Evening Market Update

Concerns About Consumer Spending Prompt Selling

Stocks fell on profit taking after yesterday’s strong gain and on concerns about the health of the US consumer. Consumer worries were highlighted by flat consumer income and spending trends, as well as unfavorable comments by Dow member Proctor & Gamble and Dean Foods, as well as industry auto sales that fell short of estimates. In other equity news, Dow component Pfizer, MasterCard Inc and Cognizant Technology Solutions reported better-than-estimated earnings, and Research in Motion unveiled the first phone using its new operating system. Elsewhere, disappointing economic reports in the form of a larger drop in factory orders and unexpected decline in pending home sales added to the negative sentiment, with Treasuries benefitting in a flight to safety.

The Dow Jones Industrial Average fell 38 points (0.4%) to close at 10,636, while the S&P 500 Index lost 5 points (0.5%) to finish at 1,120, and the Nasdaq Composite declined 12 points (0.5%) to 2,284. In moderately light volume, 1.0 billion shares were traded on the NYSE and 2.0 billion shares were traded on the Nasdaq. Crude oil rose $1.21 to $82.55 per barrel, wholesale gasoline was $0.02 higher at $2.19 per gallon, and the Bloomberg gold spot price gained $3.70 to $1,186.55 per ounce. Elsewhere, the Dollar Index—a comparison of the US dollar to six major world currencies—was 0.3% lower at 80.60.

Dow member Procter & Gamble Co. (PG $60) reported fiscal 4Q EPS of $0.71, two cents shy of the Reuters estimate, with revenues increasing 5% year-over-year (y/y) to $18.9 billion, below the consensus estimate of analysts, which called for revenues of $19.1 billion. The consumer products company said its unit volume growth accelerated but it issued fiscal 1Q earnings guidance that missed expectations. The company noted that increased marketing and price promotions drove volumes, but price adjustments lowered sales by 1%. Commentary regarding the health of the consumer was mixed, as the company saw strength in some new higher priced products, while the CEO also noted “Trading down is an impact. I frankly expect that to continue.” Shares were solidly lower.

Fellow Dow component Pfizer Inc. (PFE $16) posted 2Q EPS ex-items of $0.62, ten pennies above the Street’s forecast, with revenues including the acquisition of Wyeth jumping 58% y/y to $17.3 billion, above the $16.7 billion that was anticipated by analysts, while organic revenue growth was 3%. The drugmaker said its performance reflects a more balanced business mix and product portfolio. PFE said it sees its full-year 2010 EPS being at the upper end of its prior guidance range, and reiterated its financial targets for 2012, the first full year after losing US patent protection for Lipitor in 2011, and despite headwinds of global economic challenges, US heath-care reform, European pricing challenges and foreign-exchange fluctuations. The company did not address 2011 targets. The CEO also said Pfizer’s board would probably increase the stock dividend at its December meeting, and hopes to increase the payout ratio over the next three years. PFE was up nicely.

MasterCard Inc. (MA $201) achieved 2Q profits of $3.49 per share, above the $3.33 that the Street was looking for, as revenues rose 6.7% y/y to $1.4 billion, roughly inline with analysts’ expectations. The credit card transaction processor said revenues rose due to an increase in cross-border volumes of 15.2% y/y and growth in gross dollar volumes, which increased 8.5% compared to last year. The company noted that in recent months, US sales had slumped while Europe hasn’t been impacted by macroeconomic uncertainty, and Asia-Pacific and Latin America continued to grow at a double-digit rate. In the conference call, the CEO said revenue growth in the rest of the year would be tempered due to the uneven pace of economic recovery, especially in the US, as well as tough y/y comparisons. Shares were modestly lower in choppy trading.

Shares of Dean Foods (DF $11) were down nearly 10% after the company reported 2Q EPS ex-items of $0.29 on revenues of $2.95 billion, despite beating the Street’s earnings forecast of $0.25 per share and $2.95 billion in sales. The company said that consumers have continued to trade down toward lower-priced private-label milk over branded offerings, and gross margin y/y fell to 25.4% from 28.5% and the company gave guidance for 3Q earnings that was below estimates.

Major automakers reported their July US auto sales figures, with Ford Motor Co. (F $13) reporting adjusted sales for the month increased 0.7% y/y, Toyota Motor (TM $73) said sales fell 6.8% y/y, and Honda Motor Co Ltd (HMC $33) announced a sales decrease of 5.6% y/y. Shares of all three automakers were lower as results missed analyst forecasts. Elsewhere, Chrysler reported sales rose 1.1% y/y, which was below estimates.. Meanwhile, General Motors reported that its adjusted sales for its core brands—Buick, Cadillac, Chevrolet, and GMC—which the company will continue to produce, jumped 20%, compared to the single digit increase that analysts were anticipating.

Shares of Cognizant Technology Solutions (CTSH $61) were nearly 10% higher after the company reported 2Q EPS of $0.56, four cents per share higher than consensus estimates after sales grew 42% to $1.11 billion. The provider of IT consulting and business process outsourcing services said that spending levels were strong across all clients in all business segments and geographies, and that clients began investing again in discretionary programs to “foster growth and innovation,” noting particular strength in financial services, which had “previously been hard hit by the credit crisis.“

As expected, Research in Motion (RIMM $55) rolled out its new BlackBerry Torch 9800, the first device to run on its new BlackBerry 6 operating system, specifically designed to work with touchscreen technology, while the company also highlighted better internet browsing, social media feeds and text messaging. Shares were slightly lower.

Incomes and spending flat, inflation benign, factory and housing reports fall short

Personal income was flat in June, versus the Bloomberg survey of economists, which called for a 0.2% increase, while May’s 0.4% increase was revised down to a 0.3% gain. Personal spending was also unchanged in June, compared to expectations of a 0.1% rise, and May’s 0.2% increase was revised to a 0.1% rise. The savings rate ticked higher to 6.4% in June, after a 6.3% reading for May.

Also, the PCE Price Index, which is released with the income and spending data, was up 1.4% y/y in June, after May’s upwardly revised 2.1% increase, slightly above the consensus forecast of a 1.3% increase. The core PCE Price Index, which excludes food and energy, was flat month-over-month (m/m), versus the 0.1% increase that economists expected. Year-over-year, core prices moved 1.4% higher, above the consensus of economists surveyed, which called for a 1.3% gain.

The US consumer represents approximately 70% of the economy, and remains hamstrung by the headwinds of high unemployment and deleveraging. With economic activity slowing, the prospect of a rate hike has been pushed out until late 2011, and there are increasing calls for the Fed to do more to stimulate the economy. The Wall Street Journal today reported that the Fed may be considering a “symbolically important change” at its Federal Open Market Committee (FOMC) meeting next Tuesday that would mitigate the decline in the Fed’s balance sheet. The report indicated that the Fed could reinvest the proceeds from mortgage related holdings as they mature or are pre-paid into new mortgage or Treasury debt. The Fed did not comment on the report.

Meanwhile, factory orders (chart) declined by 1.2% m/m in June, more than double the decrease of 0.5% that economists had expected, and May’s drop was revised lower, from a 1.4% decline to a 1.8% fall. June durable goods orders—reported last week—were unfavorably revised from a 1.0% drop to a 1.2% decline. Nondefense capital goods ex-aircraft, considered a good proxy for business spending, inched up 0.2%, following the solid 4.7% jump that was seen in May.

The disappointing data continued, with the release of pending home sales, which posted a surprising decline, dropping 2.6% m/m in June, compared to the gain of 4.0% that economists were anticipating. Moreover, the 30% plunge in the gauge of the pipeline of existing home sales that was seen in May was revised slightly to a 29.9% tumble.

Treasuries were higher, extending early gains that followed the income and spending data after the drop in factory orders and pending home sales. The yield on the two-year note lost 2 bps to 0.53%, the yield on the 10-year note decreased 6 bps to 2.90% and the yield on the 30-year bond fell 3 bps to 4.03%.

Asia takes center stage in international economics

The services PMI in China accelerated in July to 60.1 from 57.4 in June. However, Chinese stocks reacted negatively to a report from the Securities Times that said the central bank may increase the required reserve ratio in October, citing unidentified officials from the banking industry. The government has already raised requirements three times this year. However, there are concerns inflation will pick up despite growth slowing, due to rising food prices after the worst flooding in more than a decade.

Meanwhile, evidence that the rate increases by the Reserve Bank of Australia (RBA) are slowing consumer spending continue to be reported, as Australian retail sales rose less than expected in June, by 0.2% versus the 0.4% that was forecasted, and building approvals fell 3.3% m/m in June compared to the 2.0% increase anticipated. The RBA met to discuss monetary policy today and RBA Governor Stevens said that households were displaying a degree of caution and the upward price pressure on housing “appears to have abated.” The Reserve Bank of Australia kept its benchmark interest rate at 4.5% as expected, saying that the expansion has been uneven, with the major advanced countries recording only moderate growth overall but growth in Asia and Latin America being “very strong.” The RBA added that with growth likely to be close to trend, inflation close to target and the global outlook remaining somewhat uncertain, it judged this setting of monetary policy to be appropriate.

The economic front in Europe was relatively light, with Spain reporting 73,800 jobs were lost in July but a separate report showed Spanish consumer confidence improved during the month, euro-zone producer prices were cooler than anticipated, and Switzerland’s consumer prices fell more than expected month-over-month in July.

Reading on the US service sector out tomorrow

With some spotty reports recently out of the consumer-related corporate earnings front, automakers posting lackluster July auto sales, major retailers set to report their July same-store sales reports—data on sales at stores open at least a year—on Thursday, and the looming labor report on Friday, the health of the consumer, which accounts for the lion’s share of the economy, is fresh on the minds of investors. Tomorrow’s release of the ISM Non-Manufacturing Index is likely to come under close scrutiny as it is a broad measure of business activity, particularly the service sector. Economists are expecting the index to dip slightly from 53.8 in June to 53.0 in July—the seventh-straight month of expansion as noted by a reading above 50—and any upside surprise, such as Monday’s better-than-forecasted reading of the ISM Manufacturing Index—the compliment report the non-manufacturing report—could help keep the recent momentum in the equity markets intact.

The Institute for Supply Management (ISM) surveys over 350 purchasing and supply executives in over 62 different industries and the underlying components of the report garner attention. Some of the components that make up the report include, backlog of orders, inventory change, and export orders, but there are some that may carry additional weight, such as prices paid, which has fallen solidly in recent months and has contributed to the recent flare up of deflation concerns.

Other releases on the US economic calendar include MBA Mortgage Applications and the ADP Employment Change, where 33,000 private jobs are expected to have been created in July, following a 13,000 increase in June.

In Europe, releases include euro-zone and UK services PMI reports, euro-zone retail sales, and UK housing prices.

In Asia/Pacific, China will report the PMI services index that includes non-government businesses, services PMIs will be reported in Russia and India, and Australia will report an index of housing prices.