by Shawn Narancich, CFAVice President of Research
Don’t Worry, Be Happy Jamie Dimon has a reputation for irreverence that was reinforced this week when JP Morgan scooped the Fed by announcing that not only had it had passed the bank stress tests, but that it also planned to boost the dividend and repurchase billions more in stock. Whether the flap at JP Morgan was justified or simply reflected a misunderstanding about the timing of the central bank’s announcement, it opened the floodgates for 18 other large financial institutions to chime in about how their balance sheets would withstand the buffeting of 13 percent unemployment paired with tumbling home and stock prices. This time around, all but government-owned Ally Financial passed the test, though Citigroup, SunTrust, and MetLife were rebuffed in their proposals to return capital to shareholders. The stress tests turned out to be a catalyst—not only for the bank stocks, which were catapulted to the top of the performance charts year-to-date—but also for the broader markets, with the S&P 500 closing at nearly a 4-year high.
A Full Year of Returns in One Quarter While the bull market continued this week, the landscape is changing and headwinds are building. The Fed proved to be a catalyst by upgrading its economic outlook ever-so-slightly, but it was enough to dampen investors’ expectations for QE3 and send bond investors to the exits. After hovering around 2 percent since last fall, the benchmark 10-year Treasury yield broke a tight trading range and rocketed upward to 2.3 percent. Utilities got clobbered and consumer discretionary stocks lost a bid. Since the rally began last fall, the number of stocks making new highs has declined, volumes have been low, the put-to-call ratio has fallen and transportation stocks have failed to keep pace with the broader market. Technically, stocks appear extended and due for a pullback.
Running Out of Gas? This week’s inflation numbers confirm our increasing concern about high oil prices, which have boosted pump prices to upwards of $4.00 a gallon. The geopolitical premium from uncertainty surrounding Iran’s nuclear program as well as actual supply tightening caused by the European oil embargo have caused benchmark Brent pricing to reach levels where demand destruction is starting to occur. While inflation remains well contained at 2.9 percent, 80 percent of the sequential increase in February’s CPI came from higher gasoline prices—and more importantly for consumer spending power—price increases are outpacing income gains. Retail sales met expectations, but higher fuel prices boosted that number as well. As such, we remain underweight consumer discretionary stocks (while positioned defensively within the sector) and equal-weight energy.
Our Takeaway from the Week While we have reservations about the fast start to this year, our longer term optimism about equities is anchored by the following:
- continued evidence of economic expansion
- attractive company valuations
- companies rich with cash able to drive mergers and acquisitions
- investor skepticism about stocks evidenced by high allocations to bonds and large sums of uninvested cash