Evening Market Update

No Near-Term Stimulus From Fed Disappoints

A modest advance after better earnings news was reversed after Fed Chair Bernanke disappointed by not providing hope for a near-term change in monetary policy. Bernanke offered little in the way of new information in his testimony before the Senate, and his prepared testimony was primarily devoted to the ways the Fed would exit stimulus, rather than provide new measures to combat the “soft patch” the economy has recently entered, and Treasuries were higher. In earnings news, strong reports were released by Apple Inc, Morgan Stanley, Wells Fargo, Eaton Corp and Dow members Coca-Cola and United Technologies. Yahoo Inc gave a mixed report, which missed revenues and gave disappointing guidance. Elsewhere, mortgage applications rose as the 30-year fixed mortgage rate hit a new record low.

The Dow Jones Industrial Average fell 109 points (1.1%) to close at 10,121, the S&P 500 Index lost 14 points (1.3%) to finish at 1,070, and the Nasdaq Composite declined 35 points (1.6%) to 2,187. In moderate volume, 1.2 billion shares were traded on the NYSE and 2.2 billion shares were traded on the Nasdaq. Crude oil fell $1.02 to $76.56 per barrel, wholesale gasoline lost $0.01 to $2.07 per gallon, while the Bloomberg gold spot price decreased $6.40 to $1,185.65 per ounce. Elsewhere, the Dollar Index—a comparison of the US dollar to six major world currencies—was 0.6% higher at 83.28.

Apple Inc. (AAPL $254) reported fiscal 3Q EPS of $3.51, well above the $3.12 Reuters estimate, with revenues jumping 61% year-over-year (y/y) to $15.7 billion, also above estimates, which called for revenues of $14.8 billion. The company said it sold 3.47 million Macs during the quarter—a new quarterly record and a 33% y/y gain—while it also sold 8.4 million iPhones, a 61% y/y increase, and 9.41 million iPods, an 8% y/y decline. Also, AAPL started selling its iPads during the quarter, and sales totaled 3.27 million units. In typical fashion AAPL reported conservative guidance, with its 4Q EPS outlook missing the Street’s forecast. Shares were higher.

However, Yahoo Inc. (YHOO $14) was under solid pressure after the world’s number-two internet search engine recorded 2Q revenues excluding traffic acquisition costs (TAC) of $1.1 billion, which came in below the $1.2 billion that the Street was expecting. The revenue shortfall is overshadowing the company’s better-than-anticipated 2Q EPS of $0.15, which topped forecasts of analysts by one penny. YHOO also provided disappointing 3Q guidance.

Meanwhile in the banking industry Morgan Stanley (MS $27) posted 2Q EPS ex-items of $0.80, well above the $0.48 that analysts were forecasting, with revenues gaining 54% y/y to $8 billion topping the $7.9 billion forecast. MS posted better-than-expected trading results, which where not impacted as much from the “challenging” markets during the quarter as analysts had braced for, with its equities trading besting the performance that rival Goldman Sachs Group Inc. (GS $147) reported yesterday. But the financial firm did say that it still has a “great deal of work to do” and it anticipates that the difficult market environment may continue in the months ahead. Elsewhere, Wells Fargo & Co. (WFC $26) reported adjusted 2Q earnings of $0.55 per share, six cents above the Street’s forecast, with revenues of $21.4 billion roughly inline with analysts’ estimates. WFC’s performance came as the company saw a “significant improvement in credit quality” with loan losses declining 16% quarter-over-quarter (q/q) and delinquent loan trends improving in many of its portfolios. MS and WFC shares rose.

In earnings reports within the Dow components, Coca-Cola Co.(KO $54) announced 2Q EPS ex-items of $1.06, above the $1.03 consensus estimate, with revenues increasing 5% y/y to $8.7 billion, matching forecasts. The beverage company said its worldwide volume growth was 5%, which is ahead of its long-term target. Moreover, industrial conglomerate United Technologies Corp. (UTX $67) posted 2Q profits of $1.20 per share, four cents above what was expected, as revenues grew 5% to $13.9 billion, exceeding the $13.6 billion that was anticipated. UTX also raised its full-year EPS guidance. KO rose, but UTX lost an early gain and finished lower.

Another report from the industrial sector was Eaton Corp. (ETN $73), which was solidly higher after the diversified manufacturer announced 2Q EPS ex-items of $1.36, above the $1.17 that analysts were expecting. Revenues increased 16% y/y to $3.4 billion, above the $3.2 billion that was expected and ETN noted that its results reflect the continued expansion in its markets around the world. The company added that while debt problems in Europe are likely to slow the rate of growth in some European markets, and the rate of economic growth in China has moderated slightly, it anticipates solid global growth continuing during the second half of the year. ETN offered better-than-expected guidance and increased its quarterly dividend by 16% to $0.58 per share.

Mortgage apps rise, Bernanke gives little hope for more stimulus

The MBA Mortgage Application Index increased 7.6% last week, after the index that can be quite volatile on a week-to-week basis, declined 2.9% in the previous week. The gain came as the Refinance Index rose 8.6%, joining a 3.4% increase in the Purchase Index. The advance in the overall index came amid a 10 basis-point drop in the average 30-year mortgage rate to 4.59%, falling below the previous record low of 4.61% that was reached at the end of March 2009.

In his semi-annual monetary policy testimony in front of the Senate, Federal Reserve Chairman Ben Bernanke reaffirmed the Fed’s view provided in the release of the minutes from the June meeting last week, that the fed funds rate is likely to remain “exceptionally low” for an “extended period,” as the progress in reducing unemployment was slower than expected and that financial conditions are somewhat weaker in recent months due to fallout from the European debt crisis, resulting in committee members having greater uncertainty about the outlook for growth and unemployment than normal.

Markets were disappointed that there was little new information provided in Bernanke’s testimony, as well as the considerable amount of prepared text devoted to the “exit strategies” the Fed would use to decrease the size of their balance sheet and normalize the composition of the balance sheet over the “longer term” and eventually reverse easy monetary policy. He reiterated that the Fed continues to assess developments, and remains prepared to take further actions “as needed.” By dedicating so much time to the “exit strategy,” investors believe that the Fed is less likely to be considering a renewed move to add stimulus to the economy.

In the Q&A session, Bernanke noted that they were “still evaluating the recovery,” and that he believed the recovery was sustainable. He said that the condition for more stimulus would be if the recovery became unsustainable. Bernanke said that the three possible actions that remain in the Fed’s toolbox to provide stimulus are changes to the language of extended period, lowering the rate paid on excess reserves, and balance sheet actions such as reinvesting proceeds from maturing mortgage debt or making additional purchases. Fed Governor Kevin Warsh has said that any expansion of the balance sheet would be subject to strict scrutiny, and he would need to be convinced that the benefits would outweigh the costs, including the erosion of market functioning.

Treasuries were solidly higher, with the yield on the two-year note falling 2 bps to 0.55%, the 10-year note declining 8 bps to 2.87% and the 30-year bond decreasing 10 bps to 3.88%.

Monetary policy reports from the UK and Japan highlight international economics

The European economic calendar was light, with the lone major release being a report showing UK policy makers voted 7-1 to keep the Bank of England’s benchmark interest rate unchanged at a record low of 0.5%, with the lone dissenting vote being in favor of a rate hike. In euro-area debt news, Portugal auctioned off just over 1.25 billion euros ($1.6 billion) of 12-month bills and although the costs for the nation to borrow funds rose solidly above the yield of a similar auction in March, the reaction was relatively modest in equity markets as it attracted bids of 1.3 times the amount offered.

In Asia/Pacific economic news, Bloomberg reported that Japan’s Cabinet Office said in its monthly report that “the economy has been picking up steadily and the foundation for a self-sustaining recovery is being laid,” while the release of the Bank of Japan’s minutes from its most recent monetary policy meeting last month revealed that policymakers felt the world economy had continued to recover moderately. Elsewhere, a reading of the Australian Leading Index increased in May, and a report showed Thailand’s trade balance unexpectedly expanded for June.

Another read on the housing market on tap for tomorrow

Pending home sales fell 30% in May, beginning what we believe is likely to be a string of weak housing data as we give back some of the gains seen prior to the expiration of the homebuyers' tax credit. With pending home sales a gauge of the pipeline existing home sales, it is no surprise that economists are forecasting tomorrow’s existing home sales report to show a 9.9% drop in sales to an annual rate of 5.10 million units for June, after an unexpected decline to 5.66 million units in May—a month which still had the support of the housing credit.

The National Association of Realtors mentioned with the May sales report that it expects one more month of elevated homes sales so the report could be discounted if sales come in stronger than forecasted. Existing home sales account for the lion’s share of total home sales and the outlook for further stabilization in the market remains lackluster, keeping the outlook for economic growth subdued and fostering an environment for the Fed to keep its accommodative policy stance intact for an “extended period.”

Elsewhere on the US economic calendar tomorrow, weekly initial jobless claims are expected to rise to 445,000 from 429,000, and the Conference Board Index of Leading Economic Indicators (LEI) for June is anticipated to decline 0.3%.

International economic releases will include euro-zone industrial new orders, consumer confidence, and PMI readings for services and manufacturing, UK and Canadian retail sales, and the Central Bank of Brazil meets to discuss monetary policy, where the forecast is that the bank will raise the benchmark Selic rate by 75 bps to 11.0%.