Evening Update

Markets Shrug – 4Q GDP is “As Good As it Gets”

Stocks ended the day lower, erasing early gains seen after a report on 4Q GDP showed a stronger-than-expected gain of 5.7% in US. After a strong start to January, stocks ended the month lower, as traders have been reacting to favorable data by “selling the news” over the past two weeks, while contemplating a global economic recovery that may have seen the best growth behind it, with the world’s largest growth driver China reining in lending, and continued reports of problems out of the Eurozone, highlighted by Greece’s debt and a stagnant economy in Spain. Technology shares led to the downside today, despite positive earnings reports from Amazon and Dow member Microsoft. Other bullish earnings news from Honeywell International and Mattel Inc were met with selling, while medical products maker C.R. Bard shares rose on better-than-expected earnings. On the bearish side of the earnings ledger, Chevron missed profits despite better-than-expected sales. In other economic news, Midwest manufacturing surged, consumer sentiment was revised higher and the 4Q Employment Cost Index rose more than expected. Treasuries rose in conjunction with the equity sell-off during the day.

The Dow Jones Industrial Average fell 53 points (0.5%) to close at 10,067, the S&P 500 Index lost 11 points (1.0%) to 1,074, and the Nasdaq Composite shed 32 points (1.5%) to 2,147. In heavy volume, 1.6 billion shares were traded on the NYSE and 3.1 billion shares were traded on the Nasdaq. Crude oil was $0.75 lower at $72.89 per barrel, wholesale gasoline lost $0.02 to $1.91 per gallon, and the Bloomberg gold spot price fell $5.28 to $1,081.83 per ounce. Elsewhere, the Dollar Index—a comparison of the US dollar to six major world currencies—was up 0.7% to 79.46. For the week, the DJIA lost 1.1%, while the S&P 500 Index fell 1.7%, and the Nasdaq Composite declined by 2.6%.

Dow member Microsoft Corp. (MSFT 28) reported fiscal 2Q EPS rose by 57% year-over-year (y/y) to $0.74, while excluding the recognition of $1.7 billion in deferred revenue, EPS came in at $0.60, compared to the $0.59 that Wall Street analysts had expected. Revenues rose 14% y/y to a record $19.02 billion, while excluding the aforementioned revenue recognition, the figure was $17.31 billion, compared to the $17.8 billion that the Street had expected. The company said exceptional demand for its Windows 7 software led to the positive top line growth, and cost management drove earnings performance ahead of revenue growth. MSFT said, through 2Q, it has sold over 60 million Windows 7 licenses making it the fastest selling operating system in history. Shares fell.

Amazon.com (AMZN $125) reported 4Q EPS of $0.85, compared to the $0.72 that the street had expected, with net revenues jumping 42% y/y to $9.52 billion, versus the $9.04 billion that analysts had forecasted. The company said sales in electronics and other general merchandise posted a 60% increase in sales, while media rose 29%. AMZN said it expects 1Q net sales to be between $6.45-7.00 billion, compared to the $6.4 billion that analysts are expecting. Additionally, AMZN said its board authorized a $2 billion common stock repurchase program. Shares pared early gains and ended lower.

Dow member Chevron (CVX $72) reported 4Q EPS of $1.53, compared to the $1.70 that was expected, with revenues of $48.0 billion, above the $40.4 billion that had been expected. CVX said its upstream profits—exploration and production—jumped 27%, while its downstream results—refining—swung to a loss of $613 million in 4Q from a profit of $2.1 billion in 3Q, leading to its total 4Q earnings falling 37%. CVX said its upstream business benefited from higher crude oil prices compared to the same period last year, while its downstream business was impacted by low margins on the sale of gasoline and other refined products due to weak demand and excess supply worldwide. Shares were lower.

C.R. Bard Inc (BCR $83) reported 4Q earnings ex-items of $1.39 per share, higher than the $1.34 Street forecast, as revenue at the maker of many disposable medical products rose 6.7% from the prior year to $676.9 million. The company said that while expected growth in 2010 would be below historic levels due to cutbacks by hospitals and individuals amid the recession, it is confident in the company’s growth strategy and believes the company has laid a solid foundation to further accelerate the development and acquisition of new products. Shares were higher.

Honeywell International (HON $39) reported 4Q EPS of $0.91, one penny ahead of what analysts were expecting, with revenues falling 7% y/y to $8.1 billion, inline with the Street’s expectations. The company’s aerospace, automation and control solutions, and specialty materials units all posted sales declines in the quarter, while sales at its transportation systems group increased. HON said that while it continues to plan conservatively for 2010, it is encouraged by improving order trends and stabilization in many of its end markets. Shares fell.

Mattel Inc. (MAT $20) reported 4Q EPS ex-items of $0.81, compared to the $0.68 that analysts had expected, with revenues increasing 1% to $1.96 billion, roughly inline with the Street’s estimate. The company said its sales in the US were down 2%, while international sales were up 3%. The company added that worldwide sales of its Mattel girls and boys brands gained 4% y/y, while its Fisher-Price brands fell 3%. MAT was lower.

4Q GDP jumps, employment costs increase more than expected

Treasuries erased early losses and ended the day higher in conjunction with a sell-off in equity markets. The yield on the 2-year note lost 3 bps to 0.83%, the yield on the 10-year note fell 3 bps to 3.60%, and yield on the 30-year bond declined 5 bps to 4.50%.

Advance 4Q Gross Domestic Product, the broadest measure of economic output, grew at a 5.7% annualized rate, higher than the 4.7% expected by the Bloomberg survey of economists, and an acceleration from the 2.2% growth reported in 3Q. Personal consumption advanced 2.0%, above the 1.8% forecast. Real final sales, which exclude changes in inventory, were 2.2% higher, versus the 1.5% that was reported in 3Q.

The GDP Price Index rose 0.6%, versus the 1.3% consensus forecast, while the core PCE Index, which excludes food and energy, gained 1.4%, versus expectations of 1.3% and the rate remains between of the Fed’s implied target of 1-2%.

The increase in GDP was primarily driven by a positive contribution from inventories of 3.4%, as stocks of goods fell at a slower rate, as well as a 1.4% contribution from consumer spending, and a 0.8% contribution from capital spending on equipment and software, which rose at a 13.3% pace in 4Q, the most since 2006. Businesses cut payrolls at an extreme rate in the face of the crisis and productivity has soared – companies are squeezing more work out of fewer employees and are reluctant to hire with demand still at low levels. As an alternative to hiring more employees in response to an increase in demand, adding technology can be a lower cost way of producing more with the same number of employees, and with capital spending near a 45-year low as percentage of GDP, this could add to future economic growth.

Elsewhere, the final the University of Michigan’s Consumer Sentiment Index (chart) improved in January by a larger amount than initially reported, increasing from 72.8 in the preliminary report to 74.4, versus the Bloomberg forecast, which called for an increase to 73.0. The current conditions component of the report advanced from 81.0 in the initial release to 81.1, but the expectations component advanced solidly from 67.5 to 70.1. Inflation expectations were nearly unchanged with the one-year outlook remaining at 2.8%, while the five-year expectation rose slightly from 2.8% to 2.9%.

Meanwhile, Chicago PM, unexpectedly improved, increasing from a downwardly revised 58.7 in December to 61.5 in January, compared to the decline to 57.2 that was forecasted by economists. A reading of 50 is the demarcation point between expansion and contraction, and the reading was the highest since November 2005. The employment index rose to 59.8 in January, up sharply from the 47.6 it reached in December.

In other economic news the Employment Cost Index for 4Q rose 0.5%, above the Bloomberg consensus, which called for the index to rise by 0.4%. Both components of the index, wages and salaries and benefits, increased.

Spain’s budget and a hike in reserve requirements in India highlight overseas news

While Greece has been the Eurozone country under concern in recent headlines, Spain was under the microscope today, after Spain’s government outlined steep budget cuts to bring its budget deficit from 11.4% last year down to the European Union deficit limit of 3% of GDP by 2013. Spain has been undergoing a severe housing slump, slow growth and rising unemployment. The International Monetary Fund said this week it expects Spain to be the only Eurozone country to remain in recession in 2010, contracting 0.6%, while unemployment was reported at 18.8% in 4Q, with 44.5% of Spain’s working population under 25 being without employment.

Reports out of the UK on consumer confidence and home prices posted better-than-expected improvement. Housing prices in the UK rose 1.2% month-over-month (m/m) and are 8.6% higher than a year ago, while being down 12% from the peak, with prices being buoyed by a lack of homes available for sale.

The Eurozone unemployment rate in December increased from a downwardly revised 9.9% in November to 10.0%, compared to the forecast of economists, which called for the rate to increase to 10.1%. The rate was stable in Europe’s two largest economies, with German unemployment at 7.5%, while France reported a rate of 10.0%.

Consumer prices out of the Eurozone rose 1.0% in December, smaller than the 1.3% amount that economists surveyed by Bloomberg had anticipated. The European Central Bank targets inflation to stay below 2% over the medium term and has forecast that inflation will remain below target throughout this year. The central bank meets next week and will announce its rate decision on Thursday, although no changes are expected to the record low 1% maintained since May last year, and the bank has signaled that its planned withdrawal of stimulus measures would be gradual.

Canada reported real GDP grew 0.4% in November, the third-straight monthly increase, lead by a 2.4% gain in the wholesale sector and 1.8% increase in mining and oil and gas extraction. The Bank of Canada earlier this month forecast 4Q GDP grew 3.3% on an annualized rate, and is predicting growth of 2.9% for 2010. The central bank has predicted that the economy will not return to full output until the 3Q of 2011, as a strong currency is curbing exports, and has pledged to keep the key lending rate at a record low 0.25% until June unless the inflation outlook changes.

A slew of data was released in Japan, as unemployment unexpectedly fell to 5.1% from 5.2%, the pace of decline in consumer prices moderated to -1.7% from -1.9% y/y, industrial production rose 2.2%, less than the 2.5% anticipated, vehicle production surged by 8.6%, and household spending rose 2.1%, higher than the 1.6% expected. The decline in consumer prices and the rise in the yen over the past nine months is forcing policymakers to remain open to further stimulus and the minutes from the Bank of Japan meeting today highlighted concern on the level of the yen, while Finance Minster Kan said today that “There are signs that the economy is picking up, but this is far from a self-sustained recovery.”

Elsewhere, the Reserve Bank of India raised the reserve requirement to 5.75%, more than the forecast of an increase of 50 bps from 5.0%, saying that economic growth would “gain momentum” over the next year and “reinforce” inflationary pressures. For the fiscal year ending March 31, the central bank raised its inflation forecast to 8.5% from 6.5% and its growth forecast to 7.5% from 6.0%, with an “upward bias” for growth, but kept its benchmark interest rate unchanged.

Lingering economic uncertainty outweighs signs of prosperity

On the heels of last week’s solid decline, stocks extended losses this week as sentiment regarding the viability of the global economic recovery continued to be uncertain with some relatively favorable data being overshadowed by a lack of conviction by traders. Earnings continued to be mostly better than expected but traders continued to take the opportunity to book profits, which particularly hit the tech sector hard, leading to a solid decline for the Nasdaq Composite Index. The aforementioned economic uncertainty—which typically does not bode well for the markets—was fueled by global credit concerns as the UK and Japan were subject of some cautious commentary from Standard & Poor’s, which warned that it does not see the UK banking industry “among the most stable,” while it lowered Japan’s debt outlook to negative from stable. These exacerbated already festering concerns about the health of the government debt of Greece—and now Portugal—and their potential ripple effects on the Eurozone economy.

Washington was also a source of uncertainty, as the markets worried about the potential that Fed Chairman Ben Bernanke could be denied a second four-year term as Federal Reserve Chairman—although the Senate did vote in favor of the reappointment on Thursday. Moreover, concerns about the impact on the financial markets of the White House’s proposed tighter regulation on the banking industry added to the uncertainty, but some of the concerns were tempered as President Barack Obama pared back his tone toward financial regulation and seemed to be focusing on job creation in his first State of the Union address to Congress.

Labor report headlines economic data next week

The ISM Manufacturing Index will be released on Monday, forecasted to fall modestly to 55.6 in January from 55.9 in December, which would indicate the sixth month of expansion in the manufacturing sector. Last month this index was surprisingly strong, increasing more than expected on a surge in orders and employment strength, while the ISM Non-Manufacturing Index yet again missed to the downside, but moved back into expansion territory, at 50.1, and January’s reading anticipated on Wednesday is forecasted to rise further, to 51.0. Manufacturing has been stronger on export strength while the service sector is more domestic-driven and has been more volatile on a month-to-month basis, suffering from the weak state of consumer spending in the US.

Wednesday will also bring the ADP Employment Change Report, where the forecast is that private sector employers shed 40,000 jobs in January after declining by 84,000 in December. The ADP report overstated job losses relative to the government’s nonfarm payrolls report for five-straight months before nearly equaling the Labor Department figure in December.

Nonfarm payrolls will headline the week on Friday, with the Bloomberg survey of economists forecasting payrolls increased by 20,000 in January, which would mark the second monthly job increase since December 2007, the month the recession began, after rising 4,000 in November and then subsequently falling 85,000 in December. The unemployment rate is estimated to be unchanged at 10.0%.

Other releases on next week’s busy US economic calendar include personal income and spending, construction spending, pending home sales, MBA Mortgage Applications, initial jobless claims, factory orders, and consumer credit.

The international economic calendar will also be heavy, with PPI, manufacturing and services PMI reports out of the UK and the Eurozone, Eurozone retail sales, German factory orders and industrial orders. In the Americas, Canada releases building permits and employment, while Brazil announces manufacturing PMI and industrial production.

In the Asia/Pacific region, announcements include Japan’s vehicle sales and leading index, China’s manufacturing PMI, and Australian retail sales and building approvals.

Additionally, several central banks will be meeting to discuss monetary policy, including the Bank of England, the European Central Bank, and the Reserve Bank of Australia.