Evening Market Update

Stocks Move Higher on Late Day Strength, Tech Left Behind

The equity markets gained momentum late in the day to finish solidly in the green, reversing a recent trend of sliding in the final hour of trading, while the Nasdaq Composite Index failed to join the rally. There were no major US economic releases today, so traders looked to enthusiastic comments made last night by Federal Reserve Chairman Ben Bernanke, who gave relatively encouraging comments on the economic recovery and said a double-dip recession is unlikely. In equity news, Dow member McDonald’s Corp reported a solid increase in May same-store sales, but warned that foreign currency fluctuations could hurt full year revenues, while fellow Dow member 3M issued a similar warning due to weakness in the euro. Elsewhere in the Dow, Microsoft Corp announced that it will offer up to $1.25 billion in convertible senior notes to pay down debt. Meanwhile, Dollar General topped the Street’s 1Q expectations and increased its full-year outlook, while General Motors announced a 1.5 million vehicle recall. Treasuries finished the day lower.

The Dow Jones Industrial Average gained 123 points (1.3%) to close at 9,940, the S&P 500 Index rose 12 points (1.1%) to finish at 1,062, and the Nasdaq Composite dropped 3 points (0.2%) to 2,171. In modest volume, 1.6 billion shares were traded on the NYSE and 2.7 billion shares were traded on the Nasdaq. Crude oil gained $0.77 to $72.21 per barrel, wholesale gasoline was flat at $1.99 per gallon, and the Bloomberg gold spot price lost $3.00 to $1,237.25 per ounce. Elsewhere, the Dollar Index—a comparison of the US dollar to six major world currencies—fell 0.1% to 88.26.

Dow member McDonald’s Corp (MCD $68) reported May global same-store sales—sales at stores open at least thirteen months—increased 4.8% year-over-year (y/y), led by a 5.7% jump in comparable stores sales in Europe. US same-store sales rose 3.4%, fueled by the company’s food and beverage value offerings, and the addition of Frappes to its McCafe coffee line-up. Sales growth in France, Germany, the UK, and Russia helped lead European sales, while sales in Australia and China helped lead a 3.8% increase in sales from its Asia/Pacific, Middle East and Africa segment. Shares finished higher, after overcoming late-morning pressure that came on comments from MCD saying it expects foreign currency translation to have a negative impact on net income per share for the full year.

Meanwhile fellow Dow component, 3M Co(MMM $75) traded higher, even after the company’s Chief Financial Officer warned at an investor conference that the weakness in the euro may negatively impact full-year EPS by $0.05. The company executive added that the impact could be greater if the euro’s decline turns out to be structural, but the existing hit is expected to be focused in the second half of the year, according to Dow Jones Newswires.

In other Dow member news, Microsoft Corp (MSFT $25) announced that it intends to offer up to $1.25 billion in convertible senior notes due in 2013 in a private offering to qualified institutional buyers, subject to market and other conditions. MSFT said it intends to use the net proceeds from the offering to repay short-term debt. Shares were lower.

Dollar General Corp (DG $30) reported 1Q adjusted EPS of $0.42, above the $0.34 that Wall Street analysts had expected, with revenues increasing 11.9% y/y to $3.1 billion, compared to the $3.0 billion that the Street had expected. Same-store sales rose 6.7%, led by customer traffic and larger average transaction amount. The company raised its full-year EPS guidance and shares were higher.

General Motors Co announced that it will recall 1.5 million vehicles in the US, Mexico and Canada to fix a defect in heated washer-fluid systems that could catch fire. GM said the recall covers models under its Buick, Cadillac, Chevrolet and GMC brands and the fix consists of disabling the washer fluid system. GM said that it will reimburse vehicle owners $100 to compensate for the system being disabled, and its analysis shows the number of incidents is very small compared to the number of vehicles on the road.

Fed Chief Bernanke offers cautiously optimistic economic view

Treasuries finished the day lower, following some relatively favorable comments toward the economic recovery from Federal Reserve Chairman Ben Bernanke, and as there were no major economic reports today. The yield on the 2-year note was up 2 bps to 0.73%, the yield on the 10-year note gained 3 bps to 3.18%, and the 30-year bond yield rose 2 bps to 4.11%. Bernanke’s comments came as he participated in a Q&A session Monday evening with ABC News journalist Sam Donaldson. The Fed Chief said that the economic recovery continues at a moderate pace and it is unlikely that US economy will double dip into a recession, but due to the jobs picture, “it won’t feel great,” as the unemployment rate is still going to be high for a while and that means a lot of people are going to be under financial stress. Bernanke added that the Fed will raise interest rates from the “exceptionally low” level before the economy returns to “full employment,” but they don’t know when that process will start. On the European debt crisis, the head of the Fed said European leaders are committed to avoiding a default in Greece and elsewhere, and ensuring the survival of the euro, and have enough money to meet obligations of debt-strapped member nations.

Fitch says UK must accelerate budget-deficit cuts

European debt fears remained in focus today as Fitch Ratings said, “The scale of the United Kingdom’s fiscal challenge is formidable and warrants a strong medium-term consolidation strategy, including a faster pace of deficit reduction than set out in the April 2010 budget,” which was issued by the recently ousted Labour Party. Also, a separate report out of Germany – Europe’s largest economy, showed its trade surplus contracted by a larger amount than forecasted, as exports tumbled 5.9%, while a business sentiment indicator in France unexpectedly deteriorated, to add to the uneasy backdrop across the pond. But some of the uneasiness was tempered as finance ministers from the euro-area agreed on how to deploy the $1 trillion bailout fund if needed to try to avoid a default of a member nation.

In other European economic news, Germany reported a stronger-than-expected increase in industrial production, France’s trade deficit contracted by a smaller amount than expected in April, Switzerland’s consumer prices unexpectedly declined and its unemployment rate remained at 4.0%, while Sweden’s jobless rate increased from a downwardly revised 9.0% to 9.5% for April.

In Asia/Pacific news, Japan issued a report showing the nation’s Leading Index came in below the forecast of economists in April. Other economic reports in Japan included a 2.0% decline in bank lending on a y/y basis in May, larger-than-forecasted gains in the country’s money supply, and a bigger-than-anticipated contraction in Japan’s trade surplus.

Back in the Americas, Canadian housing starts unexpectedly fell in May to a seasonally-adjusted pace of 189,100 units, from a revised reading of 201,800 last month. The Bank of Canada warned that housing will “weaken markedly” this year and next year, after Canada increased its benchmark interest rate last week by 25 basis points to 0.5%. Elsewhere, Brazil released its 1Q GDP, which showed the economy expanded 9.0% y/y, the fastest annual rate since Q1 1995. The announcement further supports expectations that the Brazilian Central Bank will raise interest rates when it meets tomorrow, with most economists surveyed by Bloomberg looking for a 75 bps increase to 10.25%.

Fed Beige Book on tap tomorrow

The Federal Reserve will remain in focus tomorrow with a couple key events that will likely garner the attention of traders as they try to determine when the Fed, in light of the exacerbated euro-area debt crisis and worries of a hard landing in China, will continue to make moves aimed at returning to normal monetary policy conditions. Fed Chairman Ben Bernanke will provide testimony in front of the House Budget Committee on Capitol Hill at 10:00 a.m. ET, regarding economic and financial conditions and traders will likely be looking for any elaboration on his commentary he provided on Monday evening and the Fed Chief’s take on Friday’s labor report, which showed much fewer private sector jobs were added to nonfarm payrolls.

Moreover, in afternoon trading, the Federal Reserve will release its Beige Book, wherein Fed staffers summarize anecdotal economic data from all twelve Federal Reserve districts in preparation for the next Federal Open Market Committee (FOMC) meeting scheduled for June 22-23, and is used as an input to the Fed’s decision on whether to make any changes in monetary policy. As Schwab’s Chief Investment Strategist Liz Ann Sonders and Director of Market and Sector Analysis, Brad Sorensen, CFA point out in their latest bi-weekly Schwab Market Perspective, located at www.schwab.com/marketinsight, with excess capacity at factories and little wage pressure due to still-elevated unemployment, it seems unlikely that inflation would be able to gain a stronghold in the near future, so the focus on the report will likely be squarely on the other side of the Fed dual mandate of promoting full employment and factors of economic growth, such as manufacturing, employment conditions, and the health of the consumer. The prior release of the Fed’s report showed a broadening of economic recovery, with bright spots in retail and vehicle sales and tourism, while the overall services sector was seen as mixed. Manufacturing was noted on the rebound, and housing activity had increased. Meanwhile, commercial real estate and banking were seen as weak sectors.

Other releases on the US economic calendar include weekly MBA Mortgage Applications, as well as wholesale inventories for April, which are expected to increase by 0.5% after a 0.4% rise last month.

On the international economic calendar, Japan will release its final reading of 1Q GDP, as well as April machine orders, and the Bank of England will begin its two-day policy meeting.