Evening Market Update

Equity Markets Unchanged to Close Out a Strong October

Stocks finished right at the flatline in a choppy day of trading, as investors showed little conviction ahead of next week’s Federal Reserve meeting. Domestic economic news was mixed, as 3Q GDP was slightly higher than expectations, consumer sentiment declined and the Chicago PMI unexpectedly improved, leaving Treasuries higher on the day. Earnings reports continued to dominate the equity front, led by better-than-expected numbers from Dow members Microsoft Corp and Merck & Co, although fellow Dow component Chevron Corp. missed the Street’s expectations. Additionally, Estee Lauder, Monster Worldwide and Cigna all beat analysts’ estimates, while Genworth Financial posted a surprising drop in earnings for the third quarter.

The Dow Jones Industrial Average rose 5 points (0.04%) to 11,118, the S&P 500 Index lost 1 point (0.04%) to 1,183, while the Nasdaq Composite was flat at 2,507. In modest volume, 1.0 billion shares were traded on the NYSE and 2.1 billion shares were traded on the Nasdaq. Crude oil fell $0.80 to $81.38 per barrel, while wholesale gasoline fell $0.01 to $2.10 per gallon, and the Bloomberg gold spot price advanced $14.28 to $1,358.33 per ounce. Elsewhere, the Dollar Index—a comparison of the US dollar to six major world currencies—fell 0.1% to 77.19. For the week, including dividends, the DJIA fell 0.13%, the S&P 500 Index gained 0.02%, and the Nasdaq Composite advanced 1.13%. 

Dow component Microsoft Corp (MSFT $27) posted 1Q EPS of $0.62, well ahead of the Street’s $0.55 estimate, as revenues rose 25% year-over-year (y/y) to $16.2 billion, above the $15.8 billion consensus forecast, on strong sales of the Windows 7 operating system and Office 2010. Chief Financial Officer Peter Klein on the earnings call said that the business-PC refresh cycle “should continue through at least the remainder of this fiscal year,” which ends in June, and that there was an “accelerated interest in the cloud” during the quarter, which drove a 40% sequential growth in subscriptions to the Azure platform for cloud computing. Shares were modestly higher.

Merck & Co (MRK $36), a fellow Dow member, also beat estimates, as 3Q EPS ex-items of $0.85 came in three cents better than the consensus, despite revenues of $11.12 billion falling short of the $11.24 billion forecast. Sales during the quarter were led by a 12% increase in the company’s biggest drug, asthma and allergy treatment Singulair, while cardiovascular drugs Vytorin and Zetia fell 7.6% and rose 1.4% respectively. Meanwhile, the company booked a $950 million reserve during the quarter to cover an anticipated resolution an investigation into the company’s former pain drug Vioxx. Shares traded lower.

Dow component Chevron Corp (CVX $83) announced 3Q earnings per share of $1.87, including a $0.18 negative currency impact, below the consensus $2.15 estimate, but it is unclear how many analysts included the currency impact in their estimates. Revenues of $49.7 billion beat the $49.5 billion forecast, as production grew 1% during the quarter. The company noted that they continue to “show gains in upstream production and progress on our downstream restructuring.” The company lowered estimates on currency and the impact of a moratorium on drilling in the Gulf of Mexico two weeks ago. Commenting on the Gulf, the CEO said that the company filed an application for deep-water drilling and looks forward to the timely approval to return to work “as soon as possible.” Additionally, the company announced that it would begin its share repurchase program during 4Q, after being approved by the Board in July 2010. Shares finished lower.

Estee Lauder Co (EL $71) shares moved higher by over 10% after the company reported 1Q earnings of $0.97, higher than the consensus estimate of $0.77, and the company raised its full-year earnings forecast. The maker of beauty brands such as Clinique, Origins and Smashbox, said that it saw a pick up in US department stores, saying on the earnings call that “The luxury consumer is shopping again.” In an interview quoted by Dow Jones Newswires, the CEO said that in the US and some parts of Asia, the luxury market is growing faster than the mass market, and the company in August said that China will be its second-largest Asian market behind Korea by year end. Executives said they expected a “solid” holiday season, but the US market could soften in January if unemployment remained high.

Shares of Monster Worldwide (MWW $18) surged by over 25% after the company reported a swing back to profitability, with 3Q EPS of $0.05 beating the Street estimate of break-even, as bookings growth excluding the HotJobs acquisition of 26% beat Monster’s prior forecast of 16-21%. The company also gave 4Q EPS guidance of $0.08, above the $0.05 consensus estimate, and increased its full-year bookings guidance ex-HotJobs to 20-21%, up from its prior view of 15-20%, while including the acquisition, bookings will grow 23-24%. The company said that despite high unemployment, the “push and need for skilled talent” is increasing in tempo, and that it saw increases and improvement in just about every country, which was a combination of the economy and its product and innovation.

Cigna Corp (CI $35) reported 3Q earnings ex-items from continuing operations of $1.10, better than the Street’s forecast of $1.06 on inline revenues, saying that results benefitted from smaller-than-expected use of health care benefits, as well as gains in enrollment. The company increased its full-year earnings forecast and said it now expects enrollment to grow 3.5%, up from the prior view of 3%. Shares traded lower.

Genworth Financial (GNW $11) posted 3Q EPS ex-items of $0.06, well below the $0.25 expected by analysts, while revenue increased 12% y/y to $2.67 billion. The life insurer said losses in its U.S. mortgage-insurance business widened as the housing market struggled in the latest quarter, and predicted that revenue would likely slow in the second half of the year. Shares of GNW fell over 9%.

Inline GDP boosted by the consumer, confidence declines after quarter-end

The first look at 3Q Gross Domestic Product, the broadest measure of economic output, was released this morning and showed a 2.0% quarter-over-quarter (q/q) annualized rate of growth, compared to the 1.7% increase expected by a survey of economists by Bloomberg, as personal consumption of 2.6% beat the 2.5% estimate. The GDP Price Index rose 2.3%, above the 1.8% consensus of economists, and the core PCE Index, which excludes food and energy, increased 0.8%, below the 1.0% estimate. Treasuries finished higher after being mixed initially after the report. The yield on the two-year note fell 2 bps to 0.34%, the yield on the 10-year note was 5 bps lower at 2.61%, and the 30-year bond yield lost 6 bps to 3.99%.

Breaking down GDP, consumer spending was the single largest contributor to growth, adding 1.8%, inventory building contributed 1.4%, and business spending on equipment and software contributed 0.8%, despite decelerating to a 12.8% growth q/q, down from the 20%-plus rate over the prior three quarters. Federal government spending contributed 0.7%, and state and local government was neutral to growth. On the negative side of the ledger, residential construction subtracted 0.8%, while the main negative impact to the quarter was net exports, which detracted 2.0% from output, as imports (a subtraction from growth) grew 17.4% q/q and outpaced exports, which grew 5.0% q/q. Real gross domestic purchases - purchases by US residents of goods and services wherever produced -- increased 3.9% in the third quarter, compared with an increase of 5.1% in the second.

Elsewhere, the final University of Michigan’s Consumer Index unexpectedly fell to 67.7 in October, lower than the original report of 67.9 and 68.2 reading in September, while the expectation was that the release would come in at 68.0. The index fell to the lowest level in eleven months, as the current conditions component fell to 76.6 from 79.6 in September, and despite an increase in the outlook for six months from now, to 61.9 from 60.9. Within the report, consumers’ expectation regarding inflation over the next 12 months rose to 2.7% from 2.2% in September, while the rate over the next five years, the measure tracked by the Fed, ticked up to 2.8% from 2.7%.

Finally, the Chicago PMI unexpectedly improved, rising to 60.6 in October from 60.4 in September, compared to the decline to 58.0 that was forecasted by economists. The index of business activity in the Midwest continued to expand as a reading of 50 is the demarcation point between expansion and contraction, and the employment component of the report continued to expand, along with increases in production, new orders, order backlogs, and inventories.

European data hurts sentiment, Canada economic growth matches expectations

European economic data was weak, with euro-zone inflation unexpectedly increasing to 1.9% in October, ahead of the 1.8% estimate, and just shy of the 2.0% target of the European Central Bank (ECB). Additionally, euro-zone unemployment rose to a 12-year high of 10.1%, marked on the high end by Spain’s 20.8% jobless rate. Elsewhere, consumer confidence in the UK modestly increased to a -19 reading, despite a decline in the money supply and German retail sales declined 2.3% in September, versus estimates of a 0.5% increase. European countries are fighting slow economic growth and fiscal austerity, manifested by the continued decline in Greek 10-year bonds, the spread of which rose 30 bps to 814 bps above the German 10-year bund.

In Asia/Pacific, Japanese industrial production fell 1.9% in September, far worse than the 0.6% decline expected, and deflation worsened, as CPI fell 0.6% month-over-month (m/m) during the month and 1.1% y/y. Additionally, while the jobless rate improved in Japan, household spending was worse than expected.

Back in the Americas, Canadian GDP grew 0.3% in August, in-line with economists’ expectations, and following a 0.1% contraction in July. The growth rate slowed to 1.6% on an annualized basis in the July-September period.

Equities at mercy of the greenback and expectations of Fed action

The equity markets finished modestly changed for the week as traders grappled with the looming November 2-3 Federal Open Market Committee monetary policy meeting, in which it is widely expected to announce further stimulus efforts in the form of asset purchases, known as quantitative easing (“QE2”). The currency markets were also a major focus for the week as stocks took their cue form the direction of the US dollar. The greenback posted back-to-back sessions broadly higher against its peers, pressuring commodity prices, and the equity markets weakened. The majority of the boost for the dollar came as concerns surfaced that the Fed may unveil stimulus efforts that would come up short of what had been factored into the markets. The uneasiness that surfaced was exacerbated by better-than-forecasted existing and new home sales releases and a stronger-than-expected read on consumer confidence, and continued better-than-expected earnings results, which helped cast some doubt regarding the severity of the economic situation and the outlook for the Fed willingness to deploy QE2.

However, the US currency did finish lower for the week to offset the aforementioned pressure on the equity markets following the weekend pledge by G20 world finance leaders to avoid competitive currency devaluation. Also the greenback found pressure as expectations of some form of Fed stimulus prevailed over the uncertainty regarding the size, scope, and efficacy of Fed action, aided by a durable goods orders report that showed unexpected weakness when stripping out volatile components of transportation and defense goods.

Triple play of employment, Fed meeting, and election likely to bring fireworks

Next week brings a slew of economic, central bank and election news, starting with Monday’s release of the ISM Manufacturing Index, forecasted to decrease to 54.0 in October from 54.4 in September, while the ISM Non-Manufacturing Index, to be released on Wednesday, is forecasted to increase to 53.5 in October from 53.2 in September. The level that separates expansion from contraction is 50.0.

Meanwhile, market reaction will likely focus on the midday statement release on Wednesday that concludes the two-day Federal Open Market Committee (FOMC) meeting and Friday’s release of nonfarm payrolls. No changes are expected to the fed funds target rate, currently at a level between 0-0.25%, but rising expectations about the potential for the Fed to begin another round of asset purchases due to the weak economic data have been building since Fed Chair Ben Bernanke’s speech at Jackson Hole at the end of August, and his speech in Boston on October 15, where he said that the “risk of deflation is higher than desirable.” Additionally, Fed officials have added to the speculation, particularly New York Fed President William Dudley, who has been saying since the beginning of October that unemployment and inflation levels and the timeframe over which they will return to levels consistent with the Fed’s mandate are “unacceptable.” However, the size of the potential purchase program has been widely debated, and estimates as high as $1 – 2 trillion over the next six months could set the market up for disappointment.

The week concludes with the release of nonfarm payrolls, expected to grow 60,000 in October after falling 95,000 in September, while excluding government employment, which has been distorting the headline number as temporary Census workers are relieved, private sector payrolls are expected to increase 80,000, after expanding by 64,000 in September. The unemployment rate is estimated to remain at 9.6%.

Other releases on the US economic calendar include personal income and spending, factory orders, pending home sales, MBA Mortgage Applications, the ADP Employment Change, initial jobless claims, and wholesale inventories.

Elsewhere in the Americas, Canada releases its manufacturing PMI and employment, and Brazil releases its manufacturing PMI, industrial production, trade balance and the results of the weekend run-off general election. In Europe, releases include euro-zone and UK manufacturing and services PMI reports, UK PPI and housing prices, and German factory orders. In Asia/Pacific, Australia will report retail sales, house prices, and building approvals. Additionally, China, South Korea, Taiwan and India announce manufacturing PMIs. In central bank action, the Bank of Japan, Reserve Bank of Australia, Bank of England and European Central Bank meet to discuss monetary policy.