During the past week, the deepening problem in the mortgage market has sent the markets into turmoil. It will take a while to fully grasp the consequences of the implosion of the subprime market, but it appears that the era of excess liquidity may have ended. Second quarter earnings were generally better than analysts expected; earnings along with economic data took a backseat to the credit concerns.

With 75% of the S&P 500 having reported second quarter earnings, 65% have exceeded estimates and 20.3% have reported earnings that were below expectations. Analysts are expecting earnings growth to hit 9.2% for the second quarter. Just counting those that have reported second quarter results, earnings are up 10.3%. But that does not tell the whole story. The S&P 500 is a share-weighted index, which gives a higher weighting to companies with more shares outstanding. On an equally weighted basis, earnings are up only 6.8% and on a market-capitalization basis, earnings are up 14.6%. Clearly, the big companies are doing much better than the smaller companies. It's likely that international exposure is one of drivers for this difference in results. Larger companies are much more likely to have international sales. Besides global economies being stronger than the US, revenue growth is boosted by translation gains caused by the weak dollar.

Whirlpool's domestic operations were very week with sales down 6% in North America, but international sales were up 18.6%. Almost half its international growth was due to the weak dollar. This was the driver for Whirlpools results, since not only was its U.S. business weak, but higher costs are impacting Whirlpool as well. During the conference call, the company said that it expects raw material and oil-related costs to increase $570 million this year. Just three months ago the company only expected costs to increase $500 million. Higher costs have been much more of a concern lately. We have discussed that because of hedging strategies and long-term supply contracts, companies are more immune to rising prices during the initial phases of a rising price cycle. Now that prices have remained elevated, the supply agreements get renewed at higher prices and hedging strategies become more expensive.

For a long time the weakness in the housing market was contained to the homebuilders. Previously there were pockets of weakness surrounding the homebuilding industry, but in general businesses held up as the housing market weakened. The ongoing weak housing market has started to take its toll on a wider segment of the economy. During the second quarter several companies commented that the weakness in the housing sector adversely impacted their results. Mohawk, the leading flooring manufacturer, reported that sales dropped 4% during the second quarter. While a 4% drop in sales is rather tame, its US operations are being offset by strength in Europe. Its carpet division was down 10% and the company also commented that commercial sales were strong then residential.

DuPont, similar to most other companies changed its stance on the U.S. housing market. During the conference call following the first quarter, DuPont said that, "for U.S. housing we believe we've hit bottom, down from the peak in the first quarter of last year. We're assuming in our outlook a gradual sequential increase in business starting in the second half, but still with negative comps versus last year." On Tuesday, Charles Holliday, CEO and Chairman, said, "I'm not assuming anything improving in North American housing until well into 2008." The company was able to increase prices, which helped earnings per share by thirteen cents. Unfortunately, higher costs reduced earnings per share by fifteen cents. The ethanol boom was apparent it DuPont's agriculture segment. Monsanto's profit jumped 71% from last year as U.S. farmers increased corn planting by 19% this year.

Existing home sales fell 3.8% in June to an annualized rate of 5.75 million. This was weakest month since November 2002 and lower than the 5.86 million homes economists were expecting. Compared to last year, sales were down 13.6%. The median price was slightly increased 0.3% from last year. This was the first positive year-over-year change since July 2006 and is only $100 from the all-time high reached in July 2006. The supply of homes available for sale dropped for the first time this year, which help keep the months supply even with last month at 8.8 months. Perhaps one glimmer of hope for the housing market was that pending home sales rebounded 5% in June. Of course, this is still 11% lower than last year and close to 20% off the highs reached in 2005.

Just as more companies have started to discuss weakening end markets, there has started to be weaker economic data as well. Vehicle sales in July dropped to 15.5 million units. Besides the echo effect following the employee pricing in 2004, this was the first time vehicle sales were below 16 million units in back-to-back months since 1998. Additionally, July marked the first time that the domestic automakers sold less than half the number of vehicles sold. GM sales plunged 22%, Ford's dropped 19% and Chrysler sole 8% fewer vehicles. Even Toyota experienced a 7% drop in sales. This was the first decline Toyota had reported since August 2004.

The employment report on Friday is the key economic report this week. Economists currently expect the Labor Department to report 127,000 were added in July. On Wednesday, the ADP report caused economists to rethink their estimates for Friday's employment report. The payroll services firm reported that only 48,000 jobs were added in July, less than half the 100,000 economists forecasted. Employment growth has moderated over the past since last year when 200,000 jobs were regularly being added each month, but personal income growth as remained strong. Personal income grew 6.1% year-over-year in June and spending increased 5.2% over the past year. Year-over-year income growth has been over 6% for most of the months going back to August 2004.

There is now a greater than 50% likelihood that the Fed will ease before the end of the year. Nominal GDP growth came in at 4.6% on a year-over-year basis during the second quarter. We have mentioned that the correlation between this and the Fed funds target rate is high so this does suggest there is room for the Fed to start cutting rates. Unfortunately, the Fed has to be careful not to stoke inflation. Not to mention the dollar is in a precarious position that would likely come under increased pressure if the Fed decided to start cutting rates.