MARKET REVIEW:

trueself

Argus Research
The scene was surreal, viewed on television, but the events yesterday in Athens and Wall Street had a real impact on
investor portfolios and bring back to mind the worst of the sell-off during 2008-2009. The video showed the angry protesters in
front of the Greek Parliament building, getting closer and closer to the riot police. Tension was soaring as protesters would threaten
the police line, and then fall back to the mob.
Meanwhile, in the corner of the screen, the DJIA ticker, which had dropped quickly from morning break-even levels, began
to sink. Suddenly, the Greek Police moved forcefully into the crowd, which scattered quickly into the streets. Unlike Wednesday,
no blood was shed in Athens. But in the US financial markets, the pain was sharp and swift.
At this point, the stock market, plain and simple, began to plummet. In a matter of 2-3 minutes, the Dow was down 300,
and five minutes later, it was off 500. Within 20 minutes from the end of the Greek stand-off, the DJIA had fallen a record 1,000
points intraday.
There were no bids.
Though the slide was ultimately arrested and the market recovered almost 700 points, investors are jittery as they get back
to their desks today. What exactly happened Thursday afternoon?
The Exchanges say their operations went smoothly. Are rumors of a trading error true? That surge triggered other
computerized sell-programs, which took over the trading activity.
Is the crisis in Greece, which barely accounts for 3% of Euroland GDP, such a threat that it can wipe out almost 10%
of the market cap of the US, which accounts for more than 25% of the globe’s market capitalization? When we have more questions
than answers, we always like to go back and review the fundamentals.
First, did the markets generally behave as expected? For the most part, the answer is yes. While stocks were plummeting
in a disorderly fashion, investors were flying to quality in bonds. The yield on the U.S. government 10-year T-bond fell from 3.55%
to 3.3% during the panic.
In the currency markets, the Euro dropped from 1.28/USD to below 1.26/USD. Gold prices jumped. Oil prices declined
as investors feared renewed weak global market conditions.
In this exercise, we typically look for a reaction that goes against the grain. For example, if U.S. stocks had plummeted,
and investors had also dumped U.S. bonds, the markets would have a much different problem.
Second, let’s check on the U.S. economy and corporate profits. We mentioned earlier that Greece is just a small part of
the European economy. The 16 leaders of the euro zone are meeting in Brussels today to finalize the Greek rescue plan and assess
how such financial crises can be avoided in the future. Curiously, there was no central announcement from European leaders during
the clash with the Greek police or the market meltdown. Either the Euro group lacks a central voice – in the U.S., we have President
Obama, Treasury Secretary Geithner or Fed Chairman Bernanke – or the leadership believes that the situation is relatively under
control and the sell-off in the U.S. was caused by something in our market system
In either event, in the near term, the trajectory for the U.S. economy and corporate profits appears upward. U.G.DP for
Q110 was recently reported at +3.2%, driven by solid consumer spending growth and a double-digit increase in corporate
investment into Technology.
Exports also contributed to the expansion (+5.8% in Q1), and this trend could be threatened by spreading problems in
Europe, but government spending declined (-1.7%), and the U.S. could go back to the fiscal stimulus well if the economy, which
has now expanded for three quarters in a row, begins to falter.
U.S. corporations are also coming off a strong first quarter of earnings reports. According to Argus Chief Investment
Strategist Peter Canelo, 80% of the first-quarter EPS reports were positive surprises, averaging a better-than 12% beat. In the past
month, 1st and 2nd quarter operating EPS growth rates have jumped from 29.9% and 28.6% to 46.5% and 34.2%, respectively.
Valuations also appear reasonable. At 1128 on the S&P 500, the P/E for the market is 15, in the middle of the 2000-2010
range of 13-18. On a price/sales basis, the ratio is 0.9, comfortably below the 1.0 mark that is the historical average. Discounting
a low long bond yield of 3.4%, we see fair value for the S&P 500 in the 1300-1325 range.
Of course, none of these favorable fundamentals will matter — at least on an intra-day trading basis — if the computer
programs come back on and send the markets on another wild roller-coaster. What’s more, the experiences of 2008-2009, when
investors consistently shed risky assets, have shown that market trends can play out over a period of months.
The Greek debt crisis is real, and can spread not just to Portugal and Italy, but to Spain as well. The larger sovereign debt
issue even draws in the United States, which is currently spending more than it brings in – something that cannot go on indefinitely.
Thus, the lessons learned over the past 2-3 years include not only a need to focus on the fundamentals, but also to
understand individual tolerances for risk. The VIX is back above 30 for the first time since last October. That’s a positive contrarian
long-term buy signal, and the near-term fundamentals also signal buy — but we have also seen the VIX jump from 30 to 80 in
a matter of days when fear takes over. (John Eade, President)