Evening Update

Soft Markets on Limited News

A quiet news day resulted in more profit-taking weakness for stocks today, as attention has already shifted to tomorrow’s Fed policy decision. Discontinuing a recent trend, markets were unable to stage a late rally, and equities finished near their session lows. Corporate news today focused on estimate-beating earnings reports from Fluor and Fossil, although weak topline results resulted in pressure on both stocks. Elsewhere, Clear Channel Outdoor reported an unexpected loss, CIT Group announced that it would not be able to release its financial statements before the SEC deadline, and Google revealed a new version of its search engine, as competition in that sector intensifies. Meanwhile, Treasuries rallied after a strong government bond auction and after economic data showed business productivity improved further thanks to aggressive layoffs, while a separate report showed that inventories in the economy continue to dwindle.

The Dow Jones Industrial Average fell 97 points (1.0%) to close at 9,241, the S&P 500 Index lost 13 points (1.3%) to finish at 994, while the Nasdaq Composite declined 23 points (1.1%) to 1,970. In relatively light volume, 1.2 billion shares were traded on the NYSE and 1.9 billion shares were traded on the Nasdaq. Crude oil fell $1.15 to $69.45 per barrel, while wholesale gasoline rose $0.01 to $2.04 per gallon, and gold fell $0.50 to $945.80 per ounce.

Fluor (FLR $54) reported 2Q EPS of $0.93, two cents above the Reuters estimate, as revenues fell about 8% to $5.3 billion, which came in short of the Street's $5.8 billion forecast. The engineering and construction firm said declines in oil and gas, global services, and its power segments led to the weakness in revenues. FLR added that 2Q new project awards were "substantial," increasing from $6.4 billion a year ago to $6.8 billion. FLR reaffirmed its full-year EPS outlook. Shares were lower.

CIT Group (CIT $1 ¹) was down approximately 20% after the struggling financing firm said it was unable to file its 2Q financial statements with the Securities and Exchange Commission by the prescribed deadline without "unreasonable effort and expense." CIT also said that if it does not successfully complete its debt tender offer, which would allow it to tap a credit facility to make certain debt principal and interest payments, or obtain alternative financing, it could seek relief under the US Bankruptcy Code.

Fossil Inc. (FOSL $25) reported 2Q EPS of $0.25, five pennies above analysts' forecasts, with net sales dropping 11% to $316 million, which was shy of the Street's $322 million forecast. The watch maker said its quarterly earnings topped its expectations as a result of solid same-store sales globally, stringent expense control, and its ability to reduce inventory while maintaining its global gross margins. The company raised its full-year EPS share guidance, and issued mixed 3Q and 4Q earnings outlooks. Management acknowledged that it will have an easier comparison basis in 4Q, as the company had many discontinued sales in 4Q last year, but it is cautious about getting too optimistic until it sees a firm uptick in its business. The company also pointed out that it has seen a stabilization in its European operations, and reiterated its view that as Europe entered the downturn later than the US, it would also exit the downturn later than the US. Shares were approximately 10% lower.

Clear Channel Outdoor Holdings (CCO $6) lost approximately 10% after its 2Q earnings report showed an unexpected loss of $1.94 per share, worse than the profit of $0.01 per share that analysts had predicted. The results included a large impairment charge, and an accounting adjustment related to the 2008 merger with a unit of CC Media Holdings (CCMO $1), although a per-share breakdown for the adjustment was not provided. Sales slumped 24% to $692 million, also below the $720 million that had been expected, as the recession weighed on the advertising sector during the quarter.

Google (GOOG $453) revealed a new version of its search engine, code-named “Caffeine.” The new engine, which is available at a separate address for public testing, could rank results differently for some searches, which has the potential to impact businesses which rely on searches to drive traffic. This follows the announcement that Microsoft (MSFT $23) and Yahoo (YHOO $14) – the two largest competitors of Google – will cooperate on their search operations. Shares of all three firms were lower today.

Productivity jumps, labor costs fell more than expected, inventories continue to slide

Preliminary nonfarm productivity (chart) rose at a 6.4% annual rate in 2Q, higher than the Bloomberg forecast of 5.5%. Productivity gains were the largest since 3Q of 2003, due to hours worked falling 7.3%, much more than output, which fell 5.6% versus the same period a year ago. Unit labor costs declined 5.8%, versus a drop of 2.5% that was estimated. The drop in labor costs was the biggest decline since 2Q of 2000, per Reuters.

The Commerce department said that wholesale inventories (chart) fell 1.7% in June, a larger decline than the Bloomberg consensus, which called for a 0.9% drop, and May's 0.8% decline was revised to a 1.2% drop. Wholesalers’ stockpiles in durable goods, particularly in the professional equipment sector, led the decline, but total sales rose 0.4%, boosted by a 4.5% increase in the automotive sector, resulting in the inventory-to-sales ratio—the amount of time it would take to deplete inventories at the current sales pace—dropping from 1.28 months in May to 1.26 in June. The decline in inventories at the wholesale level was the tenth-straight monthly decline and inventories sit at the lowest level in more than two years.

Treasuries were higher following the economic data and after a key Treasury auction. The government sold 3-year notes today, with the notes pricing at a yield approximately inline with where they were trading before the auction. This was the first of three auctions this week, as the Treasury plans to raise $75 billion in total this week. At the close of trading, the yield on the 2-year note had fallen 6 bps to 1.17%, the yield on the 10-year note was 10 bps lower at 3.67%, and the yield on the 30-year bond lost 9 bps to 4.44%.

Fed policy meeting underway

The Federal Open Market Committee meeting, which began today, will conclude tomorrow with the release of the Fed’s closely-watched policy statement. Although no change is expected to either the fed funds target interest rate, or the size of the Fed’s asset purchase programs, the Bank of England’s surprise increase in its quantitative easing program last week has made investors cautious about writing off the potential for more unconventional central bank measures just yet.

Even if there is no explicit change in policy at this meeting, the statement could still move markets tomorrow as Fed watchers will be closely scrutinizing the Fed’s language for clues into future changes. Investor attention has shifted recently toward how soon and how aggressively the Fed can withdraw its support of the economy, with inflation a likely outcome if the Fed is too slow to act. Fed Chairman Ben Bernanke recently affirmed in a Wall Street Journal opinion piece that the Fed has many options at its disposal when the time comes for an exit strategy, and tomorrow’s statement could address this issue further, although it is likely too early to expect many specific details in terms of timing.

The Fed is also expected to comment on its outlook for economic growth and inflation. At the conclusion of the last FOMC meeting at the end of June, the Fed acknowledged that the recession is losing steam, although it still expects the economy to “remain weak for a time.” Even though equity markets have rallied nearly 50% from their yearly lows as investors have cheered early signs that the economy is turning the corner, the Fed is likely to take a much more guarded view, as evidenced by the minutes to the last Fed meeting which showed a majority of participants still viewed the economy as “fragile” and think it could take five or six years to return to sustainable longer-term growth. Here again the Fed must be careful with its statements. If the Fed is believed to be behind the curve in recognizing a recovery in the economy, then speculation will grow that the Fed’s easy money policy will be maintained too long – increasing the risk of inflation. On the other hand, if market participants sense that rising rates are just around the corner, Treasury yields could rise – potentially short-circuiting the nascent economic recovery.

Also on the economic calendar for tomorrow is a report on the nation’s trade balance.