Evening Update

Positive Economic Data Helps Extend Stock Rally

Stocks managed to ride yesterday’s momentum to finish higher on the day, as positive economic reports and upbeat earnings combined with an optimistic vibe from the minutes of the FOMC meeting. Early gains were seen after reports showed that industrial production grew more than expected, housing starts and building permits beat projections, and import prices rose more than anticipated. In equity news, Deere & Co and Whole Foods Market Inc both reported better than expected profits and raised their full-year earnings outlooks, while Campbell Soup lowered its sales forecast. On the M&A front, Walgreen Co announced that it will acquire New York-based drugstore chain Duane Reade Holdings. In other equity news, Humana announced that it would reduce their workforce by 5% and OfficeMax reported a 4Q loss that was less than analysts expected. Treasuries extended losses after the Fed minutes were released and the dollar gained ground against other major currencies.

The Dow Jones Industrial Average gained 40 points (0.4%) to close at 10,309, the S&P 500 Index rose 5 points (0.4%) to 1,100, and the Nasdaq Composite increased 12 points (0.5%) to 2,226. In moderately light volume, 1.0 billion shares were traded on the NYSE and 2.0 billion shares were traded on the Nasdaq. Crude oil was $0.46 higher at $77.47 per barrel, wholesale gasoline was up $0.02 to $2.01 per gallon, and the Bloomberg gold spot price fell $3.95 to $1,115.50 per ounce. Elsewhere, the Dollar Index—a comparison of the US dollar to six major world currencies—was up 0.9% to 80.44.

Deere & Co. (DE $57) reported fiscal 1Q EPS of $0.57, blowing away the $0.19 that Wall Street analysts had forecasted, but revenues declined 6% year-over-year (y/y) to $4.8 billion, compared to the $4.2 billion that the Street was looking for. The farm and construction equipment maker said that global economic conditions remain “stubbornly weak” but it was able to take cost and asset discipline “to an even higher level.” Worldwide equipment sales decreased 7% during the quarter, with sales in the US and Canada falling 8% and sales outside this region declining 6%. The company increased its full-year profit outlook. Shares were solidly higher.

Walgreen Co. (WAG $34) announced that it has reached a definitive agreement to acquire New York-based drugstore chain Duane Reade Holdings in a cash transaction for a total enterprise value of about $1.075 billion, including the assumption of debt. WAG said the acquisition would immediately provide the company with a leading position in the largest drugstore market in the US. Walgreen currently operates 70 locations in the New York City area, while Duane Reade has a much larger presence with 257 stores. Duane Reade is owned by private equity firm Oak Hill Capital Partners. Shares of WAG ended higher after overcoming early losses.

Campbell Soup (CPB $34) decreased its revenue forecast for 2010 to a range of growth between 2.5-3.5% y/y from a previous forecast of between 4-5%. CPB’s updated guidance came as it announced a comprehensive plan to “boost the performance of its condensed soup portfolio.” The company reported 2009 sales of $7.59 billion, and analysts are expecting 2010 sales of $7.88 billion. CPB also reiterated its 2010 earnings view. Shares erased early losses and finished modestly higher.

Whole Foods Market Inc. (WFMI $34) reported fiscal 1Q EPS of $0.32, above the $0.26 that analysts had expected, with revenues increasing 7% y/y to $2.6 billion, inline with the Street’s forecast. The company said that given the strong sales momentum it is seeing, “there are many reasons to be bullish about our future results.” However, WFMI tempered its enthusiasm, saying that it is relatively early in its recovery and there is still a lot of uncertainty regarding where the economy, the consumer, and competition go from here. Nonetheless, WFMI raised its full-year sales and earnings outlook. WFMI was up over 12% on the day.

Humana Inc. (HUM $47) announced that it intends to reduce its workforce by approximately 1,400 positions, or 5% of its total workforce, over the course of 2010. The health benefits firm said this announcement is regrettable but necessary reduction as it is a direct result of the company’s need to align its size with that of its membership. HUM reaffirmed its guidance for 2010 EPS as the changes are not anticipated to result in any adjustments to its prior guidance. Shares were higher.

OfficeMax Inc. (OMX $15) was solidly higher after reporting a 4Q loss ex-items of $0.03 per share, a narrower shortfall than the $0.07 per share loss that analysts had forecasted. Revenues fell 3.9% y/y to $1.8 billion, slightly above the $1.7 billion that the Street anticipated. OMX said its US contract segment sales decline in 4Q, which was down 5.8% y/y, was mostly offset by an international contract operations sales increase of 13.2%. Moreover, OMX said its US contract sales decline showed “significant improvement” from the 15.4% y/y decline in the previous quarter, due to improvement from existing accounts as well as sales from new customers which exceeded prior year sales from former customers.

Fed weighs possibility of asset sales

The minutes from the January 26-27 Federal Open Market Committee (FOMC) meeting were released midday, wherein the Fed expressed more optimism about the economic recovery, raising the low end of their forecasts for growth, and as such, debated on how to unwind the extraordinary stimulus put in place to fight the crisis. While reaction to the statement on the day of the meeting focused on the dissenting vote by Kansas City President Thomas Hoenig, the minutes from the meeting showed there was talk of asset sales by several officials, contrary to the expectations by markets that such sales would be a longer-term phenomena.

The end of the mortgage-backed securities (MBS) asset purchase program has been on investors list of concerns, as the ending of the program could put upward pressure on mortgage rates during a time when the housing recovery is still tenuous, given the prospect for increasing foreclosures as many homeowners are underwater on their mortgages and unemployment is high. Traders have thought that the Fed was open to extending the MBS purchase program, so today’s revelation that the Fed was considering selling assets indicates that the exit from stimulus is nearer-term than expected.

Additionally, while markets believed only one member was proposing a move toward exit, with Hoenig suggesting changing the language on rates from keeping the fed funds rates “exceptionally low” for an “extended period” to “would be low for some time,” the minutes indicated that several members believed exit strategies, via asset sales, should begin “in the near future,” while spreading sales over a number of years, to “ensure the Fed’s balance sheet shrinks more quickly and in a more predictable manner than could be achieved solely by redeeming maturing securities and not reinvesting prepayment.”

Also, the Fed is considering increasing the spread between the discount rate and the fed funds rate, initially moving to a 50 bps spread, from the current 25 bps, and Fed Chief Bernanke last week indicated this should not be interpreted as signaling any change in the outlook for monetary policy, as this spread was narrowed by the Fed in the response to the crisis, and the widening would be a reflection of improving financial conditions.

Treasuries were lower on the day, as the yield on the 2-year note rose 5 bps to 0.85%, the yield on the 10-year note gained 8 bps to 3.74%, and yield on the 30-year bond increased 7 bps to 4.70%.

Housing and industrial production data beat forecasts

Housing starts for January were reported, showing starts rose 2.8% month-over-month (m/m) to an annual rate of 591,000 units, higher than the forecast of 580,000, while December’s figures were upwardly revised to 575,000, representing a decline of 0.7% from the previously reported -4.0%. Meanwhile, building permits dropped, falling about 4.9% m/m to an annual rate of 621,000 from last month’s unrevised 653,000. The expectation was for a decrease of 5.1% to 620,000 units. The figures were impacted by volatility in the multi-family sector, while single-family starts rose 1.5% m/m and single-family permits rose 0.4%.

Building permits are one of the leading indicators tracked by the Conference Board, as they are a gauge of potential future construction and economic growth. Despite the threat of future foreclosures adding to homes available for sale, with RealtyTrac last month forecasting 3 million foreclosures in 2010, homebuilders are building new homes after breaking ground on the fewest homes in 2009 since records began in 1959, according to Bloomberg. Homebuilder confidence has ticked up slightly in anticipation of a rebound in sales during the spring season, spurred by the extension and expansion of the tax credit.

Meanwhile, industrial production (chart) was also released this morning, and showed a 0.9% m/m increase in January, higher than the 0.7% estimate, while December was revised up to 0.7% from 0.6%. Manufacturing was higher by 1.0%, led by a 5.1% in production of autos. Capacity utilization rose to 72.6%, inline with the forecast, while it remains 8.3% below its long-term average, and combined with high unemployment and an excess in housing, explains why we continue to believe inflation will be subdued.

Meanwhile, the Import Price Index rose 1.4% m/m for January, above the expectation of economists, which called for the index to increase by 1.0%. Higher energy costs contributed to the larger-than-expected increase in the index, as total fuel imports rose 5.3% m/m, with petroleum prices increasing 4.8% and natural gas prices jumping 18.8%. Excluding fuel, imports prices rose 0.4% m/m. Year-over-year, import prices are higher by 11.5%, versus the 10.8% forecast of economists.

In other economic news, the US MBA Mortgage Application Index declined 2.1% last week, after the index, which can be quite volatile on a week-to-week basis, dipped 1.2% in the previous week. The decrease came as the Purchase Index fell 4%, teaming up with a decline in the Refinance Index, which fell 1.2%. The average 30-year mortgage rate remained unchanged at 4.94%, remaining above the record low of 4.61% that was reached at the end of March 2009.

International concerns take a backseat to US economic data

Concerns about the health of the global economic recovery were overshadowed by the large amount of data coming out of the U.S. today. There were some economic reports that deserve a mention, as UK jobless claims for January unexpectedly increased, rising by 23,500, to the highest level since 1997, per Bloomberg. Also in the UK, the Bank of England released the minutes from the central bank’s monetary policy meeting that took place on February 4th, showing that policy makers voted unanimously to pause its 200 billion-pound bond purchase program on the expectation that inflation will return to its 2% target. Meanwhile, Eurozone construction output increased by 0.5% month-over-month (m/m) in December, while the Euroarea trade surplus came in at a smaller amount than economists had expected.

Producer price index on tap for tomorrow

Tomorrow will bring the release of the Producer Price Index, forecasted to increase 0.8% m/m in January, while excluding the more volatile components of food and energy, the core rate is expected to tick higher by 0.1%. On a year-over-year basis the headline rate is expected to be up 4.4%—and this rate could continue to climb in the short-term mainly due to the relatively low comparable prices of crude oil as the economy bottomed out last year—while the core rate is expected to be 0.8% higher y/y, just below the Federal Reserve’s implied inflation target of between 1-2%. Tomorrow’s report could continue to keep inflation worries at bay, allowing the Fed to continue to focus more attention on the other side of its dual mandate of fostering economic growth. Also, given the backdrop of high unemployment and excess capacity, the prospect of higher prices beginning at the wholesale level and eventually being passed on through and eventually showing up on the receipts of the consumer still appear to be nonexistent, which is keeping expectations of a Fed rate hike in the short term tempered.

Other releases on the US economic calendar include weekly initial jobless claims, with expectations of a decrease in claims to 438,000 from a previous reading of 440,000, the Philadelphia Fed’s Business Activity Index, which is expected to increase to 17.0, from a January reading of 15.2 and the Index of Leading Economic Indicators, which is expected to increase 0.5% and would mark the tenth consecutive monthly increase in the index.

International economic releases tomorrow include the results of the Bank of Japan’s monetary policy meeting, where the benchmark interest rate is expected to be maintained at 0.1%, and CPI for Canada, which is expected to increase to 0.3% from a previous reading of -0.3%.