CWS Market Review – October 11, 2013

“Successful investing is anticipating the anticipations of others.”
– John Maynard Keynes

So we’ve reached the point that when our politicians decide against committing economic suicide, it’s celebrated as good news.

On Thursday we learned that our government may have side-stepped a wholly self-induced crisis. The S&P 500 responded with its biggest rally since the first day of the year. (Interestingly, the rally that occurred nine months ago was itself due to a deal to avert another self-induced crisis—the Fiscal Cliff.)

With this deal, nothing is finalized as of yet, but the Obama Administration has endorsed a short-term increase to the debt limit with zero policy conditions. This gives us one more month before default, and hopefully another month to get a longer-lasting deal together. Apparently, folks in Washington finally got the clue that equity markets were, shall we say, not pleased.

In this week’s CWS Market Review, we’ll take a closer look at the market’s recent turmoil. Actually, compared with the mayhem from two years ago, the stock and bond markets have been downright mellow. Or at least as mellow as traders can get. I’ll also preview one of our upcoming Buy List earnings reports. I’m expecting another strong season for our stocks. But first, let’s look at the market’s best day in nine months.

Despite the Drama, the Markets Are Calm

In last week’s CWS Market Review, I wrote that the White House and Congress would eventually reach some sort of deal simply because there was too much to lose if they couldn’t come together. I realize, of course, that one always is at risk of overestimating the maturity of our political class.

I should add that this potential deal still doesn’t address the government shutdown, which is particularly irksome for stat-heads like myself, since several important economic reports have been delayed. It’s impossible to say what the impact of the government shutdown is when we can’t even get the reports about what the economy did last month.

Economists generally estimate that the government shutdown will shave a bit off Q4 GDP. The longer it lasts, the more it will be. Speaker Boehner’s plan would push the Default Day from October 17 to November 22 (incidentally, the 50th anniversary of the Kennedy Assassination). Technically, that would be the end of Uncle Sam’s borrowing authority.

Thursday’s jobless claims report showed a spike of 66,000. But a lot of that was due to California catching up on its big backlog of claims. If you recall, the previous report was very low. Since there tends to be lots of noise in these weekly reports, many analysts prefer to look at the four-week moving average.

As I mentioned before, the stock market has been surprisingly calm, despite the risks involved with the nuclear standoff game President Obama and Congress are playing. Let’s look at two good reads of the market’s jitters. First, the Volatility Index ($VIX). On Tuesday, the VIX made news when it broke 20 for the first time in more than three months. In fact, it broke 21 as well.

The VIX is the market’s estimate of how much stock prices will fluctuate over the next month. The greater the uncertainty, the more it’s expected stocks will bounce around. Bear in mind that volatility isn’t necessarily a bad thing. As a stock picker, I don’t mind some volatility since it means that good companies have a greater opportunity to see their stocks drop down to bargain prices.

But viewed in proper perspective, a VIX of 20 really isn’t that high. It’s just that recent volatility has been so low. Last quarter, the S&P 500 had an average daily volatility of just 0.45%, which was a seven-year low. The S&P 500’s close on Tuesday was 4% below the all-time high close from a few weeks ago. In 2011, the market fell nearly 20%.

(Geeky math interlude: If you’re curious as to what exactly the VIX measures, it’s the market’s estimate for the S&P 500’s volatility over the next 30 days. The number is annualized, so we can get it down to one month by dividing the VIX by the square root of 12, which is roughly 3.46. That gives us the market’s one-standard-deviation estimate for the S&P 500’s plus/minus range for the next month.)

Let’s take a step back and remember that during the last Debt Ceiling fight two years ago, the VIX came near 50. During the height of the Financial Crisis, the VIX topped 80. Traders are nervous today over a 20 VIX. The VIX was above 20 almost continuously for five straight years during the late 1990s and early 2000s. The stock market is far calmer today.

Thanks to the news of a potential Debt Ceiling deal, the VIX plunged 16% on Thursday, to 16.48. Interestingly, the Dow almost perfectly bounced off its 200-day moving average on Wednesday (see the top chart). The index hasn’t closed below its 200-DMA all year. The S&P 500 is still well above its 200-DMA. Bespoke Investment Group noted that the stocks that did the best on Thursday were the ones that had been punished the most the week before. This was a classic snap-back rally.

I also wanted to touch on the surprising surge in the one-month Treasury bill yield. In September, the one-month yield dropped down to 0.0%. This means you got absolutely nothing for lending Uncle Sam your money for one month. But in the last few days, the one-month yield has jumped up to 0.25%. This is another event that’s gotten a lot of attention, but ultimately it doesn’t mean much. Some market participants are obviously speculating on a default. Since the rest of the yield curve hasn’t moved much, we can see that it’s mostly a short-term game. I think traders will dump this position (meaning, cover their shorts) very soon and very dramatically. As with the VIX, the rise is only dramatic when seen in the context of the very low yields we’ve had for a long time.

Janet Yellen to Be the Next Fed Chair

The other big news was that President Obama nominated Janet Yellen to be the next head of the Federal Reserve. This wasn’t much of a surprise, especially since Larry Summers withdrew his name from consideration. The market clearly likes Yellen, and she’s well-respected on Wall Street.

I don’t have much to add except that I think it’s a mistake to view Yellen as an automatic vote for the inflation doves. Right now she’s with the doves, but she hasn’t always been. In the 1990s, she was much more wary of lowering interest rates too quickly. I think some people on Wall Street aren’t aware of that. I also hope that she continues Bernanke’s policy of bringing more openness and transparency to the Federal Reserve.

Speaking of which, the Fed released the minutes from its September meeting. This is the now-famous meeting when the central bank surprised us all by deciding not to taper (for now). The market rallied on the no-taper news, and that day (September 18) marked the S&P 500’s current all-time high close. The minutes from September indicate that most FOMC members think the Fed will begin tapering its bond-buying program before the end of the year. That’s a bit of a surprise.

The Fed will meet two more times this year, once at the end of this month and again in December, just before Christmas. I think the latter meeting will probably see the first announcement of scaling back their bond purchases. But if the economic data are weak, then all bets are off.

Stryker Is a Buy up to $71 per Share

It appears that Stryker ($SYK) will be our only Buy List stock reporting earnings next week. There may be others, but none that I can confirm just yet. The week after next, several more should report. Stryker is due to report Q3 earnings after the market’s close on Thursday, October 17. Wall Street currently expects $1 per share, which is a small increase over the 97 cents per share from one year ago.

I like Stryker a lot, but I was surprised by a rate earnings miss three months ago. The company also lowered its full-year guidance from $4.25 to $4.40 per share to a range of $4.20 to $4.26 per share. The problem is that they’ve been getting squeezed on currency exchange. That’s troubling, but the important thing is that it’s not due to operations.

Stryker made news recently when they bought MAKO Surgical ($MAKO) for $1.65 billion, which was an 86% premium. That’s a hefty price tag, but MAKO is involved in robotic-assisted surgery, which is a red hot sector. I’m skeptical of this move, but I’ll give SYK the benefit of the doubt. I also expect to see a dividend increase in December. Stryker remains a very good buy up to $71 per share.

That’s all for now. Earnings season heats up next week. I have no idea what economic reports will come out next week. I can say that CPI and Industrial Production are two reports that I’d very much like to see…that is, if the government ever reopens. Also on Thursday, Stryker will report Q3 earnings. Be sure to keep checking 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 October 11th, 2013 at 7:04 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.