Newsletter | July 2012

July 30, 2012 – DJIA = 13,075 – S&P 500 = 1,385 – Nasdaq = 2,958

“Do as I Say, Not as I Do”

The historic heat wave’s impact is spreading well past damaged crops and constant demand for air conditioning.  Other troubles include a spike in heat-related illnesses and possible damage to highways and railroads - the Missouri Department of Transportation warned motorist to be watchful for roads “blowing up.”  And as demonstrated by Ben Bernanke’s recent visit to Congress, the record temperatures have melted away the little logic that remained in Washington D.C.  
 
Fed Chairman Bernanke’s recent two-day chat with Congress contained many exchanges that resulted in perplexing headshakes.  When Senator James DeMint focused on the recent scandal surrounding LIBOR and asked the chairman to comment on interest rate manipulation, Dr. Bernanke referred to it as unacceptable behavior.  News reports didn’t specifically cover whether at this point in the proceedings everyone in attendance was able to keep a straight face.  Given that at the core of QE1, QE2, and Operation Twist is the artificial suppression of interest rates, the Fed head apparently has dichotomous standards or an envious sense of humor.   

Another gem from the Senate session involved Senator Chuck Schumer who basically threw up his hands and told Bernanke that Congress was not going to be able to do anything legislatively to help the economy.  As any politician worth his or her weight would have done, New York’s senior senator first blamed the other side of the aisle for all of humanities woes.  After that he said, “Given the political realities, Mr. Chairman, particularly in this election year, I am afraid the fed is the only game in town and I would urge you to take whatever actions you think would be most helpful in supporting a stronger economic recovery.”  He concluded with “So get to work, Mr. Chairman.”  It’s unclear if the market sold off because what Senator Schumer said or due to a sense of hopelessness over the ineptitude of our public sector leadership.

Ironically it was another central banker’s babblings that moved the stock markets last week.  On Thursday European Central Bank President Mario Draghi announced that he and the rest of the policymakers would do everything that they could to save the Euro.  The global markets rallied strongly on these comments despite the lack of any details on how this was to be accomplished.  Granted there have been some subtle yet important changes in proposed solutions recently and some market commentators pointed to Draghi’s words as a line in the sand for not only the Euro but for risk assets in general.  Of course, it’s possible that the market’s move higher has more to do with sellers being exhausted more than any sort of confidence in the ECB.   

The Dow jumped 400 points during Thursday and Friday’s trading and finished the week back above 13,000.  Combined with Wednesday’s advance, the last three days of the week marked the Dow’s biggest three day advance of the year and reversed two triple digit declines on Monday and Tuesday.  Other than the Nasdaq, which was held back by a down week for Apple after slightly disappointed earnings, the major averages climbed over 1.5%. 

    Last Week    2012
Dow Jones Industrial Average   +253 pts     +7.02%
S&P 500   +23 pts +10.21%
Nasdaq Composite   +32 pts  +13.55%
Russell 2000 +4 pts  +7.43%

                                                 

Indices are unmanaged, do not incur fees or expenses, and cannot be invested into directly. These returns do not include dividends

Treasury bond yields fell to record levels early in the week but spiked higher on fears that President Draghi’s plan could be inflationary.  The 10-year Treasury note’s yield fell to 1.389% but finished the week at 1.553%.  The 30-year bond’s yield closed the week at 2.642%.  Across the pond, five countries’ two-year government bonds have traded at negative yields within the past two weeks. The obligations of Austria, Denmark, Finland, Germany, the Netherlands, and
Switzerland are yielding less than nothing. 

As mentioned, Apple’s sales and earnings growth was less than expected and the stock fell 5% before rebounding, but still closed down about $20 per share for the week.  In the social media area, Facebook dropped 12% and Zynga plunged 37% on disappointing results.   

The Commerce Department reported that the second quarter’s domestic economic output slowed to 1.5%.  Expectations had been lowered to a point where this was viewed as good news.  Furthermore, it gave those calling for more central bank help more ammunition.  Headwinds during the three months included a reduction in consumer spending and a slowdown in business hiring and investing.  The second quarter’s growth was down from 2% in the first quarter and 4.1% in 2011’s fourth quarter. 
 
Returning to the week’s irony theme, Sandy Weill appeared on CNBC and declared that Glass-Steagall Act should be reinstated.  Glass-Steagall was a banking regulation passed during the Depression that required separation of commercial banking and investment banking and insurance.  As you might remember, Mr. Weill was the driving force that led to the law’s repeal during the late 1990’s.

Mr. Weill was the architect of the marriage of Citibank and Travelers Group which already owned investment firm Solomon Smith Barney.  As we know, the combination became to be known as Citigroup and Sandy Weill lobbied hard for the dismantling of Glass Steagall.  It was abolished in 1999 and led the way for the expansion of firms such as JP Morgan, Goldman Sachs, Lehman Brothers, Merrill Lynch as the big financial firms leveraged themselves to previously unthinkable levels. 

That Sandy Weill wants to put the genie back in the bottle caused much discussion on Wall Street as the debate raged over whether it should happen but also whether it could happen.  A couple interesting points to consider is that there are only about a half-dozen banking institutions that do not comply with the old Glass-Steagall regulations.  However, these organizations control almost two-thirds of the industry.  Too big to fail indeed.   

The motivation for Mr. Weill’s change of heart is unclear.  Perhaps he really believes that the system would be stronger under a Glass-Steagall environment.  On the other hand, a cynic could even argue he is just trying to lob another shot at Jamie Dimon with whom he has a long and storied relationship. 

Whatever the reason, we would offer that a reinstatement of Glass-Steagall seems unlikely.  Given that Dodd-Frank together with a Volker Rule are encountering such heavy resistance, believing in a resurrection of Glass-Steagall might be the same as counting on a Jets Super Bowl victory this year – pretty darn remote.  Even if a few of our regulators and politicians believed in its benefits, it would have to overcome the money and power of Wall Street’s lobbyists, something few in Washington have the moral fortitude to try. 

Returning to the stock market, last week’s rally pushed the averages above the June highs.  Both bull and bear acknowledge that stocks seemed poised to make a run to 2012’s highs which are around another 3% from here.  If we can make new highs in the near term, there might be enough momentum for the move to continue throughout the second half of the year.  Of course, economic activity will have to substantially improve upon last week’s 1.5% annual growth to better support the move.  This week we get an update on the employment situation when July’s jobs data is released on Friday.  Early consensus is for the addition of 100,000 nonfarm jobs and unchanged for the unemployment rate (8.2%). 

Add to the mix such things as more European developments, this week’s two-day Federal Reserve Open Market Committee meeting, and more second quarter earnings reports which will include company guidance for the rest of the year.  It seems that pessimism abounds so any glimmer of good news could become the markets’ focus. 

August is usually a slower month for the capital markets as many take some time away from the quote screens.  This might translate into heightened volatility but with so much policy uncertainty traders won’t be far removed as they check their smart phones throughout the trading days.  August could be far from typical which then leads into the always worrisome months of September and October.  Throw an emotional presidential election into the mix and everyone should remain on their toes as well as flexible.