Evening Market Update

Tech Strength Offsets Bank Weakness, Markets Left Mixed

Stocks were mixed on the day, but the major indexes still managed to close out the week in the green. The domestic economic front was chalk full of data, including favorable reports on US inflation, retail sales and manufacturing, while an unexpected drop in a gauge of consumer sentiment tempered some of the positive sentiment. Additionally, Fed Chief Ben Bernanke issued comments that kept expectations high that policymakers were near the deployment of further stimulus. On the equity front, Google released solid 3Q earnings that beat analysts’ expectations, which contributed to the strength seen in the tech-heavy Nasdaq, while General Electric helped lead the Dow lower after it missed the Street’s top- and bottom-line estimates. In other equity news, Mattel reported lower-than-expected 3Q revenue, Advanced Micro Devices saw a decline in 3Q revenue, Capital One Financial experienced an increase in charge-offs in September, and Seagate Technology announced that it is evaluating a potential deal with an unnamed party to take the company private. Treasuries finished the day mixed.

The Dow Jones Industrial Average was 32 points lower (0.3%) at 11,063, the S&P 500 Index rose 2 points (0.2%) to 1,176, and the Nasdaq Composite gained 33 points (1.4%) to 2,469. In moderately heavy volume, 1.4 billion shares were traded on the NYSE and 2.2 billion shares were traded on the Nasdaq. Crude oil fell $1.24 to $81.45 per barrel, wholesale gasoline declined $0.03 to $2.11 per gallon, and the Bloomberg gold spot price lost $12.80 to $1,368.35 per ounce. Elsewhere, the Dollar Index—a comparison of the US dollar to six major world currencies—rose 0.6% to 76.99. For the week, including dividends, the DJIA increased 0.51%, the S&P 500 Index gained 0.95%, and the Nasdaq Composite advanced 2.78%.

Dow member General Electric Co. (GE $16 ¹) announced 3Q EPS of $0.29, two pennies above the Reuters estimate, but revenues were down 5% year-over-year (y/y) to $35.9 billion, below the $37.5 billion that the Street was looking for. The company said its revenues were impacted by lower equipment sales and reduced GE Capital assets. GE said total company orders were up 7% y/y and equipment orders rose 9%, helping the company post growth in both equipment and service orders for the first time in eight quarters. Also, the conglomerate said GE Capital credit losses continued to decline and earnings are improving. GE traded solidly lower.

Google Inc. (GOOG $601) reported 3Q earnings ex-items of $7.64 per share, well above the $6.66 that analysts had forecasted, with revenues growing 23% y/y to $7.3 billion, compared to the $7.0 billion that the Street was anticipating, while excluding traffic acquisition costs (TAC), revenues were $5.5 billion, which also topped analysts’ forecast. The world’s number-one internet search engine said its aggregate paid clicks increased about 16% y/y, and the company’s cost-per-click rose approximately 3%. Shares were solidly higher.

Advanced Micro Devices Inc. (AMD $7) posted 3Q EPS ex-items of $0.15, easily topping the $0.05 estimate of analysts, as revenues rose 16% y/y to $1.6 billion, roughly inline with the consensus estimate, but revenues did decline 2% quarter-over-quarter (q/q). The chipmaker said its 3Q performance was highlighted by solid gross margin, despite “weaker-than-expected consumer demand.” AMD said it expects 4Q revenues to be approximately flat q/q, compared to the $1.7 billion that analysts are anticipating. AMD finished modestly lower

Mattel Inc. (MAT $22) was sharply lower after the toy maker report 3Q revenues of $1.8 billion, up 2% y/y, that came in below the $1.9 billion that analysts were expecting, including “unfavorable changes” in currency exchange rates of 3 percentage points. But, MAT reported that EPS for the period was $0.77, two cents above the Street’s forecast, and said, “While the all-important holiday season is still in front of us, we remain on track to deliver solid revenue and profit growth driven by our portfolio of brands and countries.”

Capital One Financial Corp. (COF $37) reported that U.S. charge-offs – loans banks think they will be unable to collect - rose 8.38% in September, up from 8.19% in August. At COF’s credit card business, 30-day delinquencies fell from 4.56% in August to 4.53% in September, while auto-loan charge-offs dropped from 8.04% to 7.95%. COF reports 3Q earnings next Thursday, and shares of the stock followed the rest of the banking sector to the downside.

Seagate Technology Inc. (STX $16) was up over 20% after the maker of computer hard-disk drives said it is has received a preliminary indication of interest from an unnamed party about a possible deal to go private and it is evaluating the strategy and other alternatives.

Fed Chief sounds off before morning session kicked off

US Fed Chief Ben Bernanke spoke on monetary policy objectives and tools in a low-inflation environment at a Boston Fed conference before the opening bell rang. The Fed Chief failed to talk down elevated expectations of further Fed stimulus in the form of asset purchases—known as quantitative easing, also dubbed QE2—saying that there appears to be a case for further action as the actual unemployment rate of nearly 10% is “clearly too high relative to estimates of its sustainable rate.” Bernanke also said the “risk of deflation is higher than desirable,” with measures of underlying inflation trending downward, reflecting cost pressures being restrained by substantial slack in the utilization of productive resources. The head of the Fed also added that although output growth should be somewhat stronger in 2011 than it has been recently, growth next year seems unlikely to be much above its longer-term trend. If so, he noted, then net job creation may not exceed by much the increase in the size of the labor force, implying that the unemployment rate will decline only slowly. “That prospect is of central concern to economic policymakers, because high rates of unemployment--especially longer-term unemployment--impose a very heavy burden on the unemployed and their families. More broadly, prolonged high unemployment would pose a risk to consumer spending and hence to the sustainability of the recovery.”

Consumer Prices subdued, retail sales rise, and NY activity jumps, but sentiment slips

The Consumer Price Index showed prices at the consumer level were up 0.1% in September month-over-month (m/m), below the forecasted gain of 0.2% by economists surveyed by Bloomberg, and the 0.3% increase seen in August. Energy commodities and gasoline both fell for the fourth-straight month, while food items were higher for the second-consecutive month. Meanwhile, the core rate, which strips out food and energy, was flat in September, after also being unchanged in August, and compared to estimates calling for a 0.1% gain. Prices for non-food and energy commodities, apparel and shelter moved lower to offset increases in prices for medical care, used cars and trucks, and transportation services. On a year-over-year basis, consumer prices were up 1.1% in September, matching the rate in August, and the core CPI was 0.8% higher y/y, after rising 0.9% in August.

Today’s cooler-than-forecasted inflation report was met with a favorable reaction as the data reinforced the seemingly foregone conclusion of QE2 that traders have begun to price into the markets. These expectations were also primed by Fed Chief Bernanke’s comments this morning that inflation is running at rates that are “too low” relative to the levels judged to be most consistent with the Fed’s dual mandate in the longer run. Bernanke added that its longer-run inflation projections indicate that participants generally judge the mandate-consistent inflation rate to be about 2% or a bit below, in contrast, to recent readings on underlying inflation, which have been approximately 1%.

Meanwhile, advance retail sales for September rose 0.6%, compared to the forecast of economists that called for an increase of 0.4%, and August’s 0.4% gain was revised upward to a 0.7% advance. September sales ex-autos gained 0.4%, above the expectation of a 0.3% increase, and August’s 0.6% rise was revised to a 1.0% advance. Sales ex-autos and gas rose 0.4% in September, versus the 0.3% increase that was anticipated, and its August figure was upwardly revised to a 0.9% increase.

Elsewhere, the Empire Manufacturing Index, a measure of manufacturing in the New York region, improved in October, jumping to a level of 15.73, compared to the estimates of economists, which expected an increase to 6.00, from the previous month’s level of 4.14. The index moved nicely above the level of zero, the demarcation point between contraction and expansion. The report is the first major piece of data looking at manufacturing conditions in October, and next week, the Philly Fed Manufacturing Index will be released, expected to increase from -0.7 in September to 0.0 in the current month, providing further insight into the health of the sector.

In other economic news, the preliminary University of Michigan’s Consumer Sentiment Index unexpectedly fell, declining from 68.2 in September to 67.9 for October, compared to the modest increase to 68.9 that was expected. The worse-than-expected reading came as the economic conditions component of the survey fell from 79.6 in September to 73.0 in October, offsetting an increase from 60.9 to 64.6 in the economic outlook component. The report also revealed that inflation expectations for the one-year time horizon advanced from 2.2% to 2.6%, while the five-year time horizon remained at 2.7%.

Rounding out the busy day, business inventories rose 0.6% m/m in August, above the 0.5% increase that was expected, and July’s 1.0% increase was revised to a 1.1% gain. Sales rose 0.1% m/m, and the inventory-to-sales ratio—the amount of time it would take to deplete inventories at the current sales pace—increased slightly to 1.27 from 1.26.

Treasuries were mixed amid the flood of data, as some early gains were pared immediately following comments by US Federal Reserve Chairman Ben Bernanke. The yield on the two-year note was 1 bp lower at 0.36%, the yield on the 10-year note rose 6 bps to 2.57%, and the 30-year bond yield gained 7 bps to 3.99%.

Euro-zone prices rise at similar pace to U.S.

On the international economic front, euro-zone consumer prices rose 0.2% m/m in September and the core CPI was 1.0% higher y/y, both matching economists’ expectations, while a separate report showed the euro-zone trade deficit expanded by a much larger amount than was anticipated for August. Meanwhile, Japan’s final revision on industrial production in August was revised lower from a 0.3% decline to a 0.5% contraction and China’s Leading Index increased 0.7% m/m to 149.9 in August, while property prices decelerated by a smaller amount than economists expected in September. Back in the Americas, Canadian factory sales increased 2.0% in August, above the 0.5% forecast of economists, led by a 14% jump in motor vehicle sales and a 2.4% increase in petroleum and coal sales.

Favorable start to earnings season diminished by financial concerns

The equity market enjoyed a modestly higher week amid continued expectations that the Federal Reserve is nearing the deployment of further economic stimulus, aided by this week’s release of the minutes from the Fed’s September policy meeting and amplified by Friday’s speech by Fed Chairman Bernanke. The minutes revealed that many participants noted that “if economic growth remained too slow to make satisfactory progress toward reducing the unemployment rate or if inflation continued to come in below levels consistent with the Federal Open Market Committee’s (FOMC) dual mandate, it would be appropriate “to take action soon.” FOMC members lowered their projection for the increase in real economic activity over the second-half of 2010 and also reduced “slightly” its forecast of growth next year but continued to anticipate a moderate strengthening of the expansion in 2011 as well as a further pickup in economic growth in 2012. The US dollar fell broadly against the major currencies on the Fed data, moving to a record low versus the Swiss franc, nearly taking out the fifteen-year low versus the Japanese yen, falling to the lowest level versus the Australian dollar since 1983, and reaching lows versus the euro and UK pound not seen since January.

Also, 3Q earnings season began to heat up and the technology sector provided the bulk of the favorable energy, headlined by Dow member Intel Corp. (INTC $19) and Google Inc, which helped the group post solid gains as the best performing sector for the week. However, gains for stocks were hamstrung by weakness in the financial sector amid uncertainty about the potential fallout from about the foreclosure mess unfolding in the banking sector, which overshadowed a better-than-forecasted profit report from Dow component JPMorgan Chase & Co. (JPM $37). Financials posted a solid decline for the week.

Next week brings reports on housing and the Fed’s assessment on the economy

The week starts with Monday’s September reading on industrial production, expected to rise 0.2% month-over-month (m/m), the same rate of advance posted in August, and capacity utilization, forecasted to inch up to 74.8% from 74.7% in August. Industrial production has been a source of strength thus far this year.

Tuesday brings the release of the report on housing starts for September, expected to fall 3.0% m/m to an annual rate of 580,000 units, after posting a surprising 10.5% increase in August. Meanwhile, building permits, one of the leading indicators tracked by the Conference Board as it is a gauge of future construction, are forecasted to rise 0.7% m/m to 575,000 units after increasing 1.8% in August.

However, the highlight of the week will likely come on Wednesday with the release of the Federal Reserve Beige Book, wherein Fed staffers summarize anecdotal economic data from all twelve Federal Reserve districts in preparation for the next Federal Open Market Committee (FOMC) meeting scheduled for November 2-3.

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

Elsewhere in the Americas, Canada releases manufacturing and wholesale sales, retail sales, CPI and its leading index, Brazil announces employment data, and Mexico releases retail sales, its trade balance and unemployment data.

In Europe, releases include euro-zone PMI reports on manufacturing and services, as well as consumer confidence, the German IFO survey of business confidence and Zew survey of investor confidence, German PPI, and UK housing prices, starts and permits, and retail sales.

In Asia/Pacific, releases include Japan’s department store sales and leading index, Australia’s leading index, and a slew of data out of China, including 3Q GDP, PPI, CPI, retail sales, industrial production and fixed asset investment, which includes housing and infrastructure spending.

Additionally, the Bank of Canada and Bank of Brazil meet to discuss monetary policy, and the minutes from the Bank of England and Reserve Bank of Australia will be released.