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Stocks Sell Off While Bond Yields Remain Below 2%

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Stocks sold off early in the week before stabilizing Thursday and Friday. The S&P 500 was down 2.3% ending the week at 2061, down from 2108 last Friday. European and Japanese stocks lost about 1%.

Year to date, the US equity markets are flattish while Europe and Japan are up anywhere from 5 to 10% (in dollars) depending on the country. “Commodity” countries like Mexico, Brazil and Canada have all posted negative returns.

There was news of another mega-merger this week, this time between Kraft Foods and H.J. Heinz. It creates what will be the fifth-largest food-and-beverage company in the world.

Ten year Treasury bond yields were up a little but remained below 2% closing the week at 1.97%.

Renewed Middle East fears following events in Yemen boosted oil and gold prices. Oil closed at $49, up from $47 last week.

The US dollar has softened of late on foreign currency markets. The euro reached a low of 105 a couple of weeks ago and is now trading at 1.09. That’s partly because of dovish Fed comments suggesting that liftoff for US short term rates might not be this June but perhaps later in the year. Interest rate differentials between countries are a major driver of currency movements.

On Tuesday, we learned that CPI inflation firmed in February, rising 0.2% after three straight monthly declines. Gasoline prices rebounded by 2.4% m/m last month, while food prices increased by a modest 0.1% m/m. The y/y inflation rate was 0.0%.

The core CPI (ex food and energy) rose +0.2%, slightly more than expected. This puts the y/y change at 1.7% in February. This is what the Federal Reserve watches.

The WSJ reported on Wednesday that a “wave of Wall Street firms downgraded their estimates of first quarter economic growth, a sign slack in the economy actually might be building again. Bank of American reduced its estimate of growth for the quarter to near zero, while Morgan Stanley, Barclays, J.P. Morgan and Macroeconomic Advisers also cut their projections.”

Economists are struggling to interpret the health of the economy given poor winter weather and the effects of the west coast port strike/shutdown. We think it’s just a flesh wound; not to worry.

WSJ: A Tale of Two Europe’s – Germany Versus Greece. “Markets are struggling with some competing signals out of the Eurozone. On the one hand, Germany is booming – or so the latest business sentiment data suggest. But on the other, the Greece problem is looking increasingly dicey as the ECB told the country’s shaky banks to stop expanding their holdings of Greek sovereign debt. Indeed if it weren’t for Greece, global investors would likely be in a better mood as a retraction in the dollar had helped to underscore a modest pickup in risk appetites.”

WSJ: More than six years after Lehman Brothers collapsed; creditors will receive $7.6 billion. Lehman said its general unsecured creditors will have received nearly $100 billion after the distribution next week, more than 32 cents on the dollar. In 2012, creditors were expected to get less than 20 cents on the dollar.

CITY AMM reports: New York City has narrowly edged out London as the leading financial hub, winning by one point on a 1,000-point scale, according to the Global Financial Centers Index. Hong Kong, Singapore and Tokyo round out the top five.

Economists Ed Yardeni says: The dividend yield on the S&P 500 is 1.9% versus 2% for 10 year Treasury bonds. Of course, the coupon on bonds is fixed, while dividends on stocks tend to grow. For example, the dividend yield on a buy-and-hold S&P 500 portfolio purchased in 2000 is up to 2.9%. It is up to 11.9%, 29.3%, and 45.7% for portfolios purchased in 1990, 1980, and 1970.

Do you see what he is saying? In other words if you invested $100 in the S&P 500 in 1990 (and say it paid a $2 dividend that year) the annual dividend from that portfolio would have grown and would be all the way up to $11.9 in 2014 as companies increase their dividends, but bond coupons are fixed. I think this is an underappreciated fact. Rising dividends can offset the pernicious effects of inflation on your standard of living. Looking at static dividend yields vs bond yields is a bit of a head fake especially for investors with long time horizons.

Next week is the first week of the month and as usually the case the calendar is chocked full of economic releases. The employment report is the most important. Economists expect a 5.5% unemployment rate and 250,000 new jobs in February. Those would be good numbers.

Next Friday is the “Good Friday” Holiday. The markets will be closed and so will APCM. We’re going to take a break as well so we’ll be back with you in a couple of weeks – April 10.

Who’s still dancing? The March Madness college basketball tournament is in full swing. My Wisconsin Badgers will be up against Jason Roth’s alma mater at Arizona. These two teams met last year and the Badgers won by 1 point. It looks to be close again this year. It’s on at 2 pm Saturday.

Jeff Pantages, CFA®
Chief Investment Officer

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