Weekly Stock Market Update—June 14, 2013
By Steve Scranton, SVP, CFA
Chief Investment Officer

Stock Market Update

Equities lost ground this week as worry lingered about the future of the Federal Reserve’s (Fed) economic stimulus activities. With no economic news at the beginning of the week, stocks treaded water. News that Standard and Poor’s upgraded the U.S. government’s credit outlook to stable from negative had little effect.

The market sold off on Tuesday and Wednesday, with the Dow Jones Industrial Average (Dow) and the S&P 500 losing 1.6% and 1.8%, respectively over the two day period. News on Tuesday that the Bank of Japan left its monetary policy unchanged stoked fear that central banks might be growing reluctant to add more stimulative measures to support the economies. This concern persisted into Wednesday. Economic reports remained light and provided little insight into the overall macro environment.

Stocks staged a one-day rally on Thursday. The Dow gained 1.2%, while the S&P 500 rose by 1.5% as better than expected economic data mollified investor worries for one day. Retail sales for May rose by a greater than expected 0.6% and were stronger than the 0.1% increase experienced in April. Initial jobless claims data was also positive, declining by a greater than expected 12,000–to 334,000 (and versus an expected level of 346,000). Interestingly, the prior week’s claims of 346,000 were left unrevised, which is a departure from the traditional pattern this year where the prior week’s claims normally tend to be upwardly revised.

Thursday was the only day that gains were posted for the week. On Friday, stocks resumed the week’s overall downward slide as investors responded negatively to a set of disappointing economic data: 1) the producer price index (PPI) for May rose by 0.5%, coming in higher than the expected rise of 0.1% and up notably from the decline of 0.7% experienced in April; 2) industrial production in May was unchanged, coming in lower than expected growth of 0.2%; and 3) the preliminary reading of the University of Michigan’s consumer confidence index for June was lower than expected at 82.7 versus the expected reading of 84.5.

The Fed–and its economic stimulus program–will remain in focus next week as it conducts the latest policy setting meeting (the Federal Open Market Committee meeting–FOMC). Since Fed Chairman Bernanke’s comments on May 22, Week In Review concerns have risen that the Fed could taper its stimulus activities in the near future–and sooner than the equities market would like. This has caused investor angst and has driven increased swings in intra-day market behavior. For example, the Dow has experienced intra-day point swings in excess of 200 points in 7 of the past 15 trading days. The level of uncertainty has gone up tremendously in the last month. Until there is more visibility on the Fed’s plans for its quantitative easing program, expect volatility to remain heightened. The market will be intently focused on the Fed’s commentary after the conclusion of its FOMC meeting.

Current Week Month of may YTD
Dow Jones (INDU) -1.04% -0.13% 16.51%
S&P 500 (SPX) -0.88% -0.06% 15.31%
Nasdaq (CCMP) -1.17% -0.76% 14.17%
MSCI EAFE (EAFE) -0.30% -1.39% 6.84%

Updates to the Equities Buy List:

Company Name News Event Impact to Our Company View
CATERPILLAR INC (CAT) CAT announced that it has raised the quarterly cash dividend from $0.52 per share to $0.60, for a yield of approximately 2.86%. Unchanged
ABBOTT LABORATORIES (ABT) ABT authorized the repurchase of up to $3 billion of the corporation's common stock. The program replaces the previous $5 billion program that was announced in October 2008 and was recently completed. Unchanged

Fixed Income Update

Even though Fed officials have entered their self-imposed silent period ahead of next week’s Federal Open Market Operation (FOMC) meeting, they seem to be communicating to the market through Jon Hilsenrath at the Wall Street Journal. An article by Hilsenrath tries to alleviate market concerns that reducing the size of asset purchases (tapering) would lead to tightening of Fed policy.

The latest Hilsenrath post does not unwind the view that the Fed will pull back from QE3, but it does indicate that short-term policy rates will not be tightened quickly in consequence. The article does not derail the view that tapering is on the radar screen. What it changes is the perception that tapering will segue seamlessly into Fed Fund hikes.

From the Fed viewpoint, tapering is equivalent to cutting rates more slowly, not an indicator to tightening of monetary policy. Ending QE would be equivalent to freezing the stance of monetary policy, not tightening it. The market will be watching next week’s FOMC meeting and especially Bernanke’s follow up testimony.

Someday, the Fed will taper and then end asset purchases and then possibly drain reserves from the system. The market gyrations we have seen these last few weeks may have been premature but they may be a preview of the ugliness that will ensue when the Fed begins to remove accommodation. The most dangerous investments will be those with excess duration and liquidity risk. This is why we continue to manage bond portfolios to a short duration focusing on high quality credits. For the week, Treasury yields decreased 3 to 7 basis points.

Fannie Mae and Freddie Mac were back in the news as Senators Corker (R-TN) and Warner (D-VA) released a copy of a bill that proposes to abolish Fannie and Freddie this decade and replace them with a new agency, the Federal Mortgage Insurance Corporation (FMIC). This new agency would provide government guaranteed reinsurance of conforming mortgage loans. The odds of this bill getting passed into law are quite low; however, it still managed to dominate the headlines so far this week. Quite surprisingly, nowhere in 112 pages of text did the lawmakers find space to talk explicitly about who would back Fannie and Freddie senior and subordinated debt in the event of a wind down. As the market picked up on this apparent omission, a seller dominated, and spreads widened 3-4bps in the 5yr sector. Later it was pointed out that the Senior Preferred Stock Purchase Agreement (SPSPA) remains in place under the proposed bill. As such, senior and subordinated debt would be protected with respect to timely repayment. Spreads returned to previous levels as the market seems to agree with this interpretation.

Company Spotlight

Issued $1.1B in floating rate notes Buy / Buy

June 14, 2013

Current Last Week Week Change Last Year Year Change
Tax-exempt MMF 0.09 0.09 0.00 0.25 -0.16
Taxable MMF 0.03 0.03 0.00 0.21 -0.18
2-Year Treasury 0.27 0.30 -0.03 0.30 -0.03
5-Year Treasury 1.03 1.10 -0.07 0.74 0.29
10-Year Treasury 2.13 2.17 -0.05 1.64 0.48
30-Year Treasury 3.30 3.34 -0.03 2.74 0.56
5-Year Exp. Inflation 1.83 1.91 -0.08 1.81 0.03
2-Year Agency 0.39 0.39 0.00 0.44 -0.04
5-Year Agency 1.26 1.28 -0.02 1.10 0.16
10-Year Agency 2.60 2.61 0.00 2.31 0.29
2-Year Corporate* 0.76 0.75 0.01 1.10 -0.33
5-Year Corporate* 1.97 1.98 -0.01 2.03 -0.06
10-Year Corporate* 3.42 3.40 0.03 3.23 0.19
30-Year Corporate* 4.61 4.60 0.00 4.37 0.24
2-Year Municipal** 0.54 0.52 0.02 0.48 0.06
5-Year Municipal** 1.33 1.24 0.09 1.09 0.24
10-Year Municipal** 2.63 2.49 0.14 2.35 0.28
30-Year Municipal** 4.42 4.28 0.14 4.24 0.18
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*** $80.65 $81.67 -$1.02 $81.99 -$1.34
CRB $286.18 $287.67 -$1.49 $272.05 $14.13
Gold $1,389.80 $1,393.00 $6.80 $1,619.60 -$229.80
Crude Oil $97.81 $96.03 $1.78 $83.91 $13.90
Unleaded Gasoline**** $2.89 $2.87 $0.02 $2.48 $0.41

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