Weekly Stock Market Update—December 13, 2013
By Steve Scranton, SVP, CFA
Chief Investment Officer

Stock Market Update

Last Friday’s rally did not carry over into this week. The Dow Jones Industrial Average slid by 1.59% during the week, while the S&P 500 lost 1.61%, as the “Federal Reserve (Fed) watch” speculation pendulum swung in the direction of increased worry. Early in the week, Fed president Lacker commented that he sees little economic benefit from further quantitative easing actions. Then, in the middle of the week a new variable joined the picture.

Congress announced that it was nearing an agreement on a budget deal which would increase spending by ~$63 billion over the next two years while at the same time reducing the deficit by approximately $23 billion over the next 10 years. While not large, it would make another government shutdown unlikely and suggests that Washington is moving past the brinksmanship that has been in play for the past three years. Recall that in September, the Fed noted that the economy could be negatively impacted if Congress could not agree on a budget. If the budget deal is approved, it could remove a potential reason (in the equity market’s view) for the Fed to delay its decision to taper the economic stimulus program. On Thursday, the Republican-controlled House of Representatives passed the budget plan and sent it on for consideration to the Democratic-controlled Senate–which is expected to vote on it next week.

“Fed taper anxiety” certainly directed the tone of the market this week as equity investors continued to second-guess the Fed’s possible interpretation of recent economic data and events in Washington. Many market participants have been expecting that the Fed could begin tapering its quantitative easing program in January or March. However, a recent string of solid economic data has fueled the notion that the economy may be getting strong enough for the Fed to begin reducing its stimulus efforts sooner than expected. Some now anticipate that the timeline could be as early as this month or at the January meeting. With the final 2013 Fed FOMC policy meeting transpiring next week (on December 17th & 18th), the market will be transfixed on whether or not the Fed will pull the “taper trigger.”

Current Week Month of December YTD
Dow Jones (INDU) -1.59% -1.93% 23.22%
S&P 500 (SPX) -1.61% -1.60% 27.05%
Nasdaq (CCMP) -1.50% -1.42% 34.20%
MSCI EAFE (EAFE) -1.35% -3.47% 17.50%
Russell Mid Cap (RMC) -1.29% -1.15% 29.42%
Rusell 2000 (RTY) -2.11% -3.07% 31.95%

Updates to the Equities Buy List:

Company Name News Event Impact to Our Company View
COSTCO WHOLESALE CORP (COST) Costco reported 1Q14 earnings of $0.96 per share, below analysts' estimates of $1.02/share, and compared to per share earnings of $0.95 last year. Revenue rose 5.5% to $25.0 billion, but missed the average analyst estimate of $25.4 billion. Unchanged
CISCO SYSTEMS INC (CSCO) CSCO lowered its three-to-five year growth rate targets to reflect a slow down in emerging markets, and conservative customer spending. The company now expects long term earnings to grow 5%-7%, down from 7%-9%, and revenue growth of 3%-6%, lower than the previous range of 5%-7%. Unchanged

Fixed Income Update

Fixed income investors spent much of the past week digesting the rumors that Stanley Fischer will be appointed Vice Chairman of the Federal Reserve. Fischer, the former Bank of Israel Governor and IMF managing director, is held in high regard for his role in helping Israel navigate the financial crisis better than most developed countries. The rumors of Fischer’s appointment (and potential for a new Fed Governor that is more inclined to reduce Quantitative Easing) along with better than expected economic data led the fixed income markets to worry that the Fed will decrease asset purchases sooner rather than later. Throw in a slate of Treasury auctions and it all translated into an active week for the Fixed Income market.

To give some perspective on Fischer’s thoughts, in October Fischer was asked when the Fed should begin tapering its $85 billion in monthly bond purchases. He said that they “should start doing it pretty soon and to do it gradually.” These comments, along with Fischer’s views on the ineffectiveness of forward guidance by the Fed, triggered a Treasury sell off after the rumors of his appointment started to swirl on Tuesday.

Due to a compressed schedule to accommodate the holidays, the Treasury sold $96 billion across 3 different maturities and 4 more scheduled for next week. The week started off with a strong 3-year auction on Monday but the subsequent 10 and 30 year auctions came in a bit disappointing. Direct bids (submissions directly to the Treasury by primary dealers) were weak for all 3 auctions but where indirect bidders (submissions that pass through an intermediary such as a securities dealer or foreign central bank) picked up the slack on the 3-year they failed to materialize for the 10 and 30 year auctions.

Economic data also is supporting Fed tapering of asset purchases sooner rather than later as retail sales increased 0.7% versus an expected increase of 0.6% for the month of November. As we move through the all—important holiday shopping season, this figure will be closely watched.

As the year winds down corporate bond spreads are at their narrowest level since 2007. Sales of investment grade corporate bonds in the U.S. reached an alltime high for the second straight year after this week’s issuance by Deere & Co. Year to date $1.125 trillion has been raised at an average yield of 3.11% as borrowers looked to lock in lower yields. This increased issuance has been met by great customer demand. We have seen large fund flows into credit related sectors.

For the week Treasury yields ranged from down 2 to up 4 basis points.

Company Spotlight

COSTCO WHOLESALE CORP (COST)
A1/A+/A+
Reported quarterly earnings Buy / Buy
MCDONALD'S CORP (MCD)
A2/A/A
Sold €350 million of 12 year Eurodenominated debt Buy / Buy
WELLS FARGO & CO (WFC)
A2/A+/AA
Sold $750 million in perpetual preferred fixed-to- floating stock Buy / Buy

December 13, 2013

Current Last Week Week Change Last Year Year Change
Tax-exempt MMF 0.01 0.01 0.00 0.12 -0.11
Taxable MMF 0.01 0.01 0.00 0.13 -0.12
2-Year Treasury 0.33 0.30 0.02 0.25 0.07
5-Year Treasury 1.53 1.49 0.04 0.70 0.84
10-Year Treasury 2.87 2.86 0.01 1.73 1.14
30-Year Treasury 3.87 3.89 -0.02 2.91 0.97
5-Year Exp. Inflation 1.74 1.71 0.03 2.09 -0.35
2-Year Agency 0.41 0.36 0.05 0.29 0.12
5-Year Agency 1.85 1.78 0.08 0.95 0.91
10-Year Agency 3.54 3.49 0.05 2.22 1.32
2-Year Corporate* 0.76 0.74 0.03 0.70 0.06
5-Year Corporate* 2.37 2.33 0.04 1.61 0.76
10-Year Corporate* 4.11 4.10 0.02 2.93 1.18
30-Year Corporate* 4.98 5.03 -0.04 4.17 0.82
2-Year Municipal** 0.50 0.48 0.02 0.48 0.02
5-Year Municipal** 1.45 1.41 0.04 0.96 0.49
10-Year Municipal** 2.95 2.91 0.04 2.03 0.92
30-Year Municipal** 5.05 5.01 0.04 3.90 1.15
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*** $80.21 $80.32 -$0.11 $79.93 $0.28
CRB $279.67 $278.66 $1.01 $292.70 -$13.03
Gold $1,237.00 $1,229.00 $8.00 $1,696.80 -$459.80
Crude Oil $96.50 $97.65 -$1.15 $85.89 $10.61
Unleaded Gasoline**** $2.63 $2.73 -$0.10 $2.45 $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