Weekly Recap - Week ending 17-Jul-09

The S&P 500 declined 7.0% over a span of four weeks leading up to this past week.  Now, stop for a moment and let this next thought sink in:  over the span of the first four days of the past week, the S&P 500 gained 7.0%.

To be sure, nobody can say the second quarter earnings reporting period didn't start with a bang.  It was about as good as it could get with nearly every company of note that reported earnings in the past week exceeding consensus earnings estimates.  

There were some big names on the reporting roster this week, too.   Names like CSX Corp. (CSX), Goldman Sachs (GS), Johnson & Johnson (JNJ), Intel (INTC), YUM! Brands (YUM), Harley-Davidson (HOG), JPMorgan Chase (JPM), Marriott (MAR), Nokia (NOK), Google (GOOG), IBM (IBM), General Electric (GE), Mattel (MAT), Bank of America (BAC) and Citigroup (C).

By most accounts, these companies and others that joined them followed the primary rule of medicine:  first, do no harm.

The earnings reports -- Intel's in particular -- proved to be just what the ailing stock market needed. 

The bullish tone for the week was set Monday, however, when earnings news was inconsequential.  The trendsetter, if you will, was influential analyst Meredith Whitney who raised her rating on Goldman Sachs (GS) ahead of its earnings report to Buy from Neutral and took the occasion to suggest that she felt it was possible the financial sector could put together a rally of 15% or so in the short-term.

Whitney has been off the mark so far.  The financial sector gained only 9.4% this week.

Taking our tongue out of our cheek, we'll note that Goldman had a banner report, blowing past estimates and raising the bar for peer companies to a level that couldn't be reached.  Still, most of the financials easily topped consensus estimates.  The banks, however, weren't exactly pounding the table on the outlook for credit quality and neither was Harley-Davidson, which has a financing business.

The market worked through those issues, though, preferring to trade the line yet again that the overall earnings news wasn't as bad as feared.  This approach caught plenty of people leaning in the wrong direction and presumably prompted a wave of short covering that augmented this week's gains.

By and large, the market seemed to have a one-track mind as it keyed off the headlines trumpeting positive earnings surprises while ignoring a slate of qualitative comments that suggested the economic outlook still isn't as bright as the market wants to believe it is.

Railroad operator CSX Corp., for example, said volumes continued to decline across the board and that the rate of decline in the coal market accelerated in the quarter.  Marriott, meanwhile, said it is still too early to say the company is seeing green shoots. 

Separately, financing company CIT Group (CIT) was rumored to be on the verge of filing for bankruptcy if it couldn't get bailed out by private investors after the government took a rescue pass.

The week's economic data took a backseat to the earnings reports, but it didn't do any harm either. 

Inflation readings provided by the PPI and CPI reports were higher than expected due largely to rising energy prices, but the core rate of consumer inflation, which excludes food and energy, was still within the Fed's comfort zone, up 1.7% on a year-over-year basis.  More importantly perhaps, the inflation data helped dampen deflation concerns for the time being.

The Retail Sales and Industrial Production reports both showed end demand remains generally weak.  Granted total retail sales were up 0.6% versus May, but when gasoline, autos, and building materials sales were excluded, they were down for the fourth straight month.  That is notable because this core retail sales figure is used by the government in computing GDP.

Industrial production declined -0.4% in June.  That was the 17th decline in the last 18 months, but since it was the smallest rate of decline since last July, the market put a positive spin on it, thinking it was a sign of better numbers to come.  One would hope so given that it was also reported that total capacity utilization and manufacturing capacity utilization hit their lowest level -- 68.0% and 64.7%, respectively -- since records have been kept.

These weak capacity utilization numbers should help dampen inflation expectations as they are a clear reminder that there is plenty of slack on both the production and labor resource side of things to keep wage demands in check.

Initial claims fell noticeably for the second straight week while continuing claims plunged by 642,000 to 6.273 million.  That marked the biggest drop ever in continuing claims.  In fact, it was so big that few people (including us) believed it.  Nonetheless, the headlines themselves didn't hurt at all the way the market behaved in the past week.

Housing starts and building permits data were also stronger than expected and provided some added cover for the Federal Reserve, which raised its central tendency projections for real GDP for 2009, 2010 and 2011.  The market found that out by way of the minutes from the June 23-24 FOMC meeting that were released Wednesday.

In conjunction with the raised GDP outlook, the Fed also boosted its projections for the unemployment rate for 2009, 2010 and 2011 to levels that are higher than the White House's current assumptions.  We suspect the White House will have to revise its estimates upward in due time.

The White House was a focal point throughout the week for a different reason, as President Obama continued to press the urgency of passing a health care reform act. 

The Democrats in the House stepped forward with some draft legislation that would impose a surtax on American families making over $350,000 ($280,000 for individuals) to help pay for the reform effort.  The Senate was still throwing around various proposals.  The lack of any perceived agreement there we think helped the market move past the House headlines, seemingly resigned not to get caught up in the bouncing headlines until there is an actual compromise bill between the two chambers to debate.

With that, we'll come back to the earnings discussion.  The heavyweights that reported in the past week did what they are expected to do at an economic time like this -- put up results that were generally better than expected and extol efforts at picking up market share.

These industry leaders helped smooth things over after an anxious 4-week trading period ahead of the reporting season.   Where the market goes from here in the near-term will likely hinge on whether the smaller players in their industries can provide the same calming effect with their earnings results. 

The bar of expectations has risen, along with our concerns that the peloton of smaller companies that have yet to report won't be able to keep up with the lead pack.   Accordingly, we wouldn't be chasing this rally just yet.

--Patrick J. O'Hare, Briefing.com

Index	Started Week	Ended Week	Change	% Change	YTD
DJIA	8146.52	8743.94	597.42	7.3 %	-0.4 %
Nasdaq	1756.03	1886.61	130.58	7.4 %	19.6 %
S&P 500	879.13	940.38	61.25	7.0 %	4.1 %
Russell 2000	480.98	519.22	38.24	8.0 %	4.0 %