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Posted: 7/30/10 4:15 PM ET

Stocks Rebound After GDP Disappoints

The US equity markets dipped out of the gates, but managed to recover and hover near the flatline for most of the day. The early weakness was due to the release of US 2Q GDP, which showed a slower-than-anticipated rate of economic growth and a smaller-than-forecasted increase in personal consumption. However, positive reports on consumer sentiment and Midwest manufacturing activity helped to improve sentiment and move the Dow into positive territory for the week. Earnings reports headlined the equity front, as Dow members Merck & Co and Chevron both beat the Street’s bottom-line projections, but failed to meet revenue expectations. Elsewhere, MetLife, Amgen and McAfee all reported earnings that topped analysts’ expectations, while Genworth Financial fell short of operating earnings forecasts. Treasuries moved higher on the GDP announcement and managed to hold onto gains throughout the day.

The Dow Jones Industrial Average and S&P 500 Index were both flat, closing at 10,466 and 1,102, respectively, while the Nasdaq Composite gained 3 points (0.1%) to 2,255. In moderate volume, 1.2 billion shares were traded on the NYSE and 2.1 billion shares were traded on the Nasdaq. Crude oil rose $0.50 to $78.86 per barrel, wholesale gasoline gained $0.01 to $2.10 per gallon, while the Bloomberg gold spot price advanced $12.93 to $1,181.18 per ounce. Elsewhere, the Dollar Index—a comparison of the US dollar to six major world currencies—was flat at 81.62. For the week, including dividends, the DJIA gained 0.4%, the S&P 500 Index lost 0.1%, and the Nasdaq Composite declined 0.7%.

Dow member Merck & Co. Inc. (MRK $34) reported 2Q EPS ex-items of $0.86, three cents above the Reuters estimate, with revenues dipping 1.6% year-over-year (y/y) to $11.3 billion, short of the $11.5 billion that analysts were expecting. The drugmaker said it had strong performances in consumer care and animal health products. MRK lowered its full-year EPS outlook. MRK traded lower.

Fellow Dow component Chevron Corp. (CVX $76) posted 2Q earnings of $2.70 per share, compared to the $2.44 that the Street had forecasted, with revenues jumping 27.5% y/y to $51 billion, compared to the $52.2 billion that was anticipated. CVX said revenues grew mainly due to higher prices for crude oil, natural gas and refined products, which also help grow its upstream earnings—exploration and production—while its downstream profits—refining—rose on improved margins. CVX finished higher.

MetLife Inc. (MET $42) was nicely higher after the health insurer posted 2Q EPS ex-items of $1.23, above the $1.00 that analysts were expecting, while revenues, which increased 5% y/y to $12.8 billion, came in below the $13.1 billion that the Street was looking for. MET said it benefitted from strong underwriting results, higher net investment income, and its disciplined approach to expense management.

Genworth Financial Inc. (GNW $14) reported Q2 EPS of $0.08, although operating earnings, which exclude investment gains and losses, came in at $0.24, which was four cents below analysts’ estimates. The company’s life insurance business posted a 45% decrease y/y in earnings, although revenues in that business line increased 30%. Shares of GNW fell over 14%.

Amgen Inc. (AMGN $55) announced adjusted 2Q earnings of $1.38 per share, above the $1.30 that was expected, with revenues increasing 2% y/y to $3.8 billion, topping the $3.7 billion that analysts expected. AMGN lowered its full-year revenue forecast but maintained its EPS outlook. Shares were higher.

Shares of McAfee Inc. (MFE $33) climbed over 9% after the software maker posted 2Q earnings ex-items of $0.63, three cents higher than the Street’s forecast, while revenue grew 4.4% y/y to $489.2 million. The company noted particularly strong revenue growth in North America and has made two recent acquisitions of mobile security firms, making the number of internet-connected devices on which McAfee can put its technology “nearly endless”, according the company’s CEO.

2Q output slows, but consumer sentiment and Midwest activity reports soften the blow

The first look at 2Q Gross Domestic Product (chart), the broadest measure of economic output, was released this morning and showed a 2.4% annualized rate of growth, compared to the steep upwardly revised 3.7% gain in 1Q, and the 2.6% expansion that economists surveyed by Bloomberg had forecasted. Personal consumption rose 1.6%, short of the 2.4% that was forecasted and the large downwardly revised 1.9% growth seen in 1Q.

The GDP Price Index rose 1.8%, above the consensus of economists, which called for a 1.1% increase. The core PCE Index, which excludes food and energy, increased 1.1%, just above expectations which called for a 1.0% increase. The methodology used to calculate GDP was updated and revisions were made to the prior three years of data.

Breaking down the report, consumer spending added 1.15% and inventory building added 1.05%, both of which were smaller contributions than in 1Q, while business spending on equipment and software contributed 1.36%, up from 1.24% in 1Q. Meanwhile, residential construction added 0.6%, seen as somewhat unsustainable, but commercial real estate investment added 0.1%, the first positive figure since 2Q 2008. A large portion of the slower rate in 2Q versus 1Q was due to the 2.8% negative impact of net exports, as imports outpaced exports, which may have been due to auto-related manufacturing. Lastly, federal government spending contributed 0.7%, and state and local government added 0.2%.

The financials sector was downgraded to underperform and the materials sector upgraded to marketperform today by Schwab Director of Market and Sector Analysis, Brad Sorensen, CFA in his latest bi-weekly Schwab Sector Views: Fading Financials?, leaving consumer discretionary underperform and technology and health care outperform. Brad discusses the headwinds to consumer spending, including high unemployment and lack of available credit, stating that growth is leveling off after a release of pent-up demand in prior quarters, and the American shopper remains cautious. However, businesses remain flush with cash and have underinvested in capital in recent years, and may look to productivity-enhancing investments in technology as a first place to invest. Today’s downgrade of the financials sector was due in part to the negative impact on profits of the new financial regulation reform, and while the stocks experienced a relief rally as the final bill was less onerous than originally expected, once reality sets in, the stocks could fade. Materials were upgraded to marketperform as the sector may be a bit oversold and some negative factors may start to lift, as China seems to be reversing its tightening program. Read more at www.schwab.com/marketinsight.

Meanwhile, the Employment Cost Index (chart) for 2Q gained 0.5%, matching the consensus.

Elsewhere, the final University of Michigan’s Consumer Sentiment Index (chart) increased by a larger amount than initially reported in the preliminary release, rising from the preliminary reading of 66.5 to 67.8 in July, compared to the expectation of economists, who forecasted an increase to 67.0. However, the index sits below the 76.0 reading it hit in June, which was the highest level since January 2008. The upward revision came as the current economic conditions component of the report increased from 75.5 in the preliminary report to 76.5, and the economic outlook component rose from 60.6 to 62.3.

Finally, the Chicago PMI (chart) unexpectedly improved, rising from 59.1 in June to 62.3 in July, compared to the decline to 56.0 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.

Treasuries finished higher after gaining ground on the release of the GDP report. The yield on the two-year note lost 2 bps to 0.55%, the yield on the 10-year note declined 7 bps to 2.91% and the yield on the 30-year bond fell 9 bps to 3.99%.

Disappointing economic news out of Japan highlights international front

European economic data was marked by reports showing UK consumer confidence fell by more than expected in July, reaching the lowest level since August 2009, and retail sales in Germany—Europe’s largest economy—declined much more than anticipated in June. However, Sweden’s 2Q GDP expanded by a larger amount than forecasted, Italy’s unemployment rate unexpectedly declined to 8.5% in June, and the euro-zone unemployment rate remained unchanged at 10% as expected. In other economic reports across the pond, euro-zone consumer prices increased 1.7% y/y to match expectations, Italy’s consumer prices rose more than forecasted, while its producer prices increased at a rate that was below expectations, and Spain’s unemployment rate surprisingly inched higher to 20.09% in 2Q.

In Asia/Pacific news, Japan reported that its jobless rate unexpectedly rose from 5.2% in May to 5.3% in June, above the expectation of economists that anticipated the rate to remain unchanged. Other reports that were to the downside in Japan included a surprising drop in industrial production, which fell 1.5% month-over-month (m/m) in June, compared to the forecast of a 0.2% gain, construction orders fell over 10% y/y, vehicle production slowed, but came in at a 25.9% y/y rate, and the nation’s housing starts rose by an amount that was less than half of what was expected. Meanwhile, Japan’s Consumer Price Index fell on a core level—excluding fresh food and energy—by 1.5% y/y in June, a slightly smaller amount than the 1.6% drop that was anticipated. Elsewhere in the region, South Korea’s industrial production rose more than forecasted in June, while the country’s Leading Index deteriorated in June, China released a survey showing business conditions improved in July from June and Thailand’s manufacturing production, business sentiment, and trade surplus all improved.

Back in the Americas, Canada joined the US in announcing a smaller increase in economic growth than economists were forecasting. GDP increased 0.1% in May, compared to the 0.2% increase expected, and following a stagnant reading in April.

Bulls pause as data is the cause

The equity markets appeared to be poised to continue their recent upward momentum, gaining ground on Monday, aided by continued positive reports from the corporate sector, with FedEx Corp. (FDX $83) raising its 1Q and full-year outlooks. Also, an unexpected surge in new home sales—albeit off of a record low—contributed to the upbeat start to the week, as the report added to a recent string of relatively favorable data on the housing market—along with a separate report that showed an increase in the S&P/CaseShiller Home Price Index for May. However, as the week wore on, sentiment seemed to shift courtesy of some disappointing data that gave traders a reason to contemplate the recent momentum in the equity markets and the health of the recovery, prompting some profit taking, and stocks gave up gains and finished mixed for the week.

Although 2Q earnings season continued to show mostly better-than-expected results, this week some disappointing reports out of the tech sector, headlined by Symantec Corp’s (SYMC $13) soft sales and guidance that missed expectations, along with lackluster results from consumer products firms Kellogg Co. (K $50) and Colgate-Palmolive Co. (CL $79), commanded attention and helped motivate some profit taking. Moreover, some reports from the US economic calendar fostered some economic uneasiness to stymie sentiment and stall the rally, such as an unexpected drop in durable goods orders and consumer confidence falling more than forecasted. However, a large piece of the week’s dampened sentiment came from the Federal Reserve, as voting member of the Federal Open Market Committee (FOMC) offered a warning about deflation, while the Fed released its Beige Book—summarizing anecdotal data of business activity across all Fed Districts in the US—which showed slowing economic activity. The disappointing economic docket culminated with Friday’s release of the slower-than-forecasted rate of 2Q GDP growth.

Schwab’s Chief Investment Strategist Liz Ann Sonders, Director of Market and Sector Analysis, Brad Sorensen, CFA and Senior Market Analyst, Michelle Gibley, CFA have noted for some time that a soft patch in the economy is likely to emerge as we transition to more sustainable growth after the sharp V-shaped recovery we have experienced. They also point out in their latest bi-weekly Schwab Market Perspective, that the possibility of a double-dip recession is still relatively remote. As a result, they note that the only investing strategy that we believe has staying power is that of having a well-diversified portfolio with your long-term goals in mind. As a reminder, we don't recommend investing any money in equities that you may need in the next three to five years. As we've seen, things can be very volatile over time spans shorter than that, which could affect your ability to meet your financial goals. Read the rest of the analysis and more articles from Schwab experts at www.schwab.com/marketinsight.

Economic calendar will continue to ring labor and ISM reports wait in the wings

Next week there will be a heavy slate of potential market moving reports that will make up the economic calendar and will waste no time as the ISM Manufacturing Index will be released on Monday, forecasted to decline from 56.2 in June to 54.0 in July, posting the twelfth-consecutive month of expansion, as depicted by a reading above 50. Meanwhile, the compliment to Monday’s manufacturing report will come on Wednesday in the form of the ISM Non-Manufacturing Index, and the gauge of service sector activity is forecasted to dip from 53.8 in June to 53.0 in July—the seventh-consecutive month of expansion. The ISM reports, especially manufacturing data, have maintained that although growth has slowed, it is not contracting.

The health of the consumer will also be in focus following Tuesday’s release of personal income and spending for June, forecasted to show modest growth of 0.2% and 0.1%, respectively, and any better-than-forecasted strength in the release will likely stimulate sentiment and support recovery sentiment as the consumer accounts for the lion’s share of the economy.

However, the headlining event will come on the final day of the week with the release of the labor report, which is expected to show nonfarm payrolls were 60,000 jobs lighter in July, and the unemployment rate increased from 9.5% in June to 9.6% in July. But, given the noise from the government’s temporary hiring for the 2010 Census, the change in private sector payrolls—forecasted to increase by 100,000 jobs—may be the report that garners the most attention. The employment situation, along with housing, are pistons of the economic engine that have yet to fire, and any hint of stronger-than-forecasted job growth could help solidify arguments that the economy continues down the recovery path offering further support to the equity markets. Schwab’s Director of Market and Sector Analysis, Brad Sorensen, CFA in his latest bi-weekly Schwab Sector Views: Fading Financials?, notes that confidence among consumers regarding the economic recovery is waning, due to the numerous challenges consumers face, including the relatively high unemployment rate, and he is maintaining his underperform rating on the sector. If labor market sentiment improves, the economic recovery argument will receive further support, given the critical role that consumer spending plays in the economy. Read the rest of Brad’s analysis on the major sectors at www.schwab.com/marketinsight.

Other US reports due out next week include: construction spending, factory orders, pending home sales, MBA mortgage applications, ADP employment change, weekly initial jobless claims, and consumer credit.

On the international calendar for next week, euro-area PMI manufacturing and service sector reports will be released, along with similar manufacturing data from China, and euro-zone PPI retail sales, while the European Central Bank’s and Bank of England’s monetary policy meetings will dominate headlines in Europe. Other international reports include: Japan’s Leading Index, UK PPI and manufacturing, Italian GDP, German industrial production, Canada’s unemployment rate, and the Reserve Bank of Australia’s interest rate decision.

Schwab Center for Financial Research - Market Analysis Group

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Schwab Center for Financial Research ("SCFR") is a division of Charles Schwab & Co., Inc. The information contained herein is obtained from third-party sources and believed to be reliable, but its accuracy or completeness is not guaranteed. This report is for informational purposes only and is not a solicitation, or a recommendation that any particular investor should purchase or sell any particular security. The investment information mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for
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