Evening Update

Stocks Stumble into the Weekend

Markets were weak today as investors worried that nervous consumers could halt the nascent recovery in its tracks. An unexpected decline in the University of Michigan Consumer Sentiment Index sparked the concern, which combined with the disappointing drop in yesterday’s retail sales reports to convince traders to lock in some of their recent profits. Equity news today centered on earnings reports from some of the nation’s largest retailers, with JC Penny and Nordstrom both posting inline or better earnings and raising full-year guidance, although that was not enough to keep both stocks from finishing lower as analysts had already come to view the existing guidance as too low. Elsewhere, Abercrombie & Fitch missed Street forecasts, although one-off costs helped explain the miss and sales were above expectations, Autodesk topped its earnings forecasts, BB&T was reported to be close to acquiring a regional bank on the verge of bankruptcy, and Boeing confirmed another problem with its 787 Dreamliner production, although the snag is not expected to impact the aircraft’s delivery schedule. Meanwhile, Treasuries finished higher after CPI data showed no inflationary pressures, and industrial production increased for the first time in months.

The Dow Jones Industrial Average dropped 77 points (0.8%) to close at 9,321, the S&P 500 Index lost 9 points (0.9%) to finish at 1,004, and the Nasdaq Composite declined 24 points (1.2%) to 1,986. 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 $3.01 to $67.51 per barrel, while wholesale gasoline fell $0.08 to $1.94 per gallon, and gold dropped $6.95 to $948.00 per ounce. For the week, the DJIA retreated 0.5%, the S&P 500 Index slipped 0.6%, and the Nasdaq Composite slumped 0.7%.

Retailer earnings reports continue to pour in, headlined by today's announcement from JC Penney (JCP $31), where the department store reported flat 2Q EPS, versus the Reuters forecast calling for the company to report a loss of $0.01 per share. Total sales in the quarter fell 7.9% to $3.9 billion, matching the Street's estimate, and same-store sales fell 9.5%.. JCP said the strongest merchandise results were in shoes and women's apparel, and geographically, the best performance was in the southwest region of the country. On the other hand, the weakest results were in children's apparel and in the southeast region. JCP also raised its full-year outlook, now guiding to EPS of $0.75-0.90, compared to the previous range of $0.50-0.65. Analysts were already expecting 2009 EPS of $0.89, however. After rivals like Macy’s (M $15) and Kohl’s (KSS $52) already raised their full-year outlooks, analysts have begun to look on retailer guidance for 2009 as increasingly conservative. Shares of all three firms were lower today.

Elsewhere in the group, upscale retailer Nordstrom (JWN $28) reported 2Q EPS of $0.48, matching analysts' forecasts, and revenues fell 6.2% to $2.1 billion, also roughly inline with the Street's prediction. Same-store sales fell almost 10% during the period. JWN said the solid execution of its anniversary sales promotions combined with disciplined inventory and expense management allowed the company to exceed its earnings plans. The company lowered its average price for non-cosmetic products approximately 10% during the quarter, and worked to cut costs to offset the fall, as the company has yet to see a pickup in consumer demand outside of its sales promotions. "We really don't see outside of this unique sale event a change with the customer," President Blake Nordstrom said. The company raised its full-year EPS and same-store sales outlooks, with management now predicting EPS of $1.50-1.65 for 2009, compared to the $1.48 average analyst estimate, but shares were lower.

Finally, teen retailer Abercrombie & Fitch (ANF $34) revealed that it lost $0.30 per share in 2Q, much worse than the loss of $0.07 per share analysts had expected. Management noted that the results included $24.4 million in charges for store closings, but comparable EPS figures were not provided. Revenues fell 23% to $649 million, which was better than analyst expectations of $646.5 million, as same-store sales fell at a rapid 30% pace in the quarter. CEO Mike Jeffries noted that in this environment, consumers are hesitant to spend the extra money for its more fashionable merchandise. "Consumer spending patterns domestically continue to be dictated by cost and value propositions, and this is clearly a headwind for our premium brands," Jeffries said, adding that the company plans to cut its prices for the fall season but won’t abandon its core strategy. Shares were higher.

Autodesk (ADSK $25) was higher after reporting 2Q EPS ex-items of $0.24, five cents above the Reuters estimate, and although revenues fell 33% to $415 million, they were slightly above the Street's forecast. The tech software and services company said its revenue results reflect a challenging global business environment and it is pleased with the progress it made to increase its efficiency and reduce its overall cost structure. ADSK reported 3Q guidance that matched analysts' estimates. Management gave a cautiously upbeat outlook for the future, with CEO Carl Bass commenting, “We have all seen the decidedly mixed U.S. economic reports that have been published recently. Some are simply less bad relative to expectations, so I think it’s unclear that a sustainable global recovery is underway. That said, relative to what we experienced late last year and early this year, our business was less volatile as we exited the second quarter. The environment is still challenging but it feels like global demand for our products is showing signs of stabilizing.”

Several media outlets are reporting that BB&T Corp (BBT $27) will acquire Colonial BancGroup (CNB $0.41). The takeover will be backed by the FDIC, according to the report, which did not name a source, as neither the government nor the two banks have confirmed the deal. Colonial is Alabama’s second-largest bank – it has 355 branches across five states, and approximately $25 billion in assets. The bank said on August 7 that there was “substantial doubt” it could survive, which would make it the largest bank failure of 2009. An unsuccessful expansion into Florida has left the lender saddled with more than $1.7 billion in non-performing real-estate loans, and the bank is also the subject of a SEC criminal investigation. BBT shares were nicely higher today, while trading in CNB was suspended.

Dow member Boeing (BA $45 ¹) was under pressure after confirming the company stopped work in June at an Italian plant of Alenia Aeronautica—a unit of Italian aerospace and defense Finmeccanica(FINMY $8)—that was making parts for its 787 Dreamliner after wrinkles in the fuselage skin were discovered. The aforementioned flaw was found on the same day that BA delayed its first test flight for a fifth time on June 23rd, due to a separate structural flaw where the wings met the body of the aircraft. A BA spokesperson said a solution has been designed and "it's not expected to be a long time" before patches are applied to all the planes built so far. The company has not rescheduled the Dreamliner's first flight or updated its delivery schedule. Finmeccanica also downplayed the significance of the work stoppage, stating “in any case the (developments) have not had and will not have any effect on the timing of the first flight of the 787, on the certification of the aircraft or on the start of deliveries to clients."

Discount airline Southwest Airlines(LUV $9) announced that it has dropped its bid to acquire struggling Frontier Airlines (FRNTQ $0.20) because it could not reach a labor agreement with its pilots. LUV released a statement, claiming its "culture and relationships with its employees are too important to compromise.” This announcement clears the way for Republic Airways’s (RJET $6) competing bid to be accepted. Shares of LUV were lower, while RJET was higher following the report.

Consumer prices flat, industrial production gains, but consumer sentiment wanes

The Consumer Price Index showed prices were unchanged from June to July, which matched expectations. The core rate was also subdued, rising just 0.1%, again inline with estimates. When compared with the same period last year, prices continue to show a deflationary trend – mainly due to the sharp fall in energy prices – as the headline rate fell 2.1%, but the core rate was up 1.5%. Today’s report will lend support to the Fed, which has received increasing calls for a detailed “exit strategy” from the drastic measures it has taken to inject liquidity into the system. As long as inflation is restrained, the Fed’s job becomes easier as it can take its time in unwinding the stimulus, without pressure to act before it feels the economy is ready to stand on its own.

Meanwhile, industrial production increased 0.5% last month, ahead of the 0.4% rise that economists had predicted. Aside from a hurricane-related rebound in October 2008, this was the first increase in production since December 2007. Most of the increase was attributed to a jump in motor vehicle assemblies, as the auto industry has started to recover from severe production cutbacks earlier in the year when General Motors and Chrysler entered bankruptcy, but even excluding motor vehicles and parts, manufacturing production edged up 0.2%. As a result of the increase, capacity utilization improved to 68.5%, ahead of the 68.3% forecast, after plummeting to a record-low level in June, which was revised slightly to 68.1%.

However, the preliminary University of Michigan Consumer Sentiment unexpectedly dropped, falling from 66.0 in July to 63.2 in August, versus the Bloomberg forecast, which called for an advance to 69.0. The index fell to the lowest level since March—when the equity markets posted their lows of the recession. The University of Michigan said in a statement that consumers reported much less favorable assessments of their personal finances even as they were more likely to expect improved conditions in the national economy. Reuters added that the survey also revealed that the fewest consumers in the survey's sixty-year history reported improved finances, with many citing job losses, shorter working hours and smaller wage gains.

Treasuries were higher following the economic data. The yield on the 2-year note fell 2 bps to 1.07%, the yield on the 10-year note dropped 3 bps to 3.57%, and the yield on the 30-year bond lost 1 bp to 4.42%.

Mixed economic data puts markets into reverse

The sharp rally that sent stocks nearly 50% above their March lows took a breather this week as mixed economic data caused investors to question if stocks were now pricing in an earnings scenario that is unattainable. A disappointing drop in retail sales combined with an unexpected jump in initial jobless claims to spark debate about whether the economy can recover with its largest segment – consumer spending – likely to remain weak. Much anticipation surrounded the Fed policy decision, although its release on Wednesday contained little new information for investors to consider with few changes to existing Fed policies and no concrete details into when to expect a change in course.

In equity news, the week was dominated by earnings reports from the nation’s retailers. Wal-Mart Stores (WMT $52), McDonald’s (MCD $55), Kohl's, and Macy’s all showed strong quarterly performance, although comments from management teams universally noted that consumer behavior remains markedly different relative to previous years, with bargain hunting and cost-cutting still dominating the sector. Elsewhere, mortgage giant Freddie Mac (FRE $1) soared after the firm posted its first positive earnings in two years and reported that it does not expect to need further capital injections. Rounding out the news this week was a strong earnings report from semiconductor giant Applied Materials (AMAT $14). AMAT revealed that it is seeing an improvement in demand, causing it to forecast a gain in the fourth quarter, compared to the loss that analysts had expected.

More inflation data, housing reports looming next week

Next week brings the latest round of news on the housing sector, which has been improving in recent months. Tuesday brings the release of housing starts, which are expected to have increased 2.7% month-over-month (m/m) in July to an annual rate of 598,000 units, and building permits, the more forward-looking indicator of homebuilding activity, which are forecasted to have risen 2.1% m/m to an annual rate of 575,000 units. Including the expected increase in July, both series will have risen for three-straight months, after the level of single-family starts nearly equaled sales in February, an extremely unusual situation.

Existing home sales will be reported on Friday, and are expected to post a fourth-straight increase in July, rising 2.2% m/m to an annual rate of 5.0 million units. Sales continue to be driven by steep discounts offered by foreclosures, with the median existing-home price continuing to drop 15.4% year-over-year (y/y) in June. Pending home sales, which represent contracts signed, have been rising for five months, and tend to be a leading indicator for existing home sales, but changes in appraisal rules have depressed appraisal values, leading to some contracts failing to close, and the level of closed sales, while still positive, hasn’t been at the level typically expected.

The Producer Price Index, a key gauge of inflation at the wholesale level—will be released on Tuesday, and is forecasted to show a decline of 1.3% in July, after rising 1.8% in June. While food and energy are a small component of the index, they are the most volatile, and energy prices have fallen in the past month. The core rate, which removes food and energy, is expected to show a rise of 0.1% in July.