Weekly Stock Market Update—September 27, 2013
By Steve Scranton, SVP, CFA
Chief Investment Officer

Stock Market Update

After three consecutive weeks of gains, stocks delivered negative performance this week. Investor concern rose (and the stock market fell) as the government budget battle between the Republican-led House and the Democraticcontrolled Senate moved into high gear. Not only is there a wall of resistance between the Democrats and Republicans, there is also conflict in each of the parties. The Tea Party Republicans are at odds with the more traditional Republicans, while the moderate Democrats are in disagreement with the more leftist Democrats. One of the largest topics of contention centers around enactment of the impending healthcare bill–the Affordable Care Act (i.e.; ACA, also called “Obamacare”). The Tea Party is trying to use these budget negotiations as a tool to defund Obamacare. This has created an additional wrinkle of contention and fueled speculation about who will “blink” first as the ominous September 30th deadline looms. However, there is also an overall challenge at hand. Some of the “less difficult” budget concessions occurred when the budget crisis was averted the last time. This time around, cuts may need to come from areas where decisions are much more difficult.

Overall, uneasiness and lack of certainty is present–in Washington and the stock market–about how such difficult budget compromises may be reached in a few short days. If a compromise is not achieved by Tuesday, the government will run out of funding–and face a partial shutdown. The political battle–and last-minute maneuvers–is expected to go through early next week. Certainly, it is hoped that a compromise can be reached and a shutdown averted. However, there is an ominous mood in some circles that this time could be different.

In just a week, the relief rally spawned by the Federal Reserve’s (Fed) decision to leave its economic stimulus program unchanged was quickly offset by concern about seemingly irreconcilable differences in Congress’ budget negotiations. Time is running short for Washington to avert a partial government shutdown. If a budget agreement can be achieved, equity investors are likely to breathe a sigh of relief and then turn their focus to the September jobs report on Friday. After the Fed’s decision to keep its stimulus program intact, investors will scrutinize the report for a better sense of when a tapering of the stimulus program could occur. But, until Washington reaches a budget agreement, uncertainty will remain the “word du jour” for Wall Street.

Current Week Month of September YTD
Dow Jones (INDU) -1.25% 3.14 18.63%
S&P 500 (SPX) -1.02% 3.76% 20.51%
Nasdaq (CCMP) 0.21% 5.41% 26.44%
MSCI EAFE (EAFE) -0.08% 8.23% 17.65%

Updates to the Equities Buy List:

Company Name News Event Impact to Our Company View
APPLIED MATERIALS, INC (AMAT) Applied Materials and chip equipment maker Tokyo Electron have entered into an agreement to combine their businesses, forming a new holding company. AMAT shareholders will receive one share of the new company for every one share of AMAT, and each share of Tokyo Electron will be converted to 3.25 shares of the holding company. The deal is expected to close in mid to second half of 2014. Unchanged
MICROSOFT CORP (MSFT) Microsoft announced it had formed a joint venture with Chinese company BesTV New Media to design and develop games and game related products. MSFT will invest $38.7 million, holding a 49% stake, and BesTV will hold a 51% stake, investing $40.3 million. Unchanged
BED BATH & BEYOND INC (BBBY) BBBY reported 2Q earning of $1.16 per share, above Wall Streets etimate of $1.15/share, and compared to earnings of $0.98 a year ago. Revenue increased 8.9% y/y to $2.8 billion, modestly higher than expected. Unchanged

Fixed Income Update

Treasuries extended their gains this week amid speculation of a political standoff over the U.S. budget will lead to a government shutdown on October 1st. Also, with quarter end approaching and the Fed’s recent announcement to not taper yet, bond managers are feeling pressure to invest cash that had been building up.

Bickering over the budget continued in Congress as Tea party Republicans are trying to use this event to not fund Obamacare. This uncertainty has investors buying Treasuries. The effects of a government shutdown with the ensuing cut backs in government services / jobs has the potential to decrease economic output. Separately but related, the debt limit is fast approaching. Treasury Secretary Jack Lew said this week that the debt limit will be reached on October 17th as the extraordinary measures they have been using will be exhausted. We have seen this movie before. The public is unwilling to give up or decrease services they receive. With this in mind, the market is anticipating that a deal will be reached, probably with the Tea party Republicans losing. The risk is that one of these days both sides will dig in and a deal will not be reached.

Although not always indicative of how yields react in the short-term, cash flows over the long-term are important. We continue to see the same patterns in mutual fund flows that we have seen all quarter. Mutual funds are seeing outflows from municipal bond, government mortgage-backed, and U.S. Treasury focused funds. But we are consistently seeing inflows into high yield and investment grade mutual funds. Investors continue to view that interest rate risk is greater than credit risk.

It was a quiet week with Treasury yields steadily declining 8 to 11 basis points.

Company Spotlight

WAL-MART STORES INC (WMT)
Aa2/AA/AA
Sold $1.75 billion of 5 and 30 year debt Buy / Buy

September 27, 2013

Current Last Week Week Change Last Year Year Change
Tax-exempt MMF 0.04 0.04 0.00 0.23 -0.19
Taxable MMF 0.02 0.02 0.00 0.17 -0.15
2-Year Treasury 0.33 0.33 0.00 0.25 0.08
5-Year Treasury 1.40 1.48 -0.08 0.65 0.75
10-Year Treasury 2.62 2.74 -0.11 1.66 0.97
30-Year Treasury 3.68 3.76 -0.08 2.84 0.84
5-Year Exp. Inflation 1.82 1.90 -0.08 2.08 -0.27
2-Year Agency 0.39 0.43 -0.04 0.35 0.04
5-Year Agency 1.77 1.77 0.00 0.93 0.83
10-Year Agency 3.31 3.38 -0.06 2.24 1.08
2-Year Corporate* 0.80 0.82 -0.01 0.72 0.08
5-Year Corporate* 2.30 2.37 -0.07 1.60 0.70
10-Year Corporate* 3.90 4.00 -0.10 2.92 0.98
30-Year Corporate* 4.89 4.94 -0.06 4.19 0.70
2-Year Municipal** 0.50 0.56 -0.06 0.46 0.04
5-Year Municipal** 1.49 1.56 -0.07 0.97 0.52
10-Year Municipal** 2.95 3.08 -0.13 2.24 0.71
30-Year Municipal** 4.99 5.07 -0.08 4.07 0.92
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*** $80.27 $80.43 -$0.16 $79.55 $0.72
CRB $286.98 $287.44 -$0.46 $307.33 -$20.35
Gold $1,338.40 $1,332.60 $5.80 $1,777.60 -$439.20
Crude Oil $102.82 $104.67 -$1.85 $91.85 $10.97
Unleaded Gasoline**** $2.67 $2.68 -$0.02 $2.57 $0.10

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