Evening Market Update

Disheartening Labor Report Ups Economic Recovery Worry

While well off the lows of the day on Friday, a disappointing labor report that showed a larger-than-expected decline in nonfarm payrolls, soft private sector job growth, and downward revisions to last month's figures sapped sentiment and sent stocks lower, closing out the week on a sour note. Treasuries gained ground following the jobs data as investors looked for safety amid a resurgence in economic recovery anxiety. In earnings news, Dow member Kraft Foods, as well as bailed-out financial firm American International Group, both posted earnings that beat the Street, while Activision Blizzard fell short of revenue estimates and offered a disappointing EPS outlook. In other economic news, June consumer credit fell by $1.3 billion.

The Dow Jones Industrial Average dropped 21 points (0.2%) to 10,654, the S&P 500 Index was 4 points (0.4%) lower at 1,122, and the Nasdaq Composite shed 5 points (0.2%) to 2,288. In moderately light volume, 949 million shares were traded on the NYSE and 1.9 billion shares were traded on the Nasdaq. Crude oil lost $1.31 to $80.70 per barrel, wholesale gasoline declined $0.05 to $2.11 per gallon, while the Bloomberg gold spot price gained $10.35 to $1,205.30 per ounce. Elsewhere, the Dollar Index-a comparison of the US dollar to six major world currencies-fell 0.6% to 80.33. For the week, including dividends, the DJIA gained 1.8%, the S&P 500 Index added 1.8%, and the Nasdaq Composite was up 1.5%.

Dow member Kraft Foods Inc. (KFT $30) reported 2Q EPS ex-items of $0.60, eight cents above the Reuters estimate, with revenues jumping 25.3% year-over-year (y/y) to $12.3 billion, roughly inline with the Street's forecasts. The consumer products conglomerate said it achieved combined organic net revenues-revenues excluding acquisitions and divestitures-of 2.2%. KFT also said its acquisition of Cadbury helped boost its headline revenues by 22.8 percentage points. The company said it achieved strong earnings despite difficult conditions in many markets that tempered top-line growth. KFT’s operating income increased on volume and product mix gains and productivity improvements, which were partially offset by higher raw material costs and increased advertising. The company confirmed its full-year EPS outlook. KFT finished higher.

American International Group Inc. (AIG $41) posted 2Q earnings ex-items of $1.99 per share, well above the $0.98 that analysts were expecting. The company said its continuing insurance operating results remain solid, while the company continues to execute on its restructuring plans and prepares for separation from the US government. AIG traded to the upside.

Activision Blizzard Inc. (ATVI $11) announced adjusted earnings of $0.06 per share, one penny above the consensus estimate, but revenues excluding items fell 15% y/y to $683 million, below the $719 million expectation. The video game publisher said it benefitted from continued strong consumer response to its Call of Duty and World of Warcraft franchises and it "has never been better positioned for the holiday season," with its current and upcoming slate of games. But ATVI offered 3Q and full-year EPS guidance that trailed analysts’ forecasts. Shares were under solid pressure.

Private sector payrolls rise by smaller amount than forecasted

Nonfarm payrolls fell by 131,000 jobs in July, about double the consensus estimate of 65,000 expected by economists surveyed by Bloomberg. Meanwhile, excluding government hiring, private sector payrolls increased by 71,000, falling short of the 90,000 gain expected, while June's figure was downwardly revised to an expansion of 31,000, versus the initially reported 83,000 gain. The unemployment rate remained at 9.5%, while the expectation was for it to rise slightly to 9.6%. Average hourly earnings rose by 0.2% month-over-month (m/m) versus the Street's forecast of a 0.1% increase, and average weekly hours increased slightly to 34.2 from the 34.1 where economists expected it to remain.

Government payrolls fell by 202,000 as Census employment dropped by 143,000 temporary workers, while state and local government lost 48,000. Gains were paced by 36,000 in manufacturing, led by 21,000 in motor vehicle and parts, and a 28,000 increase in health services. Discouragingly, temporary help services lost 6,000 in the month on a seasonally-adjusted basis, the first decline since September 2009. Thus far this year, private sector employment has increased by 630,000, with about two-thirds of the gain occurring in March and April, as the past three months have averaged only 51,000 a month.

The report is seen as a key factor for policy makers to consider at the Fed's FOMC meeting next week, scheduled for August 10. The Fed has the dual objective of maximum employment and stable prices, and apprehension about both has been raised lately. Economic growth slowed in the second quarter, and Fed Chair Bernanke has said the less than 100,000 average monthly rate of increase in private payrolls this year is insufficient to reduce the unemployment rate materially. Bernanke has raised concerns about the number of long-term unemployed, those jobless for 27 weeks and over, which remains elevated at 6.6 million. In his congressional testimony in late July, Bernanke said that "People who are unemployed for a long period of time often see their skills atrophy or see their skills become irrelevant," and that "progress in reducing unemployment is now expected to be somewhat slower than we previously projected." Additionally, the Fed Chair said that "near-term inflation now looks likely to be a little lower."

Consumer credit fell for the fifth-consecutive month, dropping by $1.3 billion during June, far less than the $5.3 billion decline forecasted by economists, while May's figure was revised to a $5.3 billion decrease.

Treasuries moved to the upside following the labor data and remained higher into the close. The yield on the two-year note lost 3 bps to 0.50%, the yield on the 10-year note declined 9 bps to 2.82% and the yield on the 30-year bond fell 6 bps to 3.99%.

Manufacturing data headlines Euro-area economic news

The economic calendar across the pond was heavy, with some major manufacturing reads in focus, headlined by an unexpected decline in industrial production in Germany, falling 0.6% month-over-month (m/m) in June, compared to the expectation of economists, which called for production in Europe's largest economy to increase 0.5%. Also, the UK released a couple manufacturing reports, which showed industrial production unexpectedly declined by 0.5% m/m in June, while a separate report showed the nation's manufacturing production rose 0.3% m/m in June, short of the 0.4% increase that was anticipated. Other reports rounding out the European economic front include a 0.4% quarter-over-quarter (q/q) expansion in Italy’s 2Q GDP, matching expectations, UK producer input prices falling 1% m/m in June, doubling the decline that was forecasted, while output prices rose more than expected. Moreover, Italy's industrial production increased by an amount that was below expectations, France's trade deficit narrowed by a larger amount than anticipated, and Switzerland's unemployment rate dipped to 3.6% in July, inline with expectations.

Elsewhere, Russia announced a ban on grain exports from August 15 to year-end, with Russian Prime Minister Vladimir Putin urging Belarus and Kazakhstan to follow suit, as a severe drought has racked in the region. Wheat prices hit a 23-month high on the announcement.

In economic news in the Asia/Pacific region, Japan's Leading Index rose slightly more than anticipated in June, and the Reserve Bank of Australia reiterated its economic growth and inflation outlooks in its quarterly monetary policy statement.

Back in the Americas, Canada's July employment report showed that the country shed 9,300 jobs during the month, well below the 12,500 increase expected by economists polled by Bloomberg, while the unemployment rate ticked higher to 8.0% from the 7.9% in June and where economists expected it to remain.

Gains wane as week's sentiment posts a progression toward pessimism

Positive sentiment reached its pinnacle in the first half of the week with the ISM Manufacturing Index and the companion ISM Non-Manufacturing reports depicting business activity in the manufacturing and service sectors continuing to expand, supporting the argument for the economic recovery. Also, with the labor report looming, enthusiasm toward the jobs market had the markets poised for solid gains for the week, as both the employment components of the ISM reports showed expansion, and the mid-week release of the ADP Employment Change Report showed a larger-than-forecasted increase in private sector jobs. However, as the week progressed, sentiment shifted for the worse and solid gains for the week were pared significantly as focus began to hone in on the slew of disappointing US economic data, culminating with the disappointing labor report on Friday. Other unfavorable data for the week included mixed July same-store sales from the retail sector, an unexpected increase in weekly initial jobless claims, a much larger-than-forecasted drop in factory orders, and an unexpected fall in pending home sales.

All eyes on Tuesday's Fed meeting

The highlight of the week will be Tuesday’s one-day Federal Open Market Committee (FOMC) meeting and mid-day statement release. No changes are expected to the fed funds target rate, currently at a level between 0-0.25%. At the last FOMC meeting held June 23, the Fed noted that the economic outlook remains unusually uncertain, and since that time, a slew of economic reports have come in weaker than expected. News out of the consumer sector has been particularly worrisome, as it constitutes nearly 70% of GDP, with weak retail sales and job growth, prompting calls for more stimulus. In his congressional testimony at the end of July, Fed Chair Bernanke mentioned three actions the Fed could take, if needed, to further support the economy, including bolstering its verbal commitment to keep rates low for an extended period, reinvesting proceeds from its mortgage security purchases, and cutting the interest rate it pays on reserves that banks hold at the Fed.

The discussion over the direction of the general price level in the economy has oscillated between inflation and deflation, with current focus on the latter. The earlier concern was that the massive infusion of money into the system by the Fed would stoke inflation. A reading on inflation will be reported on Friday, with the Consumer Price Index (CPI), forecasted to show a 0.2% month-over-month (m/m) increase in July, while ex-food and energy, it is expected to rise 0.1% m/m. On a y/y basis, the CPI is expected to be up 1.2% and 0.9% y/y at the core level, both at similar levels as last month.

The week concludes with advance retail sales, forecasted to rise 0.5% m/m in July, after declining 0.5% in June, while sales ex-autos are estimated to grow 0.3% in July, after falling 0.1% in June. Same-store sales results-sales at stores open at least a year-reported by retailers were mixed and marked by continued steep discounts. The retail sales report includes spending at supermarkets and gas stations.

Other releases on the US economic calendar include the NFIB Small Business Optimism survey, preliminary 2Q non-farm productivity, wholesale inventories, the import price index, MBA Mortgage Applications, initial jobless claims, the University of Michigan Consumer Sentiment Index, and business inventories.

The international economic calendar will be dominated by China, which is set to release the majority of their monthly economic statistics. Scheduled Chinese data includes housing prices, money supply, new loans, the trade balance, PPI, CPI, retail sales, industrial production and fixed asset investment, which includes housing and infrastructure spending.

Elsewhere in Asia/Pacific, the Bank of Japan and Bank of Korea will meet to discuss monetary policy. Additionally, Japan is slated to announce money supply and lending, machine orders and machine tool orders, CPI, industrial production, and consumer confidence, and Australia will report unemployment, business and consumer confidence.

Economic releases in Europe will include the German CPI, wholesale prices, and initial 2Q GDP, euro-zone industrial production, CPI, initial 2Q GDP, and trade balance, UK house prices, consumer confidence, and retail sales.