I will repeat what I said yesterday and the day before, and that is if one were to walk around the floor of the N.Y.S.E. and ask the traders there if they could point out Cyprus on a map, I am certain that the majority would have no idea where it was, but yet I am also certain that all of these busy little bees were running around the place or gazing at the news flow that was continually emanating out of that place, which is basically a tax haven for wealthy Russians.
Despite the fact that foreign deposits in Cyprus banks rose by more than 60% in the past five years to over $40 billion, this is just a drop in the bucket for the estimated $2.7 trillion hidden away in all offshore banking havens. Some progress in terms of locating these hidden offshore accounts has been made in order to eliminate money laundering and tax evasion and for instance traditional tax havens such as Switzerland, Luxembourg and the Channel Islands like Jersey have witnessed a large decline in such deposits, and where do you think this money went to?
This has resulted in the situation where Russians routinely use Cyprus banks to launder illicit cash and there are estimates that more than $120 billion flows between Russia and Cyprus each year through what are called “round-tripping” arrangements by which Russians deposit money in Cyprus and then re-invest it back in Russia as a way of decreasing their potential tax liabilities at home.
So with this attempt to put a tax on foreign deposits to raise money that is needed for a bailout, the financial markets got bent out of shape for a couple of days after what Cole Porter would have called “What a Swell Party It Was”, as the Dow made those 10 consecutive higher closes and in the process made eight consecutive record high levels. But the problem with this historic move is that it pushed the VIX too low at 11.30, too close to its never to be broken 10 level for any length of time.
This resulted in the cooling off of the upside that we saw last Friday, and this past Monday and yesterday as well, which resulted in the S&P having the nerve to decline for three straight days in a row, the first time this has taken place in 2013.
And little old Cyprus is still a tiny player in this offshore banking haven business, as for instance banks in the Cayman Islands (i.e. familiar to the 2012 Republican presidential candidate) hold more than $500 billion in foreign deposits and Netherlands Antilles banks have more than $300 billion.
The Dow started out higher yesterday and reached its best level of the session with a 62 point advance at 10am after a good February housing starts report and an upward revision for January. In addition, building permits, an indicator of future activity, rose to their highest level since June 2008 with an advance of 4.6%. Then all of a sudden the potential “Turnaround Tuesday” process ended as the Dow went negative at 11:50am and then proceeded to plunge to a loss of 70 at its 1:30pm low. So now the “explanations” from market experts went from “Strong housing report overshadows negative news from Cyprus” when the Dow was higher, to “Cyprus news overshadows strong housing report” when things turned to the downside.
But at least the Dow refused to buckle under the overall downside pressure and chopped its way back in the afternoon in an irregular pattern as it finally was able to eke out a nominal gain of 4 points by the close, and once again it is the peculiar makeup of this average that allowed a handful of stocks to exert an outsize influence, and yesterday the honors went to components PG, TRV and KO, which by themselves accounted for 17 positive Dow points. The reason attributed to the overall comeback by stock indexes was that the E.C.B. issued a statement that they remain “committed to providing liquidity as needed within the existing rules”, amen.
Back in the real world, breadth numbers were at a 13/17 downside ratio and all of the other major indexes finished lower, with the S&P and Nasdaq declining by 3 and 8 points respectively. And naturally, scared investors ran into the ostensible “safety” of Treasuries for the second day in a row, bringing the yield on the 10-year maturity down to 1.91%. And the Euro got blasted down to a three-month low at 1.287 on the Cyprus parliamentary rejection of the bank tax and crude oil also got sold off for the same reason, and what does anything that happens in that little tax haven have anything do to with whether you or I will buy more or less gasoline? But let us be thankful for any day when the energy markets decline, because prices in this realm are continually being maneuvered higher by those whose interests it is to increase the “numbers” that they have invested in, as I have pointed out many times.
And what about our beloved friend the VIX? After getting down to those unsustainable levels late last week at 11.30, “something” had to happen to cool it off a bit, and once again we saw the same 2013 dynamic at work as we usually do, namely that on any down day, the nervous nellies who get involved with this item bid it up by much moe than it should be, which ultimately paves the way for the stock market to go higher because this type of action pushes it further away from its ultimate downside level than necessary, and yesterday was a classic example of this. It ended with a large gain of 1.03 to 14.39 despite the Dow ending higher and the S&P closing only nominally lower. The last time that it closed at this level was on February 27th when the S&P was 1516 versus its close at 1548 yesterday, and this shows how the same level of the VIX has allowed the market to move higher through its bizarre movements, which I believe are caused by the ETF and options trading in funds that are supposed to replicate it, but which sort of distort it, as has anyone made money on the buy side in either the VXX or TVIX, with their huge volumes and their collapse in prices to fractions of what they were a year ago?
Could the S&P finally break its three-day losing streak so we can have a “Turnaround Wednesday” instead of the one that is supposed to take place the day before? After all of the agita resulting from that little island tax haven in the Mediterranean, E.U. officials called on their fellow finance ministers to reconvene “as soon as possible” on a new aid package for Cyprus after their parliament rejected the bank deposit tax that would have helped fund the proposed bailout. As a result, the Euro is rising, which is probably the only reason that stocks are doing better here before they face their own hurdle with the 2pm release of the latest statement on interest rates and the subsequent press conference from Chairman Bernanke and does anyone remember the last time the market rallied on these types of events?
The Dow reached as high as a gain of 90 points at its best 10:20am level which by the way was an all-time high intraday level ever at 14,545, which took out the 14,539 prior double-top from late last week, and is currently ahead by 53 as this is being written to 14,509, so one can still argue that there is a triple-top that has been built up in this 14,540 or so area, which obviously needs to be taken out on the upside if the current rally is to continue. Breadth numbers are at a strong 20/9 upside ratio and the VIX is doing a number on its panicked buyers from the previous two days with a large decline of 1.74 down to 12.65, which sort of makes up for its naughtiness during the first two days of the week. It also takes out all of the buyers of 13 and 14 calls for today’s March options settlement, which now means that even more call buyers lost their money than the 3 million that was originally estimated, and just to show how futile these people are, it was reported that trading in VIX options reached a record yesterday, obviously with buying of now worthless calls the main feature, and so it goes.
Earnings for the first-quarter are starting for those companies whose fiscal-quarter ended at the end of February, and there were good reports from WSM, ADBE, GIS and LEN while FDX is dragging the Dow Transports lower after its results.
Some of the supposed safe-havens do not look so “safe” today as the bond market is declining to get the 10-year yield up to 1.93% and even gold, which has come back in favor lately, is cooling off a bit as well.
It will be nice to see if the current gains can survive what the F.O.M.C. and Chairman Bernanke have to say, as this is always a worry that market experts will put a negative spin on something that one or two members of the committee have to say about ending the stimulus programs sooner rather than later. And if the market does sell off, it will be because the Fed will say that the economy is improving, and they can point to the latest jobs report as evidence, and then investors can then impute the supposed concern that the stimulus program will end sooner because of this better economy and therefore the underpinning for the market will be taken away and this will be the reason for the late selloff, if in fact one does take place.
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 this 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: GES and ORCL; Thursday: NKE and KBH; Friday: TIF, DHI.
Economic reports include: later today– 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}.