Weekly Stock Market Update—December 6, 2013
By Steve Scranton, SVP, CFA
Chief Investment Officer

Stock Market Update

This week, investors focused on a parade of economic data releases–and how the information might affect the Federal Reserve’s (Fed) decision of when to taper its economic stimulus (Quantitative Easing) program. As the informationrich week progressed, stocks moved steadily lower, driven by investor speculation that the data (much of which was better than expected) would translate to a “sooner versus later” decision.

Friday brought a reversal of the market’s week-long downward slide, as investors reacted positively to the most anticipated news of the week. The Bureau of Labor Statistics reported an improved picture of the nation’s employment market. The non-farm payrolls report for November showed that 203,000 jobs were added during the month–well above the consensus estimate of 185,000. Given the market’s behavior earlier in the week (and for the past few months), the data should have reinforced the “sooner versus later” negative reaction. However, in response to the news the Dow Jones Industrial Average surged 1.26% and the S&P 500 rose by 1.12%. There are a couple of possible explanations for the strong Friday rally: 1) the conclusion that the employment data was not strong enough to convince the Fed to taper its stimulus program any sooner than the market already anticipates; or 2) the data suggests that the economy could be gaining traction and becoming stable enough to withstand a reduction in the Fed’s support. Next week’s market behavior should prove interesting as to whether there is follow-through from Friday’s strong rally.

Current Week Month of December YTD
Dow Jones (INDU) -0.35% -0.35% 25.21%
S&P 500 (SPX) 0.01% 0.01% 29.13%
Nasdaq (CCMP) 0.08% 0.08% 36.24%
MSCI EAFE (EAFE) -2.73% -2.73% 18.41%
Russell Mid Cap (RMC) 0.14% 0.14% 31.11%
Rusell 2000 (RTY) -0.99% -0.99% 34.79%

Updates to the Equities Buy List:

Company Name News Event Impact to Our Company View
VALERO ENERGY CORP (VLO) VLO announced its product pipeline, terminal, and logistics business - Valero Energy Partners, LP - launched an initial public offering of 15 million common units. The LP offering is expected to trade on the NYSE under the ticker "VLP". Unchanged
MICROSOFT CORP (MSFT) The U.S. Federal Trade Commission approved MSFT's deal to buy Nokia's mobile phone business. Unchanged
APPLE INC (AAPL) AAPL reported it acquired Topsy, a social networking company that specializes in analyzing Twitter data. Financial terms were not disclosed. Unchanged
W.W. GRAINGER (GWW) Grainger announced it acquired Safety Solutions, Inc., a distributor of personal protective products and safety services. The deal is expected to be accretive in 2015. Unchanged
WALT DISNEY CO/THE (DIS) DIS raised its quarterly cash dividend to $0.22 per share, from $0.16, bringing the yield to ~1.21%. Unchanged
COSTCO WHOLESALE CORP (COST) Costco reported November comparable sales growth of 2%, below the consensus estimate of 3.3%, and compared to 6% growth for November 2012. Changes in gasoline prices and foreign exchange impacted results. Excluding these effects comparable sales rose 4%. Net sales for the month increased 4.5% to $8.78 billion. Unchanged
PHILIP MORRIS INTERNATIONAL (PM) Philip Morris, along with Japan Tobacco, have acquired a 20% stake in Megapolis Distribution B.V., a Russian tobacco distributor, for $750 million. An additional $100 million will be paid to Megapolis if certain financial targets are met over the next four years. The deal is expected to close by the end of 2013, and accretive to earnings in 1Q 2014. Unchanged

Fixed Income Update

Fixed income investors continued to worry about the Fed tapering its asset purchase program. Investors were concerned that Friday’s employment report would be strong enough to cause the Fed to start tapering, possibly as soon as this month. As it turned out, even though the employment report showed an increase of 203,000 jobs, investors correctly anticipated this number and thus market reaction was muted on Friday. For the week, yields increased between 2 and 11 basis points.

Detroit was back in the news again this week. A federal judge ruled that the city of Detroit met the legal criteria to file for relief under chapter 9 of the Bankruptcy Code and win protection from its creditors. A United States bankruptcy judge ruled that the city had demonstrated enough evidence to meet the test of insolvency. To recap, the city has seen its population shrink from 1.8 million to 700,000 people in 35 years. The pension costs of earlier generations are being supported by a diminishing work force; there are ballooning annual deficits, a tax base that is decreasing substantially, and borrowing on top of borrowing. Detroit is by far the largest US city to declare bankruptcy. It is struggling with approximately $18 billion in debt and long-term obligations. The judge found that (1) the city is insolvent and has filed bankruptcy in good faith (this is important, as it means that cities cannot resort to bankruptcy on a whim) and (2) that pensions can be impaired (like other contracts) during a bankruptcy proceeding. The key language is that creditors will be treated fairly and equitably. When the city comes back with a further plan of adjustment, the negotiations will start. For most of the time period since the city filed in July, municipal unions have argued that pensions are protected under Michigan law. In this case, it would seem that the judge is saying that federal law supersedes state law. Going forward, the city will continue to enjoy the protection by chapter 9 of the Bankruptcy Code without being impeded by creditors. It also means that all unsecured creditors – pensioners, unsecured (general-obligation) bondholders, and vendors – are subject to haircuts. The judge said that the court will be very careful in exercising the power to impair pensions. This is an important point since, in some other states (notably California), some cities in bankruptcy proposed paying pensions even though they were cutting other debt. Bondholders, at first glance, would seem marginally better off as a result of the ruling. It doesn’t appear they are being put behind other classes of creditors (unions). Washington Trust Bank does not own any general obligation bonds issued by Detroit.

Company Spotlight

MICROSOFT CORP (MSFT)
Aaa/AAA/AA+
Sold $3.25b of 5, 10 & 30 year dollardenominated debt. Also sold €3.5b worth of 8 & 15 year Euro-denominated debt. Buy / Buy
MORGAN STANLEY (MS)
Baa2/A-/A
Sold $850 million in perpetual preferred fixed-to-floating stock. Hold / Hold

December 06, 2013

Current Last Week Week Change Last Year Year Change
Tax-exempt MMF 0.01 0.02 -0.01 0.15 -0.14
Taxable MMF 0.01 0.01 0.00 0.12 -0.11
2-Year Treasury 0.30 0.28 0.02 0.24 0.06
5-Year Treasury 1.49 1.37 0.12 0.60 0.89
10-Year Treasury 2.86 2.75 0.11 1.59 1.27
30-Year Treasury 3.89 3.81 0.08 2.77 1.12
5-Year Exp. Inflation 1.71 1.75 -0.04 2.05 -0.34
2-Year Agency 0.37 0.36 0.00 0.28 0.09
5-Year Agency 1.79 1.69 0.10 0.85 0.93
10-Year Agency 3.52 3.41 0.11 2.08 1.44
2-Year Corporate* 0.74 0.73 0.01 0.68 0.06
5-Year Corporate* 2.33 2.23 0.10 1.52 0.82
10-Year Corporate* 4.13 4.01 0.11 2.79 1.34
30-Year Corporate* 5.06 4.98 0.08 4.04 1.02
2-Year Municipal** 0.48 0.48 0.00 0.47 0.01
5-Year Municipal** 1.41 1.41 0.00 0.90 0.51
10-Year Municipal** 2.91 2.91 0.00 1.92 0.99
30-Year Municipal** 5.01 5.01 0.00 3.89 1.12
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 $80.68 -$0.41 $80.26 $0.01
CRB $278.66 $274.88 $3.78 $295.91 -$17.25
Gold $1,230.30 $1,250.60 -$20.30 $1,700.30 -$470.00
Crude Oil $97.66 $92.72 $4.94 $86.26 $11.440
Unleaded Gasoline**** $2.73 $2.66 $0.07 $2.47 $0.27

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