On Friday, the 30-stock Dow Jones industrial average rose 73 points, or 0.72%, to 10,270.47. The broad Standard & Poor's 500-stock index was up 6.24 points, or 0.57%, at 1,093.48. The tech-heavy Nasdaq composite index advanced 18.86 points, or 0.88%, to 2,167.88.  For the week the Standard & Poor’s 500 Index jumped 2.3% to 1,093.48.  The Dow average rose 247.05 points, or 2.5%, to 10,270.47, following its 3.2% advance the prior week.

The spike in commodities came after the greenback fell Friday on news that the trade deficit widened more than expected in September.  Commodities, which are priced in US dollar, benefit from a decline in the currency.

Nevertheless, the greenback's weakened status remains a foreign policy issue of contention, and is likely to weigh on President Obama’s tone in China.  Meanwhile, brushing aside concerns of potential asset bubbles in China, the Chairman of the China Banking Regulatory Commission, instead, cautioned the weak dollar "is boosting speculative investment in stock and property markets and will pose new, real and insurmountable risks to the global recovery and particularly to the recovery in emerging markets."

Treasury Secretary Geithner last week repeated the Administration's commitment towards a strong dollar; nevertheless, the impact of a weak dollar on improving American products' competitive positioning overseas markets is widely expected to help the sustainability of a fragile recovery in the US.

On Friday, the Walt Disney Co. (NYSE:DIS) said quarterly profit rose 18%, helped by higher revenue at its cable, broadcast and movie studio divisions.  Abercrombie (NYSE:ANF) reported better-than-estimated results, while J.C. Penney (NYSE:JCP) raised its earnings and revenue outlook, offsetting a lower-than-expected consumer sentiment post from the University of Michigan.

Among retailers reporting during the week are: Lowe's (NYSE:LOW) and Pacific Sunwear of California (NASDAQ:PSUN) today; Home Depot (NYSE:HD), Target (NYSE:TGT) and TJ Maxx (NYSE:TJX) on Tuesday; BJ's Wholesale (NYSE:BJ) and the Limited (NYSE:LTD) on Wednesday; Sears Holding (NYSE:SHLD), Gap (NYSE:GPS) on Thursday.

A busy Fed calendar includes today's comments from Bernanke; on Tuesday from Lacker, and Pianalto; on Thursday from Plosser, Fisher, Ghosn and Rattner; and on Friday from Plosser. Treasury Secretary Geithner speaks on Tuesday and Thursday.

Cisco Systems’ (NASDAQ:CSCO) CEO John Chambers said he now sees a global economic recovery, fueling a rebound in the company’s sales this quarter.  The Dow average jumped 203 points, or 2%, while the tech-heavy NASDAQ, riding high on Cisco’s forecast, bolted up 50 points or about 2.4%. 

All ten S&P 500 industry groups ended in the green, with banking shares advancing 2.6% as analyst Dick Bove of Rochdale Securities noted the group will double by the end of 2010.  Technology shares advanced 2.2%.  Qualcomm Inc. (NASDAQ:QCOM) jumped 5.4% to $43.85 and Microchip Technology Inc. (NASDAQ:MCHP) gained 3.9% to $25.37 after it was raised to “buy" from “neutral" at FTN Equity Capital Markets.  Research in Motion (NASDAQ:RIMM) jumped on news of its $1.2 billion share buyback plan as well as a Standard & Poor's ratings increase to "buy" from "hold."  A report on the semiconductor industry projected sales growth of 10% in 2010.

On the retail sales front, action was largely mixed.  About half of firms that reported numbers missed expectations as the growth proved selective. Costco (NASDAQ:COST) posted 3% same-store-sales gains excluding gasoline results; Gap (NYSE:GPS) registered a 4% sales growth and raised its third quarter guidance.  Luxury retailers Nordstrom (NYSE:JWN) showed surprising gains with its 6.5% sales increase.

On the political front, President Obama is expected to sign into law today an extension and broadening of the homebuyers' tax credits, to include both first-time buyers' credits of $8,000, and existing homeowners, in residence for over five years, of $6,500.  The measure also includes an extension of unemployment benefits by up to twenty weeks.

Sales at stores open at least a year, a key retail industry performance metric, were only down 3%, ahead of the 7% expected by analysts. Gap noted that sales at its higher-end store Banana Republic were worse than expected, but buoyed by a strong performance from sales at the value oriented Old Navy.

Estimates Continue to Rise

With the company holding its own in a very tough environment, analysts continue to raise their earnings estimate. The current year is up 8 cents in the last month to $1.33 per share. The next-year estimate is up 9 cents in the same time to $1.42, a respectable 7% growth projection.

The Chart

Shares of GPS caught a second wind in early August, building on previous gains from earlier in the year. Take a look at the nice move below.

Last Week's Momentum Zacks Rank Buy Stocks

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Yesterday, the 30-stock Dow Jones industrial average finished higher by 63.94 points, or 0.69%, at 9,344.61.  The broad Standard & Poor's 500-stock index rose 8.49 points, or 0.85%, at 1,003.24, closing above 1,000 for the first time since Monday; the technology-laden Nasdaq composite index gained 16.13 points, or 0.82%, to 1,983.20.  Twenty two of the thirty DJIA components advanced.

Although stocks traded in a tight range yesterday, the final hour of trading witnessed activity as traders picked up technology and financial stocks.  Better-than-expected results from retailers signaled consumers were beginning to open their wallets.  Gold prices extended their recent gains, and almost touched the psychologically-significant $1000 level, before giving up some gains to settle at $995.80, its highest since February.  The Vix volatility measure eased 6.2% to close at 27.10, signaling the moods were more sanguine than before.  On the New York Stock Exchange, 1.16 billion shares exchanged hands.

Nevertheless, retailers surprised yesterday.  Retailers' comparable sales data posted ahead of expectations for a 3.8% decline in August, although still off 2.9%.  Retailers' shares rose 2% as a group, with Gap (NYSE:GPS) up 7.6%, Saks (NYSE:SKS) rising 7.5%, Aeropostale (NYSE:ARO) 7%, Costco (NASDAQ:COST) 6.6%, Target (NYSE:TGT) 1.7%, Wal-Mart (NYSE:WMT) 1.6%.  Shares of Abercrombie and Fitch (NYSE:ANF) dropped 3.5%. 

The advance in the DJIA was led by financials and basic materials shares, with Bank of America (NYSE:BAC) rising 3.5% and JP Morgan (NYSE:JPM) up 3.1%.  Among the ten S&P500 industry groups, financials and basic material shares advanced 2.2%, and were the leading gainers. Indications that credit markets are showing sings of softening helped financial stocks.  Meanwhile, resource stocks rallied on expectations for continuing China growth. Alcoa (NYSE:AA) jumped 4.0% and the company’s CEO raised China's aluminum demand projection to 4% growth this year from flat.  Caterpillar (NYSE:CAT) rose 3.5% to $45.04.

• Boeing (NYSE:BA) shares responded to a report its Dreamliner 787 initial flight may occur in late to early November

• JM Smucker (NYSE:SJM) reported second quarter earnings of 92 cents a share ex-items, 12 cents better than expected, on revenues of $1.051 billion versus estimates of $1.04 billion. The company expects fiscal 2010 sales of about $4.5 billion versus consensus estimates of $4.55 billion, and earnings per share ex-items of $3.65 to $3.80 a share

Shanghai's main index jumped 126 points, or 4.5%, to 2,911.58, while Japan's Nikkei 225 stock average climbed 179.41 points, or 1.8%, to 10,383.41.  Hong Kong's Hang Seng rose 374.63, or 2%, to 20,336.36.  South Korea’s Kospi advanced 2% to 1,576.39.

Stock futures pointed to a higher open on Wall Street Thursday.  Dow Jones industrial average futures rose 24, or 0.3%, to 9,300. Standard & Poor's 500 index futures edged up 3.70, or 0.4%, to 1,000.80, while Nasdaq 100 index futures rose 3.50, or 0.2%, to 1,602.25.

On Wednesday, the unexpected drop in crude inventories helped U.S. stocks wipe off early losses and finish the day with gains of less than 1% as investors looking for reassuring sings picked up oil and other commodity stocks.  Rumors that the Obama Administration was considering a second stimulus package also helped sentiments on the Street yesterday.  However, the rumors were later dismissed, with White House spokesman Gibbs noting, "There is no imminent economic announcement."

The 30-stock Dow Jones industrial average added 61 points, or 0.7%, to close at 9,279.16.  The NASDAQ added 13.32 points, or 0.7% for a close at 1,969.24, and the S&P500 ended 6 points higher at 996, up 0.7%.  Volume remained light with only 988 million shares trading on the NYSE and advancing shares ahead of decliners by a 3-to-2 margin.

On the earnings front, the picture was mixed as Hewlett-Packard (NYSE:HPQ), Deere (NYSE:DE) and PetSmart (NASDAQ:PETM) reported earnings that beat expectations, but outlook from these companies disappointed.  Some retailers, though, were optimistic, with BJ's Wholesale (NYSE:BJ) and Limited (NYSE:LTD) offering improved yearly outlook.

Among S&P500 industry sectors, oil and gas shares advanced 1.9% and were the leading gainers.  DJIA components Chevron (NYSE:CVX) and ExxonMobil (NYSE:XOM) moved higher, up 1.8% and 2.3%, respectively.  Commodity-related issues were not far behind, with basic material shares up 0.9%, following the broad-based gain in commodities. Freeport-McMoRan (NYSE:FCX) shares surged 2.7%.  However, Alcoa (NYSE:AA) led the decliners on the DJIA after Goldman Sachs (NYSE:GS) downgraded the stock, citing Alcoa's (NYSE:AA) recent appreciation and advised rolling positions into Freeport-McMoRan (NYSE:FCX), which is on its Conviction Buy List.

Health care issues advanced 1.3%, as Merck's (NYSE:MRK) 2.5% advance led DJIA component gains. A New Jersey court upheld the firm's patent for asthma drug Singulair, and ruled against Teva Pharmaceuticals (NASDAQ:TEVA).

Despite the day's reported increase in weekly mortgage applications, financial shares failed to gain in the market advance, and eased 0.03%. News of last week's rise in mortgage applications on increased refinancing requests did not have an impact on financial shares.  Bank of America (NYSE:BAC) shares dropped 0.9% and JP Morgan (NYSE:JPM) eased 0.7%.

Retailers scheduled to report include: Barnes and Noble (NYSE:BKS), GameStop (NYSE:GME), HJ Heinz (NYSE:HNZ), Hormel Foods (NYSE:HRL), Ross Stores (NASDAQ:ROST), Sears Holdings (NASDAQ:SHLD), and Gap (NYSE:GPS).

Company Description

The Gap, Inc. is a global specialty retailer which operates stores selling casual apparel, personal care and other accessories for men, women and children under the Gap, Banana Republic and Old Navy brands. The company designs virtually all of its products, which in turn are manufactured by independent sources, and sells them under its brand names.

Another "Surprise"

When a company has beaten the consensus estimate in all but one quarter for the past 5 years it is hard to call it a surprise. On May 21 Gap announced its first quarter results that beat expectations. Earnings per share came in at 31 cents, a penny more than expected.

Overall sales dipped roughly 7% to $3.13 billion, but online sales great 13% to $267 million.

Estimates Risings

Following the recent earnings news analysts began raising forecasts. The consensus for fiscal 2010 is now $1.24, up 17 cents over the past 3 months. Estimates for 2011 are now averaging $1.33, up 16 cents over that time span.

Given these levels, earnings are expected to dip 7% this year, but should bounce back 7% next year.

Topping the Industry

Gap is the number one apparel retailer and when looking at the financials it is no surprise. The company carries no debt and tops its peers in several key categories. Gap's profit margin is 6.5%, triple the industry average. The company generates a return on equity of 21.4%, well above the norm for the industry of 7.9%.

The Chart

In a very cyclical industry Gap has managed to provide consistent earnings results. The company has beat forecasts in every quarter except one in which they met expectations.

Zacks Investment Research

* A Washington Post article said the administration if preparing to send General Motors (NYSE:GM) into bankruptcy as soon as next week: however, Treasury officials advised the June 1 deadline will remain

* AIG (NYSE:AIG) CEO Liddy announced plans to leave the company as soon as a replacement is found

* Citigroup (NYSE:C) announced likely savings of over $1 billion from technology savings this year

* Johnson & Johnson (NYSE:JNJ) announced plans to purchase Cougar Biotech (NASDAQ:CGRB) for $1 billion, or $43 per share

* Sears Holding (NASDAQ:SHLD) reported earnings of 38 cents per share, ex-items, versus last year's 43 cent per share loss, and up from Street estimates of an 88 cent loss

* Gap (NYSE:GPS) announced first quarter earnings of 31 cents per share, one cent above Street estimates, versus 34 cents a year ago, on inline revenues of $3.13 billion

* Campbell Soup (NYSE:CPB) reported third quarter earnings of 48 cents per share, versus Street estimates of 42 cents and up from 43 cents a share a year ago, despite a sales decline of 10% to $1.7 billion. The company said it expects full year adjusted earnings growth of 5-7% from 2008

The easiest thing to do is to pull down the CBO's measure (interpolated to quarterly frequency). This yields the following picture (in logs):

Two observations: (i) recessions do not necessarily coincide with negative output gaps (although they do seem to coincide with the beginning of periods of negative output gaps); and (ii) recoveries do not always coincide with positive output gaps.

This is obvious when one thinks about it, given the NBER BCDC definition of a recession as the following:

A recession is a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales. A recession begins just after the economy reaches a peak of activity and ends as the economy reaches its trough. Between trough and peak, the economy is in an expansion. Expansion is the normal state of the economy; most recessions are brief and they have been rare in recent decades.

That is a recession is the description of the first derivative of output taking on a negative value, while an output gap is a description of output relative to the output level consistent with the "normal" utilization of factors of production (also "full-employment"). For details of how CBO calculates potential GDP, see this document.

Looking at the last ten years provides another insight.

The US economy only barely made it close to full-employment in the expansion of 2001-2007/8/?, and is now declining again. I think I had realized this (especially in the course of various past debates over the surge in tax receipts, which I think has now been resolved -- see [1], [2] for a recollection.)

As I noted in the beginning of this post, I was finding it difficult to discern the most appropriate measure, so I will share the other measures I have investigated as indicators of potential (or "trend") GDP (which can then be used to calculate corresponding measures of the output gap): (1) the Hodrick-Prescott filter; (2) the Band Pass filter; and the quadratic time trend.

The Hodrick-Prescott filter is a ubiquitous two-sided filter used in time series macroeconometrics and elsewhere (I've even seen it used in the analysis of temperature data! [3]). Essentially, the HP filter calculates a trend that minimizes the weighted sum of squared deviations from trend, and squared changes in the the growth rate of the trend. This weighting is controlled by a parameter which is usually set at 1600 for quarterly data. As a public service, I'll note there are serious hazards associated with this filter, especially when trying to correlate various macro series that have been put through the same filter [4].

There is an additional problem (which is often ignored), namely that the HP filter is two-sided, so that running the filter up to the end point of data will tend to result in the trend being too close to the last data point (in our case, the output gap will be pulled to zero).

There are several band pass filters; the one most commonly used in the macroeconometric literature is the Baxter-King version.

Band pass filters are called this because (in the frequency domain) they pass through any cyclical components within a particular frequency band, and elimates the others. In the time domain, this means fluctuations that are shorter or longer than a specific length are ignored. In the business cycle area, then, in order to use this filter, one would have to have a prior on how long a "typical" business cycle is. More on both the HP and BP filters can be found in Tim Cogley's entry for the New Palgrave Dictionary of Economics [5].

The final means of identifying the output gap is to the simplest (at least in implementation) -- take the deviation from an estimated quadratic trend in time. This is not an uncommon procedure, but if you are pretty confident there is a unit root in log GDP, you might feel a little queasy about doing this [6]. But for completeness' sake, I'll show what happens when you do this as well.

Note that in order to circumvent the two-sided filter aspect of the HP filter, I have done a standard fix, which is to use an ARIMA(1,1,1) on log GDP over the 1980-08q1 period to dynamically forecast out 12 quarters, and then apply the HP filter to this "extended" series. I could have done a similar procedure for the BP filter, but opted to use the Christiano and Fitzgerald (2003) one-sided asymmetric version of the band pass filter to estimate the trend series.

First, the good news. Using the band pass filter, one finds that the output gap is still positive, at less than one percentage point of GDP in 2008q1. The HP filter indicates an essentially zero output gap. The quadratic trend indicates something similar to what the CBO indicates -- something close to a 2 percentage point negative output gap in 2008q1, versus 1.5 percentage points for CBO.

I don't want to say that there is one best version. Variations in the sample period, and the parameters used in each filter, will change the results. And of course, data revisions will mean the real-time output gaps will differ from the final revised output gaps we estimate today using either mechanical or judgmental approaches. For a pessimistic view regarding real time use, see Orphanides and van Norden (2004) [pdf].

Nonetheless, the distinction between the rate of change in economic output, and where output levels will gravitate to (and at what pace) is a useful one. And I think it will become of greater usefulness as the slowdown ends, if and when growth resumes. In particular, I'm thinking of whether the pattern of smaller -- but more persistent -- ups and downs continues (the half life of a deviation from potential has risen from 8 quarters in the 1970-90q1 period to 11.6 quarters in the 1990q2-2008q1 period).

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