Weekly Stock Market Update—March 22, 2013
By Steve Scranton, SVP, CFA
Chief Investment Officer

Fixed Income Update

Last week-end European Finance ministers agreed to give Cyprus €10 billion out of a need for €17 billion to bail out their banks. But they put a condition on these funds by insisting the remainder come from Cypriot depositors. How that would be implemented would be left up to Cyprus. Initially, they were going to tax all depositors both large and small. That was last weekend. Throughout the week, there has been much behind the scenes negotiations as protests in Cyprus have temporary stopped the tax. In the meantime, Banks in Cyprus have been closed all week and are now scheduled to open Tuesday. The reason they are closed is the fear of massive outflows from the banking sector.

These developments have caused fear that the same could happen in other countries thus harming those depositors. The end result is a flight to safety out of countries such as Greece and Spain into Germany and the U.S. although the magnitude has been relatively muted so far. How the events in Cyprus will be settled is still undecided. We could see Cyprus tax depositors, sell natural resources (to Russia), re-capitalize a bank (with a Russian bank), or even default and leave the Euro. With this uncertainty, geo-political risk is keeping U.S. interest rates at the low end of this week’s range. U.S. Treasury yields ranged from unchanged to decreasing 7 basis points.

For those interested in how and why this is happening, please read further.

Cyprus is a tiny island situated between Greece, Turkey and Israel, with a GDP of €18 billion and shrinking. Its main industry is serving as a banking and vacation spot, with a reputation for appealing to wealthy Russians of questionable repute. Cyprus has already received over €2 billion in aid from Russia, but that failed to stem the tide. With rumors of a depositor haircut floating around for weeks, funds had been flowing out of Cypriot banks, exasperating the situation. An EU finance meeting was called for the end of last week, with Cyprus’s banks estimated to need €17 billion. Meanwhile, the Northern European creditor nations, led by Germany, were weary of listening to EU economists, who, in their mind, had completely botched the estimates on the Greek bailout. While Brussels was against forcing losses for all depositors, the IMF was insisting their participation. It appears that the Germans would rather listen to the IMF than the European Commission.

Before the EU bailout meeting last week, Germany and other EU members had worked out the €10 billion figure and were insisting on the remainder coming from Cypriot bank deposits. Cyprus is synonymous with Russia to northern Europeans; so a Cypriot bailout would equate to a Russian bailout. Also, keep in mind, it is a German election year and this type of action makes Merkel look strong. The Cypriot president was given the €10 billion figure as non-negotiable. To compound the situation for Cypress, the European Central Bank (ECB) also informed him that a large Cypriot bank’s capital structure had just dropped below the ECB’s minimum requirements and would be cut off from being able to borrow from the ECB. That forced Cyprus to accept the terms of the bailout. As of Friday, negotiations continue in an effort to find a resolution that is acceptable to all parties.

Company Spotlight

Issued $7.25 billion of 5 and 10 year debt. Hold / Hold
Reported quarterly earnings. Buy / Buy
Issued $2 billion in 3 year floating rate notes. Buy / Buy

March 23, 2013

Current Last Week Week Change Last Year Year Change
Tax-exempt MMF 0.10 0.09 0.01 0.23 -0.13
Taxable MMF 0.07 0.07 0.00 0.25 -0.18
2-Year Treasury 0.25 0.25 0.00 0.37 -0.12
5-Year Treasury 0.79 0.83 -0.04 1.12 -0.33
10-Year Treasury 1.92 1.99 -0.07 2.28 -0.36
30-Year Treasury 3.14 3.21 -0.07 3.36 -0.22
5-Year Exp. Inflation 2.33 2.41 -0.08 2.07 0.26
2-Year Agency 0.32 0.31 0.02 0.46 -0.14
5-Year Agency 0.98 1.00 -0.02 1.39 -0.42
10-Year Agency 2.35 2.40 -0.05 2.92 -0.57
2-Year Corporate* 0.67 0.65 0.02 1.27 -0.60
5-Year Corporate* 1.68 1.70 -0.02 2.52 -0.84
10-Year Corporate* 3.11 3.16 -0.05 3.94 -0.83
30-Year Corporate* 4.37 4.43 -0.06 4.90 -0.53
2-Year Municipal** 0.43 0.42 0.01 0.49 -0.06
5-Year Municipal** 1.07 1.07 0.00 1.28 -0.21
10-Year Municipal** 2.35 2.33 0.02 2.68 -0.33
30-Year Municipal** 4.05 4.03 0.02 4.37 -0.32
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*** $82.38 $82.26 $0.12 $79.74 $2.65
CRB $294.70 $296.44 -$1.74 $312.27 -$17.57
Gold $1,607.20 $1,592.60 $14.60 $1,642.50 -$35.30
Crude Oil $93.76 $93.45 $0.31 $105.35 -$11.59
Unleaded Gasoline**** $3.05 $3.16 -$0.11 $3.00 $0.05

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

Stock Market Update

Equity market volatility rose this week and the year-to-date rally paused as investors struggled to reconcile competing events:

  • News and developments on the debt crisis in Cyprus. As part of its bailout plan for Cyprus, the European Union (EU) early in the week said it would impose taxes on Cypriot bank deposits to help pay for the country's bailout. EU officials noted that this measure would only be put in place for Cyprus, but the news stoked concern that: 1) savers in larger European countries could become nervous and start withdrawing funds–thus threatening the stability of the region’s banks; and 2) a collapse of Cyprus’ banking system could tighten credit across Europe and become another hurdle in the region's struggle to address its credit crisis. Investors were relieved on Tuesday when Cyprus’s parliament voted against the proposed bank-deposit levy. However, efforts to rescue the country were left unresolved. Later in the week, the European Central Bank (ECB) threatened to end emergency support of the nation's banks next week unless leaders can raise the needed 5.8 billion euros ($7.5 billion) to qualify for 10 billion euros ($12.9 billion) in rescue loans from the EU–and to avoid bankruptcy, collapse of its financial system and a possible exit from the euro. Efforts by Cypriot officials to find alternative aid included a request for help from Russia. Adding to the concern, Standard & Poor's lowered Cyprus' sovereign credit rating deeper into junk status. On Friday, news of a possible pending deal eased concerns. Meetings to consider the details were scheduled for the weekend.
  • News from the Federal Reserve’s (Fed) two-day Federal Open Market Committee (FOMC) policy meeting. The equities market was looking for reassurances on the Fed’s plans for its quantitative easing program–and they were not disappointed. Fed Chairman Ben Bernanke noted that although the U.S. economy has shown improvement in recent months, unemployment remains at a high level. He reiterated that the Fed will continue its bond purchase program until it is convinced the stimulative benefits to the economy can be sustained. Equity investors were soothed by the idea that the Fed will continue to support the economy.

Cyprus' financial crisis and its potential impact on the global economy definitely fueled investor anxiety this week. Uncertainty and a lack of visibility are two characteristics of this situation–and which are very undesirable in the equities market. Investors have become more willing to take on risk since the beginning of the year, in part because of the support which the Fed has provided. The resulting gains have been robust: the Dow Jones Industrial Average (Dow) is up 11.4%, while the S&P 500 has risen by 9.7%. A lack of resolution to the problems in Cyprus could de-stabilize this feeling of confidence, particularly given that these strong gains that have come in such a short time. Investors will be looking for an increase in certainty and visibility in regard to these latest issues in the European debt crisis.

Current Week Month of Feb. YTD
Dow Jones (INDU) -0.01% 3.39% 11.42%
S&P 500 (SPX) -0.24% 2.90% 9.70%
Nasdaq (CCMP) -0.11% 2.75% 7.74%
MSCI EAFE (EAFE) -1.49% 1.42% 5.83%

Updates to the Equities Buy List:

Company Name News Event Impact to Our Company View
MOSAIC CO/THE (MOS) Announced that it will invest up to $1 billion in a joint venture agreement with Ma'aden and SABIC to develop phosphate production facilities in Saudi Arabia, with MOS acquiring a 25% ownership stake. The deal is not final yet, with a definitive shareholder agreement expected in the first half of 2013. Unchanged
ORACLE CORP (ORCL) ORCL reported third quarter operating earnings of $0.65 per share, 4.8% above 3Q 2012, yet below the Street expectation of $0.66 per share. Quarterly revenue results were below analysts' expectations. Unchanged