Evening Market Update

Drop in Existing Home Sales Leads to Afternoon Selloff

The equity markets moved lower today, with the largest losses seen in the second half of the day on the heels of an unexpected drop in existing home sales and additional euro-area debt concerns. The energy sector took the biggest hit, even after a U.S. judge ruled against a six-month moratorium imposed by the White House on deepwater drilling. On the equity front, the CEO of Caterpillar Inc gave some optimistic comments on this year’s sales, while Walgreen Co. issued 3Q earnings that fell short of analysts’ estimates. Elsewhere, Carnival Corp issued a mixed profit report, Patriot Coal Corp announced that it will close one of its mines, and PetSmart Inc said it will raise its dividend and buy back $400 million in a share repurchase program. Treasuries moved higher late in the day as stocks fell by the wayside.

The Dow Jones Industrial Average lost 149 points (1.4%) to close at 10,294, the S&P 500 Index fell 18 points (1.6%) to finish at 1,095, and the Nasdaq Composite decreased 27 points (1.2%) to 2,262. In moderately light volume, 1.1 billion shares were traded on the NYSE and 1.9 billion shares were traded on the Nasdaq. Crude oil fell $0.61 to $77.21 per barrel, wholesale gasoline dipped $0.01 to $2.13 per gallon, and the Bloomberg gold spot price gained $7.13 to $1,240.83 per ounce. Elsewhere, the Dollar Index—a comparison of the US dollar to six major world currencies—increased 0.1% to 86.06.

Dow member Caterpillar Inc’s (CAT $64 1) CEO said that he expects the company’s sales to grow 25% this year as, “We’re coming back very strongly after the recession,” per Bloomberg News, which quoted the CEO at a business conference in Lima, Peru. The company’s Chief added that he sees strong demand for equipment coming from the mining and energy industries, particularly from rapid-growth emerging economies. CAT traded lower.

Walgreen Co. (WAG $28) reported fiscal 3Q EPS ex-items of $0.54, short of the $0.57 Reuters estimate, with revenues increasing 6.1% year-over-year (y/y) to $17.2 billion, slightly above the $17.1 billion that the Street was forecasting. The pharmacy and retailer said that it “Anticipated a challenging quarter for several reasons, including the sluggish economy, prescription reimbursement pressure compounded by a slowdown in the rate of introduction of new generics, and a lower incidence of flu compared with the beginning of the H1N1 pandemic a year ago.” WAG finished down solidly.

Carnival Corp. (CCL $33) reported fiscal 2Q EPS of $0.32, three cents above the consensus estimate of analysts, with revenues increasing 10% y/y to $3.2 billion, compared to the $3.3 billion that the Street was looking for. The cruise line said improving revenue yields combined with an 8% capacity increase and ongoing cost control efforts offset “significantly higher fuel prices.” The company traded lower after it issued 3Q and full-year EPS guidance that missed analysts’ forecasts.

Patriot Coal Corp. (PCX $13) announced that it will permanently close its Harris mine in West Virginia, following a roof collapse earlier this month. The mine produces metallurgical coal, which is used in steel production, and was expected to generate around 440,000 tons of coal this year, although it was scheduled to close in 2011 when its useful life ended. The company said in the spring that it expects to produce 7.5 million tons of metallurgical coal this year, and believes it can meet its contractual obligations through increased output from its other mines, Shares of PCX plunged over 15% on the news.

Shares of PetSmart Inc. (PETM $32) moved higher on news that the company will raise its quarterly dividend 25% and authorize a new $400 million share-repurchase program. The dividend increases to $0.125 per share and will increase the company’s annual payout by $11.8 million a year, while the share-buyback program replaces the previous $350 million program that expires in January 2012. Shares of PETM gave up early gains to finish lower.

Existing home sales unexpectedly fall, Fed meeting begins

Existing-home sales surprised to the downside, falling 2.2% month-over-month (m/m) in May, to an annual rate of 5.66 million units, compared to the 6.0% gain to 6.12 million units that economists surveyed by Bloomberg had forecasted. However, April’s 7.6% gain was revised to an advance of 8.0%. The report revealed the gains in the West and South were offset by a decline in the Northeast, while the Midwest was steady. Single family home sales fell 1.6%, while sales of multifamily homes dropped 6.8%. Moreover, the median home price rose from $172,300 in April to $179,600 in May, and is up 2.7% y/y. Treasuries moved higher late in the day as stocks lost ground, after showing little initial reaction to the housing report. The yield on the 2-year note fell 3 bps to 0.68%, the yield on the 10-year note lost 9 bps to 3.16%, and the 30-year bond yield decreased 7 bps to 4.09%.

The decline in the current month may have disappointed some but it followed solid gains in April and March—which rose 7.0%—and the National Association of Realtors (NAR) noted that existing home sales remained at elevated levels. The NAR said existing home sales, which make up the bulk of total sales, were supported by the buyer response to the homebuyer tax credit, stabilizing home prices and historically low mortgage interest rates. Since existing home sales reflect closings of home purchases and buyers had to be under contract by April to close by the June deadline to qualify for the tax credit, May’s number benefitted from government incentive, and the NAR expects one more month of elevated home sales. However, the NAR noted that approximately 180,000 home buyers who signed a contract in good faith to receive the tax credit may not be able to finalize by the end of June—when closing needs to be finalized to get credit for the tax credit—due to delays in the mortgage process, particularly for short sales.

Tomorrow, however, new home sales will be released and will provide the first glimpse into housing demand after the government stimulus has worn off. New home sales are expected to plunge 18.7% month-over-month (m/m) in May to an annual rate of 410,000 units as these sales reflect contract signings and will not benefit from the government tax credit because of the April deadline (economic calendar). New home sales jumped 14.8% in April but account for a smaller portion of the total housing sales, with today’s existing home sales report providing a broader look at sales on the housing front. However, housing affordability remains high as noted by the NAR in today’s report, which could help limit the impact of the end of the support from the government. Also, there were worries that the Federal Reserve ending its purchases of mortgage-backed securities would cause mortgage rates to spike, but rates remain below 5%—historically low, helping to make housing more affordable. Importantly, the "real" mortgage rate (the nominal 30-year fixed rate minus home-price appreciation or depreciation) is now very low (5% - 4% = 1%) relative to what it was at its peak—a lofty 22%.

In other economic news, the Richmond Fed Manufacturing Index deteriorated in May to 23 from 26 in April, but the forecast of economists called for a decline to 20, and a reading above zero denotes expansion.

Meanwhile, the two-day Federal Open Market Committee (FOMC) meeting began today and will conclude mid-day Wednesday with the release of the statement. No interest rate changes are expected, and since the last meeting, economic growth forecasts globally have been revised lower due to the European crisis and the likelihood of a slowdown in China, causing traders to push out the timing of the first US rate hike from late this year to the first half of next year. The language of tomorrow’s statement will be the main focus of traders as they will scrutinize it word for word, searching for clues on the timing that the Fed deems appropriate for beginning to increase rates. For some time now, the FOMC has maintained that economic conditions continue to warrant “exceptionally low” levels of the fed funds rate for an “extended period” and it is this language that will likely garner the most attention if any tweaks are made. Also, the status of the extra measures the Fed has taken to address liquidity and the cost of capital will continue to be monitored.

UK unveils austerity measures, inflation slows in Canada and Brazil

In European economic news, the UK announced its emergency budget today, where it revealed aggressive austerity measures, projecting to bring borrowing down from 10.1% of GDP this year to 1.1% by 2015-2016. Some highlights of the UK budget changes include an increase in the value-added tax, as well as tax increases for capital gains, a bank levy, and a two-year public sector pay freeze. The announcement exacerbated uncertainty regarding whether the European economic recovery can continue as several nations try to rein in their deficits in an attempt to implement long-term fiscal sustainability. The uneasiness overshadowed an unexpected increase in a gauge of business confidence in Germany—Europe’s largest economy. The German IFO Business Climate Index increased from 101.5 in May to 101.8 in June—the highest since May 2008—and compared to the decline to 101.2 that economists surveyed by Bloomberg had expected. In other economic news, euro-zone consumer confidence unexpectedly improved in June, Switzerland’s trade surplus narrowed, Sweden’s unemployment rate fell more than expected in May, the euro-zone current account balance fell to a deficit, and Spain’s trade deficit widened in April.

In the Asia/Pacific region, Japan issued a report showing that the nation’s supermarket sales fell 5.3% y/y in May, after dropping 4.9% in April, while Hong Kong’ s consumer prices increased 2.5% y/y in May, compared to the 2.6% increase that was anticipated by economists surveyed by Bloomberg. Additionally, Taiwan’s unemployment rate declined from 5.43% in April to 5.22% in May, versus the 5.33% that was expected.

Back in the Americas, Canada’s consumer price index rose 1.4% in May, slightly higher than the 1.3% expected by economists, but lower than the 1.8% increase seen in April. The core rate, which excludes eight volatile items, slowed to 1.8%, after increasing 1.9% last month. Brazil’s consumer price index also increased at a slower pace, rising 0.19% in the 30-day period ending June 15th. The increase was the smallest since October of 2009, but was in line with expectations.

Other than the aforementioned report on new home sales and the FOMC rate decision, the only other report on the US economic calendar will be MBA Mortgage Applications, which increased 17.7% last week.

The international economic calendar will yield PMI reports from France, Germany, Italy and the euro-zone, as well as the minutes from the Bank of England’s most recent policy meeting, and retail sales out of Canada.