Weekly Market Makers - Week Ending 10/19/12

by Shawn Narancich, CFA Vice President of Research

Black Friday

After struggling to advance for most the week, stocks succumbed to the distinctly poor tenor of third quarter earnings. Friday’s losses erased most of the week’s gains on the 25th anniversary of Black Monday, the day when stocks crashed by 22 percent in 1987. Reporting season is now the focal point of investors’ attention, and despite some rumination in the investment community that third quarter numbers wouldn’t matter as much because of QE3 et al, today’s pullback helped dispel the notion. Despite predictable gains on Friday, benchmark 10-year Treasuries lost ground for the week.

Been There, Seen That

One-quarter of the S&P 500 has now reported earnings, and although a majority of the headline earnings numbers has exceeded estimates, the revenue line of corporate America’s income statement has so far come up short. Much like what investors saw in the second quarter, more than half of all companies are reporting revenue shortfalls, headlined by such blue-chip names as Microsoft, IBM, Coca-Cola, McDonalds and General Electric. Results are emblematic of a slow growth economy where nominal GDP is growing by low-single digit rates and sales are dampened by a stronger dollar that has hindered the translation of sales earned overseas. A weaker dollar since late July presents fewer headwinds going forward, but a slow-growth economy burdened by uncertain elections and the fiscal cliff have prevented all but a few companies from projecting any sort of earnings outlook for next year. Industrial conglomerate and Dow member Honeywell was one such exception, confirming investors’ expectations for earnings to grow by double-digit rates in 2013. Far more common this week were results from industrial brethren Dover, Danaher, Parker Hannifin and Stanley Black & Decker—all of which missed numbers and guided 2012 numbers lower. 

Meanwhile, the tech sector was a mess. Humanitarians among us may be glad to know that Google CEO Larry Page has regained his voice, but investors were left speechless by the company’s results. Announced prematurely before the close of trading yesterday, Google’s quarterly sales and earnings missed by a mile. It took market makers hours to rebalance their order books heavily skewed to the sell side, but when the stock finally reopened, about $24 billion of stock market capitalization disappeared. Ghosts of earnings-troubles-past cropped up, notably the increasingly difficult challenge of squeezing ads on to mobile phone screens while getting paid rates comparable to those earned on PC screens. While mobile devices have increasingly captured the eyeballs of users worldwide, advertisers appear less willing to pay for them … which brings us to Facebook. While the stock held up relatively well following the news out of Google, we can’t help but wonder whether their earnings next week will suffer the same fate. Investors will recall that Facebook cited similar challenges when they announced lackluster second quarter results in July.

 Whistling Past the Graveyard?

We would be remiss to neglect mention of economic reports this week that suggested once again that green shoots could be sprouting in the wake of easy monetary policy worldwide. Domestic housing starts reported at four-year highs and a third consecutive month of U.S. retail sales expansion should give heart to the bulls, since consumer spending remains the largest part of the U.S. economy. Indeed, the consumer seems to be more optimistic these days, but if stop-gap legislation isn’t enacted to forestall the fiscal cliff, they could be in for a rude awakening come January 1.  

Next week promises to be the busiest of the third quarter reporting season, with investors challenged to digest earnings reports numbering into the hundreds daily. In addition to Facebook, such blue-chip names as Apple, AT&T, DuPont and Merck are due to confess their numbers.

Our Takeaways from the Week

• Earnings season is off to a decidedly poor start
• Stocks could be vulnerable to further profit taking if earnings reports continue to disappoint

Disclosures

Weekly Market Makers - Week Ending 10/12/12

by Shawn Narancich, CFA Vice President of Research

And They’re Off!

Wall Street’s quarterly rush of earnings began this week, taking the news baton from moribund economic data and the easy money policies of central banks worldwide. From money center banks Wells Fargo and JP Morgan came predictably strong earnings buoyed by 30 percent-plus gains in industry-wide mortgage volumes. Record low interest rates have incented the masses to refinance their mortgages and purchase homes, but falling interest rates are damaging net interest spreads at a time when the margin of error has been narrowed by strong gains in bank stock prices. Investors were left unimpressed. Wells Fargo and JP Morgan fell Friday, headlining a pullback for the financial sector that has led the stock market higher so far this year.

Outside of the big banks, several other names responded favorably to earnings reports, including fast food restaurant operator Yum Brands and industrial distributor Fastenal. The latter sold lots of nuts and bolts in the third quarter, enough to boost earnings by 12 percent at a time when weak industrial production and manufacturing numbers had steeled investors for much worse. In tech, perennial laggard AMD pre-announced weaker than expected earnings, citing the same weakness in PC markets that led Intel to pre-announce weaker earnings a month ago. All told, it’s too early to read much into the ultimate flavor of third quarter numbers. What we do know is that stocks gave back a couple percentage points this week while the benchmark 10-year Treasury bond rallied which now yields 1.6 percent.

Blue Burner

While energy cousin crude oil has largely marked time this year, natural gas has quietly built momentum heading into the winter heating season. Air conditioning demand has waned for the year, causing producers to inject more natural gas into underground caverns until demand for seasonal heating picks up. The so-called “shoulder season” might otherwise elicit shrugs by those claiming that there’s still too much gas behind pipes in North America, but this year is proving to be different.

Since its lows of around $2.00/Mcf in April, natural gas has rallied by 80 percent. Aside from seasonal ebbs and flows, what investors have witnessed this year is consistently robust year-over-year demand growth that has materially outstripped slowing supply gains. The key demand drivers are coal-to-gas switching (utilities substituting cheaper gas for more expensive coal to generate electricity), an unusually hot summer (boosting air conditioning usage), and the substitution of natural gas by chemical and fertilizer manufacturers (attracted by lower feedstock costs domestically).

Despite the gains for gas, most shale basins domestically still require prices substantially above the current $3.60 price to make new drilling economical. For oil projects, it’s another story entirely. At $113 per barrel, there’s no shortage of projects offering attractive rates of return, so energy companies are doing what’s in their best interest by shunning gas and embracing oil. Investors are doing just the opposite, sensing that a dearth of investment in natural gas is about to reverse the production gains that first brought the commodity to its knees.

Our Takeaways from the Week

• Stocks succumbed to profit taking as third quarter earnings season began
• Natural gas prices are rallying as waning supply gains are being more than offset by faster demand growth 

Disclosures

Weekly Market Makers - Week Ending 10/5/12

by Shawn Narancich, CFA Vice President of Research 

Green Shoots?

Investors were surprised by the improvement in domestic manufacturing reported Monday. The report showed expansion for the first time in four months and contradicted recent weakness in indicators of regional economic activity. The Fed’s zero-interest-rate policy and stated intentions to buy mortgage securities are having their intended effect, which is to say that the nascent rebound in housing continues. Consequently, some of the increase in new-build activity is beginning to show up in the manufacturing statistics. And despite the implosion of auto production in Europe, which is plumbing depths not seen since the late 1990s, U.S. auto production is rising in healthy fashion, boosted by low interest rates and easier access to credit. The manufacturing Purchasing Managers’ Index (PMI) and auto production growth point to faster domestic expansion that may incent some forecasters to raise their 1.5 to 2.0 percent third quarter estimates of GDP growth. 

 One Month Does Not a Trend Make

So that brings us to today’s employment report. Bulls will point to the Household Employment Survey (HES) that showed net job creation of 873,000 in September which, if it were the nonfarm payrolls number from the establishment survey, would likely have produced a mad dash into stocks. Notable is the fact that a large number of these jobs were booked on a part-time basis. As such, the underemployment rate—which measures part-timers who would like to be working full time and those still looking for work—remains at an elevated level just below 15 percent. In contrast to the HES, the Bureau of Labor Statistics reported a much more pedestrian gain of 114,000 jobs for September. The unemployment rate fell from 8.1 percent to 7.8 percent because it is calculated using the HES data. Given the propensity for payroll data to be revised, investors will have to see further evidence of sustained payroll gains in both measures before they ascribe a different adjective than “moribund” to the job market. While investors bid stocks up another 1 percent on the week, euphoria following the jobs numbers faded on Friday, and stocks ended nearly unchanged. Benchmark 10-year Treasury yields backed up 11 basis points on the news, trading to yield 1.75 percent.

 Meg-Proof

A well-worn saw of the business is that the only constant is change. If only they could say it wasn’t so in Palo Alto! Confirming what a persistently southeast-trending stock chart was telling investors, Hewlett-Packard dropped a bombshell on investors by slashing earnings guidance for the upcoming year. Like quicksand that swallows the unsuspecting who tread on it, the stock plunged 14 percent as a $4.00 earnings baseline that Meg Whitman blessed upon her arrival at HP dropped to somewhere in the $2.00 to $3.00 range. Contrary to what many would have thought, the company’s PC and printer business was not cited for the earnings deterioration. Rather, thank EDS,—the IT outsourcer that HP bought in 2008 for $13.9 billion. The supreme irony here is that HP management cited previous owner (and subsequent EDS client) GM as one that had decided to “insource” its IT needs.  Indeed, what’s old is new again. In spite of Meg Whitman’s pedigree, what this week’s revelation indicates is that even she is proving unable to turn the secular tide at HP, leaving the company and its shareholders high and dry.

Earnings season unofficially begins next week with aluminum producer Alcoa set to kick things off Tuesday. What seems almost certain is that the 3 percent drop in large-cap earnings currently forecast by Wall Street is likely to prove conservative. The tale of the tape will be told by where companies place earnings guidance, for a beat in one quarter without a commensurate raise for the year is tantamount to a company cutting its earnings forecast. 

Buckle up investors, earnings season awaits.

Our Takeaways from the Week

• The tone of U.S. economic data improved, spurring stocks back to near five-year highs
• Profit warnings have predominated ahead of third quarter earnings set to begin next week

Disclosures

Weekly Market Makers – Week Ending 9/28/12

by Jason Norris, CFA Senior Vice President of Research

The Replacements

Who would have thought that one of the biggest stories of the week would be about replacement referees and a blown call on a Monday Night Football game?

The replacement refs were not the only ones blowing calls this week. Apple’s new iPhone 5 omitted Google Maps which, like the call in Seattle on Monday night, caused quite a stir and prompted CEO Tim Cook to apologize. In the long run, will it matter? We don’t think so. Our longer-term concern with the stock is how long wireless carriers (AT&T, Verizon, etc.) will continue to pay the hefty $300-per-phone subsidy to Apple. We saw earlier this week that China Mobile is holding off their launch because of this concern.

Limping Along

The Commerce Department revised their second-quarter GDP estimate for the third time this year—from a 1.7 percent to a 1.3 percent annual growth rate. Durable goods orders were weak and personal income growth slowed. Stagnant economic growth is more than a U.S. and European problem, now that we are starting to see cracks in China’s Wall of Growth. Nike cited slowing in China for their disappointing growth numbers. We have also seen cautious outlooks from Caterpillar, FedEx, Norfolk Southern and global shipping company Maersk. This has been a common theme the last couple of weeks. Thirty companies have revised their earnings forecasts in the last three weeks and 90 percent of those have been negative. During this time, stocks are roughly flat. We will see if the liquidity rally in equities will hold up in the face of slowing fundamentals.

 A Tailwind in Seasonality

One thing that equities have in their favor is the calendar. Historically, stocks rally in the fourth quarter of the year. October can be mixed, but overall the trend is higher. Since 1942, the average return for the S&P 500 in the fourth quarter is about 4 percent. We expect another eventful fourth quarter in 2012 with the election as well as another debt ceiling debate. Can stocks continue their strong 2012 run this time? What we know for sure is that, in six weeks the election will be over and more certainty will come into play, which the markets tend to like.  

Our Takeaways for the Week 

• While equities have exhibited strong returns in 2012, we still believe they are attractively valued
• Slowing economic growth will be a headwind to the equity liquidity rally over the next few months
• Consumers have remained resilient as evident by the lines outside of Apple stores to purchase new iPhone 5s

Disclosures

Weekly Market Makers - Week Ending 9/21/12

by Shawn Narancich, CFA Vice President of Research

Flies in the Ointment Stocks took a breather this week following gains in the S&P 500 totaling nearly 14 percent since June. As investors digest these gains and ponder the longer-term ramifications of central bank largess, several developments bear watching. Following last week’s Fed announcement of open-ended quantitative easing, Japan anteed up and announced a further extension of its QE program. With Japan’s economy mired in a deflationary funk, the Bank of Japan’s latest action is designed to dampen the yen and thus support its export markets at a time when China, one of its biggest trading partners, is threatening to reduce Japanese imports in the wake of the countries’ ongoing territorial dispute. Just as important, Japan is attempting to keep up with the Fed; a failure by the Bank of Japan to inject more yen into its monetary base would predict the type of yen strength that Japan hopes to avoid. Competitive devaluations are not a new concept and not universally applicable to all central banks. In Europe, where the ECB has threatened quantitative easing but has yet to execute it, the euro has rallied over 7 percent in just two months. As this week’s preliminary September manufacturing statistics from the Eurozone demonstrate, a stronger euro is doing no favors for an economy that appears to be falling deeper into recession.

No Free Lunch

Against the backdrop of incrementally easier money in the developed world, three key emerging market countries have failed to follow suit in the past couple weeks: Russia, India and South Africa. Why are they not attempting to keep up with the Joneses? In a word, inflation. The fact that Russia raised short-term rates last week while both India and South Africa kept rates steady this week speaks to the relative importance of commodity costs within these nations’ consumer price baskets. While food and energy account for about 15 percent of our domestic price index, the number for emerging markets is roughly three times as large. With key commodities such as oil priced in dollars, which are likely to become more numerous thanks to QE3— and inflation levels still above 5 percent in several emerging market economies—their central banks can’t necessarily afford to open the monetary spigots any wider. Life is a series of trade-offs, and in this case, easy money policy in developed markets is not without consequences; it poses important risks to the emerging markets that have been so important to the global economic expansion. 

Shots Across the Bow?

Historically, transportation stocks have been harbingers for the broader economy and stock market and on this score, warning flags have emerged. Following Fed Ex’s fiscal first quarter earnings miss announced earlier this month, one of the world’s largest shippers reduced annual earnings guidance this week because of weakening trade flows and concerns about higher fuel costs. Meanwhile, railroad operator Norfolk Southern warned that weaker coal volumes would dent its profitability and truckers Swift Transportation and Werner both cited weak volumes to the same effect. With third quarter earnings season right around the corner and equities perched on gains approaching 20 percent year-to-date, the stock market could be vulnerable to some profit-taking amid continued evidence of slower economic growth globally. Amid the cross-currents, benchmark Treasuries remain well bid, trading to yield a slim 1.75 percent. 

Our Takeaways from the Week

• Stock prices flattened this week as investors pondered bellwether profit warnings and the nuances of central bank policies worldwide
• Third quarter earnings season is right around the corner

Disclosures

Weekly Market Makers - Week Ending 9/14/12

by Shawn Narancich, CFA Vice President of Research

Cranking Up the Printing Presses

Following last week’s gains inspired by central banking developments in Europe, Bernanke and Co. delivered another dose of monetary policy relief that sent stocks to new multi-year highs. Investors anticipated new easy-money policies to come out of the Fed’s meeting this week, but the open-ended nature of what is being dubbed QE3 left those without adequate equity exposure longing for more. Purchasing $40 billion of mortgage-backed securities each month and signaling that short-term rates will remain near zero until at least 2015 ensure that the Fed’s balance sheet will continue to grow. Capital markets reacted predictably, bidding up the price of commodities such as gold, oil, copper, as well as the stocks of economically sensitive sectors like energy, materials, and financials. The $64,000 question is whether or not more quantitative easing will perk up a moribund job market plagued by fiscal policy uncertainty. Detractors worry about the inflation risks, but with the velocity of money having slowed so much, is it any wonder that U.S. inflation stands at 1.7 percent?

Don’t Worry, Be Happy!

Meanwhile, stocks and sovereign bonds in Europe continued to benefit from policy support there. The German Constitutional Court put its stamp of approval on the new European Stability Mechanism (ESM) bailout fund, setting the stage for the European Central Bank to purchase short-term debt of troubled countries once these troubled countries formally apply for aid. Only time will tell if Italy and Spain ultimately have to do so; but for now, the brush fires in Europe have subsided. The risk-on trade has left Treasuries out of the buying party with benchmark 10-year yields backing up to 1.87 percent.

A Fresh Apple to Pick

Apple introduced a new smartphone this week for the first time since the death of founder Steve Jobs. A larger screen and new fourth generation LTE technology should make the iPhone 5 better suited to video downloading at speeds that may incent more phone users to increase their data usage. At least that’s what prime carriers AT&T and Verizon Wireless hope will happen. The phone appears to have sold out on initial production runs, so the subsidy hit to profits will wash up on the carriers’ income statements this quarter and next. New tiered data plans required for the upgrade should provide the opportunity for upsell, but the degree to which customers ratchet up to more costly plans will ultimately determine whether or not the Big Bells make money off Apple’s latest and greatest. One thing’s for sure, Apple will.

Our Takeaway from the Week 

• The promise of new money creation is driving stock prices higher despite slow economic growth

Disclosures

Weekly Market Makers - Week Ending 9/07/12

by Shawn Narancich, CFA Vice President of Research

The Draghi Put

September kicked off with a bang as U.S. stocks moved to four-and-a-half year highs on the S&P 500 and highs on the tech-heavy NASDAQ not seen since before the tech bubble burst in 2000. Entering what has historically been the weakest month of the year for stocks following a double-digit summer rally that few foresaw, stock investors could be forgiven for not expecting the handsome gains that we got this week. So what was behind the euphoria?  In a word, Draghi. The ECB president backed up his tough talk of defending the euro by detailing a plan to “purchase unlimited quantities” of short-term European debt to preserve what it sees as the proper transmission of monetary policy. The catch? Countries must first apply to the European Union’s bailout fund and agree to prescribed fiscal reforms designed to reduce budget deficits and put troubled countries back on a sustainable fiscal path.

Another Acronym

In Europe, the Outright Monetary Transactions (OMT) plan prescribes that the International Monetary Fund be used to help oversee country specific reforms while also eliminating the ECB’s preferred creditor status in the event that purchased bonds default. If countries fail to abide by the bailout conditions, then the ECB could immediately cease bond purchases that would otherwise help nations like Spain and Italy refinance their burgeoning debts at acceptable interest rates. Bottom line, the ECB took an important step this week in preventing a disorderly break-up of the euro, but plenty of challenges remain for a region troubled by one monetary policy and 17 different fiscal regimes.

Bundesbank Indigestion

The European saga continues next week when the German parliament convenes to decide whether to sanction the Eurozone’s new bailout fund known as the European Stability Mechanism (ESM). At present, Germany’s central bank remains opposed to the ECB’s purchase of sovereign debt despite the ECB’s stated intention to inoculate bond purchases to keep the money supply stable; it claims such actions are tantamount to financing affected countries’ budget deficits. Nevertheless, Prime Minister Merkel has expressed support for the ECB’s plan and appears to have the political capital necessary to strong-arm lawmakers into supporting the ESM. If she fails, countries seeking a bailout would lack the mechanism by which they would apply for aid. For this week at least, investors were heartened by the ECB’s OMT plan, bidding Italian and Spanish debt substantially higher while reducing their accompanying bond yields. The question now becomes whether or not Spain and Italy will fumble away the goodwill the ECB has earned for them by not following through with a formal request for aid. Draghi has done his job, now the ball moves to Spain and Italy’s court.

A New Normal?

Meanwhile, investors didn’t have to look far for the reason behind why central banks globally have become so accommodative. Key economic reports were poor almost across the board, from continuing manufacturing declines reported in Europe, China, and the U.S. to yet another anemic jobs report domestically. Our economy generated less than 100,000 net new jobs last month, a level far below what is necessary to sustainably lower the unemployment rate. That rate actually declined to 8.1percent in August, but the underlying cause was shrinkage in the labor force from disaffected job hunters throwing in the towel on their job search. Economic weakness was confirmed anecdotally by bellwether Federal Express and technology leader Intel, both of which pre-announced weaker than expected earnings for the quarter. These reports lend further support for the Fed to announce a new round of quantitative easing at next week’s FOMC meeting. And let’s not forget China, where stocks rallied by nearly 4 percent today on news of substantial new government supported infrastructure investment.

Our Takeaways from the Week

• Central banks and governments worldwide are pressing on the stimulus pedal to counteract what has become a disappointingly weak expansion.
• Stocks are responding to expansionary monetary and fiscal policy by setting multi-year highs 

Disclosures

Weekly Market Makers – Week Ending 8/31/12

by Jason Norris, CFA Senior Vice President of Research

The Calm Before the Storm? Though this week proved to be full of newsworthy events (the Republican National Convention, Hurricane Isaac and the Fed’s Jackson Hole meeting), none of them proved especially “market moving” as stocks and bonds ended the week flat. While volatility this year has been a fraction of what we experienced the last few summers, we expect this to change as we move closer to the election and the Fiscal Cliff.

The Big Money With corporate America earning record profits, even in this slow growth environment, many companies have begun returning that cash to shareholders. In fact, companies in the S&P 500 are estimated to pay out close to $295 billion in dividends the next 12 months, up 16 percent from the previous  year. Leading the way in this growth rate is the technology sector where total dividend payments are expected to rise from $26 billion to $42 billion; a whopping 60 percent increase. As a result, the technology sector is now the second highest payout sector in the market, behind only consumer staples. A main driver of this increase is Apple’s initiation of its dividend ($10 billion) and a 75 percent increase in Cisco’s.

One Little Victory Speaking of Apple, the company will be receiving another cash injection thanks to a judgment they won over competitor Samsung. While $1 billion is just a drop in the bucket for Apple, the real victory for them is that this judgment may give Apple an additional competitive advantage for new products going forward. We believe that competitors will have to slow their product development process to ensure they do not infringe on Apple patents. As a result, Apple’s share of the smartphone market should continue to grow.

We Hold On Even in the face of strong cash generation, retail investors are still fearful of equities. The European fiscal crisis, coupled with the Flash Crash in the spring of 2010, has resulted in a withdrawal of $300 billion in domestic equity funds since May of 2010. In spite of record lows for interest rates, taxable bond funds have been the main recipient of this cash with over $400 billion invested.

Something for Nothing Corporate Treasury departments are taking advantage of record low interest rates. To that point, $238 billion in debt was issued in the month of August, which is the highest on record. This isn’t just a U.S. phenomenon. Companies across the globe continue to issue debt at bargain basement prices. Even though absolute rates are low investment grade bonds are yielding close to 100 basis points over Treasuries.

Our Takeaway from the Week 

• We continue to favor corporate bonds over Treasuries due to additional yield, as well as strong corporate balance sheets
• Stocks should offer an increasing flow of income as corporations pay out more of their cash to shareholders
• We expect global and domestic markets to exhibit higher volatility as we move toward our election, the Fiscal Cliff and a fix in Europe

Disclosures

Weekly Market Makers - Week Ending 8/24/12

by Shawn Narancich, CFA Vice President of Research

Like Punxsutawney Phil who saw his shadow and returned to the burrow for another six weeks of winter, the benchmark S&P 500 Index broke out to a new four-year high, only to retreat and post modest losses for the week. Investors left to wonder if the weather will turn stormy for stocks this fall received a few new clues in the form of disappointingly weak orders for U.S. capital goods and continued weakness in manufacturing measures, both in China and Europe. In the plus column, evidence continues to indicate that a nascent rebound in U.S. housing has begun, with existing and new home sales both up meaningfully in July and accompanied by additional reports of reduced inventories and higher prices. With the release of Fed minutes from the July 31 meeting evidencing a tilt by policymakers toward another round of quantitative easing, Treasuries gained a bid and yields fell to 1.69 percent on the 10-year bond benchmark.

It was only appropriate that Apple became the most valuable U.S. company ever this week, because without its substantial gains, the S&P 500 would not be flirting with new highs. Besides the tremendous earnings growth it has achieved, Apple is also the single largest payer of dividends in the tech sector at a time when investors are seeking to fill income buckets being drained by the bull market in bonds. Representing a disproportionate share of the technology sector in a year when Apple is up 64 percent has helped tech reclaim performance leadership for 2012. Where it ends the year will depend in part on customer acceptance of key products about to be introduced, including the iPhone 5 next month and Microsoft’s new Windows 8 software platform in October.

As the dog days of summer meld into fall, the latest chapter in the European debt saga remains to be written. Preliminary meetings between Greek, German and French prime ministers are underway, but no decisions have been made about whether Greece will receive its next tranche of bailout funds. In part, this decision will depend on the European troika’s onsite visits scheduled for next month. Not surprising is the revelation that Greece seeks additional forbearance from its benefactors, this time in the form of delays in meeting deficit targets. While Greece does not appear to be seeking any new monies beyond the aid package already agreed upon, German leaders are fed up with Greek attempts to move the goalposts. If the next installment of cash isn’t released by October, Greece will run out of money.

Next week, the cadence of economic reports picks up and investors will turn their attention to Jackson Hole, Wyoming, where Fed Chairman Bernanke will pontificate about the economy and the Fed’s role in support of its full employment mandate.

Our Takeaway from the Week

• Stocks are testing yearly highs despite mixed economic reports domestically and expectations for additional monetary stimulus both here and abroad

Disclosures

Weekly Market Makers - Week Ending 8/17/12

by Shawn Narancich, CFA Vice President of Research

The Mice Will Play While the Cats Are Away A late summer melt-up for stocks continued this week as more benign economic data globally, and supportive domestic retail earnings, kept stocks firmly bid. If it feels too good to be true, it may be. With key European policymakers on summer vacation and trading volumes low, investors are suspicious about the gains stocks have achieved recently. While evidence indicates that hedge funds have increased their exposure to this asset class, mutual fund data continues to show neutral-to-negative equity fund flows and substantial flows into bonds. Will retail investors’ distrust of stocks prove prescient? September may prove pivotal, as Europe’s sovereign debt troubles are far from solved. Will an upcoming ECB meeting, the German high court ruling on the constitutionality of the European Stability Mechanism fund, and yet another European finance ministers’ meeting harbor the potential to deal equities a setback? For now, stocks stand within shouting distance of year-to-date highs, and were bolstered this week by positive reads on both U.S. industrial production and better than expected retail sales that rose for the first time in four months. As stocks have risen, the marginal investment dollar has exited Treasuries, which booked another week of losses.

Ringing up Gains at the Cash Register Adding incentive for investors to add equity exposure was a heavy week of retail earnings reports that painted more plusses than minuses. After struggling for what seemed like an eternity to reverse its sluggish sales, Wal-Mart has parlayed inventory investment and sharper consumable pricing to book what has now been four consecutive quarters of positive same-store sales. The stock failed to pass muster with investors, however, as 20 percent year-to-date gains already appear to have discounted a 2 percent same stores outlook and moderately lower margins. The takeaway for Wal-Mart and its chief rival Target continues to be sharper pricing and one-stop shopping for lower income audiences stressed by high unemployment and $3.85/gallon gas. And just when investors had nearly thrown in the proverbial towel on 1990’s favorite The Gap, this retailer is now putting up impressive numbers at its namesake chain, Banana Republic, and discounter Old Navy. New management and better apparel styles appear to be doing the trick -- after nearly doubling so far this year, the stock added another 5 percent this week on a 7 percent gain in same-store sales and higher margins that drove a 40 percent boost to earnings.

A New Era Investors not content to leave their feasting to retailers also bid up the stock of Cisco on news the technology networking company will return more of its cash flow to investors. The stock’s 9 percent surge this week had less to do with ho-hum earnings and everything to do with a head-turning 75 percent dividend increase. In an arguably belated acknowledgement that its heady growth of the technology boom years is a thing of the past, Cisco’s management is recognizing, like so many other blue chip companies, that returning excess cash flow to shareholders is the best option in a slow growth, low interest rate environment where investors are hungry for yield.

Our Takeaways from the Week

• The Summer Doldrums have been kind to equity investors…so far

• Encouraging earnings reports from retailers unofficially marked the conclusion of second quarter earnings season

Disclosures

Weekly Market Makers - Week Ending 8/10/12

by Shawn Narancich, CFA Vice President of Research

Irrational Exuberance? Stocks notched another week of gains as earnings season waned and news flow slowed to a trickle. Even more notable than the 1 percent increase posted by large-cap U.S. stocks this week was the fact that their European counterparts have now risen for 10 consecutive weeks—the longest winning streak in six and a half years. Lest an investor be tempted to think that the nexus of worry in Europe has passed, this week brought more evidence that the Continent is in recession, with German industrial production declining again, Italian GDP declining by almost 3 percent annually and England posting its largest trade deficit ever. To the east, China’s economy continues to weaken. Specifically, their industrial production growth is decelerating, retail sales are growing at a slower pace and Chinese exports actually fell in July. Against this macroeconomic backdrop, the inflation rate has declined to just 1.8 percent, leaving China’s central bank with plenty of leeway to cut interest rates again. For now, the surfeit of global liquidity and anticipation of more to come is supporting the equity trade and causing less risk-averse investors to lighten their allocation to bonds. Benchmark 10-year Treasuries finished the week with small losses, pushing yields up to 1.66 percent.

Exports to the Rescue What was surprising to see domestically was the resilience of trade statistics. A dip in crude oil costs underpinned a drop in imports which, when combined with record exports in June, cut the nation’s trade deficit to the lowest level in 18 months. This upside surprise could cause economists to boost their estimate of second quarter GDP, a number that was first reported a couple weeks ago to have expanded at just a 1.5 percent annual rate. Investors will get a better feel for U.S. economic progress next week when the Census Bureau releases July retail sales numbers and inflation statistics.

A Stroll down the Retail Aisle While most U.S. companies have already released their second quarter earnings reports, retailers have just begun. Macy’s headlined results this week by reporting better-than-expected earnings growth of 22 percent on low-single digit same-store sales growth, while raising estimates for the fiscal year. Contrast this encouraging result with J.C. Penney, where same-store sales fell 22 percent in a quarter that witnessed the company’s second consecutive loss. Former Apple executive and current Penney CEO Ron Johnson may want his company to become “an entirely new class of department store,” but today’s results show that the J.C. Penney makeover is far from complete. As for department store rival Kohl’s, they made money in the second quarter, but same-store sales, gross margins and earnings all fell from year-ago levels. The conclusion here is clear: Macy’s is out-merchandising its peers and taking their market share.

Our Takeaways from the Week

• The dog days of summer have arrived on Wall Street
• Stock prices remain firm on expectations for more monetary stimulus globally

Disclosures

Weekly Market Makers - Week Ending 8/03/12

by Shawn Narancich, CFA Vice President of Research

Keeping the Powder Dry

All eyes were on the U.S. Federal Reserve and the European Central Bank (ECB) this week, but both failed to deliver the immediate monetary gratification investors sought. Speculation swirled that the Fed would decrease interest on excess bank reserves held with the central bank, lengthen its forecast period for zero percent short-term rates, or possibly announce QE3. While Wednesday brought none of the above, investors were somewhat assuaged by the Fed’s post-meeting statements indicating heightened vigilance about combating further economic malaise. Simply put, the Fed is likely to act if job growth doesn’t pick up.

Stocks Ascend the Podium So what about the employment picture for July? Clear as mud. Friday brought better news from the non-farm payroll report, which showed net job gains of 163,000. Government agencies once again cut jobs, but this was offset by improving private payroll gains. However, the parallel household survey of employment used to derive the unemployment rate showed jobs declining by 190,000 last month. As a result, the reported jobless rate rose to 8.3 percent. While July is a slow month for retail sales, the nation’s cash registers were busier than last year, as monthly same-store sales outpaced estimates and rose at a faster pace than in June. This could be an indication of better back-to-school sales in August, which is a significant month for retail. With July’s ISM report once again showing contraction in domestic manufacturing, investors are left to ponder the Fed’s next move. If economic data in the interim remains moribund, our best guess is that Bernanke will jawbone vigilance later this month at the Fed’s annual confab in Jackson Hole, and announce some additional monetary stimulus at the September Federal Open Market Committee meeting. Markets responded enthusiastically to the headline jobs number, reversing losses from earlier in the week to end the period with modest gains. True to recent form, Treasury bonds pulled back, with the benchmark 10-year Treasury trading down to yield 1.58 percent.

Actions Speak Louder Than Words As for Europe, who could really be surprised by ECB Chairman Mario Draghi’s lack of follow-through from last week’s admonition that it would do “whatever it takes” to support the euro? Investors apparently, judging by the market reaction. Spanish and Italian debt prices plunged anew following equivocation from the ECB; countries like Italy and Spain will need to apply for aid from the Euro zone bailout fund as a condition for potential ECB open market purchases of their troubled debt. Faced with well publicized German criticism of quantitative easing and necessary agreement from finance ministers across the currency bloc to enact it, the ECB once again finds itself in a policy straight jacket that will limit its ability to employ blunt force monetary policy in a timely manner.

Following more than 500 additional reports domestically this week, earnings season now winds down. While we’ve yet to hear from the retailers who will report later this month, companies in general are making earnings numbers by keeping strict control of costs and using excess cash flow to repurchase stock. Amid an economy growing nominally at 3 to 4 percent, revenue gains are increasingly difficult to come by.

Our Takeaways from the Week

• Central banks disappointed investors who were anticipating additional monetary stimulus

• Stocks remain resilient because of their attractive valuations and their dividend yield in this low interest rate environment
• Disclosures

Weekly Market Makers - Week Ending 7/27/12

by Shawn Narancich, CFA Vice President of Research

Resurrection before Insurrection The Dow industrials pushed through the 13,000 barrier again as investors warmed up to the latest jawboning from European policymakers and digested what will have been the heaviest reporting week of the second quarter earnings season. Over 600 U.S.-based companies confessed their quarterly numbers. While two-thirds have met bottom-line expectations, only about 40 percent have achieved anticipated sales levels and even fewer have upped their forecasts. Benchmark U.S. Treasuries slipped as investors succumbed to European Central Bank President Draghi’s promise to defend the Eurozone economy (quantitative easing, European style), sending yields up to 1.55 percent on the benchmark 10-year Treasury as investors bid stocks higher.

Technology Indigestion As the world’s largest publicly traded company, Apple garnered investors’ full attention, reporting 20 percent-plus sales and earnings growth that most companies would cherish in a slow-growth economy. Nevertheless, it’s all about expectations on Wall Street and, in this case, Apple failed them for only the second time in 39 quarters. Growth in device sales slowed and the commonly postulated explanation is that customers are waiting for the newest iPhone 5 to be delivered this fall. If past is prologue, the pain shareholders felt from 3 percent losses this week will prove temporary.

Meanwhile, Facebook shareholders may be feeling as if they’ve been run over by a Mack truck. Meeting sales and earnings expectations – something for which most newly public companies might be commended – was not good enough. Facebook added insult to injury by admitting that advertising growth has slowed as management struggles to monetize their presence on smart phones. No, they don’t plan to build one of their own, but they do need to figure out how to get advertisers to give their mobile application a thumbs-up. Performance since IPO: -38 percent. Because Zynga’s mobile games are distributed primarily through Facebook, all is not well in Farmville, either. The stock plunged 36 percent as its profits disappeared, literally and virtually.

Can Activist Investing Turn the Tide for P&G? Not all earnings news was so bad. Consumer staples stalwarts Colgate-Palmolive and Unilever both delivered on expectations through expansion in emerging markets, showing volume and price gains that are increasingly difficult to find in this space nowadays. In the zero-sum game that characterizes these companies’ business in developed markets, reported market share gains are likely coming out of Procter & Gamble’s hide. P&G’s stock is up lately on news that activist investor Bill Ackman has taken a small stake to agitate for better results from the lumbering giant. Investors can only hope that Ackman is successful because upcoming earnings here are unlikely to impress.

Slow As She Goes Corporate America’s collectively weaker top line was confirmed by Friday’s GDP report, showing that the economy expanded by just 1.5 percent annually in the second quarter. While exports weathered a weaker dollar, slower government spending and consumer spending weighed on output. And while headline durable goods numbers were encouraging, details showed that orders excluding the volatile transportation sector fell in June. Across the pond, European purchasing manager indices confirmed a deepening recession there. In China, preliminary July numbers were more encouraging.

Earnings season continues next week, with hundreds of additional companies reporting. On the economics front, investors will get an update on U.S. manufacturing activity from the monthly Purchasing Managers’ Index, and the payroll report for July will reveal how the jobs situation is unfolding domestically.

Our Takeaways from the Week

• Earnings reports confirm a slower growth economy worldwide
• Despite economic headwinds, stocks have logged double-digit returns year-to-date

Disclosures

Weekly Market Makers - Week Ending 7/20/12

by Shawn Narancich, CFA Vice President of Research

Glass Half Full, but Cracked Investors welcomed the first full week of second quarter earnings season with surprising enthusiasm, rallying stocks for modest gains despite finishing the week on a sour note. Could it really be such a surprise that Spanish officials now foresee recession in their austerity-wracked economy next year? News that Europe formally agreed upon the 100 billion euro Spanish bank bailout was not enough to calm bond market nerves there, as the sovereign 10-year bond encountered selling pressure following a weak Spanish auction Thursday. Yields came to rest at a robust 7.2 percent for the week, a level deemed unsustainable given Spain’s large debt load and ongoing deficits. Absent these headlines Friday, Europe was refreshingly quiet this week as investors turned their full attention to earnings.

Sell the Rumor, Buy the News? With approximately one quarter of the S&P 500 having reported earnings so far, what stands out is not that over 60 percent of reporting companies have exceeded estimates, but the reaction to earnings reports and forecasts that in periods past would have resulted in selling pressure. Industrial conglomerate Honeywell is a case in point; while reporting earnings that beat estimates, sales missed expectations and management reduced revenue forecasts for the year in acknowledgement of a slower global economy. The result? The stock gained nearly 7 percent on an encouraging outlook for margins and relief that the currency hit from dollar strength wasn’t worse. In technology, Intel provided another example of this same dynamic as it reduced sales forecasts following its report of flat earnings, with the stock responding positively afterward. While it’s true that in both these cases the stocks were off 10 to 12 percent from recent highs prior to reporting, our preliminary conclusion is that investors are taking a glass-half-full approach to this earnings season. And yes, once again, companies appear to have done a good job of managing analyst expectations prior to reporting. Finally, we suspect that near-record low interest rates are making stocks incrementally more attractive to institutional investors despite retail money that continues to flee domestic equity funds.

The Fed’s Dry Powder Meanwhile, economic data stateside continues to be problematic. For a third consecutive month, the Commerce Department reported a sequential decline in retail sales, further supporting recent downward revisions to second quarter GDP. Price levels remain benign in the U.S. With headline inflation at 1.7 percent, the Federal Reserve clearly has the cover to boost monetary stimulus if the economy stalls. In testimony to Congress this week, Bernanke acknowledged that more can be done, but failed to signal imminent action amid reports that showed a rebound in industrial production and a rate of new housing starts now at its strongest rate in nearly four years. Whether or not the Fed decides to act again this year, investors are increasingly coming to realize that more monetary stimulus will not have the same efficacy as it did before; with the Federal Funds rate near zero and 30-year mortgage rates approaching 3.5 percent, how much more demand can Bernanke & Co. stimulate with the fiscal cliff threatening domestically and Europe’s debt problems looming like the Sword of Damocles internationally?

With a slow growth economy baked into expectations, benchmark 10-year Treasuries remain well bid, closing the week to yield a paltry 1.46 percent. Earnings season continues at full tilt next week, with the likes of McDonalds, Apple, and AT&T reporting their numbers in a week that will also see the government reporting its first estimate of second quarter GDP.

Our Takeaway from the Week

• A mixed bag of earnings news is being greeted in surprisingly fine fashion against a backdrop of slow economic growth globally and attractive equity valuations

Disclosures

Weekly Market Makers - Week Ending 7/13/12

by Shawn Narancich, CFA Vice President of Research

Start Your Engines Key stock indexes finished the week nearly unchanged, but it took a bank-fueled rally on Friday to stem the damage caused by deflating global growth and an inauspicious start to earnings season. Alcoa kicked things off Monday with better-than-expected results, but fell afterward on both the weak outlook for aluminum prices and fears that weaker macroeconomic data is beginning to wash up on the income statements of corporate America. Cummins provided another shot across the bow, warning that its quarterly sales would fall considerably short of estimates because of weaker engine sales in Europe and China and a stronger dollar. Into the pre-announcement, the stock was already down 25 percent from first quarter highs, but it fell materially more afterward. Wells Fargo and JP Morgan helped stem the tide of bad earnings news, with the nation’s largest mortgage underwriter benefiting from a recent surge in refinancing and a nascent rebound in new home sales. Sell on the rumor, buy on the news best characterized investors positive reaction to JP Morgan’s muddled earnings report; by realizing a $4.4 billion trading loss on its now infamous hedging gone awry, the money center bank appears to have put most of the issue behind it, while also reporting respectable capital markets numbers and strong mortgage loan originations. Bank earnings notwithstanding, Wall Street strategists are beginning to take the hatchet to S&P 500 earnings estimates.

Growth by Fiat As analysts began sharpening their pencils on quarterly earnings reports, China reported that its economy grew 7.6 percent in the second quarter, about in-line with estimates and clearly a relief to those who fear a hard landing in the world’s second largest economy. The takeaways here are more nuanced. If we can believe the numbers, China’s economy has slowed to the weakest pace of expansion since the “Great Recession” ended. The question is whether activity there has hit bottom. Comforting is the fact that fixed asset investment grew by over 20 percent in the second quarter, a pace slightly stronger sequentially, while loan growth accelerated in June. Chinese policymakers, eager to limit negative feedback loops into the real economy, are declaring that economic growth has bottomed and will improve in the second half. This comes despite private sales surveys showing that sales growth continues to weaken into July, a data point that conflicts with official data showing that consumption expenditures contribute to a growing share of GDP. One thing is certain, while Beijing can dictate new investment spending on steel and cement plants, it can’t force consumers to spend.

Shooting BRICS At present, other emerging markets would love to have the expansion that China is reporting. Brazil is top-of-mind . . . what happened to the growth? Industrial production in the land of natural resources has not only slowed, but it is now in decline as the country fights to eke out just 2 percent GDP growth for the year, a result that may well end up undershooting that of the U.S. While President Rousseff defends her country’s resource nationalism, a topic we touched on in a post earlier this year, deteriorating economic activity prompted the country’s central bank to lower rates to an all-time low of 8 percent. India’s growth is sub-par and Russia, well let’s just say that the more things change there, the more they stay the same.

What’s Old Is New Again? Alluding to Russia’s new, err, old leader brings to mind Italy, where sovereign debt yields rose for the week. Part of this was because of a Moody’s downgrade, but investors can’t help but be concerned about rumors now circulating that erstwhile ruler Silvio Berlusconi could seek to reprise his office in the next round of elections. Notably, Spanish bond yields fell as Prime Minister Rajoy announced a new set of austerity measures in what appears to be a quid pro quo for direct equity injections into the country’s banks. Insomuch as it relates to the bigger issue of Spain maintaining affordable access to the sovereign debt market, it’s mission accomplished for now. The conundrum for the southern European countries continues to be how they meet the North’s demands for budget reform without creating further economic contraction that could make budget deficits look just as bad relative to GDP. As the soap opera continues, all roads seem to lead to more European monetary stimulus. Amidst an abundance of America’s version, Treasuries remain well bid, trading to yield a near-record low of 1.49 percent.

Our Takeaways from the Week

• Earnings season is off to a shaky start, with reporting set to kick into high gear next week
• If evidence of a softer global economy continues, stocks could prove vulnerable to a reduction in profit expectations

Disclosures

Weekly Market Makers – Week Ending 7/06/12

by Jason Norris, CFA Senior Vice President of Research

“Déjà Vu All Over Again?” –Yogi Berra

Monday marked the first day of trading for the third quarter of 2012 and the end of the first half of 2012. As we reflect on the first two quarters of 2012, they look eerily similar to the first two quarters of 2011.

Just as in 2011, domestic equities staged a strong rally in the face of mixed economic data while Europe continued to put band-aids on their debt woes. Given all the policy and economic uncertainty, it’s hard to believe that the S&P 500 posted a handsome 9.5 percent return for the first half of 2012.

Domestically, the U.S. economy is holding up, with GDP expected to grow at approximately 2 percent. However, the fiscal cliff and a European recession are wildcards for the sustainability of this growth. Despite the parallels between the first half of 2011 and 2012, we don’t believe we will see a repeat of the third quarter sell-off that we experienced last year. It seems the European Union is moving, albeit slowly, towards a solution to their debt problems. Additionally, gas prices, which were climbing last year, have fallen substantially, aiding the U.S. consumer.

“Gentlemen Prefer Bonds” – Andrew Mellon, U.S. Treasury Secretary in the 1920s While equities have staged a strong rally this year, U.S. Treasury yields fell to record lows in recent months. The yield on the 10-year Treasury fell 30 basis points to 1.6 percent the first six months of 2012, resulting in a 2 to 3 percent return for bonds. Though 10-year Treasury yields hovered around a modest 2 percent for the entire first half of the year, individual investors amazingly continued to favor bonds over stocks. So far this year, over $150 billion has flowed to bond mutual funds as $50 billion has left U.S. equity funds. While stocks have delivered healthy returns, economic and policy uncertainty continue to weigh on individuals’ perception of the attractiveness of U.S. equities.

The More Things Change, the More They Stay the Same While European leaders worked towards establishing a bailout fund this week, there was further evidence that troubled nations have yet to “bite the bullet.” If those troubled nations continue to max-out their credit cards, it remains to be seen whether Germany and the other fiscally responsible EU nations (e.g., Finland and the Netherlands) will contribute to a bailout fund.

Concerns over economic growth are not just a European issue. There is mounting evidence that China will continue to see a deceleration in their rate of GDP growth over the next few years. In fact, some economists have called for Chinese growth to slow alarmingly to 4 to 5 percent; down from the 7 to 8 percent pace they are now enjoying. This may or may not be a “hard landing,” but if China does slow to this degree, it will adversely effect growth in the U.S. However, the impact does not have the same magnitude of a European recession. Exports make up 13 percent of U.S. GDP. Twenty-two percent of our exports are destined for Europe while only 7 percent land in China.

A Diamond in the Rough Barclays CEO Robert Diamond resigned this week amid allegations that the bank understated its borrowing rates in 2008 in order to mask its problems during the financial crisis. There is now speculation that the Bank of England was nudging Barclays to understate its borrowing rate to alleviate a financial panic. Authorities are now looking at more than 10 other banks to assess if they manipulated their rates as well.

This is just another black eye for the already-stained financial services industry.

Our Takeaways from the Week

• While stocks showed strong returns similar to the gains seen in the first half of 2011, we do not anticipate 2011-like sell off in the third quarter. Equities remain underowned and attractively valued

• As Europe dips into recession and China slows, we will focus on U.S. equities that have greater exposure to the domestic economy.

Disclosures

Weekly Market Makers – Week Ending 6/29/12

by Jason Norris, CFA Senior Vice President of Research

Five to Four The highly anticipated Supreme Court decision on the Affordable Healthcare Act was released Thursday morning. The results surprised most pundits, as well as us. The Court found the law to be constitutional, thus upholding the most controversial provisions of the law, the individual mandate.  The political ramifications of this decision won’t  be seen until November; however, we immediately saw the market impacts with hospitals and drug distributors rallying, HMOs falling and the rest of the sector showing a mixed response.

The long-term impact of the Court’s decision on the healthcare industry is varied. The largest beneficiaries of the law are hospitals.  As more individuals become insured, hospitals will be able to reduce their provisions to bad debts, thus adding to profitability. The impact on HMOs, should be relatively neutral. While the individual mandate will lead to greater membership in HMOs, these additional customers will be lower margin. Additionally, there still may be some people who choose to pay the penalty (tax, as defined by the Supreme Court) and wait to purchase insurance once they “need it.” This will have a negative impact on margins. However, we believe that HMOs will start to increase pricing in the individual market shortly to alleviate this potential problem. We believe large-cap pharmaceuticals will face the most negative impact due to the increased tax they will have to pay to finance the bill and a possible shift to lower cost drugs.

Viva Italia Looking at Europe, one may argue that Germany has been “outmaneuvered” by Italy twice.  First, losing 2-1 in the Euro2012 soccer tournament on Thursday, and second, (and more importantly) the Germans gave some ground on allowing the Eurozone Bailout Fund to be used to support struggling banks, as well as to make bond purchases. While this is a step in the right direction, we are still early in the process and the Germans will still play a major roll in the direction of where the funds go. Also, the current size of the fund in approximately 400 billion Euro, which is roughly only 15 percent of the Italian and Spanish debt markets, thus size ultimately may become a concern. Nonetheless, global equity markets welcomed the news, leading to strong gains on the last day of the quarter.

It's evolve or die, really, you have to evolve, you have to move on otherwise it just becomes stagnant. ~ Craig Charles Nothing can last forever, and we are seeing a stark reminder of that with two (former) “Tech Titans” this week. Only a few years ago, Nokia and Research in Motion Limited (RIM) were leading wireless telecom companies, with dominant global market share (Nokia) and a de facto Enterprise industry standard (RIM’s Blackberry handset). This week we saw RIM’s report very disappointing earnings and learned that Nokia’s relationship with Microsoft may not be as “exclusive” as once thought. As we have learned in the tech space, companies must “evolve” or they will die. Apple, Google and Samsung did this in the wireless space; and we are seeing the ramifications throughout the industry.

Our Takeaways from the Week

• We continue to favor HMOs due to their strong balance sheets, healthy cash generation, and lack of European exposure
• We are still cautious on the European economy as austerity measures have yet to take hold. We remain underweight international equities and will continue to tilt our equity exposure towards emerging markets and U.S. economic growth

Weekly Market Makers - Week Ending 6/22/12

by Shawn Narancich, CFA Vice President of Research

Europe in Remission … for a Week One of the best weekly indicators for stocks and cyclical commodities has been Spanish bond yields. As such, their decline this week told the story of both the Greek conservatives’ election win and the incrementally positive developments in Spain. With a new government in place, Greece is anticipating continued financial assistance from the European Union. Whether or not continued aid materializes will depend in large part upon how Germany views Greece’s latest attempt to extract concessions to aid packages previously granted. Indeed, what’s new is old again in Greece. While “Merkel & Co.” may agree to some leniency in the time frame demanded for Greece to demonstrate fiscal reform, the “Northern Enforcers” are likely to frown upon Greece’s idea of ceasing additional public sector layoffs. One thing’s for sure, Greece will run out of money sometime in July if additional billions of euros fail to flow their way.

In Spain, sovereign debt benefitted from bank stress test results evidencing a smaller than anticipated capital injection necessary to keep key financial institutions afloat in a modeled crisis. Spanish bonds also appear to have gained a bid from a sense that European leaders set to meet for their nineteenth European Summit next week are open to the idea of putting public debt holders on equal credit footing with Europe’s bailout facilities. Investors are headline weary of Europe, but the fact that stocks bounced back from heavy losses Thursday to finish the week with only modest losses speaks volumes about how much geopolitical uncertainty from the Continent is already discounted in stock prices.

The Bernanke Put? Economic data globally remains soft. Against this backdrop, the Federal Reserve met this week and agreed to extend “Operation Twist”—the program whereby the Fed sells short-term Treasuries and buys longer term debt. The idea here is to continue supporting what appears to be a nascent rebound in housing by driving down interest rates on the Treasury bonds that help set mortgage rates. Some investors had hoped for additional balance sheet expansion by the Fed, which could still materialize if job gains don’t.

Back at the Earnings Trough … Anecdotally, bulls and bears have much to feast on these days. Global shipping giant Fed Ex reported better-than-expected earnings this week, but revenues fell short of expectations and management warned that shipping trends are soft—particularly for time-sensitive airfreight. The latter commentary points to weakness in tech shipments, which are often flown from Asian manufacturing hubs to endpoints around the world for final consumption. Sticking with the tech theme, business software titan Oracle also reported an upside earnings surprise this week; while tech software is less cyclical, news about strong bookings in the quarter reassured investors that tech spending hasn’t crashed.

With one week to go in the second quarter, earnings warning season has unofficially begun. The stronger dollar has already led bellwether companies McDonalds and Philip Morris International to temper investor expectations for earnings; coupled with the second quarter having witnessed largely softer economic data, more companies could come to the confessional. Finally, the healthcare sector will be in view next week as the Supreme Court is expected to announce its decision about the constitutionality of Obama Care.

Our Takeaways from the Week

• Political and macroeconomic data continue to dominate the airwaves, but investors will start pivoting back to earnings as the quarter draws to a close

Disclosures

Weekly Market Makers Week Ending 6/15/12

by Shawn Narancich, CFA Vice President of Research

Another Summer Swoon? Evidence of slower global growth continued to build this week, with declining industrial production in Europe and several disappointing reads on the U.S. economy being the latest culprits. May retail sales undershot expectations and contracted, representing the second consecutive month of declining U.S. sales. Given a U.S. economy still leveraged to consumer spending, amid further signs of a weak job market, economists are reducing their estimates for second quarter GDP. With industrial production also falling short in May, expectations are building for the Federal Reserve to announce another round of monetary stimulus when the Federal Open Market Committee meets next week.

Inflation Pulls a Disappearing Act Disinflation is the silver lining of an economic slowdown both here and abroad. To that end, investors absorbed news that the consumer price index has dipped for the eighth consecutive month to 1.7 percent domestically, a level now below the Fed’s 2 percent target. What about inflation fears overseas? The trend is our friend there too with European consumer prices up 2.4 percent annually and only 3 percent in China. For the spending power that remains, it will increasingly drive real as opposed to nominal economic growth.

Europe, Ad Nauseam Spain announced a 100 billion euro bailout package for its under capitalized banks and investors were disappointed to discover that the euro zone bailout will not flow first to the banks but rather to the Spanish government. Heaping more debt onto Spain’s already large pile while subordinating Spanish bondholders to the bailout loans went over like a lead balloon, pushing Spanish benchmark 10-year bond yields there to nearly 7 percent. Before we even see details of the Spanish bank bailout program, investors are already beginning to discount a Spanish government bailout, which would certainly be even more costly. Contagion has also spread to Italy where similar duration sovereign yields again breached the 6 percent level. Amidst the gloom and doom, equity markets confounded conventional thinking and rallied another 1.2 percent domestically, while remaining largely stable in Europe. However, in contrast to recent risk-on, risk-off trades, benchmark 10 year-Treasury bonds failed to confirm the rally in stocks, closing the week up from where they started, while pushing yields down to a thrifty 1.58 percent. In a nutshell, we appear to be at that point again where bad news is good news, leading investors to discount more monetary stimulus both here and abroad.

Our Takeaways from the Week

• Amid slowing economic growth, investors appear dependent on further policy action to support additional near-term stock gains
• The Greek elections, U.S. Federal Reserve policy, and G-20 meetings in Mexico next week all loom LARGE

Disclosures

Weekly Market Makers Week Ending 6/8/12

by Shawn Narancich, CFA Vice President of Research

In China, Sell on the Rumor and Sell on the News Investors got what they were waiting for in China this week, as the central bank there took the next step to halt the country’s weakening economy with an interest rate cut The reaction in Chinese stocks?  They fell on the day prior and on the day after the move by the People’s Bank of China. While Chinese stocks remain underwater year-to-date on concerns about slowing growth and lack of a “shock & awe” stimulus program like China instituted during the financial crisis several years ago, U.S. stocks rebounded nearly 4 percent in what turned out to be one of the strongest weekly gains of the year. As investors ventured back into domestic equities, the benchmark 10-year Treasury yield went up, ending the week at 1.63 percent.

Monetary Policy to the Rescue? If U.S. equities weren’t as oversold as they were coming into the week, the result might have been different. Investors were left wanting with a lack of actionable announcements by both the U.S. Federal Reserve and the European Central Bank. Europe left its 1 percent short-term interest rate target unchanged, and Fed Chairman Bernanke failed to tip his hand to Congress about what, if any, new monetary stimulus it might offer to rejuvenate a weaker economy. With political leaders on both sides of the Atlantic far from agreement on how to address their respective fiscal challenges, investors continue to look to monetary policy as the antibiotic to stave off infection. The problem is that, with each additional dose, the infection becomes more resistant to the treatment. To conclude the analogy, surgeons general in both Europe and the U.S. have told patients that they stand ready to provide additional treatment, if necessary.

The Next Domino to Fall in Europe Central bankers will most likely get that chance, as sovereign debt yields in Spain remain above an unsustainable 6 percent level, indicating that it’s only a matter of time before this country seeks financial assistance. European finance ministers will meet tomorrow and plan to discuss the mechanics of a Spanish bailout. For its part, Spain is awaiting a key report from the International Monetary Fund that purports to show the additional capital that its banks need to remain solvent. With German Prime Minister Merkel warming to the idea of pan-euro bonds and common EU deposit insurance at some point, European leaders appear closer to embracing the necessary fiscal integration in concept. Unfortunately, no nation there yet seems willing to cede budgetary and banking oversight to a central EU authority.

A Catalyst Rich Calendar Which brings us back to Bernanke & Co. Recognizing the challenges of Europe and the looming fiscal cliff domestically, the Fed could do a QE3 but likely wants to keep its options closer to the vest for now. Results of a potential Spanish bailout, Greek elections on June 17, and additional domestic data will all bear on their decision to be made at their meeting on June 19 and 20. A key question domestically is whether recent soft payroll gains reflect payback for a record warm winter or something more sinister. Reality is probably somewhere in-between.

In a week dominated by macroeconomic policy events, Australia cut rates by another quarter of one–percent, and emerging Asian economy Vietnam cut rates by two percentage points as central bankers in the Asia Pacific attempt to fend off slower export markets to China and Europe.

Our Takeaways from the Week

• U.S. stocks rallied from oversold levels as investors continue to closely monitor events unfolding in Europe and potentially systemic contagion therein

Disclosures