Last week stocks continued their advance with the DJIA gaining 1.6% and the S&P 500 2.1% supported by better than expected consumer confidence readings on Friday. Since consumer spending represents about 70% of U.S. GDP this is a key indicator for continued economic growth. Also, last week CPI numbers were released and inflation continues to be tame with prices up from a year earlier by 1.1% well under the Fed’s target of 2%.
However, rates on the 10 year Treasury hit 1.95% on Friday as some Fed officials publicly start to question when and how to end the Fed’s program of quantitative easing. The Fed’s program of purchasing $85 billion a month in mortgages has helped the housing industry and home prices. The timing and the speed of any reduction in easing by the Fed will be crucial in its impact on stock and bond prices. Hopefully the fed will time it perfectly just as the economy is on a sustainable growth path.
Today’s history – 1932 Amelia Earhart leaves Newfoundland as the 1st woman to fly solo across the Atlantic.
“Never interrupt someone doing what you said couldn’t be done.”
- Amelia Earhart
Discussions have been increasing about stocks being overvalued. It is true that last week the U.S. equity markets hit another record high, but that was not on an inflation adjusted basis. We see this as encouraging given stocks tend to beat inflation by a wide margin over time, especially when you reinvest dividends. According to Yale University finance professor Robert Shiller, the S&P 500 hit its all-time high in early 2000. To surpass this previous peak on an inflation adjusted basis, the S&P 500 would have to appreciate another 20+ percent to 2,000 versus Friday’s closing price of 1,634 (See chart below).
From another perspective, rising stock prices seem to be thawing out the initial public offering market. Year-to-date 64 companies have become publicly traded enabling them to raise $16.8 billion. This is an increase over last year-to-date but is well below the peak in the 1990s. More IPOs show investor confidence in the equity markets and the economy. This in turn gives companies the funding access required to grow their businesses, and, in turn, their stock prices.
“No matter how good you get you can always get better and that’s the exciting part.”
- Tiger Woods
The S&P 500 hit yet another all-time high last week on better-than-expected U.S. jobs data and global monetary news.
The S&P 500 closed higher by 2% last week to close at 1,614.42. Likewise, the Dow Jones Industrial Average gained 1.8% for the week to close at a record high of 14,973.96. The NASDAQ, far from its record high, moved ahead 3.1% for the week to finish at 3,378.63. The push higher last week was prompted by better-than-expected U.S.jobs data as April non-farm payrolls came in at 165k with expectations of 140k. The European Central Bank provided further good news as the ECB cut interest rates by 0.25% along with commentary indicating a willingness to provide more stimulus, if needed.
Bonds traded lower last week as yields rose in response to U.S. jobs data and ECB monetary actions. The benchmark 10-year treasury closed the week at a yield of 1.73%. The Barclays Aggregate Bond Index is now up 0.62% for the year-to-date period.
Market valuations are no longer a bargain at 15.4x trailing EPS of $105 (2Q12-1Q13). We see the markets as more-or-less fairly valued. Despite valuations, we continue to favor equities as we do not see any other assets that we like better than equities. We would not be surprised to see the market trade sideways or lower for the next few months as is typical for this time of year (see chart below).
“In the business world, the rearview mirror is always clearer than the windshield.”
- Warren Buffett
Investors remain puzzled by the buoyancy of the stock market in the face of a sluggish economy. After a very weak fourth quarter, consensus for Q1 2013 had bounced up to 3 percent growth, so that the first go around release of 2.5% disappointed economists. As a result focus moved to all the negatives that have been noted-weak southern Europe, slower France and Germany, questionable China, uncertain U.S. consumer spending and on and on.
What has been impressive is the U.S. companies’ ability to handle the sluggish revenue picture by delivering good bottom line results. Bellwether General Electric for example reported profit improvement of around 16% as against a very modest revenue increase. 52% of companies reporting so far have exceeded expectations. The explanation – cost cutting. Companies have done this by keeping their head count down and controlling capital spending. Of course this does little to help the effort to reduce unemployment. Dividend increases have been meaningful, as witnessed last week by Apple’s fifteen percent dividend boost.
We would proffer two other explanations for this good stock market – the extremely loose monetary policy by Mr. Bernanke, “don’t fight the Fed,” and the other adage, “don’t fight the tape.” One more explanation – rates on money markets and bonds offer little competition at their current levels. In this light climbing the wall of worry is more manageable.
“Expect the best. Prepare for the worst. Capitalize on what comes.”
- Zig Ziglar
Global growth concerns pressured the market last week. China reported that its first quarter GDP grew 7.7%, which was less than its expected growth of 8%. Coca-Cola and Johnson & Johnson provided some mid-week earnings support, but energy, homebuilding and commodity-related companies slumped. Lower precious metals and energy prices dragged down their respective industries, but did lay the groundwork for lower inflation and a longer-lived domestic industrial revival.
We are in the thick of earnings season, and the market is reacting in its typical schizophrenic fashion. Just over 100 of the S&P500 companies have reported. Although there have been several prominent misses [such as IBM], ~70% of reporting companies have “beaten” forecast results. Reported revenue is lagging, due to pressure on bank’s net-interest-margin, lower commodities prices and foreign exchange pressure from a stronger dollar.
In addition to earnings, economics and energy, the markets’ tone last week was impacted by the terrorist bombing during the Patriots-Day running of the Boston Marathon. Describing the personal tragedies is beyond the scope of this update, but our emergency response and investigative response was exemplary. The support of the citizenry was [and is] inspiring. Let’s observe a moment of silence and relive the scene in the Garden Wednesday evening as Rene Rancourt led the sold out audience in a unifying rendition of our National Anthem.
“America was not built on fear. America was built on courage, on imagination, and unbeatable determination to do the job at hand.”
-Harry S Truman
Last week the S&P 500 finished up 2.3% boosted by the positive news that unemployment claims were much lower than expected. First quarter GDP estimates have also been rising with forecasters now estimating growth at around 3%, substantially better than 4Q 2012. However Friday’s retail sales figures were disappointing at – 0.4% and consumer sentiment numbers also fell. Consumers may now be starting to feel the effect of higher taxes on their pocketbooks.
This week earnings reports for the first quarter begin in earnest and analysts have been estimating growth of only about 1.5% for the quarter and the number of companies issuing lowered earnings forecasts has been higher than average. So look for continued below trend economic growth.
“I have been impressed with the urgency of doing. Knowing is not enough; we must apply. Being willing is not enough; we must do.”
-Leonardo da Vinci
Last week the S&P 500 fell 1.01%. This was only the third negative weekly close of 2013, but it was the worst week since the 1.94% plunge at the end of last year. Despite the decline, investors continued to add exposure to equity based funds. For the 1st quarter equity funds experienced net new inflows of $78.9 billion close to the 1990 quarterly record of $80 billion.
Part of last week’s decline was due to the weak March employment report. Job gains decelerated to their slowest pace since last June when investors were faced with a flare up of sovereign risk concerns. The unemployment rate slipped to 7.6%, but only because the labor force participation rate fell to a new low. However, one month does not necessarily mark the start of a new trend, because underlying private domestic demand is strengthening, led by housing. In the interim, concerns about yet another Q2 slowdown will keep monetary policymakers on track with the current pace of asset purchases.
“Pennies do not come from heaven. They have to be earned here on earth.”
The S&P 500 hit an all-time high last week so don’t worry, be happy … at least that’s what the markets have been telling us lately. We suspect that the markets will likely push higher into year-end, but it is not unreasonable to expect a 5% or so pullback in the weeks and months ahead.
The S&P 500 closed higher by 0.8% last week as the broad index surpassed its previous peak from 2007. The NASDAQ finished ahead 0.7% while the Dow Jones Industrial Average gained 0.5% for the week. The push higher last week was prompted by better-than-expected U.S. gross domestic product growth of 0.4% (ahead of expectations of 0.1%). Investors also cheered strong U.S. housing data – the largest housing price gain since 2006.
Bonds rallied last week as news of the Cyprus bailout (bail-in?) rattled investors and led to a flight-to-safety into U.S. treasuries. The benchmark 10-year treasury closed the week at a yield of 1.85%. It is a bit unsettling; to say the least, that actions by the European Union could lead to a 60% haircut for some depositors in Cyprus banks. Eurogroup President Jeroen Dijsselbloem caused quite a raucous when he exclaimed that the Cyprus plan could be a blueprint for future EU bailouts. Dijsselbloem recanted only after he was lambasted by the press for his perfunctory comments.
Market valuations are still reasonable at 14.5X 2013 EPS estimates; however, we suspect that S&P 500 earnings will move lower to $106 or so … at that point the markets would be more or less fairly valued. The Fed is still on our side so don’t worry, be happy.
“Time is free, but it’s priceless. You can’t own it, but you can use it. You can’t keep it, but you can spend it. Once you’ve lost it you can never get it back.”
- Harvey MacKay
European officials have once again come up with a Cyprus bailout plan. This time the plan will protect deposits up to E100,000 but will result in large depositors taking a haircut of 30% to 70% or more. At least one bank [Cyprus Popular] will be liquidated. The Bank of Cyprus will likely survive, but in an altered form. The Cypriot economy [only E17.5B] will experience a significant recession, probably down 25%+ peak to trough. Finally, the size of Cyprus’ surviving financial system will be much smaller.
However, Monday’s trading day suggested that the painful Cypriot rescue plan will be a template for several other Eurozone economies. The Cypriot banks will not open Tuesday [Thursday is now the target opening date]. This delay is making things worse, suggesting that restrictions on financial flows to and from Cyprus will be in place for weeks if not months.
It is becoming harder for Europeans to kick the can down the road. This makes the US dollar a safe haven, and gives our banks, with their fortress-like balance sheets, a golden opportunity to gain share around the world.
“Procrastination is opportunity’s natural assassin.”
A better way to put it, beware of Cypriots having their deposits taken by fiat – 6.75% of deposits under E100,000 and 9.9% on those over E100,000. This is certainly a most unique way to structure a bailout, one that must have kept the EU, ECB and IMF officials working long hours. It turns out Cyprus has been a favored spot for agile Russian funds to park. It’s not surprising then that Putin characterized the plan as “unfair, unprofitable and dangerous.” The plan requires approval by the Cypriot parliament; we think it probably will not pass in its current format.
A longer term problem is one of perception- the perception that the richer European nations feel comfortable beating up on the poorer and smaller (in this case). Cyprus has been told to come up with E5.8 billion as their contribution to the bailout plan. It’s not yet clear how this can be done if the deposit-snatching plan gets hung up.
Meanwhile the U.S. economy and markets have been flourishing- housing has been healthier, industrial production strong, and unemployment claims and new jobs much better. Negatives have been consumer sentiment and gasoline prices. On balance the numbers are positive and one Wall Street firm bumped up their 2013 GDP growth estimate to 3.0% from 1.5%.
“Don’t measure yourself by what you have accomplished, but by what you should have accomplished with your ability.”
- John Wooden