Weekly Stock Market Update—November 22, 2013
By Steve Scranton, SVP, CFA
Chief Investment Officer

Stock Market Update

This week got off to a slow start. A light calendar of economic reports gave investors little motivation to put fresh money to work ahead of the important Wednesday release of minutes from the Federal Reserve’s (Fed) most recent October 29-30 policy meeting. At that meeting, the Fed had decided to leave its economic stimulus program unchanged. Investors were hopeful that the minutes might provide clues on when the Fed plans to begin tapering this program–and that the clues would suggest later as opposed to sooner.

Wednesday brought the anticipated release of the minutes, which noted that officials discussed the possibility of tapering in the coming months or at the next few meetings amid expectations for better data. While the Fed indicated that such a move would happen only if economic conditions warranted it, the equities market jumped to the conclusion that it could begin to scale back the stimulus program sooner than expected, rather than later. Stocks moved lower in response to this disappointment. However, Wednesday was the “low water mark” of the week.

Stocks rallied nicely on Thursday and Friday, after investors re-evaluated what the Fed minutes had said and decided the comments were not as bad as they initially thought. As the impressive year-long rally resumed late in the week, milestones were reached by two of the major stock market indices. The Dow Jones Industrial Average (Dow) closed above 16,000 for the first time on Thursday and, following suit, the S&P 500 surpassed a record closing high above 1,800 on Friday.

Achievement of such historic highs by the equities market this week may cause concern as to whether a sell-off could be lurking in the future. To highlight the diversity of opinion that exists regarding the valuation of stocks, the case can be made for all three answers: expensive, fairly valued or inexpensive. Depending on how you decide to measure the price to earnings ratio (P/E) and which data source you use the answer will be quite different. As would be expected, the bulls are using the method that reaches the conclusion that stocks are inexpensive, the bears are using the method that derives an answer that stocks are expensive while others are using the method that shows stocks to be fairly valued. Regardless, big gains over a short period of time tend to spawn concern that profit taking could occur. A change in Fed policy would threaten the equity market’s comfort zone.

Current Week Month of November YTD
Dow Jones (INDU) 0.71% 3.61% 25.39%
S&P 500 (SPX) 0.41% 2.95% 28.99%
Nasdaq (CCMP) 0.21% 2.03% 33.82%
MSCI EAFE (EAFE) -0.01% -0.02% 20.73%
Russell Mid Cap (RMC) -0.31% 1.73% 31.02%
Rusell 2000 (RTY) 0.79% 2.33% 33.95%

Updates to the Equities Buy List:

Company Name News Event Impact to Our Company View
JPMORGAN CHASE & CO (JPM) JPM reached a resolution with governmental parties regarding residential mortgage-backed securities matters. Under the settlement, JPM will pay $9billion in cash and provide $4B in borrower relief. The cash portion consists of a $2B civil penalty, and $7B in compensatory payments, including a previously announced $4B payment to resolve FHFA's litigation claims. Borrower relief, to be completed by the end of 2017, will be in the form of principal reduction, and other direct benefits from various relief programs. Unchanged
HOME DEPOT INC (HD) HD reported third quarter adjusted earnings of $0.95 per share, $0.05 above the Street estimate. Sales increased 7.4% to $19.5 billion, topping estimates of $19.2 billion. Comparable store sales rose 7.4%, with an 8.2% increase in the United States. Management raised its 2013 earnings guidance and sales growth forecast to earnings of $3.72 per share, from previous estimates of $3.60/share, and sales growth to 5.6%, from 4.5%. Unchanged
MEDTRONIC INC (MDT) MDT reported fiscal 2Q EPS of $0.91 per share, topping the Street estimate of $0.90, vs. earnings of $0.88 a year ago. Revenue rose 2.4% to $4.2 billion, matching analysts' expectations. Unchanged
JACOBS ENGINEERING GROUP INC (JEC) JEC announced fiscal Q4 earnings of $0.84 per share, $0.04 below the consensus estimate. Sales increased to $3.14 billion, up 12.8%, and in-line with expectations. Unchanged

Fixed Income Update

Whether right or wrong, the market is interpreting this week’s comments from Fed officials and minutes of October’s FOMC meeting as positive for short-term rates and negative for long-term rates.

Ben Bernanke got the ball rolling when he spoke on Tuesday night. It was debatable if his comments were dovish or hawkish but in general the market is interpreting it to suggest that the Fed may not worry as much about the long end of the rates market as long as short rates are projected to follow a path that the Fed thinks is consistent with their guidance.

The minutes of October’s FOMC meeting seemed to add credence to this view. While it is true that the FOMC minutes tend to have a hawkish spin as they give voice to non-voting members who oppose the current Fed policy stance, it did get the attention of the market. The FOMC is considering how and when to taper asset purchases without triggering a rise in interest rates that could slow economic growth. So they want to hold interest rates near zero and they want to end asset purchases at some point. They keep pointing to better communication as a way to do both. The market seems to be thinking that the way this will be accomplished is by using tools to keep short rates low. Cutting the interest rate the Fed pays banks on excess reserves, similar to what Europe has done, has recently received increased attention to accomplish this. This overall view (keeping short rates low while decreasing asset purchases) is being supported by the market as evidenced by the yield curve.

When fears of Fed tapering first appeared in May, Treasury yields increased across the maturity spectrum, actually pricing in interest rate increases. This frustrated Fed officials. They seem to be wining their battle to get their point across now. More and more this communication strategy is convincing investors that short rates are staying low. This is most evident when looking at the spread between 5-year and 10-year Treasury securities. Five year maturities have been the battle ground between short and long rates. Since October 1st, the spread between the two has increased 21 basis points (see graph below). The mistake investors have been making is not making the distinction between short-term and long-term interest rates when they think of the general term “interest rates” going higher due to decreased asset purchases.

For the week, yields ranged between increasing 1 to decreasing 5 basis points.

Company Spotlight

Sold $2 billion of12 year debtSold $2 billion of12 year debt Hold / Hold

November 22, 2013

Current Last Week Week Change Last Year Year Change
Tax-exempt MMF 0.02 0.02 0.00 0.21 -0.19
Taxable MMF 0.02 0.01 0.01 0.12 -0.10
2-Year Treasury 0.28 0.29 -0.01 0.27 0.01
5-Year Treasury 1.35 1.34 0.01 0.68 0.67
10-Year Treasury 2.75 2.70 0.05 1.68 1.07
30-Year Treasury 3.84 3.80 0.04 2.82 1.02
5-Year Exp. Inflation 1.82 1.86 -0.04 2.01 -0.19
2-Year Agency 0.34 0.38 -0.05 0.32 0.02
5-Year Agency 1.69 1.72 -0.02 0.92 0.77
10-Year Agency 3.44 3.41 0.03 2.15 1.29
2-Year Corporate* 0.71 0.74 -0.04 0.68 0.03
5-Year Corporate* 2.24 2.22 0.01 1.57 0.67
10-Year Corporate* 4.04 3.98 0.06 2.85 1.18
30-Year Corporate* 5.04 4.98 0.06 4.05 0.99
2-Year Municipal** 0.48 0.48 0.00 0.48 0.00
5-Year Municipal** 1.41 1.41 0.00 0.90 0.51
10-Year Municipal** 2.91 2.91 0.00 1.98 0.93
30-Year Municipal** 5.01 5.01 0.00 3.91 1.10
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*** $80.70 $80.85 -$0.15 $80.93 -$0.23
CRB $275.21 $274.34 $0.87 $297.59 -$22.38
Gold $1,243.30 $1,287.40 -$44.10 $1,728.20 -$484.90
Crude Oil $94.83 $93.84 $0.99 $87.38 $7.45
Unleaded Gasoline**** $2.73 $2.66 $0.07 $2.55 $0.18

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