CWS Market Review – June 17, 2011
For a little while, on Tuesday, it looked like the market was finally going to shake off its six-week losing streak. But soon, fears of more problems in Greece sent U.S. share prices lower once again. There’s a very good chance that this will be our seventh-straight week of losses.
The reality is that Europeans have failed miserably in their attempt to contain the problems in Greece. I should add that I don’t have any bright ideas on this myself, but the Europeans seem to be going out of their way to prove themselves a dysfunctional political unit.
Put it this way: two-year notes are running around 30% in Greece. The credit swaps indicate that the market thinks there’s an 81.5% chance that Greece will default on its debt. That’s not “in the bag” but it’s very close. On top of that, Ireland and Portugal are also looking shaky, but they’re nowhere as bad as Greece is. At least, not for now.
The message is that if the Europeans are unwilling or unable to do something about Greece, there’s little reason to believe they’ll be able to tackle the next problem child. And there will be a next.
For investors, the effects of this crisis are being felt in many areas. The euro just hit a record low against the Swiss franc. This is a good measurement to watch since Switzerland is surrounded by Eurozone countries but it’s not actually in it. Folks have turned against the euro and options players are paying mightily for insurance against a euro plunge.
This week, I want to highlight some comments that Ben Bernanke made recently. The Fed Chairman acknowledged weakness in the U.S. economy and in the jobs market in particular; plus he discussed the recent rise in commodity prices. According to Bernanke, these issues, while serious, are “transitory” and he expects that they’ll soon fade. Bernanke said that the economy should firm up later this year.
What I find interesting is that the stock market still seems unusually complacent and I suspect that Bernanke has convinced investors that he’s right. Here’s an example: The Volatility Index, better known as the $VIX, typically moves in the opposite direction of the stock market. And as the stock market has moved lower, the VIX has in turn moved higher. But, and here’s the catch, the VIX hasn’t rallied as much as much as we would expect. Perhaps the market already sees reasons to be calm that haven’t become readily apparent yet.
Another example of the news/price disconnect can be in seen in the bond market. Quite simply, the bond market isn’t at all worried about inflation despite emerging signs of higher prices. This past week’s inflation report showed the highest core inflation in four years. This is important because the core inflation report doesn’t include food or energy prices which can be highly volatile. Furthermore, there’s been a clear trend of rising inflation for several months now.
But if we look at bond prices, once again we can see that Bernanke’s optimism seems to be the dominant view. The ten-year Treasury yield is back down to 2.91% after a brief spike up to 3.1%. It’s now at its lowest point of the year. Similarly, the five-year Treasury yield has fallen to 1.5% which is its lowest yield this year. In other words, bond traders seem very unimpressed by the recent inflation reports. Perhaps they value the liquidity of Uncle Sam’s debt which can be dumped quickly if needed. Or they may be convinced by Bernanke’s view.
The security that I find most surprising is the two-year Treasury. Investors are now willing to lock up their money for 24 months in exchange for 0.38% per year. Do they not know what stock dividends are? Investors are paying sky-high prices for security and very low prices to shoulder any risk which I believe is a result of the problems in Europe. Since the market peaked on April 29th, U.S. stocks have shed over $1 trillion, and the S&P 500 is now within sight of its 200-day moving average.
Outside of the inflation report, we got some modestly positive economic news. Housing starts for May increased more than forecast. Building permits rose by 8.7% in May which was the highest jump this year. Work on multi-family homes rose by 23%. Also, fewer Americans applied for unemployment benefits. This may be the beginning of a trend but we still need to see more data to confirm that a turnaround is in the works.
Now let’s turn to our Buy List, which is still ahead of the market for the year although both the market and the Buy List have had lost some luster over the last seven weeks. Leucadia National ($LUK) said that it’s selling a large portion of its stake in Fortescue Metals for $615 million. This is probably a very shrewd move. Fortescue is a large Australian iron ore producer.
Johnson & Johnson ($JNJ) said that it’s quitting the stent business. Even though J&J was an early pioneer is this field, upstarts have been grabbing market share. Interestingly, two of the more successful rivals are on our Buy List: Abbott Labs ($ABT) and Medtronic ($MDT). Johnson & Johnson said they’re going to incur a charge of between $500 million and $600 million.
Shares of Gilead Sciences ($GILD) got knocked a bit earlier this week on news of a Justice Department investigation. An analyst at Oppenheimer said this was a “minor concern” and I suspect he’s correct.
Earlier this week, I did a post on why I think Oracle is a good value. The company gave us a very optimistic forecast for this quarter so I’m expecting an earnings beat, but not a very large one. What I find interesting is that Oracle’s earnings forecast came out when the quarter was still young. They wouldn’t say something so bold that early unless they were very confident. The earnings report is due out this Thursday. Wall Street currently expects earnings of 71 cents per share while I expect 73 cents per share. Either way, Oracle is still a very good value. Oracle is a buy up to $34 per share.
The other Buy List earnings report next week will be from Bed Bath & Beyond ($BBBY). There have also been some rumors that BBBY is about to be acquired. These stories make me laugh because I would think that anyone who really knows isn’t talking.
I’m going to reiterate what I said last week: In April, BBBY said it expects fiscal Q1 earnings of 58 to 61 cents per share. I think that’s on the low side. Remember that Q4 was a blow-out quarter for them. I’m expecting a modest earnings surprise—around 63 cents per share, give or take. I hope to see Q2 guidance of 80 to 85 cents per share. I’m keeping my buy price for BBBY at $55 per share.
That’s all for now. Be sure to keep visiting the blog for daily updates. I’ll have more market analysis for you in the next issue of CWS Market Review!
– Eddy
Posted by Eddy Elfenbein on June 17th, 2011 at 7:43 am
The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.
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