Evening Market Update

Stocks Slide on German Trade Restrictions & US Housing Data

The equity markets finished in the red, but well off the lows of the day, as investors were spooked by a sharp drop in mortgage applications and yesterday’s announcement that Germany will ban naked short-selling of ten large financial institutions. In equity news, earnings reports came in mostly positive, as Dow member Hewlett-Packard Co, Target Corp, Deere & Co and BJ’s Wholesale Club Inc all topped the Street’s earnings expectations. The Dow was also helped by some upbeat comments about future profitability from the CEO of General Electric Co and an announcement that Bank of America will be selling its stake in Brazil’s largest bank for over $4 billion. In economic news, the Consumer Price Index came in at a subdued level, while mortgage applications declined on a sharp drop in purchases and foreclosures increased. Treasuries finished the day lower.

The Dow Jones Industrial Average fell 67 points (0.6%) to close at 10,444, the S&P 500 Index lost 6 points (0.5%) to 1,115, and the Nasdaq Composite was 19 points (0.8%) lower at 2,298. In moderate volume, 1.6 billion shares were traded on the NYSE and 2.6 billion shares were traded on the Nasdaq. Crude oil rose $1.77 to $71.18 per barrel, wholesale gasoline declined $0.02 to $2.02 per gallon, and the Bloomberg gold spot price fell $32.30 to $1,192.85 per ounce. Elsewhere, the Dollar Index—a comparison of the US dollar to six major world currencies—was down 1.2% to 86.30.

Dow member Hewlett-Packard Co. (HPQ $47) reported fiscal 2Q EPS ex-items of $1.09, four cents above the consensus of Wall Street analysts, with revenues increasing 13% year-over-year (y/y) to $30.8 billion, which exceeded the $29.8 billion that the Street had forecasted. HPQ said it saw double-digit growth across all regions compared to last year and with the “improving demand environment,” it raised its full-year outlook. HPQ’s enterprise storage and servers revenue surged 31% and its personal systems unit revenue—led by a 20% increase in PC shipments—jumped 21% y/y to lead the way. Shares were higher.

Target Corp. (TGT $54) announced 1Q EPS of $0.90, above the $0.87 that analysts had forecasted, with revenues increasing 5.1% y/y to $15.6 billion, roughly inline with the Street’s expectations. The company said its results reflected a “stronger-than-expected economic environment,” with sales of higher margin discretionary items particularly strong, especially in apparel. TGT added that its credit card segment was also well above expectations, as declining risk levels led to a sharp reduction in bad debt expense versus a year ago. TGT traded lower.

Fellow retailer BJ’s Wholesale Club Inc. (BJ $39) also beat the Street’s earnings expectations, as 1Q EPS of $0.49 was five cents higher than the consensus estimate of $0.44. Net sales rose 13% y/y to $2.55 billion, while comparable club sales increased 7.8% and the company raised its full-year forecast to $2.58 to $2.68, compared to analysts’ estimates of $2.61. Shares were solidly higher.

Deere & Co. (DE $59) posted fiscal 2Q EPS ex-items of $1.58, well above the $1.09 that analysts were expecting, with revenues increasing 6% y/y to $7.1 billion, compared to the $6.6 billion that the Street had anticipated. The farm and construction equipment firm said sales of large farm machinery, particularly in the US and Canada, are making a “significant” impact on the company’s performance, while construction and forestry shipments are rebounding from historic lows. DE increased its full-year earnings guidance. Shares finished higher.

Dow member Bank of America (BAC $16 ¹) was higher after Brazil’s largest bank by market value, per Bloomberg, Itau Unibanco Holding SA (ITUB $18) said BAC agreed to sell its entire stake in the Brazilian bank for about $4.4 billion. BAC will sell the preferred shares it owns in the company in a secondary offering and will sell the common shares it owns to ITUB’s parent firm. A Bank of America spokesman said the reason for the sale was to help reinforce its capital and added that ITUB was viewed as a non-core asset. BAC entered the Brazilian bank’s capital in 2006, when it sold its operations in Brazil, Uruguay, and Chile in an all-stock transaction worth $2.8 billion. ITUB was down solidly.

Fellow Dow component General Electric Co. (GE $17 ¹) overcame early losses to finish modestly higher after its CEO Jeff Immelt offered some positive comments about the company’s outlook. According to the Dow Jones Newswires, Immelt said earnings will start to grow in the current quarter and that GE will see “really strong earnings” over the next couple of years. He also reiterated that the company plans to increase its dividend next year and its hampered GE Capital unit plans to restore the dividend it had been paying the parent company by 2012.

Consumer prices remain muted, mortgage apps decline, Fed minutes released

The Consumer Price Index showed prices at the consumer level were down 0.1% in April month-over-month (m/m), compared to the forecast of economists surveyed by Bloomberg, which called for a 0.1% increase. The core rate, which strips out food and energy, was flat m/m for April, compared to the 0.1% increase that was anticipated. While food and energy is the smallest component in the CPI basket, it tends to be the most volatile and often explains a majority of changes in the index at the headline level. On a year-over-year basis, consumer prices were up 2.2% in April, compared to the forecast of 2.4%, and the core CPI was 0.9% higher y/y, compared to the 1.0% forecast.

Much like yesterday’s release of the Producer Price Index, today’s report on consumer prices did not evoke any fears about inflation. In fact, the Bureau of Labor Statistics said the 0.9% y/y rate of core CPI was the smallest 12-month increase since January 1966, suggesting the Fed does not have to worry about near-term inflation pressures stymieing its efforts to keep its extremely easy monetary policy stance, especially in light of the exacerbated euro-area concerns recently.

Also, with the outlook that the Fed will remain on monetary policy hold—evidenced by the futures market pushing out the likelihood of a rate increase from December out to 2011—and the recent re-enactments of its currency swap lines, which effectively extended its loose monetary policy conditions, support for the US dollar would seem diminished somewhat. However, given the recent flight-to-safety buying amid the euro-area debt crisis and relatively better-than-expected US economic data, the dollar has strengthened.

The Federal Reserve released its minutes from its most recent Federal Open Market Committee (FOMC) monetary policy meeting on April 27-28, in which it left the fed funds rate unchanged at a range between 0-0.25% and maintained its language with regard to the “extended period” for keeping rates at an exceptionally low rate. FOMC participants increased their 2010 GDP forecast slightly higher than its last forecast in January and its outlook for GDP in 2011 and 2012 was little changed. The report also showed that participants expected the economic recovery to continue but at a moderate pace of expansion with the unemployment rate declining gradually, with projected economic growth somewhat faster in 2011 and 2012, generating a more pronounced decline in the unemployment rate. However, the release revealed that most participants continued to see their projections of future economic activity and unemployment as subject to “greater-than-average uncertainty.”

Elsewhere in the report, FOMC members expressed a range of views on some of the details of a strategy for asset sales to return the size and composition of the Federal Reserve’s balance sheet to a more normal configuration, but a majority favored deferring asset sales for some time. Moreover, not surprisingly, the FOMC anticipated that both overall and core inflation would remain subdued through 2012, with measured inflation somewhat below rates that policymakers considered to be consistent over the longer run. The Fed’s modest outlook for the economy and its cautious commentary, along with its outlook on inflation.

In other economic news, the US MBA Mortgage Application Index declined 1.5% last week, after the index that can be quite volatile on a week-to-week basis, advanced 3.9% in the previous week. The decrease came amid a 27.1% tumble in the Purchase Index, which more than offset a 14.5% jump in the Refinance Index. The decline in the overall index came despite a 12 basis-point decrease in the average 30-year mortgage rate, which declined to 4.83%, closer to the record low of 4.61% that was reached at the end of March 2009. In a related report, the inventory of homes in foreclosure rose to 4.63% from 4.58% in the fourth quarter of last year, according to the Mortgage Bankers Association.

Treasuries finished lower, as the yield on the 2-year note was up 4 bps to 0.77%, the yield on the 10-year note gained 1 bp to 3.36%, and the 30-year bond yield was 1 bp higher at 4.24%.

Europe focuses on German short selling action, Australian’s lose confidence

Euro-area debt concerns and fears about the future of the euro-structure dominated sentiment across the pond again today. The uneasiness came courtesy of Germany’s decision late-yesterday to ban naked short selling—the premature selling of a security without owning or obtaining the approval to own the security—of 10 of the nation’s financial institutions and some derivative securities on euro-area government bonds. The concerns were exacerbated by comments from German Chancellor Angela Merkel, who said the euro is at risk and the European Union may be facing its greatest challenge with “incalculable” consequences if leaders fail to act, per Bloomberg News. Merkel added that Germany—Europe’s largest economy—will act alone if necessary in controlling “destructive” financial markets.

In other economic news, which took a back seat to the aforementioned euro-zone concerns, euro-area construction output jumped 7.6% m/m in March, following a downwardly revised 7.2% drop in February. Moreover, the release of the minutes from the Bank of England’s most recent monetary policy meeting showed a unanimous vote in keeping the nation’s benchmark interest rate at a record low of 0.5%. Elsewhere, Spain’s 1Q GDP was left unrevised at a 0.1% expansion quarter-over-quarter (q/q) and a 1.3% contraction y/y.

In Asian/Pacific news, a report showed Australia’s consumer confidence declined 7% to 108 points this month, the largest decline in 19 months. Australia’s central bank has raised interest rates six times since last October, driving variable mortgage interest rates to around 7.4%, and the recent European debt fears have contributed to a dampened sentiment down under. Minutes from the Reserve Bank of Australia’s most recent meeting show that “increases in interest rates to date have been timely”, with signs that the moves were “beginning to affect behavior.” Meanwhile, a separate report showed the nation’s wage costs rose 0.9% q/q, compared to economist’s estimates of a 0.8% gain. The Australian dollar fell to its lowest level in eight months versus the US dollar.

Philly Fed and Leading Indicators on tap for tomorrow

Economic releases on tomorrow’s US economic calendar include the Philadelphia Fed’s Business Activity Index, which is expected to rise to 21.3 from a previous monthly reading of 20.2, and the Conference Board’s Index of Leading Indicators, which economists are predicting will rise by 0.2% in April, after jumping 1.4% in March. Any positive reading will represent the thirteenth-consecutive increase in the index. The final report on tomorrow’s docket will be weekly initial jobless claims, which are expected to decrease by 4,000 to 440,000.
International economic releases will include German PPI, Italian industrial orders, UK retail sales, euro-zone consumer confidence, Canadian leading indicators, and Brazilian CPI. The Bank of Japan will hold its monetary policy meeting, while Japan will also release its 1Q GDP.