Major Averages Ease Off a Bit After Reaching Record Highs

Since reaching new all-time highs in both the Dow Jones Industrial Average and the S&P last Tuesday, April 2, the market has cooled off and in fact the S&P suffered its largest weekly decline of the year last week before rebounding once again on Monday.

Despite this cooling off, the Dow Industrials have outperformed all of the other major indexes and this discrepancy between the Dow and the rest of the market means that the troops have not been marching to the upside along with the generals lately. For instance, the Russell 2000 Index of small stocks underwent its worst weekly decline last week since last June and the Dow Jones Transportation Average suffered its worst weekly showing since last September. Both of them had reached all-time record highs last month.

As a further example of the Dow being in its own upside world, for last week it declined by a total of “only” 13 points, while the S&P (which has a traditional 1 to 9 ratio with the Dow) was lower by 16 points while the Nasdaq ended 63 points to the downside. This discrepancy has come about due to the composition of the Dow, which has benefitted this year from good showings in more defensive types of stocks such as the health care, telecom and utilities groups, and these have been the best performers this year.

These declines were a natural occurrence in reaction to a market that has followed in the footsteps of the pattern of the past three years, namely, starting the year very strongly and then declining by an average 5.2 percent during the spring to summer period. Of course, there is no guarantee that the same pattern will repeat itself this year, although last week’s worst S&P decline of the year came right on schedule, so to speak.

And it was not for lack of trying from central banks around the world, as in addition to the U.S. Federal Reserve, which has promised to keep its asset purchase stimulus programs going indefinitely, last week the Bank of Japan unleashed the world’s most intense burst of monetary stimulus ever when it promised to inject about $1.4 trillion yen into the economy in less than two years, a radical gamble that sent their currency and bond yields to record lows (i.e., 0.425 percent for their 10-year maturity). Since the Japanese economy is about one-third the size of the U.S., the scope of this program is unmatched.

This program is not without its dangers as it could leave their central bank heavily exposed to government debt and potentially huge losses if it failed to ignite some sort of inflation and at the same time investors lost confidence in these efforts to revive the economy. It could also ignite a currency war as other Asian exporters seek to remain competitive with a weaker yen.

What this showed is the determination of the four largest central banks in the world to keep their economies on the road to recovery with these monetary stimulus programs, which has to exert a positive influence on equity markets, and these four largest central banks are the U.S. Federal Reserve, the E.C.B., the Bank of Japan and the Bank of England.

What did get our stock market a bit unnerved last week were some economic reports that came in below expectations, catching overbought equities leaning the wrong way, as the March ISM Manufacturing Index showed the slowest gain in three months, the March ISM Non-Manufacturing Survey, which covers almost 90 percent of the economy, also showed a slower rate of expansion, weekly jobless claims rose to their highest level in four months and last Friday’s non-farm payroll report came in well below the lowest estimate.

A shockingly low number of jobs were created, the worst in nine months at only 88,000. The only silver lining behind this cloud was that the January and February totals were revised higher by 61,000 but the market wants to know — what have you done for me lately? The unemployment rate declined to 7.6 percent from 7.7 percent only because of the number of people who gave up looking for work and dropped out of the labor force as a result, to the tune of 496,000 people. This means that what is known as the labor force participation rate declined to only 63.3%, one of the lowest readings in decades.

Retail jobs showed the largest decline and this was obviously a function of lower consumer spending due to the increase in the social security tax deduction from people’s paychecks and also due to the fact that gasoline prices at the pump were at their highest levels ever in February and March. Job weakness could also have been a function of a word that has been forgotten about lately, and that is “sequestration,” which could become a more serious issue going forward as those federal spending cuts have only just started and could be a more substantial headwind for the economy in the next three months as many government workers will have to take days off without pay.

There might also have been some caution ahead of the earnings reporting season for the first quarter of 2013 which begins this week, with two Dow components, AA and JPM, revealing their numbers. This hesitation has come about because during the past three months there have been 86 companies issuing profit warnings as opposed to only 24 with positive guidance. This negative/positive ratio of 3.58 is the highest in the past seven years. Financials and telecom are projected to show the best earnings gains, at 11 percent and five percent respectively while energy and health care, which have done well this year, are projected to report earnings declines of 4.5 percent and 3.5 percent in that order.

Meanwhile, a part of the world that had caused market anxiety a few weeks ago seems to have quieted down, as Cyprus will finally receive a 10 billion euro loan with an interest rate of 2.5 percent. It is repayable over 12 years after a grace period of a decade. This gives the country additional room to reach a primary surplus by 2018 and basically ruins that country’s status as an offshore banking center as authorities were forced to wind down one bank and impose heavy losses on wealthier depositors in a second in return for the financial aid.


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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