Evening Market Update

Investors Indecisive as to Direction

Despite a better-than-expected improvement in consumer sentiment and another subdued reading on consumer prices that helped bring stocks into the green midday, the equity markets finished the week in the red following a smaller-than-expected increase in retail sales and a disappointing outlook from J.C. Penney Co. Treasuries ended higher amid the economic data, which also included a larger-than-anticipated increase in business inventories. In earnings news, Nordstrom met the Street’s expectations on profits and sales, but NVIDIA missed on both the top and bottom lines and provided disappointing 3Q guidance. In MA activity, Dynegy announced a definitive agreement to be acquired by an affiliate of Blackstone Group for about $4.7 billion, including debt.

The Dow Jones Industrial Average fell 17 points (0.2%) to 10,303, the S&P 500 Index was 4 points (0.5%) lower at 1,079, and the Nasdaq Composite declined 17 points (0.8%) to 2,173. In moderately light volume, 871 million shares were traded on the NYSE and 1.6 billion shares were traded on the Nasdaq. Crude oil fell $0.35 to $75.39 per barrel, wholesale gasoline lost $0.01 to $1.94 per gallon, while the Bloomberg gold spot price gained $1.25 to $1,215.10 per ounce. Elsewhere, the Dollar Index—a comparison of the US dollar to six major world currencies—fell 0.1% to 82.54. For the week, including dividends, the DJIA declined 3.3%, the S&P 500 Index lost 3.8%, and the Nasdaq Composite shed 5.0%.

J.C. Penney Co. Inc. (JCP $20) reported 2Q EPS of $0.06, one penny above the Reuters estimate, with revenues roughly flat year-over-year (y/y) at $3.94 billion, compared to the $3.96 billion that the Street was looking for. Same-store sales—sales at stores open at least a year—increased by 0.9% y/y, and the company grew its internet sales. JCP said back-to-school selling is off to a “good start.” However, the company issued 3Q EPS that missed analysts’ estimates and lowered its full-year EPS outlook, due to what “continues to be an uncertain consumer climate.” Shares were lower.

In related industry news, Nordstrom Inc. (JWN $31) announced 2Q EPS of $0.66, matching expectations, with revenues increasing 12.7% y/y to $2.4 billion, also inline with expectations. Same-store sales rose 8.4% y/y, as the company said its performance reflects a continuation of the positive sales trends from 1Q, highlighted by “well-executed sales events during the quarter.” JWN reaffirmed its full-year EPS outlook, but traded well below the flatline.

NVIDIA Corp. (NVDA $9) posted adjusted 2Q earnings of $0.03 per share, below the $0.10 that analysts were anticipating, with revenues rising 4.5% y/y to $811 million, compared to the $826 million that the Street was looking for. NVDA issued 3Q EPS guidance that missed forecasts. Shares were higher despite the results as the graphics chip maker came under heavy pressure last month when it warned about the softer-than-anticipated 2Q revenues on increased memory costs and economic weakness in Europe and China. Also, shares may have gotten a boost from the announcement that it has signed a patent license agreement with Rambus Inc. (RMBS $19). RMBS was also nicely higher.

In M&A news, Dynegy Inc. (DYN $5) announced that it has entered into an agreement to be acquired by an affiliate of the Blackstone Group L.P. (BX $11) in a transaction valued at about $4.7 billion, including the assumption of about $4 billion in debt. DYN shareholders will receive $4.50 per share in cash, representing a 62% premium to yesterday’s closing price. Separately, NRG Energy Inc. (NRG $22) reported that it has entered into an agreement with Blackstone Group L.P. to acquire certain Dynegy assets for about $1.36 billion. DVN finished higher, while both BX and NRG were lower.

Retail sales rise but miss forecasts, consumer prices gain, sentiment surprises

Advance retail sales (chart) for July rose 0.4%, compared to the Bloomberg forecast of economists that called for an increase of 0.5%, but June’s 0.5% drop was revised to a 0.3% decline. July sales ex-autos gained 0.2%, short of the expectation of a 0.3% increase, while June’s 0.1% dip was unrevised. Sales ex-autos and gas declined 0.1% in July, versus the 0.1% increase that was anticipated, but its June figure was revised to a better-than-expected 0.2% gain, from an initial 0.1% rise.

The reaction to the report was subdued, suggesting that maybe the steep losses seen this week in the equity markets on a plethora of lackluster global data may have prepared traders for today’s tepid report, or that the week’s pain had conditioned investors for the possibility of a worse-than-reported read on the retail sector. Moreover, today’s report may be easier to swallow as commentary from retailers in July same-store sales reports and earnings releases thus far has also warned that the consumer remains cautious as employment conditions remain poor and concerns about a double-dip recession fester. The cautious consumer theme was evident in today’s data, with the decline seen in sales after stripping out autos and gas, which grew 1.6% and 2.3%, respectively, in July, after these more volatile components fell by 1.3% and 2.0% , respectively in June. Declines were seen in categories such as furniture, electronics, building materials, and food & beverage, while a 1.0% fall in department stores sales and a 0.7% drop in sales of clothing and accessories led to the downside. The broad-based declines reflect, along with the aforementioned economic headwinds, the continued discounting by retailers to try to chew through inventory ahead of the back-to-school shopping season, which had yet to kick in during the month.

The inflation picture could be playing a role in the complacency among consumers, which account for the lion’s share of the economy. The continued string of data that has suggested pricing pressures pose no threat to the consumers’ buying power, with today’s Consumer Price Index (CPI) joining the subdued inflation outlooks recently by the US Federal Reserve and European Central Bank. The CPI showed prices at the consumer level were up 0.3% in July month-over-month (m/m), above the forecasted 0.2% gain by economists, after dipping 0.1% in June. Meanwhile, the core rate, which strips out food and energy, increased 0.1% in July, after rising 0.2% in June, matching estimates. On a year-over-year basis, consumer prices were up 1.2% in July, up from the 1.1% rate in June, and the core CPI was 0.9% higher y/y, after rising by the same rate in June. Inflation remaining low and even fostering some deflationary rhetoric adds to the scenery of the backdrop suggesting that consumer spending will likely remain lackluster in the short term.

Deflation concerns are growing but the typical response of lowering interest rates and flooding the market with cash has not had its desired impact. Brad notes that the problem continues to be the movement of all that money—the Fed’s balance sheet has ballooned to over $2.3 trillion and they have committed to keeping it bloated—as the money multiplier, or the velocity of money, remains extremely low. Companies and consumers are either unable or unwilling to borrow, spend, or invest so it can be lent out again. Brad adds that it may be time to at least consider an unconventional response to the "stickiness" of money—raising interest rates. It seems that there is now a bit of a malaise with regard to cheap money, with many investors believing rates will remain extremely low for the next year or two at a minimum. It may be time to consider ways to get companies and individuals to act, thereby accelerating the velocity of money. We believe the prospect of higher rates in the near term might push entities to move on borrowing and investing that they may have been waiting on, taking advantage of the low rates before they go higher.

We have suggested for some time that the economy is no longer in an emergency state and that starting to normalize monetary policy would be worthwhile. Now, with an increasing need to get money flowing, raising rates would give savers a bit of a return in money market type vehicles, potentially spur those now on the sidelines of the market into action, and give the Fed some wiggle room down the road should it need to slash rates again.

In addressing a town hall meeting in Lincoln, Nebraska, Kansas City Fed President Tom Hoenig, said that the continuation of a zero interest rate policy “is as likely to be a negative as a positive in that it brings its own unintended consequences and uncertainty.” Hoenig, who was the lone dissenter during Tuesday’s monetary policy meeting, said he agrees that the Fed should maintain an accommodative monetary policy. However, he encourages a policy that “slowly firms as the economy expands and moves toward balance”, supporting the idea of a fed funds rate at 1%, pausing for a time to allow the economy to “adjust and to gain confidence”, then move rates to 2% at the appropriate time.

Despite the uneasy economic backdrop that has intensified recently amid the string of disappointing global economic data, the preliminary University of Michigan’s Consumer Sentiment Index rose more than forecasted, improving from 67.8 in July to 69.6 for August, above the increase to 69.0 that was expected. The better-than-expected reading came as both the economic condition and outlook components of the survey both increased versus the prior month. The report also revealed that inflation expectations for the one-year time horizon ticked higher from 2.7% to 2.8%, while the five-year horizon ticked lower from 2.9% to 2.7%.

In other economic news, business inventories rose 0.3% m/m in June, just above the 0.2% increase that was expected, and May’s 0.1% increase was revised to a 0.2% gain. Sales dropped 0.6% m/m, and the inventory-to-sales ratio—the amount of time it would take to deplete inventories at the current sales pace—inched back up to 1.26 from 1.25 months in May.

Treasuries finished higher on the day amid the uneasy sentiment. The yield on the two-year note fell 2 bps to 0.53%, the yield on the 10-year note lost 7 bps to 2.68% and the yield on the 30-year bond was 9 bps lower at 3.87%.

Europe shows growth

Euro-zone 2Q GDP expanded at a 1.0% rate quarter-over-quarter (q/q), after growing 0.2% in 1Q, and compared to the 0.7% increase that economists had expected. Also, on a y/y basis, the euro-area economy rose by 1.7%, after rising 0.6% the previous quarter, above the 1.4% increase that was forecasted. The euro-zone output was supported by stronger-than-expected growth in France and Germany, as separate reports showed these economies posted higher-than-anticipated expansion in 2Q. However, Spain’s 2Q GDP rose by a smaller-than-forecasted amount versus 1Q, and contracted by a larger amount than anticipated compared to the same period last year. Other economic reports across the pond included a drop in France’s consumer prices in July compared to June that matched forecasts, and a larger-than-expected widening of the euro-zone trade surplus in June.

The Japanese yen weakened compared to the US dollar, coming off the fifteen-year high that it reached versus the greenback recently, amid growing speculation that the Japanese government may nearing an intervention to stem the surge in the Asian currency, as the strength dampens the outlook of profits of companies that rely heavily on sales in the US. Japanese officials have offered some commentary about the impact of extraordinary moves in the currency markets and that they are watching these events, but have not offered any indications that an intervention is in the offing.

After the close in Hong Kong, the government reported that 2Q GDP expanded more than forecasted compared to the same period a year ago, increasing 6.5%, after rising a downwardly revised 8.0% in 1Q, and compared to the 6.3% expansion that economists had expected. However, on a q/q basis, the economy expanded 1.4%, after a downwardly revised 2.1% gain in 1Q, and was softer than the 1.9% growth that was anticipated. Separately, Hong Kong’s Financial Secretary said the government will keep increasing land supply in an effort to curb property price increases, according to Bloomberg. In other economic news in the region, New Zealand’s retail sales rose more than expected in June.

Global data brings the pain to cause support for stocks to drain

In the wake of last Friday’s disappointing labor report, the bulls were hamstrung this week by a plethora of disappointing global economic data, which stung sentiment and sent the equity markets solidly below the flatline. Several reports showing the continued deceleration of economic prosperity in China—which led the global recovery from the recession—and lackluster reports out of the US soured the outlook for the world’s largest economy, prompting double-dip recession concerns to gain some steam. Flight-to-safety buying was seen in the Treasury markets, pushing yields even lower, while the safe-haven Japanese yen hit a fifteen-year high versus the US dollar to exacerbate the outlook for the health of the Japanese economy. Even some disappointing data out of Europe added to the string of data on the negative side of the ledger to apply further pressure on sentiment and tighten the squeeze on risk-taking appetites.

However, the biggest event of the week came from the US Federal Reserve’s monetary policy announcement, where it kept the fed funds rate near zero and maintained its language in the accompanying policy statement that rates will remain this low for an “extended period.” But the lion’s share of the reaction to the Fed’s announcement came as it downgraded its economic outlook and said it will keep its balance sheet near the $2 trillion level by reinvesting principal payments from agency debt and agency mortgage-backed securities (MBS) into longer-term Treasury securities. Initially, the markets seem to like the announcement as stocks pared a large majority of losses on Tuesday, but as traders slept on the news the reaction turned negative and the equity markets posted steep losses.

Equity news, mainly out of the tech sector, contributed to the declines for the week, with Dow member Hewlett-Packard Co. (HPQ $41) announcing that its Chairman, Chief Executive Officer, and President Mark Hurd has decided to resign his positions effective immediately. Moreover, fellow Dow component Cisco Systems Inc. (CSCO $21) posted fiscal 4Q revenues that came in below analysts’ forecasts, and its CEO said that the current environment is “unusually uncertain.”

Another read on inflation and housing due Tuesday

A slew of major US economic releases will be released on Tuesday. The Producer Price Index (PPI) is expected to show prices at the wholesale level rose 0.2% m/m in July, on the heels of a 0.5% decrease in May, while the core rate, which excludes food and energy, is expected to rise 0.1% after increasing a mere 0.1% the prior month. On a year-over-year (y/y) basis, the PPI is expected to show a 4.2% rise in July versus 2.8% the prior month on a headline basis, and a 1.3% increase at the core level, up from a 1.1% increase in June.

Additionally, a reading on industrial production will be released, expected to grow 0.5% in July after rising 0.1% in June, and capacity utilization is forecasted to increase to 74.5% from 74.1% in June.

Rounding out the busy day Tuesday is the report on housing starts for July, expected to show an increase of 2.0% m/m to an annual rate of 560,000 units, after falling the two prior months, by 5.0% in June and plunging 14.9% in May. Meanwhile, building permits, one of the leading indicators tracked by the Conference Board as it is a gauge of future construction, are forecasted to fall 1.2% m/m in July to 576,000 units after rising 2.1% in June. The increase in permits in June was driven by a 20% increase in multi-family applications, while single-family permits fell 3.4%, to the lowest level since April 2009.

The expiration of the house tax incentive has distorted recent housing data. Meanwhile, homebuilders have slowed new construction as inventory of existing homes have been meeting demand with foreclosure activity still adding to supply.

Other releases on the US economic calendar include the NAHB Housing Market Index, the Empire Manufacturing Index, MBA Mortgage Applications, initial jobless claims, the Philadelphia Fed’s Business Activity Index, and the Conference Board’s Index of Leading Indicators.

Internationally, the UK will release home prices, CPI and retail prices, Japan will provide 2Q GDP numbers as well as its Tertiary Index and Leading Index, the eurozone will report CPI and its current account, Germany’s Zew Economic Survey will be released along with its PPI, while Canada will offer manufacturing numbers and its CPI. In central bank action, the Bank of England will release the minutes to the August 4-5 monetary policy meeting.