Weekly Stock Market Update—June 21, 2013
By Steve Scranton, SVP, CFA
Chief Investment Officer

Stock Market Update

Emotions ruled the market this week, as investors struggled with speculation & hope, disappointment and interpretation. As expected, focus was squarely aimed at the Federal Reserve (Fed) and its communication about their current economic stimulus program. On Monday and Tuesday, equities rallied strongly. During this two-day period, the Dow Jones Industrial Average (Dow) and the S&P 500 rose by 1.6% and 1.5%, respectively. Investor hopes were high that the Fed might temper its recent comments about its quantitative easing activities. (Recall that on May 22nd, Fed Chairman Bernanke noted that the Fed could reduce the pace of its bond purchases in the “next few meetings” if the economy showed continued improvement and inflation remained moderate. This timeline was sooner than the equities market had anticipated.) Because the Fed’s program has helped fuel this year’s impressive stock market rally, the possibility of this support being modified sooner than expected has made equity investors uneasy–and caused a sharp rise in volatility.

Wednesday brought the conclusion of the Fed’s 2-day Federal Open Market Committee (FOMC) policy meeting and the communication that investors had been so eager to hear. Unfortunately, the equities market did not receive what it had been hoping for. Fed Chairman Bernanke indicated that the Fed may reduce the pace of bond purchases later this year, with a goal of bringing them to a halt around mid-2014 if the U.S. economy and labor market continue to improve. Bernanke’s more explicit comments on this program’s timeline caused a “re-set” to equity investors’ expectations. The market did not seem to focus on the words “may” and “if” that are highlighted above. Instead, the news drove a sharp and significant sell-off. Over the 2-day period of Wednesday and Thursday, the Dow dropped by 3.6% and the S&P 500 slid by 3.8% as investors tried to reconcile the new information and the uncertainty that it creates for an investor group that detests lack of visibility or clarity. The week wound down on Friday with stocks taking a bit of a breather from their roller coaster ride during the week. Stocks were little changed as investors seemed to re-group and reassess the events that occurred during the week.

For equity investors, the Fed’s comments this week created uncertainty and worry over an unclear future. They will now try to recalibrate this new information. Part of that effort will involve examining corporate and economic data and trying to interpret how the Fed will respond to the data–and what it will mean for the quantitative easing program’s future. This is likely to cause a heightened period of uncertainty-driven speculation and volatility. Next week could also bring intraday swings as mutual fund managers reevaluate their portfolios in light of this week’s news and while conducting end-of-quarter “window dressing” actions (which occur as they prepare for the public release of their holdings at the end of each quarter). Equity investors will also be worried about second quarter earnings season, which will get underway in mid-July. They will be searching for clues to the underlying strength of the economic environment–and how that might affect the Fed’s next moves. Volatility is likely to remain elevated during this search for clues and a resolution to the uncertainty.

Current Week Month of may YTD
Dow Jones (INDU) -1.79% -1.98% 14.34%
S&P 500 (SPX) -2.09% -2.23% 12.80%
Nasdaq (CCMP) -1.93% -2.79% 11.84%
MSCI EAFE (EAFE) -3.75% -4.36% 3.62%

Updates to the Equities Buy List:

Company Name News Event Impact to Our Company View
ORACLE CORP (ORCL) ORCL reported fourth quarter operating earnings of $0.87 per share, in-line with the consensus estimate, and above earnings of $0.82/share a year ago. Revenues of $10.96 billion missed the $11.12 billion analysts had expected. Unchanged
CISCO SYSTEMS INC (CSCO) CSCO announced its intention to acquire Composite Software, Inc., a data v irtualization software and services company, for approximately $180 million in cash and retention based incentives, in exchange for all Composite shares. The acquisition is expected to close in the first quarter of fiscal 2014. Unchanged

Fixed Income Update

The day the market has been waiting for finally arrived on Wednesday. This was the day the Federal Open Market Committee met followed by Fed Chairman Ben Bernanke speaking at a press conference. The FOMC made no changes to their policy language but made an important change to their outlook noting that they now see downside risks as "diminished" since the fall. They made several changes to their forecasts, including revising GDP growth slightly down this year, up in 2014, and down in 2015, while revising down unemployment rate over the same period of time, implying a low labor force participation rate assumption. Despite lower unemployment, they revised down core inflation forecasts. The immediate reaction to this modestly hawkish assessment was a selloff in Treasuries. During the press conference, Treasuries continued to sell off.

Fed Chairman Bernanke, in his afternoon press conference on June 19, indicated for the first time slowing the pace of Fed asset purchases (i.e. tapering) could begin later this year if growth, inflation, and the labor markets meet FOMC expectations. It’s a very conditional tapering; the pace of purchases may vary, but his press conference commentary nevertheless marked a possible turning point. Another new development was Bernanke for the first time stating that a labor market threshold for terminating any further asset purchases could be a 7.0% unemployment rate. Moreover, he said that threshold could be reached by mid-2014.

His comments caused fits in the markets as bond yields and the dollar soared while stocks and commodities tumbled. The markets are ignoring a couple of key words such as “if” expectations are met and “could” begin later this year. Regardless, the markets may be getting ahead of themselves. Either traders are reading between the lines and concluding the timeline to tightening could be a lot faster than Bernanke implied and they expected, or traders are feeling out the proper place for interest rates without the Fed’s interference in the market. Rates may rise until the economy is hurt, which would mean they are too high from a supply-and-demand for credit perspective.

Market activity has been very volatile since Bernanke’s press conference. With dealers holding less trading positions as a result of new regulatory pressures, they are less likely to put good bids on bonds that investors are trying to sell. Bond mutual funds and exchange traded funds (ETF’s) continue to see large outflows feeding the selling pressure. Therefore, we are seeing great opportunities to buy securities at very favorable levels.

For the week, Treasury yields increased 9 to 40 basis points.

Company Spotlight

ORACLE CORP (ORCL)
A1/A+/A+
Reported quarterly earnings. Buy / Buy

June 14, 2013

Current Last Week Week Change Last Year Year Change
Tax-exempt MMF 0.08 0.09 -0.01 0.26 -0.18
Taxable MMF 0.03 0.03 0.00 0.21 -0.18
2-Year Treasury 0.36 0.27 0.09 0.30 0.06
5-Year Treasury 1.42 1.03 0.39 0.72 0.70
10-Year Treasury 2.53 2.13 0.40 1.62 0.91
30-Year Treasury 3.58 3.31 0.27 2.69 0.89
5-Year Exp. Inflation 1.66 1.84 -0.17 1.76 -0.10
2-Year Agency 0.46 0.38 0.08 0.42 0.04
5-Year Agency 1.53 1.23 0.30 1.06 0.47
10-Year Agency 2.90 2.58 0.32 2.26 0.64
2-Year Corporate* 0.84 0.75 0.09 1.06 -0.22
5-Year Corporate* 2.25 1.94 0.31 1.97 0.28
10-Year Corporate* 3.71 3.40 0.31 3.16 0.55
30-Year Corporate* 4.82 4.59 0.24 4.27 0.56
2-Year Municipal** 0.54 0.55 -0.01 0.46 0.08
5-Year Municipal** 1.36 1.35 0.01 1.12 0.24
10-Year Municipal** 2.70 2.65 0.05 2.32 0.38
30-Year Municipal** 4.47 4.43 0.04 4.24 0.23
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*** $82.35 $80.67 $1.68 $82.29 $0.06
CRB $278.08 $286.18 -$8.10 $267.16 $10.92
Gold $1,292.90 $1,387.60 -$94.70 $1,565.50 -$272.60
Crude Oil $93.86 $97.85 -$3.99 $78.20 $15.66
Unleaded Gasoline**** $2.76 $2.90 -$0.14 $2.35 $0.42

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