Weekly Stock Market Update—May 10, 2013
By Steve Scranton, SVP, CFA
Chief Investment Officer

Stock Market Update

The 2013 stock market rally continues its nearly uninterrupted upward trek. This week, the Dow Jones Industrial Average (Dow) rose by 1.11%, while the S&P 500 tacked on a gain of 1.29%. This brings year to date gains for the Dow and S&P 500 to 16.43% and 15.43%, respectively.

At the beginning of the week, an absence of new economic news and corporate earnings releases got the market off to a slow and quiet start. However, upside momentum built in the middle of the week. Although first quarter corporate earnings season is beginning to wind down, investors still responded positively to some better than expected earnings reports. The week’s most noteworthy economic report, initial jobless claims, declined by 4,000 in the prior week–to 323,000—and came in lower than the expected reading of 335,000. Of note, the prior week’s claims of 324,000 were revised up, to 327,000.

First quarter earnings data has been at the forefront of investors’ minds since early April. As of Friday, 441 of the S&P 500 companies have reported their earnings results. As we had noted at the beginning of April, the investment community was looking for first quarter earnings to grow at a modest 1.1% year/year. This expectation had come down meaningfully: in October, 7.1% growth was forecast. As such, corporate America had a much lower hurdle to clear–which they did. Overall, first quarter earnings growth for the S&P 500 companies came in at +5.1% year/year. On the other hand, revenue trends did not exceed expectations. Revenue came in at 0% year/year, missing the expected anemic 1.0% growth rate. Corporate America once again found ways to extract costs out of their operations and grow their bottom line (earnings results) in spite of no help from revenue growth (top line).

Stocks continue to achieve record levels. This week, the Dow broke through the 15,000 level for the first time and the S&P 500 touched a record intraday high at 1,626.03. Both indices have posted gains every month this year. They have also defied predictions by some that a lack of positive catalysts and mixed economic data will cause an imminent pullback or correction. With the Federal Reserve (Fed) continuing to support the economy through its current quantitative easing program, it appears that the market’s upward momentum may be more enduring than some have expected.

Current Week Month of May YTD
Dow Jones (INDU) 1.11% 2.04% 16.43%
S&P 500 (SPX) 1.29% 2.39% 15.43%
Nasdaq (CCMP) 1.79% 3.35% 14.31%
MSCI EAFE (EAFE) 1.20% 1.06% 12.01%

Updates to the Equities Buy List:

Company Name News Event Impact to Our Company View
NATIONAL OILWELL VARCO INC (NOV) / VALERO ENERGY CORP (VLO) On 5/6/13 we sold National Oilwell Varco (NOV), replacing with Valero Energy Corp (VLO). Sell/Purchase
WALT DISNEY CO/THE (DIS) DIS reported fiscal second quarter operating earning of $0.79 per share, better than the Street estimate of $0.77, and well above earnings of $0.58 per share a year ago. Unchanged
INTL BUSINESS MACHINES CORP (IBM) IBM raised its quarterly cash dividend to $0.95 per share, from $0.85, and added $5 billion to its current stock repurchase program. Unchanged
MICROSOFT CORP (MSFT) The company announced that current CFO of Microsoft Business Division (MBD) Amy Hood, will succeed outgoing CFO Peter Klein. Unchanged
COSTCO WHOLESALE CORP (COST) COST reported April same store sales increased 4%, modestly below the consensus estimate of 4.5%. Net sales for the month rose 6.7%. Unchanged

Fixed Income Update

Fannie Mae and Freddie Mac (the government owned mortgage companies) made headlines this week and again, it was in a good way. Following last year’s $17.2 billion profit, Fannie Mae is set to show an increase of close to $60 billion in net worth for the last quarter.

How did they get in a position to do this? Currently more Americans are buying homes. Prices are rising at their fastest rate since the housing bubble burst. Banks are lending only to the most qualified buyers and fewer homes are falling into foreclosure. All of this is a boon to Fannie Mae and Freddie Mac, which own or guarantee half of all U.S. mortgages and back nearly 90 % of new ones. Most importantly, Fannie Mae is utilizing tax credits they earned from losses on delinquent loans suffered during the housing crisis. By applying those credits to its 2013 taxes, Fannie Mae reduced what it owed the government and boosted its profit. Of the $58.7 billion earned, nearly $51 billion was attributed to using the tax credits. Under a federal policy adopted last summer, Fannie and Freddie must turn over their entire net worth above $3 billion in each quarter to the Treasury. Fannie reported its net worth in the first quarter was $62.4 billion. As a result, Fannie Mae will pay a dividend of $59.4 billion to the U.S. Treasury by June 30th. Once that is paid, Fannie Mae will have repaid $95 billion of the $116 billion it received. Since this is an accounting profit, Fannie Mae does not have enough cash on hand to make this payment. Unless Fannie Mae sells assets, they will have to ramp up their borrowing in order to make the payment. The net effect for investors could be less Treasury supply and more Agency supply.

As the week comes to a close the weakening of the Japanese Yen has come to dominate investors’ attention. The Japanese yen broke through the psychologically important 100 USD/JPY level. As this has happened, the near term result has been global sovereign debt yields increasing. The Japanese are actively trying to weaken their currency to help their export economy and create higher inflation to break the deflationary environment they have been in for the last couple decades.

For the week, Treasury yields have increased 2 to 15 basis points.

Company Spotlight

BERKSHIRE HATHAWAY-BLK CEDEA (BRKB)
Aa2/AA+/AA
Issued $1.0 billion of 5 and 30 year debt Buy / Buy
JPMORGAN CHASE & CO (JPM)
A2/A/A+
Issued $2.0 billion of 5 year debt Buy / Buy
GENERAL ELECTRIC CO (GE)
Aa3/AA+/#N/A N/A
GE Capital sold $250M in 5 year notes Buy / Buy
EMERSON ELECTRIC CO (EMR)
A2/A/#N/A N/A
Reported quarterly earnings Buy / Buy

May 10, 2013

Current Last Week Week Change Last Year Year Change
Tax-exempt MMF 0.14 0.17 -0.03 0.35 -0.21
Taxable MMF 0.05 0.06 -0.01 0.23 -0.18
2-Year Treasury 0.24 0.22 0.02 0.26 -0.02
5-Year Treasury 0.81 0.73 0.08 0.76 0.05
10-Year Treasury 1.89 1.74 0.15 1.87 0.02
30-Year Treasury 3.09 2.95 0.13 3.04 0.05
5-Year Exp. Inflation 2.07 2.06 0.01 1.97 0.10
2-Year Agency 0.30 0.31 0.00 0.39 -0.08
5-Year Agency 0.94 0.90 0.04 1.08 -0.14
10-Year Agency 2.24 2.19 0.05 2.51 -0.27
2-Year Corporate* 0.62 0.63 -0.01 1.28 -0.66
5-Year Corporate* 1.59 1.57 0.02 2.29 -0.70
10-Year Corporate* 2.97 2.94 0.03 3.63 -0.66
30-Year Corporate* 4.22 4.19 0.03 4.73 -0.52
2-Year Municipal** 0.40 0.40 0.00 0.49 -0.09
5-Year Municipal** 1.00 0.98 0.02 1.06 -0.06
10-Year Municipal** 2.17 2.12 0.05 2.19 -0.02
30-Year Municipal** 3.99 3.95 0.04 4.19 -0.20
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*** $83.19 $82.13 $1.06 $80.11 $3.07
CRB $288.68 $290.17 -$1.49 $294.59 -$5.19
Gold $1,442.10 $1,464.20 -$22.10 $1,595.50 -$153.40
Crude Oil $95.92 $95.61 $0.31 $97.08 -$1.16
Unleaded Gasoline**** $2.86 $2.83 $0.03 $2.79 $0.07

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