After Tuesday’s strong start to the week that resulted in a record close for the Dow despite some weak underpinnings as bond yields rose to 13-month highs, the potentially negative consequences of such a stunning move were evident yesterday as the major averages started out lower and ended lower, albeit off of their worst intraday levels. For instance, the Dow kept sinking right out of the opening gate and fell to its worst level of the day with a 180 point intraday decline at 11am, from which it tried to recover on two occasions to a loss of only 70, but this was the best that it could do and as a result it sagged into the close and finally ended down 106.

Breadth numbers were horrible at a negative 1/6 downside ratio and the VIX rose by .35 to 14.83, less than it should have but let us also remember how flaky it has been acting as its diehard supporters continue to buy calls on it as well as the various ETF products that have sprung up around this item. This is basically self-defeating because the further the VIX stays away from its various support levels, which can now be identified as 12.50, the low for the year at 11.30 and the level from which it cannot go below for any length of time, namely the ultimate downside stopper at 10, the market can continue to go higher. So this method is sort of useless unless the market undergoes a larger correction than what it has done so far this year. On the other hand, I saw a statistic that since the end of World War II, the S&P has never had a year in which it did not decline by 5% or more for the entire year, and so far this year the worst correction has been the 3.8% setback in the middle of last month.

The Dow has now gone 103 straight sessions without declining for 3 days in a row, which is a record streak, the S&P has gone 132 sessions without a 5% decline and the last one of this magnitude or greater was the 7.7% setback from last September 14th to November 15th and this has been the longest such streak since there were173 days that ended on February 20, 2007. And in the meantime, the S&P has advanced by 25% since those November lows. This is why these inevitable setbacks have to be viewed in light of the larger picture as mentioned above, which is still to the upside unless proven otherwise.

The yield on the 10-year Treasury note declined back down to 2.12% after the largest monthly increase in these yields in nine years as after a weak two-year note auction on Tuesday, buyers were strong for the five-year auction yesterday. The Euro rose up to 1.294 as it moved higher despite German unemployment rising by more than four times as much as the experts had predicted as apparently the easing up on austerity policies favored by Germany to deal with the E.U. debt crisis without new spending programs were viewed positively. The best thing to come out of yesterday’s session was that crude oil prices had the nerve to decline by $2 a barrel down to $93 on the prospects for larger supplies in today’s inventory report, and this was a four-week low as the summer driving season is here, and don’t you think that the oil companies and other interested bullish participants in this market are doing to do something about that soon?

And as has been the case all month, once again it was those high-yielding defensive stocks that had done so well earlier in the year that led the way down, with utilities, telecom and consumer staples issues taking it on the chin, as Dow components MCD, PG, JNJ, VZ and KO accounted for 65 negative Dow points alone, which was more than half of the downside total. On the other hand, those financial issues have been unstoppable on the upside lately and selected technology issues did better, with AAPL, NFLX and Dow components CSCO and HPQ all showing to an upside advantage.

Oh no- here we go again, as those contradictory comments out of the Fed last week has kind of thrown out of whack the expectations for investors, as for instance the market is rising today on the ostensible “explanation” that the old “bad news is good news” syndrome is at work. This is because three economic reports released this morning all came in below expectations, which now shows that the Fed is not going to take its foot off of the easing pedal as soon as last week’s late in the week and Tuesday’s panic selling indicated that they might. Weekly jobless claims rose by more than expected up to 354,000, a 10,000 increase from last week’s upwardly revised number and April pending home sales, although they reached their highest level since April 2010, still
came in short of expectations. And the latest revision of first-quarter G.D.P. showed that it rose by 2.4% as opposed to the initial estimate of 2.5%. So now we are going to be in one of those really sick phases of the market where investors have to root for these reports to come in below expectations for the reasons just mentioned as opposed to the stock market doing well because it is reflecting a better economy, and this is what we will have to deal with going forward.

The Dow opened higher after a move upward in the various stock index futures that had been down in the overnight session after the Japanese stock market took another downside beating of around 3% to bring its total recent losses to worse than 10%, which puts it in an official correction mode after it had rallied more than 30% this year. The Dow is currently ahead by 62 points, sort of where it has been for the past few hours, and breadth numbers are at a positive 18/12 ratio and the VIX is once again reluctantly going lower by .26 to 14.57.

Some of the recently beaten-down groups like utilities are doing a little better today, as are those mortgage-REIT’s which got blasted to yearly lows but are hopefully stabilizing at current levels. One group that has been on a real upside tear lately has been the banks, which continue to push to new multi-year highs but in most cases still well below their all-time highs with the exception of JPM.

The bond market is sort of quiet today ahead of the results of the seven-year auction, with the 10-year yield around 2.12%. The Euro is rising to a three-week high against the dollar at 1.305 on those weaker reports that now show that the Fed will continue its stimulus programs longer than thought just a few days ago, and if this is not the sickest thing I have seen, as mentioned above, then I do not know what is, namely this completely schizophrenic and shifting perception of what Fed policy is supposedly going to be. Gold is naturally following the Euro higher on the same reasoning and crude oil could not stand to be lower, as it found support at $91.65 and is moving up on the same perception of Fed stimulus, so here again is another example of market experts using this sort of reasoning as a crutch until the next time that the process reverses itself the other way.

As we approach the last trading day of the month tomorrow, the S&P has shown an advance of 3.7% in May, which will now mean that the market has gained for seven straight months in a row, the longest such streak since September 2009.

As earnings season is basically over for the first-quarter, with 497 S&P companies that have reported, 70% have beaten the estimates, which compares to the average from the last four quarters at 67% and the average from 1994 of 63%. Revenues have only beaten in 48% of the companies, and this compares to an average beat rate of 62% in the last year and 52% since 1994. Earnings are projected to gain 5%, which is now above the January estimate of 4.3% and well above the April 1st projection of only 1.5%, which is an obvious reason why stocks have done so well lately.

Economic reports this week will end with: Friday: April personal income and spending, May Chicago Purchasing Mangers’ Survey, U. of Michigan final May Consumer Sentiment Survey, May NAPM Milwaukee Index.
First quarter earnings rose by 6.2%, increased by 5% for the second-quarter, were flat for the third-quarter and were 6.3% higher in the fourth-quarter. The current projection is now for a gain of 5% in the first-quarter of 2013.

The S&P trades at 15 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 and it has been 14.4 for the last 10 year’s average.

After four consecutive quarters of negative G.D.P. growth, we have had 15 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% in 2013, according to various surveys, with 2.5% in the first-quarter and then in the low 1’s for the second and third-quarters before a fourth-quarter acceleration to over 4%.

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}.