After 10 straight up-days and eight consecutive record high closes in the Dow, Friday’s options expiration closeout was just what the doctor ordered to finally cool things off, and the session ended the longest consecutive string of gains since 1996.
The Dow opened lower and fell to its worst level of the day, a 69 point loss after the preliminary March U. of Michigan Consumer Sentiment Survey showed an “unexpected” decline when a gain was forecast and this finally showed the effects of the high gasoline prices and lower take-home pay as a result of the higher social security payroll deduction. But the index still had some fight in it as it followed the 2013 script by rallying back from those worst levels of the day to achieve “only’ a 20 point loss at 11:40am, which turned out to be the best that it could do and then proceeded to chop around and end with a decline of 25 points, which broke the glorious upside streak it had recently attained.
Breadth numbers were negative at a 14/16 ratio and the VIX, which got as high as a .69 point gain at the Dow low, in line with the loss, finally ended unchanged at 11.30, which I mentioned in Friday’s notes was not good because on other down days this year the VIX has had a strong tendency to rise by much more than it should (i.e. today’s action, which will be discussed later), which then has given the major averages more room to advance. And of course the volume was huge on this quarterly options expiration session, which once again goes to show that the trading was all related to options closeout strategies and other artificial types of maneuverings which have nothing to do with the everyday buying and selling that has taken place this year.
And typical of its quirky construction, BA by itself accounted for 14 points of Dow gains and the index was also helped by strong performances in AXP and BAC, both of which attained new 52-week highs as result of Fed decisions made Thursday evening. The latter rose to its highest level since May 2011 on Fed approval to buy back as much as $5 billion in stock, which would be its first repurchase since the financial crisis. It will also be allowed to redeem $5.5 billion in preferred shares. On the other hand, mighty JPM sold off as the Fed wants them to submit new capital plans to regulators to address deficiencies found in their planning processes and also as a result of a Senate investigation which found that their well-known C.E.O. had misled investors and avoided regulators as losses escalated during the infamous “London whale” scandal last year, which was the result of a “monstrous” derivatives bet according to the Senate report.
It was mentioned how a larger than usual percentage of options on the most widely participated in individual item of all, namely the SPY, went out worthless because of the huge number of calls that expired with no value despite the fact that this item was at a multi-year high last week. The details of these numbers were listed in Friday’s notes and will not be repeated here.
And perhaps the stock named after a fruit has finally found a bottom after a decline of 285 points, or 40% from last September’s high and after there have been a number of downgrades at the low prices as opposed to the large number of upgrades at its all-time high of 705. At the same time, those high-priced Nasdaq stocks that have done very well this year are taking a well-deserved rest after going up to levels that sort of appear to be unsustainable, and this would include such good 2013 performers as AMZN, ISRG, NFLX and GOOG.
The 10-year yield on Treasury notes declined back down to 1.99% on the ostensibly weaker U. of Michigan report after having failed at the 2.06% level earlier in the week after one better economic report after another drove the Dow to that astounding streak of advances. And how about those who bought the Euro on Friday on the assumption that the Fed will maintain its easy money policies which will keep the dollar under pressure, and were they ever in for a rude surprise today after what happened over the weekend in Cyprus, and more on that later. And crude oil and gold joined the upside Euro party as well on the weaker dollar scenario.
With the VIX at 11.30 and all sorts of overbought readings present, one would think that the market was due for some kind of setback, and similar to three weeks ago on a Monday as well when that unemployed Italian comedian Beppe Grillo sent financial markets into a panic for one day only, the same sort of thing is happening today over perhaps the most obscure European country of all, and if one went down to the floor of the N.Y.S.E. and asked the traders there to point out the island nation of Cyprus on a map, what percentage of them do you think would have any idea where it is?
But never mind, as the goings-on in that nation, which accounts for less than half a percent of the 17-nation Euro currency area G.D.P., was able to spook investors, especially in the overnight Sunday session as the S&P stock index futures actually declined by as much as 24 points at their worst level, which would have implied a Dow decline of 200 points or so. So what happened in that completely insignificant country to account for investors initially getting so bent out of shape? Apparently there was a plan to seize money from bank deposits in exchange for a financial rescue of 10 billion Euros by the E.U. Initially the plan would have taxed deposits up to 100,000 Euros at a rate of 6.75% and at a rate of 9.9% above that level. This would have shaved down the cost of the bailout down to that 10 billion Euro number from the initial figure of 17 billion Euros, which is close to the size of the country’s 18 billion Euro economy.
Then the plan was shaved down to a 3% rate on the former amount and at 10% for deposits between 100,000 Euros and 500,000 Euros and at 12% for deposits greater than that amount. Deposits of less than 20,000 Euros would be completely exempt. Apparently there will be a vote on these various proposals tomorrow. So what was the big wup about this? And in order to justify the panic early selling, market experts said that the raid on these bank accounts could trigger new convulsions in the overall E.U. financial crisis that began in 2009 with Greece. There was also the fear that the move is a large step that would limit support for bank creditors across Europe and it also shows that policy makers will risk financial market disruptions in order to avoid sovereign defaults.
And sure enough, the financial media went through all kinds of convulsions when it saw pictures of Cypriots lining up at cash machines which then ostensibly raised the specter of capital flight elsewhere and threated to disrupt the market calm that has existed since the E.C.B. pledge last September to backstop the debt of troubled nations. So with no government in Italy, Spain in the depths of both a political and economic crisis and Greece struggling to meet the terms of its own bailout, this supposed “crisis” in a completely insignificant country was used as an excuse to cool off a market that was severely overbought after the recent string of advances as mentioned above. And the country most bent out of shape over this is Russia, which has an astounding total of $31 billion on deposit in that country for no what would appear to be no other reason than tax avoidance at home. In fact, 31% of the total bank deposits in that country were from outside the E.U. for what other purpose than tax evasion. And in addition to potentially lowering the tax on deposits as mentioned above, the government said that depositors who keep their account intact for two years will receive securities linked to future revenue from the country’s gas reserves, and how do you like that for an enticement?
The VIX is once again acting in a way that will allow for future market gains as when the Dow was on its low as mentioned above, it rose by a panic-like advance of 2.22 to 13.52, or by twice as much as it should have. As things have calmed down, it is now higher by 1.45 to 12.75 versus that Dow 15 point loss, which is really much more than it should be, and this will set up the situation for the next upside move.
Naturally, bond yields are declining on a panic “flight to quality” scenario, as the 10-year Treasury note declined by the most in three weeks down to 1.90% and it is currently at 1.96%, handing those early buyers a loss right away. The Euro naturally is getting sold off with its largest decline in 14 months as it got as low as 1.288 before some clam set in here as well, as it is now at 1.297. And the only good thing that came out of the initial early negative reaction was that crude oil prices were lower by around $1 a barrel but have since rallied back as equity markets here have stabilized. And take a look at gold, which is continuing its recent rally on its newly discovered roll as a safe-haven as well after gold experts had turned almost universally bearish, but that $1,560 level appears to be the low for this recent correction. On the other hand, industrial metal copper declined to a four-month low on the supposedly negative implications of the Cyprus situation.
In a sort of revenge of the nerds scenario today, there are some components that are doing well, and the first one has to be HPQ, which has now doubled in price from a multi-year low last November, and the second one is CAT, which is one of the few industrial-type stocks that has declined recently as the Dow itself pushed toward its record highs. These two are accounting for 11 points of Dow advances just by themselves. And continuing the trend that started late last week, the stock named after a fruit is once again taking out its revenge on its new legion of detractors by rising nicely as the other high-priced Nasdaq leaders as mentioned above continue to cool off.
We have been pointing out 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 14.1 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.
There will actually be some interesting earnings next week for the start of the first-quarter reporting period for those companies whose fiscal quarter ended in February, and the list is as follows – Tuesday: ADBE; Wednesday: LEN, GES, FDX and ORCL; Thursday: NKE and KBH; Friday: TIF, DHI.
Economic reports include; today – March NAHB housing market index; Tuesday – February housing starts and building permits; Wednesday – the always important F.O.M.C. interest rate statement; Thursday – weekly jobless claims, March Philadelphia Fed Manufacturing Index, February existing home sales and February L.E.I.
First quarter earnings rose by 6.2%, increased by 5% for the second-quarter, were flat for the third-quarter and were 6.2% higher in the fourth-quarter. The current projection is for a gain of 3.5% in 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}.