Evening Market Update

Litigation and Potential Political Fallout Weighs on Shares

Stocks were under solid pressure, led by financials, after a report that Federal prosecutors are expanding their investigation of Goldman Sachs to include potential criminal misconduct with regard to mortgage trading, and energy names were lower on the growing fallout from BP Plc's oil spill in the Gulf of Mexico and the implications for offshore drilling in the US. Today's decline came despite an inline 1Q GDP report which showed consumer spending strength and no signs of inflation, as well as better-than-expected reports in the form of the Chicago PMI and University of Michigan's Consumer Sentiment Index. In earnings news, Dow member Chevron and McAfee had mixed earnings reports, MetLife exceeded estimates, while D.R. Horton returned to a profit. In other equity news, Massey Energy is reported to be under an FBI probe related to its mine explosion earlier this month. Treasuries were higher on the equity market weakness, while the talks between the EU and IMF regarding aid for Greece are expected to come to a conclusion this weekend.

The Dow Jones Industrial Average fell 159 points (1.4%) to close at 11,009, while the S&P 500 Index lost 20 points (1.7%) to 1,187, and the Nasdaq Composite declined 50 points (2.0%) at 2,461. In heavy volume, 1.6 billion shares were traded on the NYSE and 2.7 billion shares were traded on the Nasdaq. Crude oil rose $0.98 to $86.15 per barrel, wholesale gasoline was $0.04 higher at $2.40 per gallon, and the Bloomberg gold spot price gained $11.55 to $1,178.40 per ounce. Elsewhere, the Dollar Index-a comparison of the US dollar to six major world currencies-was down 0.2% to 81.81. For the week, the DJIA lost 1.8%, the S&P 500 Index fell 2.5%, and the Nasdaq Composite declined 2.7%.

Dow member Chevron Corp. (CVX $81) reported 1Q EPS of $2.27, compared to the $1.95 consensus estimate of Wall Street analysts, with revenues growing 33% year-over-year (y/y) to $48.18 billion, but short of the $57.2 billion that analysts were forecasting. The company said its upstream earnings-energy exploration and production—increased by $3.3 billion versus last year on higher prices for crude oil and higher production to $4.7 billion. However, its downstream earnings-refining business-fell from $753 million to $196 million. Shares closed lower in choppy trading.

Goldman Sachs Group Inc. (GS $145) was under solid pressure following a Wall Street Journal report that the Manhattan US Attorney's Office is conducting a criminal investigation into whether the company or any employees committed securities fraud with regard to its mortgage trading business. GS did not comment and the report said a spokesperson for the Manhattan US Attorney’s Office declined to comment.

In related corporate legal news, shares of Massey Energy Co.(MEE $38) were under solid pressure on media reports that the mining firm is under criminal investigation by the FBI surrounding the mine explosion earlier this month, which killed 29 people. FBI and Justice Department officials have not commented and MEE said it is aware that investigators are interviewing witnesses, but not aware of the nature of their investigation and it will cooperate with the probe.

MetLife Inc. (MET $46) reported 1Q EPS ex-items of $1.01, four cents above the Street's expectations, with revenues increasing 17% y/y to $13.1 billion, above the $12.9 billion that the Street was forecasting. The company said improved equity market levels, solid underwriting results and its expense savings efforts contributed to its performance. MET's premiums, fees and other revenues rose 12% y/y, driven by growth in both its US and international businesses. Shares closed nearly unchanged, erasing an early gain.

Homebuilder D.R. Horton Inc. (DHI $15) posted a fiscal 2Q profit, with earnings of $0.04 per share, versus a loss of $0.34 per share last year, and compared to the flat profit expectation of analysts. Revenues rose 16% y/y to $897 million, above the $874 million that the Street was looking for, with net sales orders increasing 55% y/y and closings up 19%. The company said market conditions in the homebuilding industry are still challenging, with rising foreclosures, significant existing home inventory levels, high unemployment, tight mortgage lending standards, the expiration of certain government support and weak consumer confidence. DHI was nicely higher.

McAfee Inc. (MFE $35) reported 1Q EPS ex-items of $0.60, three cents below the expectation of analysts, with revenues rising 12% y/y to $503 million, short of the $513 million that the Street was forecasting. The technology security firm said it had record performance in its consumer business, but it experienced delays in the closing of certain large deals, modest growth in the midmarket segment and foreign currency headwinds that were greater that it anticipated. MFE also issued 2Q guidance that missed analysts' estimations. Shares were sharply lower.

The energy sector was bogged down by further implications from BP Plc (BP $52) oil well leak, which has the potential for a moratorium on offshore drilling. NOAA has said the government is estimating BP to be leaking 5,000 barrels a day into the Gulf of Mexico-up from an earlier estimate of 1,000 barrels per day, while the Wall Street Journal is reporting that industry experts are estimating a much higher amount of leakage, of up to 25,000 per day.

First read on US output comes in roughly inline with expectations

The first look at 1Q Gross Domestic Product, the broadest measure of economic output, was released this morning and showed a 3.2% annualized rate of growth, compared to the 5.6% advance in 4Q, while the Bloomberg forecast of economists called for output in the first quarter of the year to increase 3.3%. Personal consumption advanced 3.6%, above the 3.3% that was forecasted. Real final sales, which exclude changes in inventory, were 1.6% higher, versus the 1.7% that was reported in 4Q.

The GDP Price Index rose 0.9%, matching the consensus of economists. The core PCE (personal consumption expenditures) Index, the inflation gauge that the Fed prefers to use as it excludes the volatile food and energy categories, increased 0.6%, the lowest level since records began in 1959, according to Bloomberg, in line with the 0.5% estimate.

Contributions to growth were more even during the quarter, as inventory building added 1.6% to 1Q GDP, while last quarter's 3.8% contribution was a disproportional percentage of growth, consumer spending added 2.6% this quarter and capital spending on equipment and software contributed 0.8%. Meanwhile, net exports subtracted 0.6%, as imports (a subtraction from GDP) outpaced exports, and while federal government spending contributed 0.1%, state and local government deducted 0.5%. Residential construction subtracted 0.3% and commercial real estate investment deducted 0.4%.

Elsewhere, the Employment Cost Index for 1Q rose 0.6%, slightly above the Bloomberg consensus, which called for the index to rise by 0.5%.

Elsewhere, the final University of Michigan's Consumer Sentiment Index was revised higher from 69.5 in the preliminary report to 72.2 in April, compared to the increase to 71.0 that economists surveyed by Bloomberg had expected. However, the reading for this month was below the 73.6 in March. The current economic conditions component of the report was revised higher from 80.7 to 81.0, and the index of expectations six months from now was boosted to 66.5 from 62.3. The report showed the one-year and five-year inflation outlooks were left unrevised at 2.9% and 2.7%, respectively.

In other economic news, Chicago PMI rose more than anticipated, advancing from 58.8 in March to 63.8 in April, compared to the rise to 60.0 that was forecasted by economists. The index of business activity in the Mid-West continued to expand as a reading of 50 is the demarcation point between expansion and contraction, and it hit the highest level since April 2005. Key components of the report such as production, new orders, and employment all moved further into expansion territory, to support the advance, while prices paid also posted a solid increase.

Treasuries, which showed little reaction to the GDP data, erased early losses and ended the day higher. The yield on the 2-year note was down 4 bps to 0.96%, the yield on the 10-year note lost 7 bps to 3.66%, and the 30-year bond yield was 7 bps lower at 4.52%.

Greece aid prospects continue to dominate headlines

Uncertainty regarding the size of Greece's financial aid, the duration, and what further austerity measures the nation may have to make to gain approval to use the funds continued to be in focus ahead of an impending agreement between euro-zone and International Monetary Fund (IMF) officials, with an agreement expected over the weekend. However, officials have expressed optimism that Greece will at least take control of funds to meet maturing debt that comes due in mid-May. Moreover, banks in Europe were further hamstrung after Moody’s Investor Service downgraded nine Greek banks in response to the exacerbated issues facing the debt-ridden nation’s economy.

The economic front was also in focus across the pond to mix sentiment, headlined by an unexpected deterioration in a UK consumer confidence gauge for April, larger-than-expected increases in Italian and Spanish unemployment rates, while the euro-zone unemployment rate remained unchanged at 10.0% in March. Elsewhere, inflation data was in focus, with euro-zone CPI rising 1.5% y/y in April, inline with economists' expectations, Italian CPI and PPI both topping forecasts, while French producer prices rose by an amount that was expected.

The Bank of Japan (BoJ) left its benchmark interest rate unchanged at 0.1%, as expected, saying that its economy faces the “critical challenge of overcoming deflation” and returning to a sustainable growth path with price stability. The BoJ added that it will aim to maintain the extremely accommodative financial environment. Other reports from the Japanese economic calendar included the nation's jobless rate ticking higher to 5.0% in March, versus the expectation of economists that it would remain at 4.9%, CPI falling 1.1% y/y in March to match forecasts, and industrial production increasing 0.3% month-over-month (m/m) in March, short of the 0.8% that was anticipated. In other Asian economic news, South Korea's industrial production rose 1.6% m/m in March, compared to the 0.5% increase that was expected, and Thailand’s trade surplus widened in March. In Australia, mining shares were weak on concerns the government is nearing the announcement of a tax hike on the industry.

Financial fears causes rally to slip gears

As the markets continued to show relatively modest enthusiasm toward another string of mostly better-than-expected earnings reports, stocks came under pressure as attention remained on the financial sector and the exacerbated euro-zone debt situation, which proved to resuscitate the bears. Amid the backdrop of uncertainty regarding the impact of impending financial regulation that is being shaped on Capitol Hill, sentiment was soured on the financial sector with Goldman Sachs supplying the lion's share of the bitter taste this week. Goldman executives provided marathon testimony mid-week in Washington related to fraud charges from the Securities and Exchange Commission (SEC), while the week culminated with Friday's report that Federal prosecutors are conducting a criminal investigation of the firm's mortgage trading business. Making matters worse for stocks this week, euro-zone debt fears continued to fester, with Standard & Poor's downgrading Greece's sovereign credit rating to junk status, while also cutting the ratings of Portugal and Spain, which flared up contagion concerns in the euro-zone, prompting some fears that the global economic recovery could be threatened.

However, there were some reports that promoted optimism regarding the recovery, limiting the losses for the equity markets, highlighted by the Federal Reserve keeping the fed funds rate unchanged at a range of 0-0.25% and keeping its economically-accommodative extended period language in the statement. Moreover, the Federal Open Market Committee (FOMC) modestly upgraded its outlook for its view of the labor market from stabilizing to beginning to improve. Other reports that supported optimism about the economy and helped the US equity markets show some relative resiliency in the face of the debt problems in Greece included the S&P/Case-Shiller Home Price Index showing the first y/y increase in home prices since December 2006 and a much better-than-expected improvement in consumer confidence.

Busy economic week to be highlighted by employment report and situation in Greece

Economic releases next week start with Monday's release of the ISM Manufacturing Index, expected to show an increase to 59.8 in April from 59.6 in March, with 50 being the level that separates contraction versus expansion in the economy. Meanwhile, the ISM Non-Manufacturing Index, which has been more volatile on a month-to-month basis, is expected to increase to 56.0 from 55.4, and will be released on Wednesday. Manufacturing has been stronger on export strength and as factories ramped up after businesses allowed inventories to plunge by unsustainable amounts, while the service sector is more domestic-driven and has been suffering from the weak state of consumer spending in the US. Both reports were very strong in March, with multiple components in each report coming in at multi-year high readings, showing gains in new orders, inventories and employment.

Wednesday will also bring the ADP Employment Change Report, where the forecast is that private sector employers added 25,000 jobs in April after declining by 23,000 in March. The ADP report is a reading of the state of the job market excluding government payrolls, which are expected to be boosted by Census hiring over the next several months.

Nonfarm payrolls will headline the week on Friday, with the Bloomberg survey of economists forecasting payrolls grew by 180,000 in April, after adding 162,000 in March, while the unemployment rate is estimated to be unchanged at 9.7%. Jobs data will start getting a boost from the government, as the Census Bureau has said it expects to hire 181,000 workers from January to March and 971,000 in the following three months, peaking in May, where they are anticipating adding 500,000 workers.

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

The international economic calendar will also be heavy, including euro-zone and UK retail sales and PPI, as well as manufacturing and services PMI reports, and German industrial production and factory 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, China and India's manufacturing PMI indexes, and Australian retail sales, housing prices and building approvals.

Several central banks meet to discuss monetary policy, including the Reserve Bank of Australia and the European Central Bank.