Evening Market Update

New Year Cheer Extends to First Day of 2011 Trading

The New Year’s party continued over to the financial markets today, as US equities finished in positive territory on the first trading day of 2011. The upbeat mood came courtesy of some favorable global manufacturing data, highlighted by the seventeenth-straight month of expansion in the US ISM Manufacturing Index. On the equity front, Dow member Bank of America said that it has reached a deal to repurchase bad mortgage loans from government-sponsored entities Freddie Mac and Fannie Mae, Inspire Pharmaceuticals reported disappointing Phase-3 results for its cystic fibrosis treatment, and Clorox offered 2Q EPS guidance that was far short of analysts’ expectations. Treasuries finished lower amid the strength in equities and following the favorable economic data, which also included a larger-than-expected rise in construction spending.

The Dow Jones Industrial Average rose 93 points (0.8%) to 11,671, the S&P 500 Index was 14 points (1.1%) higher at 1,272, and the Nasdaq Composite gained 39 points (1.5%) to 2,692. In moderate volume 1.1 billion shares changed hands on the NYSE and 1.9 billion shares traded on the Nasdaq. Crude oil rose $0.17 to $91.55 per barrel, wholesale gasoline was flat at $2.43 per gallon, while the Bloomberg gold spot price lost $6.58 to $1,414.20 per ounce. Elsewhere, the Dollar Index—a comparison of the US dollar to six major world currencies—rose 0.2% to 79.16.

Dow member Bank of America Corp. (BAC $14 ¹) announced that it has reached an agreement with Government Sponsored Entities (GSEs) Federal Home Loan Mortgage Corp. (FMCC $0.33)—Freddie Mac—and Federal National Mortgage Association (FNMA $0.33)—Fannie Mae—to resolve repurchase claims involving certain residential mortgage loans sold to the GSEs by entities related to BAC’s Countrywide Financial Corp. BAC said it expects to take a writedown of about $3 billion in fiscal 4Q 2010 to buy back residential mortgage loans sold to FMCC and FNMA. BAC said through this writedown it believes that it has addressed its remaining exposure to repurchase obligations for residential mortgage loans sold directly to the GSEs.

“These actions resolve substantial legacy issues in the best interest of our shareholders,” BAC’s President and CEO Brian Moynihan added. Meanwhile, Freddie Mac’s CEO said he is pleased to reach the agreement and he believes it is in all parties’ best interests, while Fannie Mae said the agreement is a “fair and responsible” resolution. Shares of BAC, FMCC and FNMA were solidly higher.

However, shares of Inspire Pharmaceuticals Inc. (ISPH $5) down nearly 60% after the company said a Phase-3 trial of its treatment for cystic fibrosis failed to meet its primary or key secondary efficacy endpoints. ISPH said it will conduct a thorough analysis of the data to fully understand the results from this trial and the impact on future development of its treatment and on the company going forward.

Elsewhere, Clorox Co. (CLX $62) was lower after the consumer products firm said it expects 2Q EPS, excluding a goodwill impairment charge, to be between $0.57-0.63, below the $0.74 that analysts were anticipating. The company said the economic environment in 2Q has “remained challenging,” and its categories in the US have “remained soft.”

Manufacturing activity expands again, while construction spending topped forecasts

The ISM Manufacturing Index improved to a level that matched expectations of economists surveyed by Bloomberg, increasing from an unrevised 56.6 in November to 57.0 in December. A reading above 50.0 depicts expansion and the index has posted seventeen-straight months above that mark. Leading the way, production and new orders both moved above 60, while the employment component of the release decreased from 57.5 to 55.7. Moreover, the prices paid component moved higher, rising from 69.5 in November to 72.5 in December, limiting the enthusiasm of the report as it may have fostered concerns about rising inflation. Also, higher prices paid for raw materials could begin to pressure corporate profits as the current economic conditions may be hampering the ability to pass along higher input costs to consumers.

After talk about another round of asset purchases by the Fed, the stock market began rising at the end of August, increasing consumer wealth and boosting confidence, resulting in the best holiday sales since 2005. The Fed noted this wealth effect on consumers and the economy, and to this extent, the quantitative easing program has already begun to work. While Treasury yields have increased in response to improved confidence in the recovery, they are somewhat in contrast to the Fed’s goal of lowering rates. As such, tomorrow’s midday release of the minutes from the December Federal Open Market Committee (FOMC) meeting, as well as Fed Chairman Ben Bernanke’s Congressional testimony on Friday, will be closely dissected to determine the Fed’s view on recent moves in both the financial markets and the economy. Quantitative easing, or QE2, only began in early November, but some investors are questioning whether the program will be completed as initially announced.

In other economic news, construction spending rose more than anticipated, rising 0.4% month-over-month (m/m) in November, twice the gain seen by economists, and following the 0.7% increase seen in October. Residential and nonresidential spending both posted increases to lead the better-than-forecasted gain.

Treasuries ended lower following the data and as the equity markets were higher. The yield on the two-year note was 1 bp higher at 0.60%, the yield on the 10-year note gained 5 bps to 3.35%, and the 30-year bond added 4 bps to 4.38%.

Mostly positive manufacturing data overseas

There were some favorable reports on manufacturing activity in Europe, with Italy’s PMI Manufacturing gauge increasing to 54.7 in December, from 52.0 in November, and compared to the slight increase to 52.2 that economists were expecting. Also, the euro-zone Manufacturing PMI for December was unexpectedly revised higher than previously reported, as the reading improved from 56.8 in the preliminary report, to 57.1. Other reports were mixed, with France’s manufacturing activity being unexpectedly revised higher, while Germany’s manufacturing read was surprisingly revised to the downside, although it remained at a level depicting expansion.

In the Asia/Pacific region, Friday’s release of the China PMI Manufacturing report showed activity slowed from 55.2 in November to 53.9, compared to the 55.0 reading that was anticipated by economists. While the index remained at a level depicting expansion, with a reading above 50, it was the first deceleration in manufacturing growth in five months, per Bloomberg. The decline in the index may have soothed some concerns regarding further monetary policy tightening actions by the Chinese government, which deployed a plethora of measures in 2010 to try to control inflation and thwart the formation of asset bubbles. Elsewhere, South Korea’s trade surplus expanded more than what economists had expected, with both exports and imports rising solidly and above forecasts, while India’s PMI Manufacturing report showed a deceleration in activity in December, but it continued to expand. Market action was light with markets in Japan and Australia were closed for holidays, along with some markets in China.

Tomorrow, in addition to the minutes from the December Federal Open Market Committee (FOMC) meeting, the only other US economic report slated for release is factory orders, forecast to fall 0.2% in November following a 0.9% decline in October. The international economic calendar will include: labor data in Germany, mortgage approvals, consumer credit, and manufacturing PMI numbers in the UK, and CPI figures out of the euro-zone and Italy.