Weekly Stock Market Update—March 1, 2013
By Steve Scranton, SVP, CFA
Chief Investment Officer

Week in Review

A rise in uncertainty led to increased volatility this week, as equity investors attempted to sort out the week’s news and how it could affect the economic landscape—and individual companies’ opportunities to attain revenue and earnings growth in the future. Daily swings in market action were influenced by various factors.

  • Monday–Dow and S&P 500 down 1.6% and 1.8%, respectively. Equities opened in positive territory on Monday morning on hopes that the weekend’s elections in Italy might yield a future leader supportive of the country’s austerity efforts. Also bolstering sentiment was more acquisition news: this time an offer by the chairman of Barnes & Noble (BKS) to buy its retail business. However, as the day and press reports wore on, stocks sold off sharply. Italian election exit polls showed a deadlock after the general election failed to give any party a parliamentary majority. Potential for another election rekindled concern about the threat of prolonged instability and the prospects of achieving a stable government in Italy— and its ability or willingness to adhere to economic reforms and debt reduction. Adding to the negativity was an increase in worries about the possible economic impact of U.S. spending cuts that will take effect starting Friday if lawmakers fail to reach an agreement on spending issues. The sell-off demonstrated that concern about Europe’s debt struggles have not yet receded.
  • Tuesday–Dow and S&P 500 up 0.8% and 0.6%, respectively. The markets rebounded on Tuesday, bolstered by economic data and comments from Federal Reserve (Fed) chairman Ben Bernanke. On the economic front: 1) the S&P/Case-Shiller home price index for December rose by a better than expected 0.9% and came in better than the 0.6% rise in November; 2) the Conference Board's consumer confidence index for February rose to a much better than expected 69.6 and versus a reading of 58.4 in the prior month; and 3) new home sales in January rose by a strong 15.6%–much higher than the expected increase of 3.0% and improved from the 3.8% decline in sales during December. Fed chairman Bernanke, in testimony before the Senate Banking Committee, strongly defended the Fed’s bond-buying stimulus program, reiterating that the benefits exceed the costs. He also tried to dispel recent concern that these actions might be wound down sooner than previously indicated. However, he also urged lawmakers to avoid the spending cuts set to go into effect, which he warned could combine with tax increases to create a “significant headwind” for the economy.
  • Wednesday–Dow and S&P 500 both up by 1.3%. The week’s equity rally continued on Wednesday as Fed chairman Bernanke remained consistent in his comments before Congress. On day two of his semiannual testimony, which was in front of the House Financial Services Committee, chairman Bernanke again noted the benefits coming from the Fed’s stimulus program—and which outweigh the costs. He also commented that the quantitative easing program continues to have the support of a “significant majority” of the Fed officials–thus diffusing the concern raised last week about whether the stimulus program might be ended earlier than the markets have expected. Adding to the positive tone, data was released showing that pending home sales for January rose by 4.5%–much higher than the expected increase of 1.9% and stronger than the decline of 1.9% experienced in December. On the negative side, durable goods orders for January fell by a greater than expected 5.2%–but which did not seem to phase the equities market.
  • Thursday & Friday–Dow up 0.1%; S&P 500 up 0.2%. The major equity indices treaded water for the rest of the week, as the clock ticked down to the deadline for spending cuts set to begin on Friday. Overall, President Obama and Congress failed to reach a solution. As such, federal spending cuts will be coming. However, they will likely be uneven and lumpy, and may be hard to discern at first. It will remain to be seen over the next weeks and months what will be announced in the way of job losses, spending reductions and furloughs across the nation. Economic data was also mixed during the last two days of the week: 1) the first revision of 4th quarter gross domestic product (GDP) showed an increase to +0.1% from the original -0.1% reading, but was below expectations for the revision to be +0.5%; 2) initial jobless claims declined by 22,000 last week–to 344,000–and coming in better than the expected level of 360,000; 3) personal income for January declined by a greater than expected 3.6%, while personal spending increased by 0.2%–in line with expectations; 4) the final reading for the University of Michigan’s consumer confidence index in February came in modestly better than expected, at 77.6; 5) construction spending for January declined by 2.1%, coming in below the expectations for an increase of 0.4% and below December’s increase of 1.1%; and 6) the Institute of Supply Management’s (ISM) manufacturing index for February came in at an improved 54.2, better than the expected reading of 52.5.

After a strong January, with the Dow and S&P 500 both rising by more than 5%, additional gains were tougher to come by in February. During February, the Dow increased by 1.8%, while the S&P 500 gained 1.4%. These gains may be tested in the coming months, as concern about Europe’s debt situation, federal spending cuts, the economy, and political negotiations over the May debt ceiling deadline continue to ebb and flow–and exert pressure on sentiment.

Current Week Month of Feb. YTD
Dow Jones (INDU) 0.68% 0.25% 8.04%
S&P 500 (SPX) 0.22% 0.23% 6.86%
Nasdaq (CCMP) 0.27% 0.30% 5.18%
MSCI EAFE (EAFE) 0.57% #VALUE! 4.35%

Updates to the Equities Buy List:

Company Name News Event Impact to Our Company View
HJ HEINZ CO (HNZ) / MEAD JOHNSON NUTRITION CO (MJN) On 02/26/2013 we removed Heinz (HNZ) from the large cap equity buy list, replacing with Mead Johnson Nutrition (MJN). Sell/Purchase
HOME DEPOT INC (HD) HD reported fourth quarter adjusted earnings of $0.67 per share, $0.03 better than the Street estimate, and raised the quarterly dividend to $0.39 per share, up from $0.29. Further, the company provided full year 2013 guidance that exceeded anyalysts' expectations and announced a $17 billion share repurchase authorization. Unchanged
AMERICAN TOWER CORP (AMT) Fourth quarter operating earnings of $0.34 per share were below the consensus estimate of $0.42. Unchanged
MYLAN INC (MYL) MLY reported 4Q 2012 operating earnings of $0.65 per share which topped the Street expectation of $0.64. Additionally, the company announced an agreement to acquire Agila Specialties Private Limited, the generic injectable product segment of Strides Arcolab Limited, for $1.6 billion cash plus $250 million in contingent payments. The transaciton is expected to close in fourth quarter 2013. Unchanged

Fixed Income Update

U.S. Treasury yields seem to be breaking through the tight range that they have been stuck in for the last two months. The combination of political uncertainty in Italy, comments from Federal Reserve Chairman Ben Bernanke, weaker economic data, and sequestration concerns have moved yields 2 to 11 basis points lower.

Activity picked up on Tuesday following election results in Italy where no party won a majority in the Senate. The concerns that Italy will back track on the austerity programs and reforms that Prime Minister Monti had started to put in place might fall apart led Italian yields much higher and started a flight to quality that benefited U.S. Treasuries.

Ben Bernanke weighed on eventual quantitative easing exit strategies while speaking to Congress. The plan had been to stop reinvesting some or all principal payments from its securities, revise its interest rate outlook, raise the federal funds rate and then start selling housing debt to eliminate it from the central bank’s portfolio in three to five years. The one comment he added this time was that he said they could hold some of the securities a little longer or just let them run off (mature). This was a little surprising to the market and eased some selling pressure.

Finally, adding to the drive to lower yields was weaker economic data. Even though global economic data was mixed, the weaker reports are getting the focus. China, Italy, U.K., and the U.S. all had weaker manufacturing numbers.

Over the last few weeks we have heard many reports in the media about what the consequences of the governments forced sequester will be that goes into effect today.

While the sequester is widely advertised as cutting spending over a ten year period, there is no actual reduction in overall spending levels. Rather, the sequester slows the overall growth in spending slightly between 2013 and 2023, with spending increasing by $2.40 trillion during that time period instead of the $2.54 trillion without it.

Federal spending would go up under sequestration. That’s mainly because the spending cuts heavily target the discretionary side of the budget, leaving programs like Social Security, Medicare and Medicaid (the main drivers of our future debt) almost untouched. As a result, the impact of sequestration on overall federal spending represents a small reduction in the growth of spending rather than an actual spending cut.

Putting the sequestration cuts into perspective, only $44 billion of the $85 billion sequester will be cuts in actual federal outlays for 2013. This pales in comparison with the projected $3.553 trillion of spending. We will continue to hear many stories such as the following: The Federal Bureau of Prisons would cut $338 million, furloughing 36,700 staff. This will endanger the safety of staff and over 218,000 inmates. It will be interesting to see what happens and what doesn’t. But while there is no doubt that some of the cuts will be tough on some interest groups, in particular the ones who are the most dependent on government spending, the impact is likely to be much smaller than these warnings would suggest.

From the bond market’s perspective, anything that reduces the amount of debt that the Treasury has to issue is an overall positive.

Company Spotlight

PEPSICO INC (PEP)
Aa3/A/A
Sold $3.75 billion of 3 and 10 year debt. Buy / Buy
BERKSHIRE HATHAWAY-BLK CEDEA (BRKB)
Aa2/AA+/AA
Reported quarterly earnings. Buy / Buy

March 1, 2013

Current Last Week Week Change Last Year Year Change
Tax-exempt MMF 0.12 0.12 0.00 0.28 -0.16
Taxable MMF 0.07 0.07 0.00 0.22 -0.15
2-Year Treasury 0.23 0.25 -0.02 0.29 -0.06
5-Year Treasury 0.75 0.83 -0.08 0.89 -0.14
10-Year Treasury 1.85 1.96 -0.11 2.03 -0.18
30-Year Treasury 3.06 3.15 -0.11 2.03 -0.18
5-Year Exp. Inflation 2.30 2.32 -0.01 2.08 0.23
2-Year Agency 0.28 0.29 -0.02 0.40 -0.12
5-Year Agency 0.91 0.98 -0.07 1.18 -0.26
10-Year Agency 2.28 2.35 -0.08 2.69 -0.41
2-Year Corporate* 0.65 0.66 -0.01 1.26 -0.62
5-Year Corporate* 1.63 1.70 -0.07 2.35 -0.72
10-Year Corporate* 3.05 3.12 -0.07 3.77 -0.72
30-Year Corporate* 4.29 4.35 -0.05 4.80 -0.50
2-Year Municipal** 0.43 0.44 -0.01 0.45 -0.02
5-Year Municipal** 1.01 1.06 -0.05 0.95 0.06
10-Year Municipal** 2.23 2.28 -0.05 2.25 -0.02
30-Year Municipal** 3.95 3.99 -0.05 2.25 -0.24
Fed Funds 0.25 0.25 0.00 0.25 0.00
Prime Rate 3.25 3.25 0.00 3.25 0.00
Dollar*** $82.27 $81.48 $0.78 $78.79 $3.48
CRB $290.36 $293.52 -$3.16 $324.32 -$33.96
Gold $1,575.80 $1,572.80 $3.00 $1,722.20 -$146.40
Crude Oil $90.88 $93.13 $3.00 $108.84 -$17.96
Unleaded Gasoline**** $3.14 $3.27 -$0.13 $3.02 $0.12

Note: Agency and Municipal yields are as of the previous business day.
* Composite A
** General Obligation AA+
*** Int'l value of the U.S. dollar (Avg. exchange rate between the dollar and 6 major world currencies).
**** Futures price per gallon