Ho, hum, another day, another dollar, as the old-time civil servants used to say, as the Dow set its third consecutive all-time high record close yesterday and both it and the S&P rose for the fifth consecutive session. And once again, the financial stocks led the way higher, primarily in anticipation of the Fed saying that 17 out of the 18 largest banks could withstand a deep recession and maintain capital above a regulatory minimum, the so-called famous “stress tests”, which means a 5% Tier common ratio, and this is a regulatory minimum and measure of financial strength.
The Dow chopped its way to a new all-time high ever price of 14,354 which represented a 58 point gain at 11:10am. It then chopped its way to the “worst” level of the session with “only” a 17 point advance at 2:10pm before another late upside spurt, similar to the day before, got it to an eventual 33 point final closing level, at 14,329. And even the Nasdaq pulled its own weight for a change as it ended with a 10 point closing gain as believe it or not, the stock named after a fruit had the audacity to rally back from an early decline down to as low as 421 before ending at 430, which was the complete opposite of what it had done the day before.
Of course, since this stock is known for closing below the strike price with the largest call open interest and above the put price with the largest open interest as well, thereby causing what is called the “maximum pain” for its weekly option buyers, yesterday’s market action in this stock should have come as no surprise, as the call strike price with the largest number of participants is at 450 and the put strike price that has the most participation is at 420, which means that in order to cause that maximum pain to the largest number of option buyers, it should finish somewhere between these two levels, which it looks like it is going to do today. And by the way, as Casey Stengel used to say – “You can look it up”, as this phenomena has taken place every week since the stock was at its high at over 700 and even at the present time after it has fallen those 285 points, in other words, finishing below the largest number of call positions and above the largest number of put positions.
In fact, this has become such a common occurrence that there are those who believe that the stock has become a derivative of its options instead of the traditional definition of option prices as a derivative of the stock. And today’s nominal gain in the stock will put the vise on both call and put buyers even closer than the two strike prices just referred to.
Breadth numbers were positive at a 17/12 ratio and the VIX finally did something that it had not done in while, namely close with larger losses relative to the advance in the Dow instead of the other way around, as for instance it ended with a decline of .47 down to 13.06 relative to that Dow advance of 33. But repeating what I said yesterday, the last time it was at this level was on February 8th when the S&P was 1518 versus yesterday’s close of 1544. Of course, now that it is getting close to the downside support level of 12.30, it will be interesting to see if this low enough level is enough to stop the upside for a while, and obviously today’s February jobs report will be the determining factor.
And how about the bond market, which raised the yields once again on the better economic news with the 10-year Treasury note back up to 2%, still within the recent range but certainly at the higher end of that range. And the Euro also made a nice upward move, with the recently beaten-down common currency rising by the most in eight weeks against the dollar as E.C.B. President Draghi had the nerve to say that the economies of the E.U. will gradually improve later this year and at the same time gave no hint that he was going to raise rates there. In fact, the E.U. is now projected to show a decline of 0.4% in its G.D.P. for this year, worse than the prior projection for a decline of 0.3%. But never mind, the fact that bond yields in Spain continued to decline was also cited as a positive factor for the common currency, which rose by a full cent up to 1.3100. At the same time, the Japanese yen declined to its lowest level against the dollar since August, 2009 at 94.9, which is what the government there wants, in order to stimulate their exports.
And sure enough, crude oil finally got into the upside act as well, despite the fact that inventories in the latest weekly supply report were much higher than expected, but never mind, if equities are rising, this must mean that optimism about the economy is improving as well.
So what was the latest friendly piece of economic news that spurred the market to continue its recent gains? Sure enough, it was the fact that weekly jobless claims declined to a six-week low and the four-week moving average fell to its lowest level since March, 2008. On the other hand, the January trade deficit widened out to $44.4 billion from December’s three-year low at $38.1 billion, which was one of the reasons why the latest estimate of fourth-quarter G.D.P. was revised upward to 0.1% from its first reading at -0.1%.
Then there becomes the question of whether or not the market is overvalued at its new highs for the Dow and close to new highs in the S&P. At the October 2007 top, the price/earnings multiple for the Dow was 17 and for the S&P it was 17.5. Today it is 15.9 for the Dow and 13.9 for the S&P assuming that earnings for the latter are going to be $111 this year. The bullish argument is that the market is still undervalued at this level and the bearish one is that investors do not have faith in earnings expansion, which is why the multiples are lower this time. One also has to take into account the record low levels of interest rates at the present time in calculating why the p/e multiples are lower now as well, because stocks do compete with bonds for investor participation.
Then there was the anticipation for today’s jobs report, which still had consensus estimates from the experts lower than the ADP projections that were released on Wednesday, so something had to give here. I have always maintained that the worst thing you want to see is a rising market ahead of a major event, and if the market’s most recent gains were primarily due to those higher ADP numbers, which are 198,000 private payroll jobs for February and 215,000 for January, if the official numbers came in below the ADP levels, a very extended market could be in for some sort of correction.
But the market was so confident that today’s jobs report would come in better than expected that the various stock index futures were trading about 50 points higher for the Dow even before the 8:30am release of the report. And sure enough, the headline number was a whopper, with a gain of 236,000 after a 10,000 loss in government jobs which meant that private payrolls were higher by an almost unbelievable 246,000, which is 48,000 more than what ADP had said on Wednesday. The unemployment rate fell to a four-year low at 7.7%, the lowest since December 2008, which reflected the additional jobs plus people leaving the labor force as well. On the other hand, the revisions for the previous two months were lower in the order of 15,000 fewer jobs, so ADP was really off here just as they were too low on the February number. Construction jobs increased by the largest amount since March 2007 and the length of the work-week increased as well. Manufacturing, factory, healthcare and social services jobs rose also.
This means that job gains were 195,000 per month for the last three months, still short of the 250,000 a month needed to really take a bite out of the unemployment number, but it appears as if this is going in the right direction.
The market continued its recent euphoria as a result of the headline numbers with an immediate Dow gain of 84 points right out of the starting gate, which has been its best level of the day and might be the top when the final bell rings. From that high, it proceeded to make a fast decline to “only” a 5 point advance, heaven forbid, at 10:15am, from which level it naturally turned around to the upside, which follows its pattern of the past three days. It is currently ahead by 37 as this is being written. Breadth numbers are strong at an 18/11 positive ratio and the all-important VIX is declining by what it should be relative to the Dow advance, as it is lower by .37 to 12.69, so the 12.30 battle could be enjoined early next week. Of course this very low level of the VIX is probably the main factor preventing the Dow from regaining those early morning highs.
And naturally the bond market is selling off on the better economic news once again, as the yield on the 10-year Treasury note has now reached an 11-month high at 2.05%, as investors can now say that the Fed’s stimulus efforts are finally paying off. The dollar is making a strong rally on the back of the jobs report, with the Euro down under 1.3000 once again, which is actually hurting the price of crude oil somewhat, and this pattern of strong stocks and lower energy prices is in a sense the best that investors and consumers can hope for.
Even news from overseas was primarily beneficial, as Japan’s economy actually had the nerve to expand in the fourth-quarter when the consensus was for a decline, as it rose by a whopping 0.2% and it was reported that Chinese exports in February gained a large 22%, almost three times as much as consensus. And how about the fact that when the Dow came down to its lows as mentioned above, the reason put forward was that Fitch Ratings lowered their credit rating for Italy, how dare they, and one could see that when the market wants to go higher, any sort of negative news is brushed off. Even the kind of news that in the recent past might have caused selling in equities was ignored this time as the market has not quite reached oversold enough levels to stall out, although one would like to believe that with the VIX getting close to support, the upside should start getting a bit more labored from current levels.
Ironically, financial stocks for the most part are selling off after their huge rallies this week in advance of the stress tests, with the exception of C as they asked permission from the Fed to buy back $1.2 billion in shares after this same request was rejected last year.
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 13.9 times the projected 2013 earnings of $111. Earnings were $85 in 2010, $92 in 2011 and $102 in 2012. The estimate for 2013 is $111, a gain of 9%. 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 have had 14 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. G.D.P. rose 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}.