After gaining for 10 straight days in a row for the first time since 1996 and setting all-time record highs in the process for eight consecutive days, the Dow finally underwent a two-day decline along with the other major averages, finally bringing the upside party to an end for the time being.
And what a great party it was, as a series of better economic reports, the ongoing asset purchases from the Federal Reserve and fourth-quarter earnings that topped initial projections all forced reluctant buyers into the market at ever higher levels.
This column has already addressed these factors in previous weeks but another reason for what had been the steady move higher was that investors in U.S.-based funds put $11.3 billion in new cash into stock funds last week, the most since late January as the Dow was extending its streak of record highs. This brought the total to $53 billion this year into U.S.-based and global stock funds, which means that for the first time since 2007, investors have put more money into equity funds than they have withdrawn, and total withdrawals were an astounding $560 billion since that time.
The latest economic reports were also used as further justification for the gains, as February retail sales rose at their fastest rate in five months and this was quite an accomplishment considering the fact that gasoline prices at the pump are the highest ever for this time of year and payroll taxes have risen by two percent due to the higher rate for social security contributions. These gains come on the back of the better employment numbers and improvements in housing and show that the economy is picking up steam, although not enough to cause the Federal Reserve to deviate from its current very accommodative monetary policy stance. And so-called “core sales,” which strip out automobiles, gasoline and building materials and which most closely correspond with the consumer spending component of GDP, rose as well. In addition, further proof of an improving employment picture was that weekly jobless claims fell last week to their lowest level since last June, their third straight weekly decline, and the four-week moving average reached its lowest level in five years.
But some cooling off in the recent string of better reports appeared last Friday, as the preliminary March U. of Michigan Consumer Sentiment Survey showed a sharp decline when a gain was expected and this was the reason for the market’s decline, which ended the winning streak as described above.
I had put forward the idea in last week’s column that “what might finally stop the upside momentum of the stock market is the fact that the volatility index, otherwise known as the VIX, and which moves in the opposite direction of equities themselves” declined at the end of last week to 11.30, its lowest reading since February 2007. Since history has shown that it cannot go below 10, this meant that the market was extremely overbought and looking for some excuse to go lower.
And that “excuse” came over the weekend from the island nation of Cyprus, of all places. Instead of dysfunctional Italy, still without a government, the newest market anxiety came from a nation that accounts for less than one-half of one percent (0.2% to be exact) of GDP for the EU In fact, during Sunday’s overnight session, the various stock index futures fell as much to indicate that the Dow could open lower on Monday morning by more than 200 points until cooler heads prevailed and it ended “only” 62 points lower.
So what happened in that insignificant country to account for investors getting so bent out of shape? The answer is that there was a plan to seize money from bank accounts in exchange for a financial rescue plan of 10 billion euros by the EU. Initially the plan would have taxed deposits up to 100,000 euros at a rate of 6.75% and at a rate of 9% above that level. This would have shaved the cost of the bailout to that 10 billion euro number from the initial figure of 17 billion euros, which is close to the size of the country’s 18 billion euro economy.
Then the plan was revised down to a 3 percent rate on 100,000 euros and 10 percent for deposits between 100,000 and 500,000 euros and 12 percent for deposits greater than that amount. Deposits of less than 20,000 euros would be completely exempt, and a vote was scheduled to be held yesterday on this change. In addition to potentially lowering the tax on deposits, the government said that depositors who keep their accounts intact for two years will receive securities linked to future revenue from the country’s gas reserves, and this is an enticement?
So why did investors get so bent out of shape over this? The answer is that the raid on these bank accounts could set off new convulsions in the overall EU financial crisis that began in 2009 with Greece. This led to the fear that this is a step that would limit support for bank creditors all across Europe and also showed that policy makers will risk financial market disruptions in order to avoid sovereign defaults.
Pictures of Cypriots lining up at cash machines were thought by some to now raise the specter of capital flight elsewhere and threatened to disrupt the market calm that has existed since the ECB pledge last September to backstop the debt of troubled nations. So with no government in Italy, Spain in the depths of both a political and economic crisis, and Greece struggling to meet the terms of its own bailout, this supposed “crisis” in a completely insignificant country was used as an excuse to cool off a market that was severely overbought in any event.
And the country most upset by this was Russia, which has an astounding $31 billion on deposit in a country that is basically a tax haven. In fact, 31 percent of the total bank deposits in Cyprus are from outside the EU, for what purposes other than tax evasion.
If the 2013 pattern holds true, this latest market selloff should be met by new buying from those investors waiting for the traditional pullback to enter into a market that might have gotten away from them. Finally, I urge all investors to pay attention to today’s FOMC statement for any clues as to how much longer the Fed is going to be flooding the system with cheap funds.
Donald Selkin is the Chief Market Strategist at National Securities in New York, a veteran in the securities industry for 36 years who is widely quoted in the financial media.
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