Evening Market Update

S&P Adds Fuel to the Greece Fire

Despite better-than-expected earnings from Dow members 3M Co. and DuPont, and a favorable report from Texas Instruments, the markets were unable to overcome the growing uneasiness toward debt issues in the euro-zone, exacerbated by Standard & Poor’s downgrading the sovereign credit ratings of Greece and Portugal, and the grilling of Goldman Sachs executives on Capitol Hill. The negative sentiment also eclipsed the first year-over-year increase in the S&P/Case-Shiller Home Price Index in nearly four years and a larger-than-expected reading of consumer confidence. Treasuries moved decidedly higher in a flight-to-safety as a result of the anxiety over the crisis. In other earnings news, Ford Motor Co. posted a mixed report, announcing much better-than-forecasted profits but revenues were short of analysts’ forecasts, Office Depot Inc fell short of the Street’s expectations, and Macy’s Inc raised its full-year same-store sales and EPS guidance. Elsewhere, Dow member IBM increased its dividend and added $8 billion to its share repurchase program.

The Dow Jones Industrial Average fell 213 points (1.9%) to close at 10,992, while the S&P 500 Index lost 28 points (2.3%) to 1,184, and the Nasdaq Composite shed 51 points (2.0%) to 2,471. In moderately heavy volume, 1.7 billion shares were traded on the NYSE and 2.7 billion shares were traded on the Nasdaq. Crude oil rose $0.22 to $84.44 per barrel, wholesale gasoline was $0.01 lower at $2.33 per gallon, and the Bloomberg gold spot price soared $17.20 to $1,170.70 per ounce. Elsewhere, the Dollar Index—a comparison of the US dollar to six major world currencies—was up 0.9% to 82.23.

Dow member 3M Co. (MMM $88) reported 1Q EPS ex-items of $1.40, above the $1.20 consensus forecast of Wall Street analysts, with revenues increasing 25% year-over-year (y/y) to $6.3 billion, versus the $5.9 billion that analysts were anticipating. MMM said each of its six business segments posted double-digit sales growth and it also raised its full-year outlook. MMM bucked the downtrend and finished nicely higher.

Fellow Dow component DuPont (DD $39) announced 1Q earnings of $1.24 per share, well above the $1.06 that was anticipated by analysts, with revenues increasing 23% y/y to $8.5 billion, compared to the $8.0 billion that the Street had forecasted. The company said its sales benefitted from 19% higher volume, as Asia Pacific volumes jumped 65% and volumes in emerging markets were up 28%. DD also benefitted from a 2% increase in local selling prices. DD also raised its full-year EPS guidance, but shares were lower.

International Business Machines (IBM $129) announced that its Board of Directors declared an 18% increase in its regular quarterly dividend to $0.65 per share. Also, the Dow member said it has authorized $8 billion in additional funds to use in the company’s stock repurchase program. Despite the announcement, shares finished lower.

Texas Instruments Inc. (TXN $27) reported 1Q EPS of $0.52, compared to the $0.51 that the Street had expected, with revenues increasing 54% y/y to $3.2 billion, above the $3.1 billion that analysts were expecting. The company said momentum continues into 2Q as demand for its products “remains strong,” and it adds more manufacturing capacity to support its customers. TXN issued 2Q guidance that exceeded the Street’s estimates, and shares were lower.

Ford Motor Co. (F $14) posted 1Q EPS ex-items of $0.46, much higher than the $0.31 that analysts had forecasted, while revenues improved by $3.7 billion y/y to $28.1 billion, but compared to the $28.9 billion that the Street expected. The company said based on its improving performance and the gradually strengthening economy, it now expects to deliver solid profits this year. Shares were under pressure.

Office Depot Inc. (ODP $7) announced 1Q EPS of $0.07, one penny shy of the Street’s forecast, as revenues fell 5% y/y to $3.07 billion, just shy of the $3.13 billion that analysts were anticipating. Sales at its North American retail division and business solutions unit fell 6% and 9% y/y, respectively, while its international group sales rose 2% y/y. Shares were down over 15%.

Macy’s Inc. (M $24) increased its full-year EPS and sales guidance, saying that its “very strong results” so far this year reflects continued progress on its key strategic initiatives, which it believes are still in the early stages. The department store said while predicting the future remains difficult amid macro-economic uncertainty, it increased its same-store sales—sales at stores open at least a year—outlook to a range of 3-3.5% growth, from a 1-2% gain that it previously expected. Also, the company said its EPS are forecasted to be between $1.75-1.80, from its earlier outlook of between $1.55-1.60. Analysts were anticipating the company to post EPS of $1.77 for the year. Shares were lower.

Home prices rise versus last year, consumer sentiment jumps

The S&P/Case-Shiller Home Price Index was released showing an increase in home prices of 0.6% year-over-year (y/y) in February, short of the increase of 1.3% that economists surveyed by Bloomberg had expected. However, month-over-month (m/m), home prices were 0.1% lower, matching forecasts and snapping an eight-month winning streak.

The report has some positive elements as the y/y increase was the first since December 2006 and given that the report lags the March sales data—which saw both new and existing home sales rise more than forecasts—we may see continued improvement in the index. However, there are some factors that are likely to keep optimism of meaningful stabilization in the housing market tempered. First, there remains a huge amount of overhead supply of homes that could flood the market as another wave of foreclosures could be set to break onto the housing shores. The Federal Reserve—which is set to begin its two-day monetary policy meeting later today—noted in its last policy discussion that the pace of foreclosures was “likely to remain high” and recent data on the incidence of seriously delinquent mortgages pointed to the possibility that the foreclosure rate could move higher over coming quarters. Fed policymakers said the prospect of further additions to the already very large inventory of vacant homes “posed downside risks to home prices.” Moreover, it remains to be seen whether the nascent signs of the housing market stabilization can continue to develop after the various forms of government support, such as the homebuyer tax credit, which is expected to expire in April, are taken away.

In other economic news, the Conference Board released its consumer Confidence Index report, which improved to a level that exceeded expectations, rising to 57.9 in April, compared to the expectation of an improvement to 53.5. However, March’s reading was slightly downwardly revised to 52.3 from 52.5. The headline number gained as respondents’ gauge of the present economic situation being “good” rose, while those saying conditions are “bad” declined. Also, those saying jobs are “hard to get” decreased, while those saying jobs are “plentiful” moved higher. The report also revealed that expectations of improvement for the next six months increased and those anticipating worsened conditions fell.

Treasuries finished solidly higher on flight-to-safety buying amid the deteriorating sentiment surrounding the debt issues in the euro-zone. The yield on the 2-year note was down 10 bps to 0.95%, the yield on the 10-year note lost 12 bps to 3.69%, and the 30-year bond yield was 10 bps lower at 4.57%.

Euro-zone debt crisis adds more actors to the drama

Anxiety over whether Greece will receive funds from the EU and International Monetary Fund’s (IMF) 45 billion euro rescue package in time to avoid a default and what further austerity measures it will have to deploy were exacerbated by Standard & Poor’s lowering its sovereign credit rating on the debt-ridden nation three notches to BB+, considered “junk status,” from BBB+. The rating agency cited its “updated assessment of the political, economic, and budgetary challenges that the Greek government faces in its efforts to put the public debt burden onto a sustained downward trajectory.” The spread on Greek 10-year bonds over German bunds grew to 675 basis points, the widest since 1998, following the downgrade. Additionally, S&P lowered Portugal’s credit rating —another nation in the euro-zone that has had its debt levels come under scrutiny—saying that it expects the Portuguese government “could struggle to stabilize its relatively high debt ratio over the outlook horizon until 2013.”

The concerns surrounding the debt crisis eclipsed some positive economic releases in the region, including a consumer confidence measure in Germany—Europe’s largest economy—which rose more than economists had expected. Other reports that were released across the pond included a larger-than-forecasted 1.7% m/m increase in German import prices during March, compared to the 1.1% rise expected, and a surprising 1.5% drop in producer prices in Sweden, which were anticipated to rise 0.1%. Meanwhile, French consumer confidence in April deteriorated to a level of -37, below economists’ forecasts of -33, while Italy’s gauge of consumer confidence unexpectedly improved to 107.9 during the same month on a more optimistic employment outlook.

In the Asia/Pacific region, South Korea’s preliminary 1Q GDP expanded more than economists expected y/y and quarter-over-quarter (q/q), posting increases of 7.8% and 1.8%, respectively. As well, Australia’s 1Q producer prices rose more than anticipated q/q and was down y/y by a smaller amount than was forecasted. Elsewhere, Taiwan’s Leading Index rose 0.3% m/m in March and Hong Kong’s trade deficit widened by a larger amount than expected. While there were no economic reports released in China, the country’s crackdown on property speculation hampered property issues in the nation amid festering concerns about what impact the government’s recent efforts to combat the formation of asset bubbles could have on the industry.

FOMC meeting in focus tomorrow

Tomorrow’s midday statement following the conclusion of the Federal Open Market Committee (FOMC) meeting’s two-day meeting will be scoured for clues about the pace of tightening that the Fed’s is contemplating in the future, as well as the manner in which the Fed will remove excess liquidity from the banking system, while no changes are expected to interest rate policy at this meeting. It is unclear whether the Fed feels the economic recovery is strong and stable enough to compel the need to remove the “extended period” language as to the timing of keeping rates at an exceptionally low rate at this meeting, a move that would likely be met with markets pricing in an increased likelihood for rate hikes sooner than currently anticipated, or whether the Fed believes it can wait, with the next meeting scheduled for June 22-23.

With excess reserves at unprecedented levels, the risk is that an unleashing of this amount of liquidity could spark inflation pressures once the economy is firing on all cylinders, demand for credit returns and the money multiplier kicks in. While the near-term inflation outlook is benign, the Fed has already begun to remove emergency measures put in place during the crisis, and feels that reducing the quantity of reserves will improve the Fed’s control of financial conditions by leading to a tighter relationship between the interest rate paid on reserves and the effective fed funds rate.

In order to reduce these excess reserves, the Fed has discussed the possibility of raising the interest rate paid on funds deposited at the Fed, term deposits, which are analogous to certificates of deposit, as well as reverse purchase agreements. Lastly, the timing of when the Fed would begin to sell assets, specifically mortgage-backed securities, from their balance sheet has been debated within the Fed, as reverse repos and term deposits only temporarily drain liquidity and would not permanently reduce the size of the Fed’s $2.5 trillion balance sheet. The debate concerns the risks to the economy if assets were sold too quickly, pressuring rates higher, while others believe letting mortgage assets decline naturally as they age would take too long.

The other report on tomorrow US economic calendar is the MBA Mortgage Applications Index.

Internationally, releases include German CPI, Canadian house prices, and Australia’s leading index. Additionally, the central bank of Brazil will meet to discuss monetary policy.