion shares were traded on the Nasdaq. Crude oil rose $0.71 to $70.16 per barrel, while wholesale gasoline lost $0.02 to $2.03 per gallon, and gold climbed $0.75 to $946.85 per ounce.

Applied Materials (AMAT $14) posted flat fiscal 3Q EPS ex-items, compared to the Reuters estimate that called for the company to report an $0.08 per share loss. Revenues fell approximately 39% to $1.1 billion, but were up about 11% compared to 2Q, and the Street had expected the world's largest chip-equipment maker to post 3Q sales of just $953 million. "Today, there are more indications that demand is growing and for the first time in a long while, we see positive trends in our business. Economic decline in the U.S., Europe and Japan appears to be moderating," CEO Mike Splinter told analysts. The company expects 4Q EPS to be between breakeven and $0.04, which topped analysts' expectations that called for the company to post a loss of $0.05 per share. Shares were higher.

Macy's (M $16) reported 2Q EPS ex-items of $0.20, topping the $0.17 estimate of analysts. Revenues fell 9.7% to $5.2 billion, largely inline with the Street's forecast, as same-store sales fell 9.5% The company said it successfully lowered inventories and managed expenses to align more closely with current levels of business. Macy’s also raised its full-year EPS guidance, but the expected range of $0.70-80 is mostly below the average analyst estimate of $0.79. The company expects same-store sales in the second half will decline by 5– 6% Shares were higher.

Toll Brothers (TOL $23) was up more than 10% after it reported preliminary fiscal 3Q net signed contracts rose 3% to 837 units, noting that this is the first time in 16 quarters that net signed contracts have exceeded year-ago figures. The luxury homebuilder's CEO said, "Although some of our markets are still stuck in the mud, many are improving." He added that it does feel as if the fence-sitters are looking for reasons to jump in on the side of buying, and "price is no longer the overwhelmingly dominant factor." The company's cancellation rate was 8.5% in the quarter, which was down from 19.4% in the same period a year ago.

Sara Lee (SLE $10) reported adjusted 2Q earnings of $0.29 per share, five cents above analysts' expectations, as revenues fell 9.8% to $3.2 billion, which was slightly below the Street's forecasts. The bakery goods maker saw weakness in international sales, driven by unfavorable foreign currency exchange rates, offset by increased sales in its North American fresh bakery and retail units. SLE was nearly 10% lower as the company issued a full-year revenue outlook that came in below analysts' expectations.

Microsoft (MSFT $24) and Nokia (NOK $13) announced a partnership on smart phones. As part of the deal, Microsoft will offer its mobile Office applications such as Excel, Word, and PowerPoint on Nokia devices. Placing the business software applications on Nokia phones should help it counter the dominance of Research in Motion’s (RIMM $71) Blackberry device, the current smart phone of choice for business users. "This is giving some of our competitors – let's spell it out, RIM – a run for their money," said Nokia executive vice president Robert Andersson, adding "I don't think BlackBerry has seen the kind of competition we can provide them now." MSFT and NOK gained following the announcement, while RIMM ended lower.

UBS (UBS $15) finished higher after reporting it has come to an agreement with the US government over a dispute involving thousands of Americans that have opened accounts with the Swiss bank, helping them to avoid paying taxes in the US. Final details of the arrangement have not yet been provided, with the company stating “At the request of the US and Swiss governments, UBS has agreed not to comment further pending the formal signing of the agreement, which is expected to occur in the near future.”

Trade deficit widens, but less than expected

The trade deficit (chart) increased from $26.0 billion in May to $27.0 billion in June, versus the Bloomberg estimate calling for the deficit to reach $28.7 billion. Goods and services imports rose 2.3%, the first increase in 11 months as oil prices rose, while exports increased 2% on foreign demand for industrial supplies and materials and capital goods. Crude oil imports for the month jumped from $13.4 billion in May, to $16.6 billion, reflecting a jump in the average price per barrel of $7.96 to $59.17.

In other economic news, the MBA Mortgage Application Index declined 3.5% last week after increasing 4.4% in the previous week, in an index that can be quite volatile on a week-to-week basis. The decline was attributed to the Refinance Index, which fell 7.2% and an increase in the average 30-year mortgage rate by 21 basis points to 5.38% versus the previous week, while the Purchase Index was up 1.1%. The average 30-year mortgage rate remains steadily above the record low of 4.61% that was reached at the end of March.

Fed acknowledges improving economy, delays any policy changes

concluded its two-day meeting today and, as widely expected, kept its fed funds target at a range of 0.00-0.25%. In terms of economic conditions, the Fed noted that economic activity is now leveling out, which is a slight improvement relative to the previous Fed statement in late June which described the economy as still contracting, although at a slower pace. The Fed declined to give any further details in terms of when or how it expects to execute an exit strategy, and some of the key language in the previous statement was maintained – most notably the fact that the Committee still expects economic activity to “remain weak for a time,” which will necessitate a continuation of the extraordinary easing policy “for an extended period.” Inflationary pressures are also still seen as low at present, with the slack in the economy offsetting cost pressures from energy and commodity prices.

There were no changes to the size of the Fed’s asset purchase programs. As previously announced, the Fed will purchase up to $1.25 trillion of agency mortgage-backed securities and up to $200 billion of agency debt by the end of the year. The Fed did comment on its third asset purchase program, which involves buying up to $300 billion of Treasuries. That program was set to expire next month, and the Committee said that in order to ensure a smooth transition, it will gradually slow the pace of these transactions and it now expects to reach the $300 billion limit by the end of October. Compared to the Fed’s other asset purchase programs, the Treasury plan has been somewhat more controversial as it has the potential to make the Fed look like it is merely printing money to pay for the White House’s ballooning spending plans. The Fed said it will continue to monitor the size and composition of its balance sheet, and will make adjustments to its credit and liquidity programs “as warranted.”

Treasuries turned mixed after the report, with 2-year notes moving higher, although longer-dated bonds remained lower. In the end, the yield on the 2-year note fell 2 bps to 1.15%, while the yield on the 10-year note increased 4 bps to 3.71%, and the yield on the 30-year bond added 9 bps to 4.53%.

Consumer spending reading on the docket

Advance retail sales for July will be reported tomorrow, expected to show sales rose 0.8%, after posting a 0.6% increase in June. Ex-autos, sales are expected to rise 0.1%, after registering a 0.3% rise in June. Retailers released same-store sales figures last week, and despite some weak results and a later back-to-school season, some retailers were able to post positive comparable store sales and others fell less than expected, prompting increases in quarterly guidance.

Consumers are continuing to deleverage or save instead of spend. Excluding autos, gasoline and building materials, the figure the government uses to calculate the consumer spending component of GDP, retail sales have been anemic, falling 0.1% in June and were unchanged in May.

Other releases on tomorrow’s economic calendar include initial jobless claims, expected to fall to 545,000 from 550,000 the week prior, and business inventories, expected to have declined 0.9% in June.