March 2010 Recap

Equity markets finished the fourth quarter strong, as market participants celebrated the Federal Reserve’s commitment to keeping exceptionally low rates in place for “an extended period.”

Economic data was mixed throughout March. Investors were excited early in the month by February’s labor report, which showed payrolls dropped less-than-expected. The strength of the labor market is widely considered the key factor determining the pace of household spending. The jobs situation is lagging previous recoveries, though, and may be weighing on consumers, which was evident with the preliminary consumer sentiment index contracting.

Weak housing starts and softening home price indicators dampened sentiment a bit, but also provided additional reasons for the Fed to keep interest rates at emergency levels. Low inflationary indicators also supported accommodative policy, with consumer prices remaining flat month-over-month and capacity utilization well below its long-term average.

Inflation remains a concern in the future and the Fed is walking a tightrope with its exit plan, but equity markets appear content with the Fed’s direction for now.

All equity asset classes moved higher in March, led by domestic REITs. REITs continue to benefit from merger and acquisition activity, headlined by the bidding for General Growth Properties, which filed for the biggest real-estate bankruptcy in U.S. history.

Small cap stocks outperformed their larger counterparts. This is somewhat surprising given the fact that credit is still relatively tight for small caps. Smaller businesses are also more likely to be affected by the healthcare legislation passed by Congress in March.

Speaking of healthcare legislation, hospitals and drugmakers appear to be the biggest winners as they pick up a glut of new paying customers. Meanwhile the insurance industry is coming out of all this relatively unscathed. In the end, the most controversial proposals – a government-run insurance option and direct government negotiation on drug prices for Medicare – were eliminated from the bill.

In overseas markets, concerns about Greece eased as the bailout of the debt-ridden country gained clarity. Despite nice gains in March, international markets have underperformed the S&P 500 in 2010, with performance for U.S. investors in many developed markets hurt by the relative strength of the U.S. dollar.

Treasury yields rose to their highest levels since late last year as investor’s appetite for risk improved following last month’s volatility in the credit markets. After a bout of flattening at the beginning of the month, the curve steepened back up to finish where it started at 280 basis points spread between the 2-year and the 10-year, just 11 basis points shy of its all time high of 291 set on February 22. The Barclays Aggregate Bond Index was down 0.12 percent for the month, with corporate debt being the best performing sector in the index.

A lot was written this past month on the end of the “Greatest Bull Market in Bonds Ever,” with many analysts calling March 2010 the beginning of the next rate cycle. A rising rate environment will hurt longer-term bonds significantly more than shorter-term bonds; given our bias toward the shorter-end of the curve, we consider our portfolios well positioned to weather such an environment. The majority of bonds we hold will allow us to reinvest more quickly than if we were to buy longer-term debt and take advantage of higher yields.

Peter Lazaroff, Investment Analyst
Cliff Reynolds, Investment Anlayst

Daily Insight: ADP, Chicago PMI, and Q1 Results

U.S stocks lost a little ground yesterday, falling back to the low-end of this range tight range (at least in terms of near-term standards) we’ve been in over the past 11 sessions. A disappointing employment survey got stocks off to a bad start as they hit the day’s nadir just 30 minutes into the session. The market did showed a little life by mid-day as the S&P 500 moved into positive territory, but retreated again in the final hour. With stocks closed tomorrow even as we get the March payrolls report, traders are just not willing to get in front of this data and hold those positions into the weekend.

It’s more than appropriate for the Exchange to close and observe Good Friday – don’t get me wrong I’m not at all inferring the market should open. Rather, the Labor Department should delay the employment report until Monday. The monthly jobs report is almost always released on the first Friday of the month, but this is the most market-moving data we receive and thus should be held until next week.

Only two of the major 10 industry groups closed higher yesterday, energy led the way and financials posted a slight gain. Consumer discretionary shares led the decliners, with technology and industrials rounding out the three worst performers.

Yesterday ended the first quarter and the major indices recorded another strong three-month period, marking the fourth-straight quarterly gain. Mid and small-cap stocks led the way, as the international indices lagged – you can see the results in the table below the jump via the YTD column.

For the quarter just ended, the Dow Industrials gained 4.11%; the S&P 500 added 4.87%; the NASDAQ Composite rallied 5.68%; the S&P 400 (mid-cap) surged 8.70%; the Russell 200 (small cap) jumped 8.51%. Overseas indices lagged as the main international index for developed economies rose just 0.22% and emerging markets added 2.11%
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Brent Vondera, Senior Analyst

Daily Insight: Case-Shiller and Consumer Confidence

U.S. stocks wavered during the entire session. The major indices put their intraday highs and lows in before 10:30 CDT, then pretty much flat-lined until a little pop in the final hour of trading. The Dow Industrials was the best performer of the big three, but it was all due to one stock: 3M’s 3.5% jump accounted for 22 Dow points, which more than offset weakness from Boeing, Travelers, AT&T and IBM.

For the broad market, technology, industrials and basic materials led the S&P 500 to a fractional gain. Financials led the decliners. Utility and telecoms also closed lower.

The market is just kind of trading in this range of 1160-1175 on the S&P (10840-10955 for the Dow) as traders probably don’t want to get ahead of the March jobs report on Friday. Stocks will actually be closed on Good Friday.

It will be interesting to watch how the market reacts to what will be the best payroll numbers in more than two years. We’ve got a good shot at a 200K-plus increase; we’ll be watching the private sector readings as we’re expecting to get 100K from 2010 census hiring, which is only temporary employment. Will the market celebrate the good news if private-sector payrolls rise 100K? Or will traders worry that such a number will hasten some Fed tightening and sell off? I think we really need to see a substantial multi-month move in payrolls before the Fed signals they begin to mildly end ZIRP. We shall see.
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Brent Vondera, Senior Analyst

Market Minute: Interest rates and the bond market

A colleague of mine asked me to touch on fixed income this week. Ask and you shall receive…

Bond funds have been extremely popular in the past 12 months, maybe even too popular. In 2009, equity mutual funds had net outflows of $35 billion while bond funds saw $421 billion of net inflows. So far this year, investors have placed about $89 billion with bond funds, or five times the rate in the first quarter a year ago. This is somewhat surprising given the powerful stock market rally over the last 12 months.

One explanation for the staggering bond flows could be the reality check investors got regarding their true risk tolerance. Pre-crisis, I commonly heard people insist they could handle more risk in the stock market or resist the idea that bonds play an important role in meeting long-term goals. If investors became more risk adverse following the crisis, then we should expect to see a spike in flows into bond funds.

A second explanation is that people got hungry for yield as they watched the stock market soar higher and their cash earned nothing. Chasing yield is a very dangerous game, especially under the belief that bonds can’t fall in value. But bond prices can fall if the Fed is forced to raise rates aggressively to fight off inflation, which seems like a reasonable possibility, and the interest rate shock would only be made worse by the fact that short-term rates are starting from zero.

I’m not suggesting this is any reason to sell all your bonds – I hope my readers stick to a more disciplined long-term investment plan– but it is worth discussing after seeing rising yields in last week’s U.S. Treasury auctions.

Rates for U.S. Treasuries were higher last week in part due to weaker demand from foreign investors such as Japan and China, but rates also reflect concerns about the massive supply of U.S. debt flooding the market and the inflationary effect of increased government spending. (You can read more about last week’s rise in rates in a post by Cliff Reynolds here.)

A sharp rise in long-term interest rates may be the biggest risk to both stock and fixed income markets today. In fact, I would expect to see a correction in the stock market if 10-year Treasury yields were to suddenly rise from today’s level of 3.87% to 4.5% in the near-term. That is because Treasuries are the benchmark for lending across the economy. Higher Treasury yields weigh on the economy by increasing mortgage rates, corporate borrowing costs, and interest on rising government debt.

I want to re-emphasize that I would only be worried about a significant near-term rise in rates. I say this because rates will go up at some point – government borrowing needs and the economic recovery make this inevitable. Nobody can know for sure when this will happen, although the Fed will telegraph the move by removing the phrase “extended period” from their view of the duration of “exceptionally low” rates.

Thanks for reading.

Peter Lazaroff, Investment Analyst

Daily Insight: Income & Spending, Dallas Fed, Profits

U.S. stock futures were higher in pre-market trading yesterday and that upbeat sentiment flowed into the official session. The major indices held onto almost all of the early-session gains, unlike the past two days in which morning rallies were completely rejected in the afternoon.

A better-than-expected Economic Sentiment reading within the Eurozone and a surprise 4.2% rise in Japanese retail sales drove the day’s relative optimism. A good spending number for February in the U.S., even though it was not accompanied by an increase in income, kept that momentum going.

Energy shares led the way as the price of crude rose 3% to close at $82.36/barrel. Other outperformers were utility, health-care, industrial and basic material shares. The indexes that track technology and consumer discretionary stocks were the only losers on the session.
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Brent Vondera, Senior Analyst

Daily Insight: Another prevention plan, GDP and confidence

U.S. stock indices ended mixed on Friday as the Dow and S&P 500 ended slightly higher, while the NASDAQ, mid and small cap indices failed to close above the cut line.

It was another session in which early gains were rejected as we headed into the afternoon session. Comments from former Fed Chairman Greenspan, calling the recent rise in Treasury yields the “canary in the mine” (regarding the government’s fiscal situation), may have been a factor weighing on investor sentiment. Stocks also had to deal with the downed South Korean naval ship along a disputed border with the North -- and naturally the rumors that follow.

Even though the S&P 500’s gain was only fractional, eight of the 10 major industry groups closed higher on the session. Basic material, consumer discretionary and industrials led the way. Health care and technology shares were day’s only losers.

For the week, the Dow Industrial gained 1.0%; the NASDAQ Composite rose 0.80%; and the S&P 500 added 0.50%. The gains marked the fourth-straight week of increase for all three indices.
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Brent Vondera, Senior Analyst

Fixed Income Weekly

Rates rose significantly in a week dominated by poor Treasury auctions and public statements by Ben Bernanke and other Fed officials. The yield on the two-year finished the week 6 basis points higher at 1.05%, while the yield on the ten-year rose 16 basis points to yield 3.85%. The broad bond market was down .51% for the week. US credit followed stocks higher while MBS held steady ahead of next week’s end to the Fed’s mortgage purchases.

I have spoken a lot about yields being stuck in a range for the past 15 months or so, and much of the same is likely to persist until the market senses that the Fed is closer to the removal of emergency levels of liquidity. The graphs below show the current range for the 2-year and the 10-year.


The 2-year and 10-year are in two different places within their ranges. The ten-year sits at the top of its range while the 2-year is more in the middle. As a result we now have record levels of steepness and liquidity is still being heavily favored in the market as investors continue to guard against rising rates. Despite differing greatly now, 2 and 10 year yields are set to converge as the Fed begins to reverse monetary policy. This isn’t a revolutionary view. Short term rates stand to move higher when the Fed tightens, and long term rates may actually come down depending on how the market views the Fed’s stance on inflation. Right now, the Fed isn’t even considering inflation as an issue, which could prove troublesome if they aren’t able to recognize the effects of their policy soon enough. Inflation expectations according to breakeven yields on 10-year TIPS are holding steady at around 2.25%, essentially unchanged since the beginning of this year.

I’m not saying the current position of rates is unjustified. In my opinion it makes sense for rates to be where they are. Bernanke commented briefly this week on the meaning of the “extended period” language, stating that there is no set period of time to be assigned to those words. I didn’t expect to hear him say “extended period means 6 months”, but questions from house members forced him to talk more about the subject than he felt comfortable with I think.

Below is the excerpt from his prepared remarks detailing asset sales.

If necessary, as a means of applying monetary restraint, the Federal Reserve also has the option of redeeming or selling securities. The redemption or sale of securities would have the effect of reducing the size of the Federal Reserve's balance sheet as well as further reducing the quantity of reserves in the banking system. Restoring the size and composition of the balance sheet to a more normal configuration is a longer-term objective of our policies. In any case, the sequencing of steps and the combination of tools that the Federal Reserve uses as it exits from its currently very accommodative policy stance will depend on economic and financial developments and on our best judgments about how to meet the Federal Reserve's dual mandate of maximum employment and price stability.

In my mind his remarks telegraphed a removal of at least some of the longer-term securities on the Fed’s balance sheet (i.e. MBS, Treasuries and Agency debt), before an actual rate hike. He still maintained that reverse repurchase agreements, where the Fed would essentially lend out their securities for a predetermined amount of time, are still an option but talked more about actual sales more than he has ever before. In my eyes the MBS purchases were even more “emergency” than bringing the funds rate at zero, making it the logical choice to remove first. With that being said, there is no way to really know until they decide to move. Until then I will speculate.


Have a good weekend.

Cliff J. Reynolds Jr., Investment Analyst

Daily Insight: Bernanke shifts market, jobless claims

U.S. stocks rebounded yesterday morning as traders returned to dabble in some riskier assets after a 24-hour respite. The DJ Industrial Average got within 44 point of 11000 and the S&P 500 looked ready to gear up to tackle the pre-Lehman collapse level of 1250 as it moved past the 1175 mark at one point. But the rally was rejected after lunch and the major indices went into freefall in the final hour of trading to completely erase the earlier gains.

Fed Chairman Bernanke, during Congressional testimony officially intended to explain the eventual exit strategy, made it abundantly clear that this discussion in no way signals the Fed is ready to pull back on their extraordinary level of accommodation. In fact, he explicitly stated that the economy continues to require the support of a record low fed funds rate. These statements follow comments from other Fed officials on Monday that also suggested the Fed will remain on hold. Monetary tightening is a ways away and that’s ecstasy to stock traders.

However, that morning rally evaporated as people apparently read Bernanke’s text and noticed a little comment touching on actual sales of mortgage-backed securities when the Fed does begin to withdraw stimulus. What? Actual MBS sales, instead of just letting them pay down? Now, such action would really be a ways down the road, as doing so anytime in the near future would obliterate the housing market – and Bernanke was there to talk about an exit strategy so it shouldn’t be surprising that he brough this topic up. But just as traders find ecstatic delight in ZIRP, they view even the mention of asset sales by the central bank as anathema and this was probably behind the late-session pullback.

The third ugly Treasury auction in a row, this one being the issuance of $32 billion in seven-year notes, may have also played a role in the market’s reversal.

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Brent Vondera, Senior Analyst

Mortgage Apps, Durable Goods Orders, New Home Sales

U.S. stocks pulled back a bit on Wednesday as sovereign debt worries continued after Fitch lowered Portugal’s credit rating, and warned of another to come, and the latest housing market data showed new-home sales slipped to an all-time low, for the second month in a row. An overall positive report on durable goods, although uneven with a number of components showing orders declined, wasn’t enough to offset the negatives.

Nine of the 10 major industry groups lost ground on the day, led by telecoms and consumer staples – strange for a traditional safe-haven like consumer staples to lead the declines on an overall down day for stocks, I don’t get that one. Financials were the only group to close in the black, boosted by Bank of America shares after the bank announced plans to expand in Beijing. I guess traders ignored the news that BofA will have to reduce principal values on more mortgage loans.

Treasury securities got clocked, the yield on the two-year jumped 11 basis points to 1.09% (which is hardly attractive but that’s a large one-day increase) and the 10-year yield soared 14 basis points to 3.83%. Tuesday’s $44 billion two-year auction was met by relatively weak demand, and that was followed by yesterday’s 5-year auction in which Treasury had to pay up in yield as demand was considerably weaker than prior auctions. We’ll see more than $100 billion in monthly government debt issuance until the cows come home, at some point that should cause yields to break through this very low-level range. (More on this below the jump)
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Brent Vondera, Senior Analyst

Tracking Volatility with the VIX Index

Volatility, as measured by the VIX Index, has fallen to 17.5% so far in 2010. Often referred to as a “fear gauge,” the VIX moves up as investors buy bearish options (puts) on the S&P 500 and down when investors sell these options.

The VIX tends to drift between 10 and 20 under normal circumstances, but moved above 80 following the Lehman Brothers bankruptcy in November 2008. Since then, the VIX has returned to more historically normal levels – today it sits at 17.9 compared to the historical average of 20.3 – for several reasons.

For starters, there is a lack of participation in the options markets by institutional investors who are afraid of getting trapped in the event of a quick market movement – a symptom of the scars from the credit crisis. Internal risk management systems are also limiting banks from facilitating options trades as the return of capital trumps the return on it.

And we can’t ignore the influence that vast amounts of liquidity has in driving down volatility while pumping up risky assets such as stocks or corporate bonds. Other policy responses to the crisis have reduced price swings too. For example, the Federal Reserve bought up to $1.25 trillion in mortgage-backed securities (MBS) sold by agencies Fannie Mae and Freddie Mac, basically meaning that the Fed is the market for such debt. No surprise such a big buyer would help keep volatility under wraps.

Increased volatility could spell trouble for equities, but don’t become fixated on the VIX in hopes of predicting the market’s future direction. While options activity reflects market participants’ expectations of future market conditions, their outlook and sentiment can change at a moment’s notice.

A widely publicized study released this month by Birinyi Associates showed that the VIX “is a measure of current volatility with little or no predictive or indicative value regarding the course of the market,” but the study does suggest that high volatility may be a contrarian indicator. Birinyi Associates concluded that the contrarian value of low volatility is less clear.

This Wall Street Journal article suggests that the futures contracts on the VIX may be a better gauge for predicting stock market moves. This means that investors should be bullish when the futures are significantly lower than the VIX and bearish when futures are higher. Data from Bloomberg shows that July futures on the VIX are trading at 23.25, August futures at 23.40, and September futures at 23.60 – all considerably higher than the 17.91 level today, but still not what I would consider crisis levels.

What could be pushing futures on the VIX higher?

The Fed’s MBS purchase program ends this month, which could very well allow volatility to pick up again. Other looming concerns such as rising government debt levels or a potential overheating in Chinese markets could also provide impetus for bigger price swings. VIX futures may also be pricing in a pullback in the stock market following the strong run we've had over the past five weeks.

It’s hard to imagine the VIX continues to trend lower, but the pick-up in volatility that futures are predicting is relatively minor and not worth losing sleep over.
Peter Lazaroff, Investment Analyst

Daily Insight

U.S. stocks gained ground for a second-straight session, pushing to a new 17-month high. The broad market hasn’t endured a significant sell-off (which I’ll define as more than a 1% move) in 20 sessions. The market appears to be strangely complacent as just one of the five down days during this 20-session stretch has been to the degree of 0.5% and three have been only fractional losses.

The National Association of Realtors reported that existing home sales came in a bit better-than-expected during February, showing activity fell 0.6% for the month. This followed record declines during the previous two months. Even though the headline figure beat expectations, the inventory data within the report suggested trouble lies ahead for home prices. As a result, stocks moved into negative territory following the report. However, comments from two Fed officials suggested that the central bank was likely to remain extremely accommodative for longer than the market had previously expected and that gave fuel to a rally that began around lunch and accelerated in the final 30 minutes of trading.

Specifically, it was the later of the two speeches, delivered by San Francisco Fed Banks President Janet Yellen, that was likely behind the rally late in the session. She stated: “The economy will be operating well below its potential for several years.” The market hears that and gets juiced that the Fed will keep monetary policy floored for well beyond a six month time frame.

Not surprisingly, commodity-related basic material stocks led the rally – the commodity trade rolls on dovish Fed comments. Industrials and tech were the other leaders. All 10 major sectors gained ground on the session.
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Daily Insight: The Cost of Entitlement

U.S. stocks rallied shortly after the open and held the gains to the close. A rebound in commodity prices, helped by a lower dollar, overshadowed concerns that higher interest rates (India’s monetary tightening) and rising public-sector debt will derail the global recovery.

The rolling concern over European sovereign debt issues that was eminent in pre-market trading didn’t last long. To be specific, the worries lasted exactly 30 minutes into the regular trading session as that’s how long it took for stocks to rebound into positive territory – and for the dollar to give up its early-session rally and turn lower. As we’ve been talking about, the only thing the greenback has going for it right now is fear.

Consumer discretionary, basic material and tech shares led the way. Energy and utility stocks were the only losers out of the major 10 sectors. The price of crude reversed an earlier decline, but the shares didn’t follow suit.

It is interesting to watch consumer discretionary shares rally with oil over $80, pump prices inching closer to $3 (national avg. at $2.82), 10% unemployment and high household debt levels. The index that tracks these shares has doubled over the past year and is just 18% below the all-time high hit in 2007 (for perspective the broad market remains 25% below its peak). Something doesn’t exactly seem rational with this picture, if you ask me. Either job growth is going to come back with a vengeance and justify this move, or…well you know where I’m going with this.
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Brent Vondera, Senior Analyst

Fixed Income Weekly

A fairly slow week was highlighted by comments from the FOMC and February’s CPI reading that flattened the curve as short-term yields and long-term yields moved inversely to each other. The two-year Treasury yield rose 4 bps to .99% while the ten-year fell 2 bps to 3.68%.

Consumer prices were unchanged in February from the previous month, versus an expected .1% rise, the first time the index didn’t print a positive change since last March when prices fell -.1%. The actual reading missing expectations by .1% isn’t huge news, but a larger trend of decreasing inflation expectations made its presence felt in the marketplace this week. Breakeven yield’s, which measure the spread between yields on TIPS and nominal Treasurys, fell steadily throughout the week. Ten-year breakevens fell 7 basis points to 220 as investors demanded higher real yields while nominal yields fell. Some of the movement on the long end of the curve is due to some positioning before next week’s $118 billion in Treasury issuance but words from the Fed this week also had an impact.

The “extended period” language was left unaltered, which indicates that the Fed intends to keep rates where they are for at least the next 4-6 months. A fed hike in early 2010 was a popular thought last fall, but any chance of that has been put off until the summer at the soonest. Implied probabilities point to a 28% chance of a hike to .5% by the August meeting, lower than the 50% chance the market was assigning to that at the beginning of the year. Regardless, removal of the “extended period” language will have to come first. If you follow the 4-6 month buffer between the removal of the language and the actual hike, the language will have to be dropped after the next meeting if we are to get a hike in the summer.


Have a good weekend.

Cliff J. Reynolds Jr., Investment Analyst

Plant some seeds in Monsanto (MON)

I’ve mentioned recently that it is difficult to find bargains in the market today, but it may be time to plant some seeds in Monsanto (MON).

The stock market rally has left behind the seed giant as falling grain prices sapped demand for seed and profits from selling herbicides were squeezed by generic competition. Not only has MON lagged the broader market, but it has trailed its peers in the fertilizer and agricultural industries.

But MON has two game-changing products about to hit the market that can drive margins and market share gains for years. The first is SmartStax corn, which has the broadest array of genes available for fighting pests both above and below ground and for tolerating pesticides. The second is Roundup Ready 2 Yield soybeans, which promise higher yields (more beans per pod).

Success of these products will further expand MON’s dominance over the food chain and help win back investors frightened by the shrinking herbicide unit and regulatory concerns. As the saying goes: be greedy when others are fearful.

“Wait, did he just say dominance over the food chain?” Yes, I did.

World population is growing and appetites are growing in developing countries with rising wealth (see related article). With only so much land and water for farming, seed technology that improves crop yield is essential to the planet’s food supply. And unlike fertilizer, the market for genetically tweaked seeds still is largely underpenetrated outside the U.S.

When it comes to the U.S. seed market, MON has at least one of its patented genes in 90% of soybeans and 80% of corn. And competitors can’t seem to catch up, choosing to partner with MON rather than compete. Pouring 10% of sales into research and development, MON has an unmatched product pipeline that Credit Suisse estimates is worth $11 to $17 per share alone. Add this to an intrinsic value between $85 and $88 for the core business and the shares appear to be a steal.

Of course, those who plant seeds in MON shares today must be patient as the upside is limited until we see positive yield performance on the company’s newest products from this fall’s harvest, these results will drive longer-term acreage targets. But, given the decent valuation, strong product pipeline, and solid fundamentals in the agricultural biotech industry, MON represents a compelling long-term investment.

Peter Lazaroff, Investment Analyst

Healthcare stocks may rally on reform bill

Bloomberg reports that U.S. health stocks are poised to rally if the overhang of uncertainty is removed by the passing of a healthcare reform. The argument in this article is extremely similar to a post of mine from January (see: Healthcare sector trending up).

The most visible positive catalyst for the industry is that the worst-case reform scenarios – a single-payer system or a public plan with a Medicare-linked fee schedule – are no longer a threat. Managed care companies like WellPoint (WLP) and UnitedHealth Group (UNH) stand to gain new customers as coverage expands to people who previously went without insurance.

A common concern for these insurers is that the government will restrict profitability by scrutinizing rate hikes as we’ve seen in recent months in California, but this concern is not justified. The fact that is important to consider is the cap Congress proposes to put on the medical-loss ratio – the percentage of premium revenue used to pay patient bills – is well above the industry’s historical average, which means that they will not be impinging on profitability as much as feared.

Overhaul or not, health insurers have always found ways to make money and preserve profitability despite government regulation. I don’t expect that to be any different this time around. Managed care, as well as pharmaceuticals, are still looking very cheap relative to the rest of the market, and removing the uncertainty surrounding reform will provide a catalyst to expand valuations throughout the healthcare sector.

Peter Lazaroff, Investment Analyst

Daily Insight: Jobless Claims, CPI, Philly Fed

U.S. stock indices ended mixed as the Dow and NASDAQ gained ground, while the broad S&P 500 closed fractionally lower. Mid and small cap stock indices also closed to the downside.

The broad market bounced between gain and loss on several occasions, as traders were conflicted by the positive of a strong manufacturing report yet the negatives of increased jobless claims and speculation the Fed will move to raise the discount rate – I wouldn’t call that a negative but traders don’t seem to like it much.

The discount rate is the rate at which banks can borrow from the Fed. They last raised the rate on February 18 as they are in the process of normalizing the spread between the discount rate and fed funds – normally disco is one full percentage point above that of fed funds, but the spread was cut to 25 basis points during the crisis and now stands at 50 basis points above fed funds. Now, it’s not like the market sold off on this speculation, the S&P 500 was essentially flat (but then again the rumor was fairly silly as it is unlikely the Fed would leak this news), but if traders are going to get a bit antsy about an increase in the discount rate, what’s going to happen when the Fed eventually begins to increase fed funds?

The 10 major sectors within the S&P 500 were split as five gained ground, while five declined. Industrials’ and health-care led the gainers; energy and financials led the declining sectors.

The Dow was boosted by shares of Boeing, 3M and IBM, which accounted for 60% of the index’s gain.
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Brent Vondera, Senior Analyst

Daily Insight: Dollar, EU Second Thoughts, Mortgage Apps, PPI

U.S. stocks gained ground for a third-straight session, and the only two down days of the past 15 sessions were nothing more than fractional declines, on the heels of Tuesday’s Fed statement – yesterday’s reported decline in producer prices for February only reinforced the fact that the Fed won’t feel pressure on the inflation front to remove their unprecedented level of accommodation anytime soon. (Not that the Fed would be focused on inflation if it were a threat, not with 10% unemployment, banks that need a super-steep yield curve and a housing market that remains beaten down…but this is for another discussion I guess.)

The broad market did give back about a third of its earlier gains late in the session, but held on to record solid performance.

Energy shares led the advance (first time for that in a while) along with financials and materials. All 10 major sectors gained ground on the session, but there were clear laggards as utilities and health-care shares were the deepest under-performers.

The Dow Industrial Average followed the S&P 500 in making a new 17-month high, surpassing what had been the recent high of 10,725 hit on January 19. Shares of Exxon, Chevron and Caterpillar led the Dow higher – energy stocks had conspicuously lagged the broad market over the past couple of months, but with crude now testing $83/barrel, they’ve found a bid.
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Brent Vondera, Senior Analyst

Daily Insight: Import Prices, Housing Starts, FOMC Statement

U.S. stocks gained good ground on Tuesday after S&P affirmed their credit rating on Greek government debt of BBB+ (they had threatened to lower that rating) and the EU signaled they’d sidestep “no-bailout” rules and provide emergency loans to that government. The market rally accelerated in the afternoon after the Fed confirmed the rate on fed funds will remain floored for an extended period (yeehaw!) and provided the impetus for traders to push past that 1150 market on the S&P 500 – had been stuck there for three sessions. The broad market sits at a new 17-month high.

Basic material, financials and industrial shares led the advance. All 10 of the major S&P 500 sectors gained ground on the day, but consumer staples and health-care (the traditional area of safety) along with telecoms were the laggards.

And speaking of commodity-related basic material shares, the price of oil is back above $82/barrel this morning – call it a Bernanke bounce. I’m watching for the price to breach $85, which hasn’t occurred since economic mayhem began in late 2008. At some point the market is going to view higher energy prices as another noose around the consumer’s neck. In quick order we could have both oil and stocks at fresh 17-month highs, both are unlikely to move higher in tandem for very long.

Sovereign debt default concerns eased again yesterday, here’s the ebb and flow we’ve been talking about, as European finance ministers laid out unspecific groundwork for a financial lifeline to Greece. If Greece runs into trouble rolling their debt, EU officials will provide emergency loans as members pool funds. The meeting didn’t provide an actual euro amount of these potential emergency loans.
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Brent Vondera, Senior Analyst

General Electric (GE) to raise dividend in 2011

General Electric (GE) CFO Keith Sherin told investors the company would like to grow the dividend in 2011. Sherin said losses and delinquencies from GE Capital are going to peak sometime in 2010, which could allow for “a real earnings snapback,” going forward.

Substantial improvement to the leverage ratio and GE Capital, vastly improved capital market conditions, and projected earnings of $23 billion over the next two years support the idea of hiking the dividend. The company’s equipment and service and equipment backlog stands at $175 billion and is “slowly turning.”

In other news, financial reform proposals put GE under the Federal Reserve’s regulation, but do not force a break of the parent company and the finance unit. It appears GE will be able to keep its controversial industrial loan and thrift banks based in Utah.

The market seems to finally be warming up to GE and I feel vindicated.

Peter Lazaroff, Investment Analyst

Fixed Income Weekly

Treasurys were slightly lower across the curve after a quiet week of trading. The curve was 4 basis points flatter at end the week at +275 bps, 17 bps under the all time record set on Feb 22.

A strong credit market last week was followed up by heavy issuance of corporate debt this week. According to Bloomberg, some $30 billion in corporate bonds were issued by close of business Thursday, bringing the year to date total to just shy of $200 billion. Credit spreads have been steadily moving lower while Treasurys have remained in a tight range. CFOs are definitely aware of this and are taking advantage of the environment to raise cheap capital. And thanks to today’s news that Obama plans to nominate San Francisco Fed President Janet Yellen to Vice Chairman of the Federal Reserve, one of the most dovish of the 12 Fed Presidents, companies will likely see better chances still to borrow cheaply. The term “dovish” is used to describe those who favor easy monetary policy, as opposed to “hawkish” policy makers, who traditionally lean toward tighter monetary policy. The effect of ZIRP on the cost of debt is two-fold. Rates are low, and as investors stretch out to grab more yield in the face of measly low-risk returns, spreads will continue to tighten as long as rates stay here.

The FOMC meets next week and is expected to stand pat on rates, but all eyes will be reading the comments that accompany the rate decision. Namely, “the exceptionally low/extended period” section. Not much is being said one way or another on that, but I expect to hear more speculation early next week. I don’t think the committee is ready to remove them yet, but we are certainly closer than we were in January.


Have a good weekend.

Cliff J. Reynolds Jr., Investment Analyst