Tech Optimism Betrayed After the Close

Google's weak results cast a pall over a day of market records.
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Ramping up their optimism over second-quarter earnings generally and tech stocks specifically, traders took a break from worrying about the subprime mortgage market Thursday, sending major averages to another round of milestones.

Buoyed by strong reports from

IBM

(IBM) - Get Report

and strength in

Hewlett-Packard

(HPQ) - Get Report

, the

Dow Jones Industrial Average

rose 0.6% to notch its first-ever close above 14,000. Further aided by strength in

Juniper Networks

(JNPR) - Get Report

, the

S&P 500

climbed 0.5% to a record 1553.08, while the

Nasdaq

jumped 0.8% to 2720.04, its best level in more than six years.

But the tech-based optimism looked somewhat misplaced after the close, as Wall Street put a heavy hand on the "sell" button as news of

Google's

(GOOG) - Get Report

disappointing earnings hit the tape. Google was falling 7.7% in recent after-hours trading.

A sell-the-news reaction also greeted post-close results from

Microsoft

(MSFT) - Get Report

, which beat both profit and revenue expectations, though its success was dampened by its Xbox 360 gaming system. Microsoft was down 1.6% in recent after-hours trading following a 1.9% rise to a 52-week high in the regular session.

Advanced Micro Devices

(AMD) - Get Report

, which posted a second-quarter loss but better-than-expected revenue, was higher in after-hours trading, building on recent gains. Elsewhere,

SanDisk

(SNDK)

missed analysts' earnings expectations, although the company reported better-than-expected revenues. Its shares were up 3.4% in recent after-hours trading, after falling 2% during Thursday's session.

Including Thursday's post-close earnings reports, the season is off to a slightly weaker start than recent quarters, according to John Butters, analyst at Thomson Financial. With 116 of the S&P 500 companies having reported, the growth rate for the quarter (including actual reports combined with estimates for the remaining companies) is 4.9%.

Thus far, 60% of companies are beating expectations, which is in-line with the long-term averages, but lower than the average over the past eight quarters when 68% of companies beat estimates. Companies that are surpassing expectations are beating analysts' estimates by just 2.4%, below the long-term average of 3.4% and the average over the last eight quarters of 4.3%. Thus far, the consumer discretionary sector is faring worst, missing estimates by 11%.

Butters notes that the homebuilders account for much of that discretionary weakness, while some "high profile" earnings disappointments from

Pfizer

(PFE) - Get Report

and Google contribute to the overall tepid season thus far.

Traders may have been tired of thinking about subprime problems Thursday, but they certainly didn't go away, nor did weakness in the banking and brokerage segments of the stock market.

Standard & Poor's

downgraded more subprime debt Thursday, a week after it put the 418 classes of residential mortgage-backed securities and synthetic collateralized debt obligations under review. The downgrades affect $3.8 billion of securities, some of which were sliced into junk territory. Thursday's cuts follow on the ratings agency's decision last Thursday to downgrade $7 billion worth of subprime-related debt.

The ratings downgrades could create more selling pressure in the market for collateralized debt obligations and mortgage backed securities, which will continue to impact valuations in the high-yield bond and leverage loan market. Indeed, risk premiums on the derivatives index tied to high-yield bonds have widened to about 395 basis points, or 3.95%, over comparable, no-risk Treasury bonds, from its low of 250 basis points in early June. And, the index tracking leveraged loans has widened to 295 from 115 basis points at its June low point.

In a report and subsequent conference call with clients, JPMorgan analysts were less than optimistic about subprime defaults, according to news reports. The firm predicts defaults will increase and that as many as 50% of borrowers in the subprime mortgage market will not be able to refinance their loans when they reset.

Federal Reserve

Chairman Ben Bernanke also addressed the subprime problems in his second day of testimony on Capitol Hill. "The credit losses associated with subprime have come to light and they are fairly significant," said Bernanke to the Senate. "There will be significant financial losses."

The brokerage sector suffered again Thursday, with the Amex Securities Broker Dealer Index down 0.8%.

Bear Stearns

(BSC)

fell another 0.3%,

Lehman Brothers

(LEH)

declined 1.7% and

Goldman Sachs

(GS) - Get Report

fell 1.5%.

Bernanke stayed mostly on script about inflation and growth Thursday, noting that the Fed needs to see more convincing evidence that inflation is tamed and that inflation expectations are under control. "Inflation expectations are where the rubber of the Fed's forecast meets the road of reality with inflation expectations as data comes in," says MKM Partners' chief economist Michael Darda.

The market took his comments to mean the Fed remains on hold with interest rates at 5.25% at least for the remainder of the year.

Friday, the rubber meets the road in the stock market with earnings reports from Dow components

Caterpillar

(CAT) - Get Report

and

Citigroup

(C) - Get Report

. With that we'll see if the market skids back under 14,000 or steamroll ahead.

In keeping with TSC's editorial policy, Rappaport doesn't own or short individual stocks. She also doesn't invest in hedge funds or other private investment partnerships. She appreciates your feedback. Click

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