Evening Update

Markets Dislike Uncertainty

Stocks closed at the lows of the day, now posting a loss for 2010, as two weeks of earnings have been met with “sell on the news” reactions due to likely elevated expectations, while policymakers have added to negative sentiment by raising uncertainty about the future of banking regulation, monetary policy in China, and the fate of Fed Chair Ben Bernanke. Yesterday’s announcement from the Obama Administration to restrict the size and scope of business for banks had the financials leading to the downside again, while energy and materials stocks continue to decline on concerns that China may need to raise rates sooner-than-expected due to the fast pace of growth in that nation. Bernanke’s term as Chair of the Fed expires next week, and politicians made noise about where their vote stands. Technology stocks, one of the standout sectors of 2009, were solidly lower despite strong results from Google and Advanced Micro Devices. Dow members General Electric and McDonald’s rose on favorable profit reports, while American Express fell despite earnings that beat the Street. Elsewhere, Capital One Financial’s earnings beat was discounted by traders as it was due to a lower provision for loan losses, Intuitive Surgical rose on strong earnings, and Harley-Davidson posted a larger-than-expected loss. In other news, Fannie Mae and Freddie Mac were under pressure on comments from House Financial Services Committee Chairman Barney Frank, and Rambus received a favorable patent infringement judgment against Nvidia. Treasuries were mixed and there were no major US economic reports today.

The Dow Jones Industrial Average fell 217 points (2.1%) to close at 10,173, the S&P 500 Index dropped 25 points (2.2%) to 1,092, while the Nasdaq Composite lost 60 points (2.7%) to 2,205. In heavy volume, 1.5 billion shares were traded on the NYSE and 2.8 billion shares were traded on the Nasdaq. Crude oil was $1.54 lower at $74.54 per barrel, wholesale gasoline decreased $0.02 to $1.97 per gallon, and the Bloomberg gold spot price fell $0.13 to $1,093.83 per ounce. Elsewhere, the Dollar Index—a comparison of the US dollar to six major world currencies—was down 0.1% to 78.27. For the week, the DJIA lost 4.1%, while the S&P 500 Index fell 3.9%, and the Nasdaq Composite declined by 3.6%.

Dow member General Electric (GE $16 ¹) reported 4Q EPS of $0.28, two cents above the forecast of Wall Street analysts, as revenues were down 10% year-over-year (y/y) to $41.4 billion, but above the $40.0 billion that had been expected by the Street. The company said it saw encouraging signs in its businesses at year-end, with infrastructure orders up $3.7 billion from 3Q to $22.1 billion, and equipment orders up 25% versus the previous quarter. CEO Jeff Immelt said that its capital finance business is executing well in a difficult environment, and every segment at its GE Capital unit was profitable with the exception of commercial real estate. On a conference call with analysts, GE said it plans to grow its dividend with earnings in 2010. Shares were up modestly.

Google Inc. (GOOG $564) reported 4Q EPS ex-items of $6.79, topping analysts’ estimates, which called for the world’s largest internet search engine to post earnings of $6.50 per share. Revenues rose 17% year-over-year (y/y) to $6.7 billion, but excluding traffic acquisition costs (TAC) of $1.72 billion, revenues were slightly higher than the $4.9 billion that analysts had expected. GOOG’s sites revenues—revenues of company owned sites, which represented 66% of total revenue—rose 16% y/y, while its network revenues—revenues at GOOG’s partner sites representing 31% of total revenues—jumped 21% versus the same period last year. Shares are lower despite the results, continuing the early trend in earnings season in the tech sector, in which traders are booking profits on the heels of better-than-expected reports.

Elsewhere in technology, Advanced Micro Devices (AMD $8) was down solidly despite reporting a 4Q loss per share from continuing operations of $0.08, better than the $0.18 loss expected by the Street. Including a $1.238 billion impact from a legal settlement with Intel Corp (INTC $20), the company reported a profit of $1.52 per share. In other patent infringement cases, Rambus Inc (RMBS $25) reported an International Trade Commission judgment in their favor, finding that Nvidia Corp (NVDA $16) infringed on three patents. Shares of RMBS were higher, while NVDA and INTC fell.

McDonald’s (MCD $64) reported 4Q EPS ex-items of $1.03, one penny above the Street’s forecast, as revenues increased 7% y/y to $6.0 billion, roughly inline with analysts’ forecasts. The Dow component said its global same-store sales—sales at stores open at least 13 months—rose 2.3% y/y, with all segments reporting positive results. US same-stores sales rebounded in December, rising 1%, compared to sales declines in October and November. Meanwhile, MCD said European same-store sales for 4Q were “strong” against robust prior year results, with the UK, France, and Russia leading the segment’s operating income growth for the quarter. Also, MCD said Asia/Pacific, Middle East and Africa delivered impressive double-digit operating income growth, fueled by results in Australia, expansion in China and operating efficiencies and lower commodity costs in many markets. Shares were nearly unchanged, following the market decline during the day.

Fellow Dow member American Express (AXP $40) reported 4Q EPS of $0.59, above the $0.57 that analysts had expected, with net revenues coming in flat versus last year at $6.5 billion, but exceeding the $6.1 billion that was expected. AXP said its provisions for loan losses were down 47% y/y, reflecting continued improvement in credit quality during the latter part of 2009. Also the company said it ended the year on a positive note with cardmember spending up 8% and credit indicators showing further signs of improvement. However, the company cautioned that the economic recovery now underway is likely to be modest, and it still faces the challenge of high unemployment levels, depressed real estate values, and shrunken household balance sheets, but the overall economy and the company are in stronger shape than they were a year ago. Shares were solidly lower despite the results.

Meanwhile, fellow credit card firm Capital One Financial (COF $37) reported 4Q EPS of $0.83, compared to the $0.45 estimate of analysts, but shares were heavy pressure as analysts are pointing out that the better-than-expected profits were a result of a release of loan loss reserve funds, which drove a $353.5 million decrease in its loss provision expense from the prior quarter.

Intuitive Surgical (ISRG $340) rose over 10% after posting 4Q EPS of $1.95, above the $1.71 estimate of analysts, with revenues jumping 40% y/y to $323 million, above the $293 million forecast of the Street. The surgical robotics firm’s CEO said outstanding patient outcomes and growing robotic surgery adoption with patients and the medical community led to the better-than-expected performance during the quarter.

Harley Davidson (HOG $24) was down solidly after posting a 4Q loss of $0.63 per share, compared to the $0.32 per share loss that analysts had expected, with revenues falling 40% y/y to $765 million, roughly inline with the Street’s forecast. HOG said the results were impacted by a 53% drop in motorcycle shipments. The company said it expects a 5-10% y/y decline in motorcycle shipments in 2010 and it believes 2010 will “continue to be a challenging year.”

Outside of the corporate earnings focus, government controlled mortgage finance firms Fannie Mae (FNM $1) and Freddie Mac (FRE $1 ¹) were under pressure after comments from House Financial Services Chairman Barney Frank at a hearing on executive compensation. Frank said, “As I believe this committee will be recommending, abolishing Fannie Mae and Freddie Mac in the present form and coming up with a new whole system of housing finance (is in order),” per the Dow Jones Newswires. CNBC reported that Frank has said in the past that the current structure of FNM and FRE cannot exist, citing a senior congressional staff person. The White House is expected to release a proposal for what to do with the firms later this year.

Economic front headlined by Europe today, while quiet in the US

Treasuries were mixed today and there no major US economic reports. The yield on the 2-year note fell 5 bps to 0.78%, the yield on the 10-year note was flat at 3.59%, while the yield on the 30-year bond gained 2 bps to 4.51%.

Markets were abuzz with talk about the fate of Fed Chair Ben Bernanke, as his term is scheduled to expire January 31, with a second-term on the docket for Congress, and politicians are making noise about the state of their votes. If he is not confirmed by January 31, then the Vice Chair, Donald Kohn would serve as the acting Chair in the interim, but the FOMC committee could still reappoint Bernanke as the Chair of the FOMC.

There were some economic reports across the pond, with Eurozone new industrial orders growing more than forecasted by economists surveyed by Bloomberg, France’s business confidence rising more than anticipated, while UK retail sales came in short of expectations.

Financial reports overshadowed by Obama’s proposal and China’s policy dilemma

Not surprisingly, financial issues were among the worst performers for the week as President Obama proposed to combat risk taking in the banking industry. Also, it was not a shock to see materials pace the broad-based decline in the equity markets for the holiday-shortened week amid the global economic recovery uneasiness as the steep growth in the Chinese economy could force the nation’s central bank to tighten monetary policy sooner than expected. However, when the week began, stocks appeared to be poised to extend gains for the New Year as healthcare issues led a solid advance in anticipation of Tuesday night’s victory for the Republican Party, which gained a key Senate seat by winning a special election in Massachusetts, putting major healthcare reform in question.

In a week that promised to be dominated by focus on the corporate sector as 4Q earnings season ramped up, several major reports were overshadowed by the aforementioned developments. A much better-than-expected profit report from Goldman Sachs (GS $154) headlined a plethora of earnings reports from the financial sector, but shares came under pressure, while Wells Fargo’s (WFC $27) unexpected profit fell on deaf ears and shares finished lower. Other reports in the group that are worth a mention included Morgan Stanley (MS $28) and Dow member Bank of America (BAC $15 ¹) both missing the Street’s estimates, while Citigroup (C $3) matched analysts’ forecasts. Outside of the financial sector, International Business Machines (IBM $125) reported profits that bested the Street’s forecast, but its guidance—which was higher than anticipated—came under scrutiny, suggesting some were expecting a more favorable outlook.

Next week chock full of economic data in addition to FOMC meeting

A busy economic week starts with Monday’s report on existing-home sales, expected to have decreased 9.8% m/m in December to an annual rate of 5.9 million units after surging the prior three months as the initial expiration of the tax incentive loomed. Existing home sales reflect closings from contracts entered one to two months earlier, while new home sales are a more current reading on activity in the housing market, as they reflect contract signings. The new home sales report will be released on Wednesday, and is forecasted to increase 4.2% m/m in December to an annual rate of 370,000 units, after falling in three of the past four months, highlighted by an 11.3% decline in November. Tuesday’s release of the S&P/CaseShiller Home Price Index rounds out the housing data, expected to show prices declined 5.0% y/y for November.

Durable goods orders will be reported on Thursday, expected to rise 2.0% m/m in December, building on a 0.2% gain in November, while ex-transportation, orders are forecasted to have grown 0.5% m/m, after surging 2.0% in November. This series is volatile on a month-to-month basis.

Friday brings the Advance Gross Domestic Product (GDP) report for 4Q, the first reading on the broadest measure of economic output for 4Q, and considered a proxy for corporate profits. The consensus forecast has been rising, now at an annualized rise of 4.6% in 4Q, after rising 2.2% in 3Q (versus the initial reading of 3.5%). Personal consumption is expected to have increased 1.8% after growing 2.8% in 3Q and the GDP Price Index is expected to have advanced 1.2%, with the core PCE Index, which excludes food and energy, increasing 1.3%. While the report is backward looking, it is closely watched due to its comprehensive nature and potential impact on monetary policy.

All eyes will be on the two-day Federal Open Market Committee (FOMC) meeting that concludes with the release of the statement mid-day Wednesday. No changes are expected to interest rate policy at the meeting. Market participants continue to watch for any clues that indicate the timing of when the Fed expects to contemplate tightening, focusing on the language used by the Fed with regard to the “extended period” for keeping rates at an exceptionally low rate.

Other reports on next week’s US economic calendar include the Chicago Fed National Activity Index, the Richmond Fed Manufacturing Index, the MBA Mortgage Applications Index, initial jobless claims, the Conference Board Consumer Confidence Index and the University of Michigan consumer sentiment survey. Additionally, President Obama will be giving his State of the Union speech on Wednesday night.

Economic releases in Asia/Pacific next week include Japan retail sales, jobless rate, household spending, consumer prices, construction, housing starts, and vehicle production, and the Bank of Japan monetary policy meeting. China will release its leading index and Australia will announce PPI, CPI and its leading index.

In Europe, releases include German CPI, consumer confidence, employment and the IFO survey of business confidence, French employment, consumer spending and confidence, UK 4Q GDP, home prices and consumer confidence. Releases in the Americas include November GDP for Canada, Brazil employment and the monetary policy meeting for the central bank of Brazil.