Stocks Pause Ahead of Bernanke Testimony and the Sequester
The S&P 500 finished the week modestly lower as investors locked in some profits after seven consecutive weekly gains.
Performance for Week Ending 2/22/13:
The Dow Jones Industrial Average (Dow) rose 0.13%, the Wilshire 5000 Total Market IndexSM (Wilshire 5000SM) fell 0.39%, the Standard & Poor’s 500® Index (S&P 500) lost 0.28% and the NASDAQ Composite Index (NASDAQ) shed 0.95%. Sector breadth was negative as 7 of the 10 S&P sector groups finished lower. The Materials sector (-2.95%) was the worst performing sector while Consumer Staples (+1.70%) was the best.
||Closing Price 2/22/2013
||Percentage Change for Week Ending 2/22/2013
||Year-to-Date Percentage Change Through 2/22/2013
*See below for Index Definitions
MARKET OBSERVATIONS: 2/18/13 - 2/22/13
The S&P 500 finished the week modestly lower as investors locked in some profits after seven consecutive weekly gains. This “pause to refresh” appeared to reflect renewed concerns over the pace of growth in Europe, caution ahead of this Friday’s “sequester” deadline and growing worries over consumer spending due to the recent rise in gasoline prices and the uptick in the payroll tax. The worries offset optimism sparked by the recent wave of merger and acquisition activity. Following several large deals during the prior week, last week saw a major combination of two large office supply retailers along with several other smaller deals.
Adding to the negative bias was the more “hawkish” than expected tone to the January Federal Open Market Committee (FOMC) meeting minutes. The minutes revealed that the FOMC continued to debate the benefits and costs of additional asset purchases with “several” participants thinking the committee should be ready to “vary” the pace of purchases. In addition, a “number of participants” said the committee may need “to taper or end its purchases before it judged that a substantial improvement in the outlook for the labor market had occurred.” In contrast, “several others” judged that the costs of ending purchases too soon “were significant” and that purchases should continue until a substantial improvement in labor markets is generated. The minutes sparked concern that the Federal Reserve (FED) could take away the monetary “punchbowl” sooner than expected. While I viewed the meeting minutes as pretty evenly balanced between doves and hawks, investors however appeared spooked by the widening division between the two. The key take away from minutes, in my opinion, should be that the FED’s top dogs, Bernanke and Yellen, remain firmly in the dovish camp. Investors should also pay heed to the action in the bond market. Historically, the threat of tighter policy has resulted in a surge in bond yields. Instead, bond yields over the days following the release actually declined. This suggests that equity investors may be premature in their conclusion of tighter policy.
Investors will now look ahead to Tuesday when FED Chairman Bernanke is scheduled to testify before the Senate Banking Committee.
Also creating some worry in the market place was the lower than expected forward guidance from retail giant Wal-Mart. The company lowered first quarter earnings guidance citing the recent rise in gasoline prices, the delay in tax refunds and the negative impact from the increase in the payroll tax. With over two-thirds of the U.S. economy driven by consumer spending, Wal-Mart’s results are viewed as a barometer of the financial health of the consumer – stay tuned.
Sequester on Deck
As mentioned last week, while the so called fiscal cliff was avoided, policymakers now face a March 1 deadline when automatic across-the-board spending cuts—commonly known as “sequestration” – are set to take effect. If the cuts are allowed to phase in, funding for many federal government activities will be reduced beginning this Friday. According to the Congressional Budget Office, a full sequester implementation would trim economic growth by an estimated 0.7% this year, while the Bipartisan Policy Institute predicts it would cost the nation 1 million jobs.
Chris Krueger of the Guggenheim Washington Research Group opines that Congress is very likely to miss the March 1 deadline and some version of sequester will begin. Krueger however feels that some sort of agreement (a “punt” or “pass”) will likely be cobbled together by the end of March, which should ultimately soften the economic blow.
The U.S. economy and markets have exhibited incredible resiliency over the past several years even in the face of a credit rating downgrade, the lead up to the fiscal cliff negotiations and the perennial worries over a double dip recession. Importantly, none of these events knocked the recovery or the markets off kilter, which suggests that the sequester will not either as the fundamentals of the U.S. economy remain strong enough to power through any fiscal contraction.
Buy the Dip
According to a recent report from Goldman Sachs, hedge funds on a year-to-date basis are currently lagging the broader markets by approximately 4 percentage points. This follows 2012 performance when the average hedge fund lagged the S&P 500 by an average of 8 percentage points. The underperformance is likely leading to “performance anxiety” amongst this set of institutional investors which in turn is likely to foster a “buy the dip” mentality. This race to play catch up should be viewed as a potential baffle to downside risk.
As mentioned in these missives over the past few weeks, sentiment readings have moved to elevated levels, the market (from a technical point of view) had become “overbought” and fear in the market place—as measured by the CBOE Volatility Index—recently hit multiyear lows. This combination had arguably left the market “priced for perfection” and therefore raised the odds that data points and/or news flow that went against the “bullish grain” would likely send investors heading for the exits.
I continue to believe that periodic pullbacks—which we have been generally devoid of as of late—are healthy in the sense that they help keep expectations in check and ultimately weed out excesses that tend to get built into stock prices. These periods of consolidation allow for the digestion of gains and usually set the stage for the next leg higher.
Last week’s batch of economic data signaled that inflation remained muted, the rate of change in growth in the housing sector recovery may be beginning to taper off and the manufacturing sector remained a mixed bag. On the housing front, the Commerce Department reported that housing starts during the month of January fell 8.5% to an annual rate of 890K units. The results were short of the 920K expected by economists; however, the December data was revised to 973K from the initial estimate of 954K. Building Permits—which tend to be a leading indicator of future construction—came in at 925K units, modestly ahead of the 920K expected by economists. Existing home sales, which account for the bulk of U.S. housing activity, rose 0.4% during January to an annual rate of 4.92 million units. The data was slightly ahead of the 4.90 million units expected by economists. The new/existing sales data was followed by reports showing a third decline in the past four weeks for mortgage applications as well as a slight dip in homebuilder’s sentiment. Inflationary pressure remains muted with both the consumer and producer prices indices suggesting little upside momentum in prices. On the manufacturing front, the Philadelphia Federal Reserve reported that manufacturing activity in the greater Philly area unexpectedly contracted for a second straight month. The Philly report was in conflict with a recent surge in manufacturing activity in the New York region (the Empire index) as well as a report from Markit showing that manufacturing at the national level remained firmly in expansionary territory.
Fourth quarter earnings season continues to wind down with the majority of companies reporting better than expected results. Through Friday, 445 members of the S&P 500 have reported fourth quarter earnings with overall results up by 8.0% (note: coming into the quarter expectations were for a 2.5% growth rate). Of the 445 companies, almost 69% have beaten expectations while just over 21% have fallen short. The current “beat” rate remains solidly ahead of the 61% long-term average. Revenues have expanded by 3.2%, slightly ahead of the 2.9% estimate at the end of the year.
The Week Ahead:
The focal point of the upcoming week will be on Tuesday when FED chairman is scheduled to deliver his semi-annual testimony on monetary policy to the Senate Banking Committee. Following the release of the January 29/30 FOMC meeting minutes last week, investors will look to Bernanke ’s testimony for further clues on the duration of the FED’s bond buying program. The economic calendar will also be of great interest with reports on consumer confidence, new home sales, durable goods orders, the first revision to the Q4 GDP report and the Institute for Supply Management’s manufacturing index. With almost 90% of the S&P 500 companies having already reported their results with a heavy emphasis on retail companies (Lowe’s, Home Depot, Target, Gap and Best Buy, among others). With the “sequester” set to kick in on Friday, news flow out of Washington will also be monitored very closely.
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.
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