Weekly Stock Market Update—August 23, 2013
By Steve Scranton, SVP, CFA
Chief Investment Officer

Stock Market Update

This week felt like that phrase from a 1910 British music hall song–“different verse, same as the first.” This phrase references frustration that can be felt when someone tells the same story repeatedly. And so it was this week, as investors remained intently focused on “Fed watch.” The equities markets ended mixed for the week, with the Dow Jones Industrial Average (Dow) down 0.40%, and the S&P 500 up slightly, +0.49%. Much less onerous than the 2% sell-off experienced by the Dow Jones Industrial Average (Dow) and the S&P 500 last week.

The key event of the week was Wednesday’s release of the Federal Reserve’s (Fed) Federal Open Market Committee (FOMC) minutes from the July meeting. The equities market was hopeful that information from the minutes would shed more light on when, and at what pace, the Fed might begin to taper its economic stimulus activities. To investors’ chagrin, the minutes did not provide much insight as to when the Fed may begin to scale back its $85 billion bondbuying stimulus program. It was noted in the minutes that a number of committee members agreed that a change to its pace of purchases was not yet appropriate and a few felt it would “soon be time to slow somewhat.” On the other side of the discussion, some members noted the “importance of being patient and evaluating additional information on the economy before deciding on any changes to the pace of asset purchases.” These comments did not increase clarity or certainty for the equities market. The disappointment resulted in a 120 point drop in the Dow immediately following the release of the information. For the day, the Dow and the S&P 500 dropped by 0.7% and 0.6%, respectively—the largest daily decline during the week.

Thursday brought a reversal in market behavior, with stocks moving solidly higher and erasing much of the previous day’s losses. The relief rally was driven by news on the global front. Improved manufacturing data in China and Europe more than offset the lingering worries about the Fed’s tapering timeline. The market also experienced an unexpected and troubling event Thursday. Trading on the NASDAQ was abruptly halted at around 12:20 P.M. EDT and full trading was not re-established until three hours later, at ~3:25 P.M, and leaving only ½ hour for traders to sort out the ensuing confusion. The unexpected system freeze, cited to be caused by “technical issues,” fueled renewed concern about the reliability of trading on the U.S. securities exchanges.

As we have noted in our commentaries during much of August, the equities market continues to struggle with the uncertainty about the Fed’s stimulus program. “How much” and “when” remain the key questions. With the Dow and S&P 500 up 16.53% and 18.27% year to date, respectively, there is less incentive for equity investors to put fresh money to work until answers to these questions become clearer.

Current Week Month of August YTD
Dow Jones (INDU) -0.40% -2.85% 16.53%
S&P 500 (SPX) 0.49% -1.12% 18.27%
Nasdaq (CCMP) 1.54% 1.03% 22.19%
MSCI EAFE (EAFE) -1.61% 0.90% 11.09%

Updates to the Equities Buy List:

Company Name News Event Impact to Our Company View
CISCO SYSTEMS INC (CSCO) CSCO reported fiscal 4Q operating earnings of $0.52 per share, on sales of $12.42 billion, versus the consensus estimate of $0.51/share on revenues of $12.40 billion. Unchanged
APPLIED MATERIALS, INC (AMAT) Announced fiscal third quarter operating earning of $0.18 per share, $0.01 below analysts' estimates. Unchanged
EASTMAN CHEMICAL CO. (EMN) On 8/19/13 we purchased Eastman Chemical Co. (EMN), replacing Mosaic (MOS), which was sold on 8/1/13. Purchase
HOME DEPOT INC (HD) HD reported second quarter earnings of $1.24 per share, up 23% (y/y), and $0.03 better than the Street estimate. Revenue increased to $22.5 billion, up 9.5%, and above forecasts of $21.8 billion. In conjunction with the earnings release the company raised its fiscal 2013 sales and earnings guidance. Unchanged
MEDTRONIC INC (MDT) Reported fiscal 1Q earnings of $0.88 per share, matching the consensus estimate, and compared to earnings of $0.85/share a year ago. The company reaffirmed its full year 2014 guidance. Unchanged
MICROSOFT CORP (MSFT) MSFT announced that CEO Steve Ballmer will retire within the next 12 months, as soon as a succesor is chosen. Unchanged
QUALCOMM INC (QCOM) Announced an agreement to sell its North and Latin America transportation and logistics business, Omnitracs, Inc., to private equity firm Vista Equity Partners, for $800 million in cash. The transaction is expected to be completed during QCOM's fiscal 2014 first quarter. Unchanged

Fixed Income Update

The negative sentiment in the bond market continues. This week’s main story was the release of July’s FOMC (Federal Open Market Committee) minutes. Investors were looking for clues to see if the Fed would reduce the size of its asset purchase program. Currently this stands at $85 billion a month. The breakdown consists of $45 billion of U.S. Treasuries and $40 billion of mortgage backed securities. Even though they did not indicate any changes, the market reaction has been hawkish meaning that investors are believing that the Fed will start to taper (decrease) the size of its asset purchase program starting in September. The FOMC members continue to use the word “if” economic data supports a reduction in purchases; market participants continue to focus on the strong data and discount the weak.

This bias is clearly evident in the large outflows being experienced in bond mutual funds and exchange traded funds (ETF’s) that invest in longer dated maturities. According to TrimTabs Investment Research, withdrawals for the month through August 19th are already the third highest on record following $69.1 billion of withdrawals in June and $42 billion in October 2008. Unlike individual bonds that have a final maturity date and mature at par ($100), ETF’s and bond funds don’t.

Compounding the supply/demand imbalance is the low foreign demand for U.S. Treasuries by foreign central banks (mainly emerging markets) and private foreign investors. The net result is yields are in the process of finding a new equilibrium and at the moment that is a very volatile endeavor.

For the week, yields of U.S. Treasury securities ranged from decreasing 5 basis points to increasing 6 basis points.

Company Spotlight

MICROSOFT CORP (MSFT)
Aaa/AAA/AA+
CEO announced plans to retire in twelve months. Buy / Buy

August 23, 2013

Current Last Week Week Change Last Year Year Change
Tax-exempt MMF 0.07 0.07 0.00 0.20 -0.13
Taxable MMF 0.02 0.02 0.00 0.17 -0.15
2-Year Treasury 0.38 0.34 0.04 0.26 0.12
5-Year Treasury 1.62 1.56 0.06 0.70 0.92
10-Year Treasury 2.81 2.83 -0.01 1.68 1.14
30-Year Treasury 3.80 3.85 -0.05 2.79 1.01
5-Year Exp. Inflation 1.82 1.80 0.02 1.94 -0.11
2-Year Agency 0.49 0.45 0.04 0.35 0.14
5-Year Agency 1.97 1.84 0.12 0.99 0.97
10-Year Agency 3.53 3.46 0.06 2.27 1.25
2-Year Corporate* 0.87 0.80 0.07 0.78 0.10
5-Year Corporate* 2.58 2.45 0.13 1.70 0.89
10-Year Corporate* 4.15 4.07 0.08 2.99 1.16
30-Year Corporate* 5.06 5.02 0.03 4.14 0.92
2-Year Municipal** 0.60 0.61 -0.01 0.45 0.15
5-Year Municipal** 1.57 1.50 0.07 1.03 0.54
10-Year Municipal** 3.23 3.13 0.10 2.32 0.91
30-Year Municipal** 5.19 5.11 0.08 4.10 1.09
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*** $81.37 $81.26 $0.11 $81.36 $0.01
CRB $290.79 $292.49 -$1.70 $307.24 -$16.45
Gold $1,396.60 $1,371.70 $24.90 $1,669.60 -$273.00
Crude Oil $106.31 $107.46 -$1.15 $96.27 $10.04
Unleaded Gasoline**** $3.00 $2.97 $0.03 $2.77 $0.23

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