Similar to what happened three Monday’s ago when the strong showing in the Italian parliamentary elections by that unemployed comedian Beppe Grillo sent the major averages reeling to their worst showing of the year, another event in Europe also caused the market to pause yesterday after the Dow had made that historic string of 10 advances in a row and eight consecutive record high closes in a row as well.
Instead of dysfunctional Italy, this time the agita came from the island nation of Cyprus, and I am certain that if you asked the floor traders on the N.Y.S.E. where this country was located, most of them would probably point in some other direction than the real one, but this word was on all of their lips yesterday. What this means is that an extremely overbought market, with the VIX close to the lowest level that it can ever get to, namely to slightly under 10 with its close on Friday at 11.30, was sort of cruising for a bruising in any event.
And the ostensibly “terrible” news from this island nation that accounts for just one-half of one per cent of G.D.P. for the E.U. was able to spook investors, especially in the overnight Sunday session as the S&P stock index futures 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 revised 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 later today. 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 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 various stock index futures did improve in the Sunday overnight session from their traditional European-panicked state and as a result, the Dow opened with a loss of 110 points at its worst level and immediately proceeded to move higher from there, and actually had the nerve to show a 7 point advance at its best 2:30pm levels before once again selling off late in the session to finish with a closing 62 point loss.
Breadth numbers were negative 12/18 and the VIX once again acted in the same peculiar manner that it has on other down days this year as it rose by much more than it should have, ending with a closing gain of 2.06 to 13.36 and even when the Dow was at that brief 7 point gain as mentioned above, the VIX would have no part of it as it was still higher by 1.27 at that time. And once again, the fact that it gained by much more than it should have relative to the Dow decline ultimately will pave the way for further market gains as it moves away from its ultimate downside support level, which is just below 10.
The 10-year yield declined to 1.96% but at the depths of the panic, it got down to as low as 2.90%, which already hands its buyers at that level with losses the same day. The Euro also collapsed in the early going down to as low as 1.288, its cheapest level since last December, but it also recovered and ended at 1.296. Crude oil had the nerve to end higher on the possibility of less harsh terms for bank depositors as mentioned above, and this item will do anything and look anywhere for some sort of “bullish” explanations to rally once it gets below $90 a barrel. And gold re-discovered its role as a “safe haven” just as most precious metals experts got bearish right at the bottom of the $1,560 correction level a couple of weeks ago.
Yesterday was sort of a revenge of the nerds day, as Dow component HPQ made another new recent high and CAT, the one large industrial stock that has been going lower while the others in this family have made new all-time highs recently, also did well for a change and these two accounted for 9 positive Dow points. And how about the stock named after a fruit, which continues to wreak vengeance on its bearish detractors, whose ranks grew as the stock made its low some 285 points, or 40% off of its best level. It continued last week’s pattern of rising while the other large Nasdaq stocks which have done so well this year took another day off, and this group includes AMZN, GOOG, NFLX and PCLN.
It was pointed out that bank accounts in Cyprus pay an interest rate of 5%, so if a person left his money there for the past five years, they would still be ahead even if they had to pay the proposed fee as put forth over the weekend relative to what a person would have if they had left their money in a U.S. bank account at virtually no interest at all, so take that all of you people who are concerned about what is happening to their money in these Cyprus banks.
The market today is trying to undergo a classic “Turnaround Tuesday” session, as it jumped out to a higher start in reaction to a better February housing starts report which rose by 0.8% and January was revised higher as well. More importantly, building permits, an indicator of future activity, rose to their highest levels since June 2008.
As a result, the Dow rose to its highest level of the day with a gain of 62 points just before 10am, before slipping to its worst level of the day at only a 7 point gain just after11am, and then rebounding back, as it is currently ahead by 35 as this is being written. Breadth numbers are positive at a 16/12 ratio and the VIX is feeling it once again, as it went from a decline of .44 down to 12.92 when the major averages were on their highs as mentioned above and as soon as things got a little shaky by 11am as both the S&P and the Nasdaq went nominally negative, it decided to push to the upside once again, and is currently up by .14 to 13.50 while the Dow is higher by those 35 points. Now whether this has anything to do with tomorrow’s March VIX options expiration is not certain, but the March VIX options stop trading tonight and settle on tomorrow’s opening, so if there is any sort of sharp move in stocks either way, the settlement price of the VIX for those options can adjust one way or the other.
In any event, assuming that the settlement price is 13.50 there will be an astounding 3 million calls that go out worthless with strike prices as high as 80, would you believe it, and these higher strike prices really have to represent the nervous nelly pessimistic crowd out there. To be fair, there are also puts that will go out with some value because of this low level of the VIX, and they amount to less than 500,000, which of course pales in comparison to the number of worthless calls that will predominate. And if one wants to add to the “worthless” number, there are around 250,000 puts that will go out with no value, and they are below the 13 level obviously.
The bond market is once again finding a “safe-haven” bid as the yield on the 10-year maturity has declined to its lowest level in two weeks, down to 1.89%, on concerns that Cypriote lawmakers may reject the taxes on bank deposits that would be a pre-condition of receiving their aid package. And the Euro is getting hit badly on the downside as well because of these same concerns, as it declines to 1.2850, its lowest level since November. And gold is feeling it once again, as it continues to regain its “safe haven” status after losing it for the longest time, and that $1,560 support level appears to be the bottom for the time being.
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 – tonight: ADBE; Wednesday: LEN, GES, FDX and ORCL; Thursday: NKE and KBH; Friday: TIF, DHI.
Economic reports include: 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}.