Evening Update

Rally Takes a Breather

Stocks closed off session lows, after an initial negative reaction to an unexpected decline in service sector activity and a larger-than-expected loss of private sector jobs was met by late-day buyer interest. Financials were much higher throughout the day, and received a mid-session boost from comments by American Express CEO Kenneth Chenault, who said “credit metrics are showing the first signs of improvement in 18 months” in an interview on Fox Business News. Earnings reports from Dow members Proctor & Gamble and Kraft Foods bested earnings estimates but missed revenue forecasts. Elsewhere Garmin, Whole Foods Market, Polo Ralph Lauren, Foster Wheeler and Agrium all posted upside earnings surprises, while Electronic Arts offered disappointing commentary despite beating estimates. In other equity news, CF Industries said it is prepared to raise its offer for Terra Industries. Other economic news today included an unexpected rise in factory orders and an uptick in mortgage applications, and Treasuries were lower.

The Dow Jones Industrial Average fell 39 points (0.4%) to close at 9,281, the S&P 500 Index lost 3 points (0.3%) to finish at 1,003, while the Nasdaq Composite declined 18 points (0.9%) to 1,993. In heavy volume, 1.8 billion shares were traded on the NYSE and 2.4 billion shares were traded on the Nasdaq. Crude oil gained $0.55 to $71.97 per barrel, while wholesale gasoline fell $0.01 to $2.05 per gallon, and gold lost $1.88 to $965.07 per ounce.

Proctor & Gamble(PG $54) reported fiscal 4Q EPS of $0.80, two cents ahead of the Reuters estimate, but revenues fell 11% to $18.7 billion, which missed the Street's forecast of $19.3 billion. The Dow component and consumer goods producer said unfavorable foreign exchange reduced revenues and volume declined 5%. PG issued 1Q revenue guidance that missed expectations and it narrowed its full-year revenue outlook. Shares fell.

Fellow Dow member Kraft Foods (KFT $28) announced 2Q earnings of $0.56 per share, two pennies above analysts' forecasts, and revenues declined 5.9% to $10.2 billion, which was $200 million below the Street's expectations. The company said it had solid performance across all geographies, organic revenues rose 2.9%, reflecting the impact of cost-driven pricing actions and positive volume and product mix. KFT raised its full-year EPS guidance. KFT was under pressure.

American Express(AXP $30 ¹) shares got a boost mid-session after CEO Kenneth Chenault, said “credit metrics are showing the first signs of improvement in 18 months” in an interview on Fox Business News. He said that he expects bankruptcies to rise in the 2H versus 1H. He added that the biggest decline in consumer spending occurred among the most affluent consumers, and that the economy, not the housing market, is driving the current spending decline.

Garmin(GRMN $34) surged over 20% after reporting 2Q EPS ex-items of $0.83, much higher than the $0.51 the analysts were expecting, as revenues of $669 million were roughly in line with the Street's forecast, but were up 53% versus 1Q, and its largest segment, automotive/mobile, rose 68% sequentially. The personal navigation device maker said while macroeconomic conditions continue to dampen consumer demand, it is pleased with the solid margins and earnings in 2Q, achieved by various initiatives taken to improve productivity, reduce expenses, and utilize the strength of its balance sheet. Gross margins improved to 52.6% from 44.9% in 1Q, while operating margin was 29.8% versus 13.3% in 1Q.

Shares of Whole Foods Market (WFMI $29) rose 15% after the company posted fiscal 3Q profits of $0.25 per share, five cents above the Street's forecast, with revenues increasing 2% to $1.9 billion, generally in line with expectations. The company said it saw its first sequential improvement in same-store sales in six quarters, driven by both average transaction count and basket size trends. Additionally, the CEO said that the company had seen sales of branded items increase and less trading down by customers. WFMI raised its full-year EPS guidance to $0.80-0.82 from $0.65-0.70. The company announced that it would launch a “healthy eating” initiative in the fall.

Engineering and construction company Foster Wheeler (FWLT $28) posted 2Q EPS of $0.96, much higher than the analyst estimate of $0.62, on inline revenues of $1.3 billion. Gross margin improved on prior cost-cutting measures. Despite challenging business conditions and a more competitive environment, the company’s backlog grew 10% from a year earlier, to $1.98 billion, while new orders fell 4.8% to $512 million. The company noted “an extensive prospect list” of clients planning to proceed with projects, and expects several clients to make award decisions in the 2H of 2009. Shares were higher by 15%.

Polo Ralph Lauren Corporation (RL $68) reported 1Q EPS of $0.76, besting the consensus estimate of $0.50, on inline revenues. CEO Ralph Lauren said that the company navigated well through uncertain times and attributed the results to market share gains, as “each of our brands has a unique channel of distribution and is focused on a specific customer.” He added that the outlook for global consumer spending remains unpredictable but said that “our brands are highly desired” and the company remains committed to investing in strategic growth objectives. Shares rose.

Videogame publisher Electronic Arts (ERTS $20) reported a 1Q EPS loss ex-items of $0.02, better than the $0.13 loss expected by analysts. However, the company maintained its prior full-year EPS forecast, saying that “The industry is weaker than we originally expected, and we remain cautious on the macro-environment.” The CEO said that retailers were more cautious in their initial orders and inventory. In response, the company is planning on increasing its marketing spending, funded by cost cuts in other areas. Shares were lower.

CF Industries (CF $83) announced that its board is prepared to increase its offer to acquire Terra Industries(TRA $30) to 0.465 shares per each share of TRA, and based on yesterday's closing price, the bid would be worth $37.20 per share, or a total of $3.71 billion. The previous offer was worth $33.88 per share based on Tuesday's closing price, which TRA called inadequate. CF also said it was prepared to return at least $1 billion of cash to stockholders of the combined company after the deal closes, likely accomplished through share repurchases. TRA has not commented on the offer. Shares of both companies rose.

Canadian firm Agrium(AGU $49) recently offered to acquire CF, but it was rejected, and AGU said it remains committed to acquiring CF. Separately, Agrium said that earnings in its 2Q were the second highest quarterly level ever, at $2.35 per share, much higher than the $1.81 estimate, and within the company’s guidance of $2.00-2.40. The company said it’s starting to see signs of improving demand fundamentals as the fall season approaches, and continues to anticipate a recovery in potash demand later in the 2H of 2009. Agrium shares were higher.

Service sector report disappoints, private sector jobs fall, but factory orders surprise

Treasuries were mostly lower on the day, with prices higher following the disappointing ISM Non-Manufacturing Index report, then selling off in late day action. The US Treasury announced its next series of auctions for next week, which was inline with expectations of a new record $75 billion, but reminded traders that issuance continues unabated. The Treasury said that the current borrowing calendar is “sufficient” to meet the government’s needs and auction sizes are likely to rise in a “gradual manner” over the medium term. The yield on the 2-year note rose 1 bp to 1.21%, the yield on the 10-year note added 8 bps to 3.76%, and the yield on the 30-year bond increased 11 bps to 4.57%.

Private sector jobs fall more than expected

The ISM Non-Manufacturing Index (chart) for July unexpectedly fell to 46.4 from 47.0, while the forecast was for the index to rise to 48.0 in July. The separation point between contraction and expansion is a reading of 50. The index for new orders fell to 48.1 from 48.6 and employment deteriorated to 41.5 from 43.4. Prices paid fell to 41.3 from 53.7, indicating a significant decrease in prices paid from June, after one month of prices increasing. New export orders fell to 47.5 from 54.5, after the export component reported a month of growth last month, and import orders fell to 45.0 from 47.0.

The data stands in stark contrast to the June report, as well as the ISM Manufacturing Index released Monday, which improved to 48.9 from 44.8, much better than the 46.5 forecast, and showed improvement in orders, prices and employment. Recent economic reports have been trending in the right direction, despite volatility in individual data points.

Elsewhere, ADP reported that private sector jobs fell 371,000 in July, more than the Bloomberg estimate of a loss of 350,000 jobs, but June was favorably revised from -473,000 to -463,000. The ADP report is the first read on employment conditions this week, which will culminate with the labor report from the Bureau of Labor Statistics, which is scheduled for release on Friday and expected to show 328,000 jobs were shed from nonfarm payrolls in July, and the unemployment rate rose from 9.5% to 9.6%. However, the ADP report has not always moved in concert with the broader report, although adjustments have been made recently. Weekly initial jobless claims will be the next piece of employment data to precede the labor report, expected to fall by 4,000 to 580,000 tomorrow (economic calendar).

In other economic news, factory orders (chart) unexpectedly rose for the month of June, as orders gained 0.4%, versus the consensus of economists surveyed by Bloomberg, which called for a decrease of 0.8%. May's 1.2% advance was downwardly revised to 1.1%. Excluding transportation, orders rose 2.3%. Nondefense capital goods orders ex-aircraft, considered a good indicator of business spending, rose 2.6% after gaining a downwardly revised 4.3% in May. June's durable goods orders—reported last week—were favorably revised from a 2.5% decline to a 2.2% drop.

In secondary economic news, the US MBA Mortgage Application Index rose 4.4% last week after falling 6.3% in the previous week, in an index that can be quite volatile on a week-to-week basis. The gain was attributed to the Refinance Index, which rose 7.2% and a drop in the average 30-year mortgage rate by 19 basis points to 5.17% versus the previous week, while the Purchase Index was up modestly. The average 30-year mortgage rate remains steadily above the record low of 4.61% that was reached at the end of March.

The economic calendar is relatively quiet tomorrow, with initial jobless claims being the sole US release, with 580,000 claims expected, down from the prior week’s 584,000.