Evening Market Update

Equity Markets Recover From Bank Uneasiness to Finish Flat

Stocks finished the session slightly below the flatline after showing some resiliency in a late-afternoon comeback from the day’s lows. The banking sector traded broadly lower on uneasiness toward growing uncertainty on how the sector will handle the questions regarding foreclosure practices. Additionally, expectations of the need for further quantitative easing were extended after the release of disappointing domestic economic data, including an unexpected increase in US weekly initial jobless claims, a hotter-than-forecasted read on wholesale inflation, and a wider-than-anticipated trade deficit. On the equity front, Yahoo Inc. benefited from a Wall Street Journal report that suggested it may be a takeover target of AOL Inc and several private equity firms, while rival Google reported solid 3Q earnings that beat analysts’ expectations after the close. In other equity news, for-profit education firm Apollo Group Inc withdrew its 2011 business outlook amid ongoing regulatory and other scrutiny that is challenging the proprietary education industry, and grocery store chain Safeway Inc topped the Street’s profit expectations. Treasuries moved lower on the economic data and following weak demand in a 30-year bond auction.

The Dow Jones Industrial Average was flat at 11,095, the S&P 500 Index fell 4 points (0.4%) to 1,174, and the Nasdaq Composite lost 6 points (0.2%) to 2,435. In moderate volume, 1.1 billion shares were traded on the NYSE and 2.0 billion shares were traded on the Nasdaq. Crude oil fell $0.36 to $82.65 per barrel, wholesale gasoline declined $0.03 to $2.14 per gallon, and the Bloomberg gold spot price gained $7.60 to $1,379.75 per ounce. Elsewhere, the Dollar Index—a comparison of the US dollar to six major world currencies—fell 0.6% to 76.59.

Shares of Yahoo Inc. (YHOO $16) were nicely higher amid a report from the Wall Street Journal that internet service provider AOL Inc. (AOL $25) and several private equity groups are discussing the possible acquisition of YHOO. The report cited people familiar with matter, who also said discussions were preliminary, not including YHOO, and the private equity firms have expressed an interest in either a teaming up with AOL or a separate transaction, which would take YHOO private. Meanwhile, Reuters reported that sources said the private equity firms also approached News Corp. (NWSA $14) about a possible deal for YHOO and talks began about two weeks ago. None of the entities involved has commented on the report. Shares of AOL traded solidly higher, while NWSA was under some pressure.

In related industry news, Google Inc. (GOOG $541) reported 3Q EPS of $7.64 after the close, higher than the $6.67 that analysts’ were expecting. Revenue ex-traffic acquisition costs came in at $5.58 billion, which also beat the Street’s estimate of $5.27 billion.

Apollo Group Inc. (APOL $38) was down about 25% after the for-profit education firm withdrew its prior business outlook for fiscal 2011, given the transitional state of its business in light of the ongoing regulatory and other scrutiny that is challenging the proprietary education industry. The announcement came as the company reported fiscal 4Q EPS ex-items of $1.31, compared to the $1.26 Reuters estimate, with revenues increasing 17.4% year-over-year (y/y) to $1.26 billion, roughly inline with the Street’s forecasts.

Safeway Inc. (SWY $22) reported 3Q EPS ex-items of $0.35, four pennies above the consensus estimate of analysts, with revenues down 1% y/y to $9.4 billion, inline with the Street’s forecast, while same-store sales—sales at stores open at least a year—fell 2.0% y/y due to a decline in price per item. However, the grocery store chain said the trend in price per item improved during the quarter and it expects this trend to continue. SWY said it expects full-year EPS to be at the low end of prior guidance. Shares were nicely higher.

Producer prices and jobless claims rise, trade deficit widens

The Producer Price Index showed prices at the wholesale level rose 0.4% month-over-month (m/m) in September, after increasing 0.4% in August, and above the forecast of economists surveyed by Bloomberg, which called for a 0.1% rise. The increase was due to a 1.2% increase in food prices, while energy prices gained 0.5%. Prior to the September reading, both food and energy prices had decreased in four of the last five months. Meanwhile, the core rate, which excludes food and energy, increased 0.1% m/m, matching the increase that economists had expected. On a year-over-year basis, headline producer prices were 4.0% higher, and the core rate was up 1.6%.

As the Fed noted at its September Federal Open Market Committee (FOMC) meeting, inflation is “somewhat” below the level consistent with its mandate of maximum employment and price stability. In response, the Fed stands ready with an open checkbook to support a continued economic recovery, likely in the form of another round of asset purchases, known as quantitative easing, or dubbed QE2.

With the steep decline in the US dollar potentially posing a threat to consumers’ discretionary spending propensity, some attention may be beginning to shift to the inflation side of the Fed’s dual mandate, and tomorrow’s complimentary report of the Consumer Price Index may carry more weight as it is a closer look at what pricing pressures face the consumer. Economists are expecting the headline rate to come in at a 0.2% gain for September, and a 0.1% increase after stripping out food and energy. The CPI will be monitored for indications that higher wholesale prices are being passed along to consumers.

Meanwhile, weekly initial jobless claims increased by 13,000 to 462,000, versus last week's figure which was upwardly revised by 4,000 to 449,000, and compared to the consensus estimate of economists, which called for claims to come in at 445,000. The four-week moving average, considered a smoother look at the trend in claims, rose by 2,250 to 459,000, and continuing claims fell by 112,000 to 4,399,000, compared to the 4,450,000 that was anticipated by economists.

Elsewhere, the trade deficit widened more than expected, increasing from a slightly downwardly revised $42.6 billion in July to $46.3 billion in August, versus the estimate of economists calling for the deficit to come in at $44.0 billion.

Treasuries finished lower following the inflation, employment, and trade reports, as well as a disappointing 30-year bond auction that showed lower-than-average demand. The yield on the two-year note was 2 bps higher at 0.38%, the yield on the 10-year note rose 8 bps to 2.50%, and the 30-year bond yield gained 9 bps to 3.91%.

Quiet on the European economic front, Asia central banks in focus

The economic calendar in Europe was relatively light with a report showing Spain’s consumer prices rose 0.1% m/m in September, compared to a flat reading expected by economists, being the lone major piece of data released today.

In Asia/Pacific, Japan’s machine tool orders were upwardly revised to a 113.6% y/y increase in September, from a preliminary estimate of a 112.9% y/y gain, but down from the 170.0% y/y surge that was seen in August. Elsewhere, New Zealand’s retail sales were unexpectedly flat m/m, versus the expectation of a 0.3% increase, while the Bank of Korea left its benchmark interest rate unchanged at 2.25%. In other central bank news, Singapore surprisingly tightened its monetary policy, despite a report showing its 3Q GDP contracted an annualized 19.8% quarter-over-quarter (q/q), compared to the drop in output of 15.7% that economists anticipated. The nation’s central bank tweaks its currency rate to fight price stability instead of changing a key interest rate like most other global central banks, and it announced that it will steepen and widen its target trading band for the Singapore dollar as its seeks to maintain a “modest and gradual appreciation,” with the balance of risks weighted toward inflation going forward.

Back in the Americas, Brazil’s retail sales rose 2.0% in August, higher than the 1.6% gain economists were expecting. The increase was fueled by record low unemployment that fell to 6.7% in August and increased bank lending, which expanded in August at its fastest pace since July 2009.

Advance retail sales joins CPI report to highlight busy economic docket tomorrow

In addition to the aforementioned report on consumer prices, tomorrow, the week will end with a look at the retail sector as advance retail sales will be released, forecasted to increase 0.4% m/m in September, while excluding autos, sales are expected to grow 0.3%. And after stripping out autos and gas, sales are also anticipated to gain 0.3%. For August, sales at all three levels exceeded economists’ expectations on strength in clothing items, as the back-to-school shopping season ramped up. September’s numbers should also benefit from early fall shopping as a majority of retailers posted better-than-forecasted same-store sales results for the month last week, with credit being given to favorable back-to-school and back-to-college traffic.

Other releases on the US docket tomorrow include the Empire Manufacturing Index, which is expected to have increased to 6.00 in October from a September reading of 4.10 and business inventories, which economists are predicting to have grown 0.5% in October. Rounding out the busy day on the economic front will be the preliminary reading of the University of Michigan Consumer Sentiment Index, which is expected to have improved to 68.9 in October, up from 68.2 in September.

On the international front, economic releases will include Japanese industrial production and capacity utilization, Chinese property prices, euro-zone CPI and trade balance, and Canadian manufacturing sales.