Weekly Stock Market Update—July 12, 2013
By Steve Scranton, SVP, CFA
Chief Investment Officer

Stock Market Update

A combination of rising hopefulness and decreasing uncertainty fueled strong gains in the stock market this week. The Dow Jones Industrial Average (Dow) and the S&P 500 rose by 2.2% and 3.0%, respectively, on these areas of investor attention:

  1. Rising hopefulness. Focus turned to corporate earnings this week, as the second quarter of 2013 made its debut. Although only six companies reported earnings results this week, anticipation was high and drove market strength in the early part of the week. As usual, Alcoa (AA) unofficially kicked off earnings season, reporting earnings after Monday’s market close. Although one company’s results do not “make” the quarter, AA’s slightly better than expected results drove an increase in hopefulness about possible upcoming results for all companies.
  2. Decreasing uncertainty. The week’s gains were further fueled in the second half of the week by news from the Federal Reserve (Fed). The Federal Open Market Committee (FOMC) released its June meeting minutes on Wednesday, which showed that while many want to scale back the quantitative easing program before year-end, a number of the members want more reassurance that the labor market is improving before commencing a tapering strategy. Interpretation of this communication was mixed. However, later in the day, investors were encouraged after a speech from Fed Chairman Ben Bernanke, in which he noted that “highly accommodative” monetary policy is needed for the economy for the foreseeable future and that the current unemployment rate may be overstating the job market's health. The markets posted strong gains on Thursday as investors reacted positively to this commentary.

Second quarter corporate earnings season will kick into high gear starting 7/15/13. The investment community expects earnings, as represented by the S&P 500 group of companies, to increase by 2.4% versus last year’s second quarter. This estimate is down considerably from the growth rate of 6.1% forecast at the beginning of the quarter (3 months ago, in April) and much lower than the growth of 5.4% experienced in the first quarter. Revenue during the second quarter is expected to rise by 1.4% versus last year’s second quarter. It is also expected that this quarter could demonstrate a negative impact from the sequester. Analysts continue to forecast a pickup in earnings in the second half of the year. Current expectations are for earnings to grow by 7.9% in the third quarter and by 12.4% in the fourth quarter. Whether or not these are viable forecasts will become more evident as company management teams confirm or lower their outlooks for the future. This will be among information which receives the highest focus in the coming weeks.

Current Week Month of July YTD
Dow Jones (INDU) 2.22% 3.81% 19.59%
S&P 500 (SPX) 3.01% 4.69% 19.17%
Nasdaq (CCMP) 3.49% 5.84% 20.04%
MSCI EAFE (EAFE) 3.97% 4.58% 9.32%

Updates to the Equities Buy List:

Company Name News Event Impact to Our Company View
COSTCO WHOLESALE CORP (COST) COST reported June same store sales increased 6%, above the consensus estimate of 5.4%, and well ahead of June 2012 comparable sales growth of 3%. Net sales for the month of June increased 8.3% to $9.92 billion, up from $9.16 billion a year ago. Unchanged
JPMORGAN CHASE & CO (JPM) JPM reported earnings of $1.60 per share for 2Q 2013, better than the Street estimate of $1.44, and up from $1.21 per share reported for the same year ago period. Unchanged
INTL BUSINESS MACHINES CORP (IBM) IBM announced its intent to acquire SoftLayer, a privately held vendor of cloud computing infrastructure services. The company has created a new division called Cloud Services, which will combine SoftLayer and IBM’s existing offerings. The price of the deal was not disclosed. IBM expects to complete the transaction in the third quarter. Unchanged
MICROSOFT CORP (MSFT) Microsoft announced a new organizational structure, titled 'One Microsoft', that will align the company into broader functional categories, which focus on Operating Systems, Cloud and Enterprise, Apps and Services, and Devices and Studios. The goal is to emphasize the integration between MSFT products while highlighting the company's broad portfolio. Unchanged
EMC CORP (EMC) EMC announced a deal to acquire ScaleIO, a privately held storage software company. ScaleIO will be part of EMC's flash product division. Financial terms were not disclosed. Unchanged
ABBVIE, INC (ABBV)& ABBOTT LABORATORIES (ABT) On 7/11/13 we sold Abbott Laboratories (ABT) and reinvested the proceeds to AbbVie, Inc. (ABBV). Sell/Purchase
AT&T INC (T) Shares of AT&T (T) have been placed on hold. Lowered to Hold
VALERO ENERGY CORP (VLO) VLO released an iterim update, revising down its second quarter earnings to range from $0.80-$0.90 per share, below the Street expectation of $1.27/share, on lower discounts for crude oil, higher compliance costs, and increased refinery maintenance costs. Unchanged

Fixed Income Update

The Fixed Income markets got a little whipsawed this week, especially on Wednesday and Thursday. Over this time period, the Fed sent out three very different messages.

First, the Fed minutes of their last FOMC meeting came out on Wednesday. Initially the minutes were seen as mildly dovish as the committee continued to deliberate the fate of its current quantitative easing (QE3) program. With this the bond market rallied as it was viewed that there was no hurry to taper. Second, as Fed watchers dug into the appendix of the minutes, the Summary of Economic Projections (SEP), they uncovered the following: "about half" of FOMC participants "indicated that it likely would be appropriate to end asset purchases late this year," and the bond rally reversed. Finally, very late in the day at an academic conference, Bernanke soothed the markets with talk that "the unemployment rate probably understates the weakness in the labor market.” He also commented on the downside risks to inflation “would be a good reason to remain accommodative." And finally, he expressed a willingness to "push back against" tighter financial conditions if necessary.

The take-away from all this is that investors should learn three lessons: 1) When in doubt, listen to Bernanke. He is a believer in full transparency and in a committee approach to policy. When he speaks he is doing his best to convey the true views of voters on the Committee. 2) Know what the words the Fed uses mean in Fed speak. The minutes give non-voting QE skeptics a platform to air their concerns. One should be wary of any hawkish comments in the minutes that mention just "some" or "a few" "participants." Focus should be on sentences that reveal what "members" (the 12 voters) believe and discount sentences about what "participants" (all 19 voters and non-voters) believe. The members set policy. 3) Knowing who votes (members) and what their leanings are is most important.

It is hard to quantify the terms the Fed references in the FOMC minutes. BofA Merrill Lynch Global Research has done a good job at what they call decoding the Fed speak. The following is their interpretation of some of the terms used in the FOMC minutes: one = 1, a couple = 2, a few = 2 to 3, some = 3 to 5, a number = 4 to 7, several = 5 to 8, many = 7 to 9, most = 10 to 17, generally = 17 to 18, all but one = 18, all = 19. Full transparency is not necessarily what one would think.

For the week, Treasury yields decreased 5 to 20 basis points.

Company Spotlight

Issued $3B fixed and floating-rate bonds in a three part offering. Buy / Buy
Aa3/AA+/#N/A N/A
Issued #3.5B of fixed and floating-rate notes in a three-part offering. Buy / Buy
Reported quarterly earnings. Buy / Buy
Reported quarterly earnings. Buy / Buy
Fitch Ratings affirmed the company's default rating at 'A' and revised the rating outlook to Negative from Stable. Hold / Hold

July 12, 2013

Current Last Week Week Change Last Year Year Change
Tax-exempt MMF 0.05 0.05 0.00 0.22 -0.17
Taxable MMF 0.02 0.02 0.00 0.19 -0.17
2-Year Treasury 0.34 0.40 -0.05 0.26 0.09
5-Year Treasury 1.41 1.61 -0.20 0.62 0.79
10-Year Treasury 2.58 2.74 -0.16 1.48 1.11
30-Year Treasury 3.63 3.71 -0.08 2.56 1.07
5-Year Exp. Inflation 1.87 1.90 -0.03 1.78 0.09
2-Year Agency 0.50 0.56 -0.06 0.38 0.12
5-Year Agency 1.68 1.86 -0.18 0.95 -0.10
10-Year Agency 3.19 3.26 -0.06 2.12 1.07
2-Year Corporate* 0.85 0.92 -0.07 0.95 -0.10
5-Year Corporate* 2.34 2.55 -0.22 1.81 0.52
10-Year Corporate* 3.89 4.06 -0.16 2.97 0.92
30-Year Corporate* 4.91 5.01 -0.10 4.08 0.83
2-Year Municipal** 0.69 0.67 0.02 0.47 0.22
5-Year Municipal** 1.68 1.58 0.10 1.08 0.60
10-Year Municipal** 3.11 3.02 0.09 2.27 0.84
30-Year Municipal** 4.99 4.91 0.08 4.19 0.80
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*** $82.97 $84.45 -$1.48 $83.66 -$0.69
CRB $286.66 $280.72 $5.94 $290.27 -$3.61
Gold $1,283.70 $1,212.70 $71.00 $1,565.30 -$281.60
Crude Oil $106.18 $103.22 $2.96 $86.08 $20.10
Unleaded Gasoline**** $3.12 $2.90 $0.22 $2.50 $0.62

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