About the only person who ended yesterday’s disastrous downside session with a smile on his face was the Italian comedian from Genoa, Beppe Grillo, whose gathering of protest votes against the economic difficulties and political corruption, combined with those of disgraced former Prime Minister Silvio Berlusconi’s center-right coalition sent equity markets reeling. With more than two-thirds of the vote counted, projections showed that the center-left coalition might have a narrow lead in the lower house of parliament. On the other hand, no political party or coalition appeared to be able to attain a majority in the upper house or Senate, which resulted in a deadlock. This is the exact opposite of the result that was hoped for and that Italy desperately needs to deal with their recession that is expected to produce a negative G.D.P. of one percent this year, worse than the overall 0.3 percent economic decline for the E.U. region as a whole. This election result will make it more difficult to deal with this recession, the high rate of unemployment especially among younger voters and a huge public debt which is around 125% of their G.D.P.
What must have spooked investors was that this political stalemate brings back bad memories of the Eurozone debt crises of recent years with a lack of clarity on whether there will be the austerity needed to end the economic uncertainty in the E.U.’s third largest economy.
As if the Italian political situation did not give investors enough to worry about, this coming Friday, March 1 could see $85 billion slashed from U.S. government budgets as the President warned about the harm that the cuts will do to Americans as he broke down the loss of jobs and services in each of the 50 states. Naturally the Republicans, who are in favor of budget cuts, said that the President’s warning was a scare tactic and demanded that Mr. Obama deal with sequestration in a more deliberate manner rather than across-the-board budget slashing.
The President has urged lawmakers to buy some time for a more inclusive budget deal with a short-term proposal that would increase revenues by eliminating some tax breaks for the wealthiest Americans. Senate Democrats have proposed a plan that zeroes in on those tax loopholes and Republicans have said that they would put forward a plan of their own. In the meantime there have been practically no negotiations between the White House and Congress on these issues, as Republicans argue that the President can surely bring out a plan to eliminate two to three percent (the amount of the $85 billion sequestration) from a $3.5 trillion federal budget.
Meanwhile, as Friday’s deadline approaches, each side blames the other, with the President warning that hundreds of thousands of people could lose their jobs and Republicans claiming that the White House is using scare tactics.
Perhaps even more than a comedian being able to determine the political outcome in any country (but let it be remembered that this is Italy after all) as a bizarre reason for the market shellacking that took place, was the early advance of 81 Dow points right off of the opening bell and this level was attainted by 10am. The Dow then went negative at 11:30am, continued to drift lower to a 60 point decline by 3:15pm, at which time things went into a bizarre and revolting downside meltdown, and I think it is bizarre because at the time of this lower acceleration, all of the ostensibly negative news from Italy was out there, so once again one would have to lay the blame on the shoulders of these high-frequency and other types of traders who try to game the system for as much benefit to themselves as possible. As a result of the late plunge, the Dow ended with a 216 point closing decline, which meant that in the last 45 minutes of the session, it collapsed by 156 points. Now I was not born yesterday and am not naïve to the machinations of the markets, having lived through every market meltdown over the past 40 years or so, but this one did appear to have been a bit maneuvered, as witnessed by the fact that even after the late selling, the various stock index futures closed above fair value and stayed positive all through the overnight session even as Asian and European markets underwent their own little meltdowns. Of course, one can also ask what the Dow was doing within 83 points of its all-time high record level on the early upside burst as mentioned above in the first place? Are things that great after the market had reached extremely overbought levels with almost 90% of the S&P stocks trading above their 50-day moving averages, a sure sign that there has to be some cooling off.
Breadth numbers were absolutely horrendous at a negative 3.5/1 ratio and even more bizarre than the decline in the major averages themselves was the reaction of the VIX, which went positive at 10:45am even when the Dow was higher, as if it smelled a rat, so to speak. Then when the major averages themselves turned negative, it went completely bonkers on the upside and ended with a humungous gain of 4.82 to 18.99, its highest level since it was coming off of the fiscal cliff panic at the end of 2012. Of course at that time the S&P was only 1426, so if one wants to take the optimistic view, if the S&P is starting from a much higher level at yesterday’s close of 1487 with the VIX at the same level as it was when the S&P was 1426, then this gives the major averages room to go considerably higher from here, although I do not believe that the S&P will make a new high this year, as do most of the other people who try to predict these types of things. The VIX, its gain of 34% in one day was the largest such increase since the first-ever downgrade of the U.S. credit system that led to the panic selling in August 2011.
And naturally the outside markets acted the way that they are programmed to act in such a panic situation, as we saw the old “flight to quality” mentality return to the bond market, as the yield on the 10-year Treasury note fell to 1.87%, which was its largest percentage decline since last November. In addition, the Euro continued getting sold off on the obvious anxiety that the Italian elections produced, as it declined to 1.3060 from the 1.322 level at which is started the day.
The combination of higher stock index futures and bargain hunting after yesterday’s downside debacle has resulted in a generally better market today, as economic data once again is lessening some anxieties. A good earnings report from Dow component HD is also helping as well, although the Dow is sort of flying solo and the Nasdaq is lagging badly. January new home sales rose to the highest level since July 2008 and the CaseShiller Home Price Index rose in December by the most in more than six years. In addition, February Consumer Confidence made a sharp upward rebound from the prior month.
As a result of these better reports and a near-term oversold condition, the Dow shot out to its best level of the day with a 127 point advance just at the time that Fed Chairman Bernanke began his Congressional testimony. And naturally what did a person think was going to happen once he started talking, and the answer is obviously lower, as the Dow proceeded to decline to its worst level of the day so far with an advance of only 39 points at 11:45am before rebounding to its current 80 point gain.
But all is not right here, as breadth numbers are only nominally positive at a 17/13 ratio while the S&P is being hindered by losses in its still largest component, the stock named after a fruit which is now lower for 9 out of the past 10 days despite all of the pollyanish price forecasts from its still loyal analyst contingent. In fact, if the Dow ends the day with a gain of 80 points or less, the Nasdaq will be negative, courtesy of declines in AMZN, formerly unstoppable GOOG which is perhaps finding the air above 800 a little too thin, and some hesitant trading in the shares of PCLN ahead of its earnings report tonight.
The VIX is trying to make amends for its bizarre upside move yesterday, as it is lower by 1.67 to 17.32, which is more than it should be relative to the current Dow advance of 80 points. The bond market is sort of unchanged today, as is the Euro, but gold is all of a sudden re-discovering its role as a supposed “safe-haven” from the $1,560 support level which now looks to be a near-term bottom. Crude oil is lower, down to $92.55 a barrel so if there is one thing that we can thank the clown for, it is that his strong election showing is ostensibly going to raise new worries about the E.U. situation and then presto, this must mean that people are going to drive less and prices then decline from levels that they should not have been in the first place, and so it goes with that market.
With earnings season now in the home stretch, of the 451 S&P companies that have reported so far for the fourth-quarter, 71% of them have beaten the earnings consensus and 66% have beaten on the revenue side as well. Earnings are now projected to be ahead by 6%, better than the 1.9% projection at the start of the reporting period. It is also interesting to see this number slowly rise as the earnings period is moving along, which has sort of justified the strong upward move that we have seen in stocks this year. The percentage of companies that has beaten consensus has been 65% over the past four quarters and 62% since 1994.
Economic reports this week will be plentiful, but the February jobs report will not be this Friday, the first day of the new month, but will instead be released next Friday, March 8. The lineup is as follows – Wednesday – January durable goods orders, January pending home sales; Thursday – next estimate of 4th quarter G.D.P., weekly jobless claims, February Milwaukee NAPM Index, Kansas City February Manufacturing activity Index, Chicago Purchasing Managers’ Survey; Friday – January personal income and spending, February final U. of Michigan Consumer Sentiment Survey, January construction spending, February vehicle sales, February ISM Non-Manufacturing Survey.
Earnings are basically coming to an end for the fourth-quarter and next week will be dominated by retailers as the season finishes up. Tonight – PCLN; Wednesday – GRPN, TGT, DLTR, YJX and JOY; Thursday – GPS, KSS and technology CRM.
First quarter earnings rose by 6.2%, increased by 5% for the second-quarter, and were flat for the third-quarter. 6% gains for the fourth-quarter are projected at the present time, in addition to a gain of 3.5% for the first-quarter of 2013. The S&P trades at 14.9 times the projected 2012 earnings of $102, according to the analysts who follow these companies. Earnings were $85 in 2010 and were $92 in 2011. The estimate for 2013 is $108, a gain of 6%. The average P/E multiple for the S&P going back to 1954 has been 16.4.
After four consecutive quarters of negative G.D.P. growth, we had 12 consecutive quarters of positive growth, starting with the third-quarter of 2009, every quarter in 2010, every quarter in 2011, and every quarter in 2012 except for the fourth-quarter, whose first estimate came in at -0.1%, but the number is still subject to revision. G.D.P. now has risen by 2.2% in 2012, and is projected to increase by 2% next year, according to various surveys.

Donald M. Selkin