Weekend Summary

Stocks Fall on Goldman SEC Action, but Bounce Off Lows

Despite favorable earnings reports from Dow members Bank of America and General Electric, market action picked up to the downside after the SEC announced a fraud charge against Goldman Sachs Group Inc. regarding a product tied to subprime mortgages in morning action. Traders took the news as a reason to book profits and move to the sidelines after a nice run in stocks and ahead of the weekend. Economic news in the US was mixed on the day, with larger-than-expected increases in housing starts and building permits being offset by an unexpected deterioration in a gauge of consumer sentiment, while Treasuries were solidly higher in a flight-to-quality, as traders took off risk-based trades. In other equity news, Google and Advanced Micro Devices’ better-than-expected earnings reports were met with early selling. Moves by the Chinese government aimed at reining in property speculation highlighted overseas news.

The Dow Jones Industrial Average lost 126 points (1.1%) to close at 11,019, the S&P 500 Index fell 20 points (1.6%) to 1,192, and the Nasdaq Composite declined 34 points (1.4%) to 2,481. In heavy volume, 1.8 billion shares were traded on the NYSE and 2.9 billion shares were traded on the Nasdaq. Crude oil was $2.43 lower at $83.08 per barrel, wholesale gasoline was $0.05 lower at $2.28 per gallon, and the Bloomberg gold spot price fell $23.15 to $1,136.10 per ounce. Elsewhere, the Dollar Index-a comparison of the US dollar to six major world currencies—was up 0.4% to 80.78. For the week, the DJIA rose 0.2%, while the S&P 500 Index lost 0.2%, and the Nasdaq Composite gained 1.1%.

Shares of Goldman Sachs Group Inc. (GS $162) were over 10% lower after the Securities Exchange Commission (SEC) announced that it charged the financial firm and one of its employees for defrauding investors by misstating and omitting key facts about a financial product tied to subprime mortgages as the US housing market was beginning to falter. The SEC alleges that GS structured and marketed a financial product that hinged on the performance of subprime residential mortgage-backed securities (RMBS) and GS failed to disclose to investors vital information about the financial product, in particular the role that a major hedge fund played in the portfolio selection process and the fact that the hedge fund had taken a short position against the financial product.

The chief of the SEC's structured and new products unit said, "The SEC continues to investigate the practices of investment banks and others involved in the securitization of complex financial products tied to the US housing market as it was beginning to show signs of distress." During the trading day, GS said the charges are "completely unfounded in law and fact” and it will "vigorously" contest them and defend the firm and its reputation.

After the market close, Goldman issued further comments addressing the SEC compliant, saying that the firm lost $90 million on the transaction, that extensive disclosure was provided, that ACA, the largest investor in the transaction under review, had a role in selecting the portfolio of securities, and that Goldman never represented that Paulson & Co was going to be a long investor.

Dow member Bank of America (BAC $19 ¹) reported 1Q EPS of $0.28, easily topping the $0.09 that Wall Street analysts had forecasted, with revenue declining 11% year-over-year (y/y) to $32.3 billion, compared to the $27.9 billion that was expected. The company said its provision for credit losses-the charge taken during the quarter to cover losses on loans the company does not expect to collect-fell by $3.6 billion y/y to $9.8 billion, reflecting "an improvement in credit quality." Also, the company said strong capital markets activity, including record sales and trading driven by corporate and investment b"nking positions, helped drive results for its global banking and markets. BAC's CEO said, "With each day that passes, the 2010 story appears to be one of continuing credit recovery, and our results reflect a gradually improving economy." Shares were lower amid the uneasiness toward the industry.

Fellow Dow component General Electric Co. (GE $19 ¹) announced 1Q EPS of $0.21, five cents above the Street’s forecast, with revenues down 5% y/y to $36.6 billion, compared to the $37.3 billion that analysts had forecasted. The company said the decline in revenues reflected the acceleration of downsizing at its GE Capital unit. GE’s Chairman and CEO said, "We saw encouraging economic signs, including increases in airline passenger miles and freight loadings, declines in receivables delinquencies, and growth in local advertising markets." The company added that it is "very encouraged" by GE Capital's performance, which earned $600 million in 1Q, and the unit’s losses "seem to have peaked." Shares were under pressure amid some profit taking and after the company said the SEC has requested information about its September 2008 statements regarding public comments pertaining to the funding of its commercial paper programs. A GE spokesperson said the company is fully cooperating with them and are "entirely confident our disclosures were accurate."

Google Inc. (GOOG $557) reported 1Q EPS ex-items of $6.76, compared to the $6.58 that analysts were expecting, with revenues of $5.06 billion, excluding traffic acquisition costs, versus the $4.9 billion that the Street had forecasted. The world's number one internet search engine said it performed very well in 1Q, driven by strength across all major verticals and geographies. However, shares are under pressure, suggesting some had expected the company to exceed analysts’ expectations by a wider amount.

Advanced Micro Devices (AMD $9) posted 1Q EPS ex-items of $0.09, compared to the loss of $0.07 per share that analysts were anticipating, with revenues increasing 33% y/y, but down about 5% quarter-over-quarter (q/q) to $1.6 billion, compared to the $1.5 billion analyst expectation. The chipmaker said its computing solutions unit revenue declined 5% versus last quarter due to lower microprocessor unit shipments, partially offset by an increase in microprocessor average selling price. Shares were under pressure amid analysts' concerns about competition with Dow member Intel Corp. (INTC $24), which easily topped the Street’s top and bottom line results on Wednesday, and after AMD said it expects 2Q revenue to be down seasonally.

Housing starts and permits rise more than expected, consumer sentiment disappoints

Housing starts for March were reported, showing starts rose 1.6% month-over-month (m/m) to an annual rate of 626,000 units, higher than the expectation of 610,000. February was meaningfully revised higher to 616,000 from the originally reported 575,000, representing an increase of 1.1% versus the initially reported 5.9% decline. Importantly, building permits, a leading indicator of future construction activity, rose 7.5% m/m to an annual rate of 685,000, much better than the 625,000 expectation, and February’s building permits was also upwardly revised to 637,000 from the originally reported 612,000, representing a 2.4% increase versus the originally reported 1.6% decline.

It is estimated that nearly 25% of homeowners have negative home equity, and after a respite, foreclosures are again on the rise. RealtyTrac estimates that bank repossessions are on pace to top 1 million this year. The concern is that the housing market could renew a downward trend if inventory begins to grow rapidly as banks ramp up foreclosures, while the market at the same time loses support in the form of the tax credit and the possibility that interest rates could rise as the Fed has ended support for mortgage-backed securities. However, the Housing Affordability Index released by the National Association of Realtors is still near a record high, at 176.0 in February, indicating that a family with the median income has 176% of the income necessary to qualify for a conventional fixed rate mortgage loan on a median-priced home, assuming a 20% down payment and a 5.13% mortgage rate prevailing at the time.

A steep yield curve typically forecasts strong recovery, supports the financial sector as well as business investment, as it makes the spread between the cost of capital and the return on capital very wide. Add the fact that there’s presently a record spread between corporate cash and capital spending as well as a decade’s worth of pent-up demand, and you have a recipe for a capital-spending revival...or even a boom. While it is generally believed that when interest rates are rising, stocks are falling and vice versa, the recent rise in long-term yields should be viewed in the near-term as a sign of relief that the US economy has escaped deflation.The high correlation between yields and stocks can be sustained in the near to medium term, but that the longer-term trend is down once inflation heats up. Although stocks could underperform bonds in the near-term, relieving some of the dramatic moves recently built into the market, the equity market outlook remains healthy.

In other economic news, the University of Michigan's Consumer Sentiment Index (chart) unexpectedly deteriorated, declining from 73.6 in March to 69.5 in April, compared to the increase to 75.0 that economists surveyed by Bloomberg had expected. The current economic conditions component of the report fell to 80.7 from 82.4, and the index of expectations six months from now fell to 62.3 from 67.9. The report showed the one-year and five-year inflation outlooks were 2.9% and 2.7%, respectively, with the one-year outlook up from 2.7% in the previous reading.

Treasuries were solidly higher in a bout of flight-to-quality buying amid the equity market sell-off, and the yield on the 2-year note fell 3 bps to 1.02%, while the yield on the 10-year note lost 2 bps to 3.84% and the 30-year bond yield declined 1 bp to 4.72%.

International economic releases highlighted by Greece and China

The Chinese State Council announced measures to rein in property speculation and try to avoid the formation of asset bubbles, by increasing down payments for second homes to at least 50%, up from 40%, and saying that mortgage rates for second homes must be a minimum of 110% of benchmark rates. Also, it said that banks should also raise down payment ratios and rates for third homes "by a broad margin" and increase down payments for luxury homes to 30% from 20%.

Greece uncertainty continued in the news, a day after the Greek Prime Minister asked for a meeting on Monday with the EU, IMF, and European Central Bank. EU finance ministers told Greece to brace itself for IMF conditions, prompting Greek 10-year bonds to reach yields near the rate set before the announcement of the 45 billion euro financial aid package that European regulations had agreed to put in place if the Greek nation was unable to raise capital on its own in the open markets, but the finance ministers said that Greece doesn’t have an immediate plan to trigger the rescue package.

In other economic news, the euro-zone CPI rose 0.9% month-over-month (m/m) in March, matching economists’ expectations, while a separate report showed the euro-area posted a trade surplus of 2.6 billion euros for February, versus the expectation of a deficit of 500 million euros, and South Korea’s department store sales rose 4.6% in March y/y, the slowest rate of growth in eight months.

Another week of solid gains drained by financial fraud pain

The week was poised for another period of solid gains and the economic recovery appeared to be turning another corner courtesy of increased optimism toward the health of the corporate sector. The lion's share of the increased corporate sector sentiment came as 1Q earnings season got under way, but not without some initial uncertainty as Dow member Alcoa Inc. (AA $14) posted smaller-than-expected revenues in its unofficial christening of the season. However, the early uneasiness was quickly overcome as fellow Dow components Intel Corp. (INTC $24) and JPMorgan Chase & Co. (JPM $48) both posted profits that easily exceeded expectations, increasing the outlook that the technology sector could continue to help pace the recovery and that the financial sector continues to stabilize and may be set to contribute more to the economic prosperity.

Meanwhile, United Parcel Service Inc's (UPS $69 ¹) positive pre-announced 1Q results added to the backdrop, while the economic front also provided some sustenance for the bulls. March advance retail sales came in better than forecasted, the Federal Reserve Beige Book-a tool depicting business activity in the Federal Reserve's 12 districts around the nation used by the Federal Reserve to debate monetary policy-showed economic conditions have "increased somewhat" since the last report across 11 of 12 Districts. Moreover, the Empire Manufacturing and Philly Fed Manufacturing Indexes' measures of manufacturing activity in the New York and the Mid-Atlantic regions-both expanded by larger amounts than forecasted, offsetting an unexpected jump in jobless claims-volatility around Easter was blamed-and a smaller-than-expected rise in industrial production, pushing the Dow Jones Industrials over 11,000 and the S&P 500 Index above the 1,200 mark for the first time since September 2008. However, Friday's fraud charges against Goldman Sachs sparked global concerns that reached beyond the financial sector, prompting profit taking, which pared a large majority of the week's gains and ended the week on surprisingly sour note.

Next week chock full of economic data

Thursday's release of the Producer Price Index (PPI) is expected to show prices at the wholesale level were up 0.5% month-over-month (m/m) in March, on the heels of a 0.6% decline in February, while the core rate, which excludes food and energy, is expected to rise a mere 0.1% after increasing 0.1% the prior month. On a year-over-year basis, the PPI is expected to show a 6.0% increase on a headline basis, but only a 0.9% increase at the core level. The release comes after the Consumer Price Index (CPI) this week showed a modest 1.1% y/y increase on a core basis, indicating that inflation is not a current concern.

Housing data ramps up with Thursday's release of existing-home sales, expected to have increased 5.6% m/m in March to an annual rate of 5.3 million units. Sales of existing homes reflect closings from contracts entered one to two months earlier, while new home sales, expected to show a 5.0% increase in March to an annual rate of 324,000 units when released on Friday, are a more timely indicator of conditions in the housing market, as they reflect contract signings.

Durable goods orders will also be reported on Friday, expected to have risen 0.2% m/m in March after increasing 0.5% in February, while ex-transportation, orders are forecasted to have grown 0.7% m/m, after advancing 0.9% in February. The durable goods data is volatile on a month-to-month basis as the large size of orders for items such as airplanes and military equipment can have a tendency to distort the data.

Other reports on next week's US economic calendar include the Index of Leading Economic Indicators, the MBA Mortgage Applications Index, and initial jobless claims.

Economic releases in Asia/Pacific next week include Japanese consumer confidence, machine tool orders, and leading indicators index, Australia will announce its leading index, while the Reserve Bank of India meets to discuss monetary policy.

In Europe, releases include euro-zone PMIs for services and manufacturing, industrial new orders, German producer prices and the IFO survey of business confidence, as well as UK home prices, retail sales, and 1Q GDP.

Elsewhere in the Americas, the Canadian leading indicators index will be released and the Bank of Canada meets to discuss monetary policy.

France's CAC-40 Index was 1.9% lower, Germany’s DAX Index traded down 1.8%, Britain’s FTSE100 Index finished off 1.4%, and Greece’s Athex Composite Index declined 1.6%.