In a testament to the underlying strength of the market so far this year, after that huge down day last Monday as a result of the Italian comedian and the disgraced former Prime Minister getting enough votes to prevent a majority governing collation in that country shook things up a bit on the downside, the market put its head down and gained for the rest of the week so that the major averages all ended higher despite that worst one-day S&P showing since early November.
And Friday’s market action was typical of what we have been seeing lately, namely the willingness of buyers to enter on any kind of price decline, as for instance the Dow reached a fast early morning low of 117 points at 9:40am, from which level it began to chop irregularly higher and actually got positive at 10:30am, from which level it broke into higher ground for the rest of the afternoon and finally ended with a 35 point closing advance, which meant that it made an intraday upside reversal of around 150 points or so.
Breadth numbers ended at a positive ratio of 17/13 and the VIX once again demonstrated the kind of behavior that is allowing the market to keep adding to its gains, as for instance it ended the session with a decline of .15 to 15.36, less than it should have relative to the Dow’s advance. As an example of how the VIX is allowing the market to go higher, on February 21st, it closed at around the same level that it did on Friday, but on the former date, the S&P was 1502 as opposed to its 1518 close on Friday. And as a further example of how the too-exuberant buying of so-called downside “protection” has worked to the markets’ advantage this year, when the Dow was on its early morning low as mentioned above, the VIX got as high as a 1.31 point gain up to 16.82, higher than it should have been, which allowed the market to turn those early losses into closing gains.
It was somewhat ironic that the “explanations” as to why bond yields declined last week, with the 10-year maturity down to 1.85% from its recent move over 2%, the Euro declining under 1.300 for the first time in two months and crude oil prices reaching their lowest level of the year, were all ostensibly the result of a weak European economy and concerns over the budget sequestration that went into effect on Friday. The President himself said that these budgetary reductions will be a “slow grind” on the economy. But yet the stock market keeps advancing at the same time that other “risk-on” trades are going the other way, so someone has to be right and someone has to be wrong here.
As an example, some market “experts” claim that the many economic and legislative hurdles that stocks face are “unwarranted”, whatever that is supposed to mean. And when stocks rally, the experts claim that some sort of compromise will appear that would postpone the sequestration while others point out that the $85 billion cuts are only a small fraction of a $15 trillion economy. On the other hand, these outside markets are declining as stocks are rising because the experts say that such items as E.U. manufacturing declining for the 19th straight month, Italian bond yields going higher than they were before last week’s election and European unemployment rising to a record 11.9%, are all forcing investors out of items such as the Euro, crude oil and gold and into the supposed “safety” of bonds because of anxieties over slowing worldwide economic growth, but yet stocks see the glass as half-full at the same time that other markets see it as half-empty. One would like to believe that this discrepancy cannot go on indefinitely, but as long as the VIX remains above the 12.30 support level, it would appear that equities still have room to grudgingly advance.
As an example of this, Friday’s lowest January personal income report, the worst in 20 years, was partly responsible for the weaker opening along with poor overseas news. Then better news from the final February U. of Michigan Consumer Sentiment Survey along with the February ISM Manufacturing Survey showing its best expansion since June 2011 got investor’s bullish attitudes flowing once again. And then one can also make the argument that government spending or lack of it is not as closely correlated with corporate earnings as some investors fear.
On the other hand, more serious issues could arise over the temporary budget expiration on March 27th and the debt-ceiling discussions that were postposed to May and failure to resolve the debt-ceiling issue could once again raise the possibility of another disastrous downgrade of the U.S. credit rating that might replay the August 2011 fiasco all over again.
Things started out lower today on news of a report that China’s services industries rose in February at the slowest rate since September, for want of any other reason as earnings season is virtually over and there were no economic reports here. As a result, the Dow began with a decline of as much as 59 points at its worst level on a few occasions this morning but then rallied back to a loss of only 7 as a top Fed official said that their aggressive monetary stimulus programs are warranted because of how much below full potential our economy is operating. The costs of the $85 billion in monthly asset purchases more than offset the dangers of a prolonged period of economic malaise, in this person’s opinion, and this individual is considered a close voting ally of Chairman Bernanke.
Since that 11:30am high, the major averages are slipping once again as this is being written, with the Dow lower by 45 points, led by industrial cyclical stocks such as BA, CAT, 3M and UTX, partly due to the fact that half of the automatic cuts in spending that went into effect are in defense programs. The government will reduce spending by $1.2 trillion over the next nine years, counting the $85 billion that went into effect for this fiscal year. These cuts will result in a 0.6% decline in economic growth this year according to the Congressional Budget Office and a 0.5% slowdown according to the I.M.F.
Breadth numbers are at an 11/18 negative ratio and the VIX is actually behaving itself with only a nominal rise of .07 to 15.43 as the Dow is lower by those 45 points and was actually negative when the major averages were on their late morning highs as mentioned above, For some reason, retail stocks are doing well but defense and aerospace issues are selling off, to no one’s surprise. And to add insult to its recent injury, the stock named after a fruit has now lost its standing as the most valuable company in the world, as its relentless steady decline this year has now pushed its market cap slightly below that of XOM, which is not doing too well either lately, but is sort of holding its own as opposed to the former ,which gets hammered day after day with little relief in sight so far and after the farcical aspects of last week’s shareholders meeting, when the company took no action to raise the dividend and after the discredited comments from one prominent hedge fund advisor about the likelihood of a stock split which has caused this person to lose credibility, at least for the present time. By the way, both of these two most valuable companies are now worth slightly below $500 billion, a far cry from the failure historically of any company to hold above $650 billion in worth.
The Euro continues its recent decline to the lowest level against the dollar in almost three months, at 1.298 as Italy is now going to be holding new elections and economic reports which continue to show weakness. Crude oil now has an “8” in front of it, which is perhaps the best news to come out of the investment universe recently, ostensibly on the poor economic news from China but more likely due to the fact that it was way too high in the first place, thanks to the greed of hedge funds, high frequency traders and university endowments who make investments in it through various instruments only because they think it is a number that is destined to go higher and also because of the fact that gasoline prices at the pump were at their highest levels ever in February and really had to come down somewhat.
With earnings season now in the home stretch and a few retailers still to be heard from, of the 474 S&P companies that have reported so far for the fourth-quarter, 72% of them have beaten the earnings consensus and 67% have beaten on the revenue side as well. Earnings are now projected to be ahead by 6.2%, 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 highlighted by the February jobs report on Friday, and more on that as the week moves along. We will also get: Tuesday – February ISM Non-Manufacturing Survey; Wednesday – January factory orders, Fed Beige Book, ADP jobs estimate; Thursday – January trade deficit, weekly jobless claims and Janaury consumer credit; Friday – January wholesale inventories in addition to the big enchilada.
First quarter earnings rose by 6.2%, increased by 5% for the second-quarter, and were flat for the third-quarter. 6.2% 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

Don Selkin is the Chief Market Strategist at National Securities Corporation, member FINRA/SIPC, (NSC) and provides the Fair Value analysis for CNBC each morning. The commentary provided in this Market Letter is intended to provide our customers with timely market analysis and should not be considered a research report. This Market Letter may contain, and is limited to: Discussions of broad based indices; Commentaries on economic, political or market conditions; Technical analyses concerning the demand and supply for a sector, index or industry based in trading volume and price; Statistical summaries of multiple companies’ financial data, including listings of current ratings; and, Recommendations regarding increasing or decreasing holdings in particular industries or securities. This Market Letter does not make a financial or investment recommendation or otherwise promotes a product or service of the firm. This Market Letter contains only news, facts, and commentary on information previously reported from a news source believed to be accurate and reliable by the author. These news sources include the following: {Bloomberg Financial, Reuters, Associated Press}.