Evening Market Update

Markets Falter Amid Plethora of Mixed Reports

Stocks finished well entrenched in negative territory as disappointing underlying components of better-than-expected earnings reports from Apple Inc. and Dow member IBM and an unexpected rate hike by China’s central bank added the majority of the pressure to today’s action. The negative sentiment was further exacerbated by a report that the NY Fed is part of a group suing Bank of America, adding to its mortgage problems and overshadowing its upbeat profit report. Elsewhere, Dow member Coca-Cola beat analysts’ estimates, as did Goldman Sachs, but lower-than-expected revenue from Dow member Johnson & Johnson took the shine off of its positive profit report. In other earnings news, UnitedHealth Group bested the Street, Harley-Davidson’s financing unit helped it achieve better-than-expected earnings, EMC Corp guided higher and reported results inline with estimates, while defense company Lockheed Martin saw a sharp decline in profits, but above analysts’ forecasts. Treasuries finished higher amid the downdraft in stocks, and amid a surprising decline in building permits, which eclipsed an unexpected rise in housing starts.

The Dow Jones Industrial Average tumbled 165 points (1.5%) to 10,979, the S&P 500 Index declined 19 points (1.6%) to 1,166, and the Nasdaq Composite faltered 44 points (1.8%) to 2,437. In moderate volume, 1.3 billion shares were traded on the NYSE and 2.2 billion shares were traded on the Nasdaq. Crude oil dropped $3.64 to $80.16 per barrel, wholesale gasoline fell $0.10 to $2.05 per gallon, and the Bloomberg gold spot price plunged $35.30 to $1,333.15 per ounce. Elsewhere, the Dollar Index—a comparison of the US dollar to six major world currencies—rose 1.6% to 78.26.

Dow member International Business Machines Corp. (IBM $138) reported 3Q EPS of $2.82, above the $2.75 consensus estimate of analysts surveyed by Reuters, with revenues increasing 3% year-over-year (y/y) to $24.3 billion, slightly exceeding the $24.1 billion that the Street had forecasted. The company said during the quarter it grew revenue in its hardware, software and services businesses, while it achieved “excellent” performance in its growth markets unit, reflecting continued strength of the infrastructure build-out in these countries. IBM raised its full-year EPS outlook. However, shares came under pressure after the company’s technology services contracts declined.

Apple Inc. (AAPL $309) announced 3Q earnings of $4.64 per share, exceeding the $4.09 that the Street anticipated, with revenues rising 67% y/y to $20.3 billion, well above the $18.9 billion that analysts expected. The company said international sales accounted for 57% of the quarter’s revenue. AAPL sold 3.89 million Macs in 3Q, a 27% y/y increase, and 14.1 million iPhones, 91% y/y growth, while sales of 9.05 million iPods where down 11% y/y. Moreover, the company sold 4.19 million iPads during the 3Q, but the results triggered a negative reaction from the Street as analysts were expecting closer to 5 million in unit sales. Additionally, the company said the gross margin was down from 41.8% a year ago to 36.9%, versus the 38.2% that was expected, which also pressured shares. AAPL offered 1Q revenue guidance that exceeded expectations, but its 1Q EPS outlook came up short of forecasts.

Goldman Sachs Group Inc. (GS $157) achieved 3Q EPS of $2.98, above the $2.28 that analysts were anticipating, with revenues of $8.9 billion, topping the $7.9 billion that the Street had forecasted. The company said its results reflect “solid performances” across its businesses, led by its investment banking unit, but economic conditions continue to be “challenging” in a number of important markets. The company’s trading and principal investments were down 36% y/y as activity levels were “significantly lower” in its fixed income, currency and commodities unit. Shares traded to the upside.

Dow component Bank of America Corp. (BAC $12 ¹) posted 3Q profits, excluding a $10.4 billion goodwill impairment charge, of $0.27 per share, eleven cents above the consensus estimate, with revenues increasing 2.6% y/y to $26.7 billion, versus the $27.1 billion that analysts were expecting. The company said its credit costs declined for the fifth-straight quarter as net charge offs—loans that the company does not expect to collect—were $2.4 billion lower than 2Q, driven by continued improvement in delinquencies in both its consumer credit card and real estate portfolios. BAC also said it benefitted from strong asset management fees out of its wealth management business. Separately, CNBC reported that the New York Federal Reserve is part of a consortium of investment firms that has filed suit against BAC related to failed mortgage securities through Countrywide Financial that BAC acquired in 2008. BAC was lower.

Fellow Dow member Coca-Cola Co. (KO $60) reported 3Q EPS ex-items of $0.92, compared to the $0.89 that was estimated by analysts, with revenues increasing 5% y/y to $8.4 billion, besting the $8.3 billion that was anticipated on the Street. The beverage company said it had “strong” worldwide volume growth of 5% during the quarter. Shares were slightly higher.

Rounding out the busy reporting day for the Dow, Johnson & Johnson (JNJ $63) announced 3Q EPS of $1.23, compared to the $1.15 that was forecasted by analysts, but revenues declined 0.7% y/y to $15.0 billion, short of the $15.2 billion that was expected. However, JNJ raised its full-year EPS outlook. JNJ finished lower.

Elsewhere, UnitedHealth Group Inc.  (UNH $35) reported 3Q EPS of $1.14, well above the $0.84 that analysts had expected, with revenues increasing 9% y/y to $23.7 billion, also exceeding the $23.3 billion that was anticipated. UNH said revenues benefitted from strong growth in both its health benefits and services units, and key performance metrics and costs were in line with or better than company expectations. The company raised its full-year outlook, but shares were lower amid the broad-based decline in the equity markets.

Meanwhile, EMC Corp. (EMC $21) managed to finish in positive territory after it increased its full-year revenue and EPS guidance to a level above the Street’s forecast, and said it expects to repurchase up to $1 billion in its common stock in 2010. The technology information infrastructure firm also posted 3Q EPS that matched expectations and revenues that exceeded expectations.

Harley-Davidson Inc. (HOG $30) posted 3Q EPS of $0.40, up from $0.24 a year earlier, as a turn-around in its financing unit aided results, showing a profit of $50.9 million for the quarter compared to a $31.5 million loss in the same period a year ago. Overall revenues declined 2.0% to $1.09 billion as retail sales for its motorcycles saw a 7.7% decline sales amid weak consumer spending. In a conference call with analysts, the company’s CEO said that, “The economy has yet to turn around in a convincing way”, but added that it doesn’t appear to be getting worse. Shares finished lower.

Aerospace and defense company Lockheed Martin Corp. (LMT $69) reported a 3Q profit of $1.57 per share, down 28% from a year ago as a result of a charge related to an executive buyout program, but above the average Reuters estimate of $1.53 per share. Revenues rose 5.6% to $11.38 billion, but fell short of analysts’ forecasts which called for $11.59 billion in sales. As well, LMT lowered its outlook for the year, reducing its EPS guidance by $0.40 per share to a range of $6.75-6.95 and revenues by $600 million to a range of $44.9-45.9 billion. LMT ended lower.

Housing starts and building permits paint a mixed picture

Housing starts for September came in above expectations, rising 0.3% month-over-month (m/m) to a 610,000 annual rate, while the forecast was for starts to fall to 580,000, and the rate for August was upwardly revised to 608,000. However, building permits unexpectedly fell 5.6% m/m in September to an annual rate of 539,000, and the figure for August was upwardly revised by 2,000 to 571,000. The expectation was for permits to increase to 575,000 units. The figures were swayed by the volatile multi-family sector, and single-family starts grew 4.4% and permits rose 0.5%. Treasuries have turned modestly to the upside.

The housing market, a former large contributor to job growth, remains weak, and construction is subdued. Homebuilder sentiment has slightly improved, as builders noted some “flickers of interest,” but a sentiment reading of 16 in October remains well below the 50 level that would mark optimism. New home sales remain depressed due to the large amount of vacancies and foreclosures of existing homes, suggesting little need to build new homes.

Treasuries finished higher amid the weakness in the equity markets and the surprising decline in building permits. The yield on the two-year note lost 1 bp to 0.35%, the yield on the 10-year note fell 3 bps to 2.48%, and the 30-year bond yield lost 4 bps to 3.92%.

China raises interest rates

The People’s Bank of China surprisingly increased interest rates for the first time in three years, upping its one-year lending rate by 25 basis points to 5.56% and the one-year deposit rate by 25 basis points to 2.50%. The move is the central bank’s latest attempt to temper rising property prices and inflation in the eastern nation that has led the world in the global recovery.

In other central bank news, the Reserve Bank of Australia released the minutes from its October monetary policy meeting, which revealed the arguments to hold rates steady were “finely balanced,” and while the RBA recognized that it could not wait indefinitely to see whether risks materialized, members judged that they had the flexibility to do so on this occasion.

In other economic news in the region, the Japanese government downgraded its assessment of the economy for the first time since February 2009, due to the negative economic impact of the surging yen which has hit levels near the 1995 highs compared to the US dollar, while Hong Kong’s unemployment rate remained at 4.2%, which was expected to decline to 4.1%, and South Korea’s department store sales rose 6.4% y/y and the nation’s discount store sales surged 18.0% y/y.

Across the pond, Germany’s ZEW Survey of Economic Sentiment, a reading of what investors and analysts expect for economic activity six months from now, fell from -4.3 in September to -7.2 for October, compared to the -7.0 reading that economists had expected. In other economic news in Europe, the ZEW Survey of euro-zone sentiment unexpectedly remained in positive territory, and euro-zone construction output declined, while a gauge of UK business optimism deteriorated more than expected.

In the Americas, Brazil increased taxes on foreign inflows of investments for the second time this month, to try to prevent appreciation of the Brazilian real and protect exports from what the nation’s Finance Minister called a global “currency war,” per Bloomberg. Moreover, the Bank of Canada expectedly kept its benchmark interest rate unchanged at 1.00%.

Fed economic preview ahead of November meeting

The focus of the weekly economic calendar is set to be released mid-day tomorrow, with the Federal Reserve’s 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. The Fed is concerned about the possibility of a period of falling prices, or deflation. In his speech on Friday, Fed Chair Ben Bernanke indicated “risk of deflation is higher than desirable,” and that there was “a case for further action” by the Fed, but he cautioned that possible costs must be weighed against benefits. Meanwhile, New York Fed President William Dudley has repeatedly said that in regard to the Fed’s dual mandate of maximum employment with price stability, the current situation is “wholly unsatisfactory.” As such, many market watchers believe that another round of quantitative easing, or QE2, is almost assured, and markets have begun to price in this possibility before it happens.

The other release on the US economic calendar is the weekly MBA Mortgage Applications Index.

International releases scheduled for tomorrow include the leading index for Japan and Australia, unemployment in South Korea, PPI in German, industrial orders in Italy, wholesale sales in Canada, and retail sales in Mexico. Reports from policymakers in the UK will be under focus, with the minutes from the Bank of England’s last meeting and the release of the fiscal budget.