Lack of Fear is Becoming a Little Scary

Performance for Week Ending 8/17/12: The Dow Jones Industrial Average (Dow) rose 0.51%, the Wilshire 5000 Total Market IndexSM (Wilshire 5000SM) gained 1.0%, the Standard & Poor’s 500 Index (S&P 500) added 0.87% and the NASDAQ Composite Index (NASDAQ) tacked on 1.84%. Sector breadth was mixed as ...

August 20, 2012    |    By Mike Schwager

Performance for Week Ending 8/17/12:

The Dow Jones Industrial Average (Dow) rose 0.51%, the Wilshire 5000 Total Market IndexSM (Wilshire 5000SM) gained 1.0%, the Standard & Poor’s 500 Index (S&P 500) added 0.87% and the NASDAQ Composite Index (NASDAQ) tacked on 1.84%. Sector breadth was mixed as 6 of the S&P sector groups finished higher, while 4 finished lower. The Technology sector (+2.34%) was the best performer, while the Utility sector (-1.49%) was the worst.

Index* Closing Price 8/17/2012 Percentage Change for Week Ending 8/17/12 Year-to-Date Percentage Change Through 8/17/12





Wilshire 5000




S&P 500








*See Last Page for Index Definitions

MARKET OBSERVATIONS: 8/13/12 - 8/17/12

U.S. stocks finished higher for the sixth straight week reflecting growing confidence that the U.S. economy is gaining traction. Most global markets also finished higher on the week as investors were comforted by comments from German Chancellor Merkel stating that Germany is "committed to doing everything we can" to maintain the euro. These remarks echoed recent comments from European Central Bank President Mario Draghi.

Despite the gains, the action in the U.S. markets was more of a grind on light volume than an elevator ride higher. The action may be suggesting that markets are running on tired legs and may be on the verge of entering into a period of “price discovery.” This process often results in a sideways slumber as investors trying to gauge what has been discounted into the markets and what is likely to come to fruition.

The 10%-plus rally off the June lows has essentially been driven by the notion that stimulus junkies will get another shot of “monetary morphine” at the September FOMC meeting. The recent improvement in economic data is beginning to cast some doubt over whether the Fed will act at the meeting. As has always been the case, the Fed’s decision will be data dependent with a particular focus. on inflation and employment trends. With that said, all eyes will be focused on the August 31 keynote speech by Fed Chairman Bernanke at the Jackson Hole symposium. The gathering has been used in recent years as a forum to telegraph future monetary actions and investors are expected to parse every word of Bernanke’s speech for clues on the Fed’s thinking. With interest rates already near record lows, Fed policy has essentially become a blunt tool, in my opinion. However, at this stage of the game, it is less about interest rates and more about boosting investor confidence. In other words, the current environment is less about credit and more about credibility. If policymakers fail to deliver, conceivably, a round of profit taking could occur.

While current economic conditions may not be dire enough for the Fed to pull the trigger at the September meeting, we must also be cognizant that “Operation Twist” remains in place through year end, so in effect; policy efforts are currently being carried out. In fact, when the extension of “Twist” was announced, Chairman Bernanke referred to the action as “substantive.”   Recall that at the conclusion of June FOMC meeting, Fed officials committed to swapping of $267 billion of short term notes (three years or less) for maturities in the six to 30 year range. The program is geared toward keeping downward pressure on the longer end of the yield curve in an effort to maintain low borrowing costs for businesses and consumers.

Regardless of whether the Fed applies their foot to the monetary gas pedal, Bernanke is sure to warn that monetary policy is no panacea and fiscal initiatives also need to be addressed. While most political handicappers feel the tax cuts and spending issues set to expire at the end of the year (aka the “fiscal cliff”) will be extended into the New Year, the vitriol in Washington means nothing is a sure thing. Failure to address the fiscal cliff would create a significant drag on the U.S. economy and potentially push the U.S. economy into recession. Bernanke is well aware of this doomsday scenario and could refrain from near term action in an effort to keep some dry powder in the event that a decision on the fiscal cliff isn’t reached.

Economic Round-up
Last week’s batch of economic data had a positive tone. After three consecutive months of declines, the Commerce Department reported that Retail Sales during the month of July rose by a better than expected 0.8%. Retail Sales excluding Autos also rose by 0.8%. On the inflation front, both the consumer and producer price indices signaled that inflationary pressure remains muted. On the labor front, the 4-week moving average for initial jobless claims dipped to the lowest since late-March. The housing market showed fresh signs of stabilization. While housing starts during the month of July fell 1.1%, building permits—which tend to be a leading indicator of future construction—came in at 812K units, the highest rate since August 2008. Elsewhere, the National Association of Home Builders Housing index jumped to the highest level in five years.

On a mildly troubling note, the Philadelphia Fed Business Outlook Survey contracted for a third straight month. The Philly Index is watched closely as it tends to be a fairly good barometer for the broader ISM-Manufacturing index. Despite the weakness, markets essentially shrugged off the report as the data showed sequential improvement on most metrics. In other words, the second derivative of the data seems to be signaling that things are generally getting “less bad”.  

VIX Signaling a Lack of Fear
The market’s resiliency over the past several weeks and the high levels of complacency in the marketplace are something to keep a close eye on. While the “gloom and doom” headlines have mostly fallen off the front pages, there still remains uncertainty surrounding the developments in the Eurozone, the slowing growth outlook in China and the looming fiscal cliff in the US. Last week, the CBOE volatility index (VIX), which tends to be a good barometer of fear in the market, fell to the lowest level in over five years. Investors appear to be saying that the worst case scenario may have already been reflected in stock prices and hopes for more Central Bank easing seem to be outweighing the many known unknowns. Sentiment (fear & greed) however tends to be a good contrarian indicator and the current lack of fear in the marketplace may be hinting that a “pause to refresh” could be on the horizon.

From a Technical point of view, trend and momentum clearly remain favorable, however, it should be noted that the S&P faces some tough resistance at the 1420/22 area (this represents the year-to-date high, or looked at differently, the level where the strong rally off the October lows ran out of steam).

Q2 Earnings
With earnings season just about wrapped up, year over year growth in the second quarter looks to be little changed. Through Friday, 476 members of the S&P 500 have reported second quarter earnings with overall results flat (0%) from year ago levels. During the quarter, 68% of the companies beat analyst expectations while 21.5% fell short.  The “beat” rate was solidly above the 61% long-term average, but slightly off the pace of recent quarters. On a sector level, Industrials (+8.3%) and Technology (+7.2%) reported the strongest results while the Materials sector (-17.1%) posted the weakest results. Revenue growth for the quarter rose by a meager 0.7%. Looking ahead, consensus expectations, according to Bloomberg, are for third quarter earnings to fall by 1.7% and then to jump by 10.4% in the fourth quarter. Overall earnings for 2012 are expected to rise by 5.7%.

The Week Ahead:
With second quarter earnings season essentially wrapped up and the economic calendar containing only a handful of reports this week, markets will likely be subject to news flow out of Europe as well as political wrangling here in the US. Economic reports of interest include existing home sales, new home sales, the Chicago Fed index, initial jobless claims and durable goods orders. Also of interest will be the release of the minutes from the July 31/August 1 FOMC meeting. Investors will look for clues on the Fed’s policy outlook and for additional details surrounding the Fed’s pledge that they “will provide additional accommodation as needed” to bolster the U.S. economy.


I continue to believe that the U.S. equity markets remain well positioned for positive performance over the course of the next few quarters especially relative to cash and safe-haven Treasury bonds. This upbeat view reflects the markets attractive valuation, the overall healthy nature of corporate balance sheets, the recovering (albeit modestly) economy, expectations that corporate profits will remain favorable, and the pledge from the Federal Reserve that monetary policy will remain accommodative through at least late-2014. In light of these favorable dynamics, I continue to believe that market weakness represents an attractive entry point, especially for longer-term investors.

Potential Risks/Wildcards: : Expectations that equity prices will trend higher over time assumes that a resolution to the debt problems in Europe will be found, that monetary policy will remain accommodative, and that no major fiscal policy mistakes are made. An adverse outcome to any of the above factors would likely lead to a reevaluation of the bullish outlook.


The Dow Jones Industrial Average is a price-weighted average of 30 blue-chip stocks that are generally defined as the leaders in their industry. It has been a widely followed indicator of the stock market since October 1, 1928.

Wilshire 5000 Total Market IndexSM represents the broadest index for the U.S. equity market, measuring the performance of all U.S. equity securities with readily available price data. The index is comprised of virtually every stock that: the firm's headquarters are based in the U.S.; the stock is actively traded on a U.S. exchange; the stock has widely available pricing information (this disqualifies bulletin board, or over-the-counter stocks). The index is market cap weighted, meaning that the firms with the highest market value account for a larger portion of the index.

Standard and Poor's 500 Index is a capitalization-weighted index of 500 stocks. The index is designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

The Nasdaq Composite Index is a broad-based capitalization-weighted index of stocks in all three NASDAQ tiers: Global Select, Global Market and Capital Market. The index was developed with a base level of 100 as of February 5, 1971.

The S&P/TSX Composite Index is a capitalization-weighted index designed to measure market activity of stocks listed on the Toronto Stock Exchange (TSX). The index was developed with a base level of 1000 as of 1975.

CBOE Volatility Index (VIX) shows the market's expectation of 30-day volatility. It is constructed using the implied volatilities of a wide range of S&P 500 index options. This volatility is meant to be forward looking and is calculated from both calls and puts. The VIX is a widely used measure of market risk and is often referred to as the "investor fear gauge."


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