What is the market telling us?
The good news for U.S. equity investors is that the S&P 500 total return year-to-date through Friday April 12, 2013 was 12.09%. The bad news is that three counter-cyclical sectors have led the advance: healthcare at +20.57%, consumer staples with +17.32%, and utilities up +16.52%. These defensive sectors trounced two of the cyclical sectors, namely information technology and industrials, up +4.07% and +10.87, respectively. When defensive stocks lead performance, it typically does not indicate a great deal of positive conviction in the market outlook. Also, when central bank "easy money" is flowing, lower-quality, credit dependent equities tend to outperform. But we have seen the opposite with "widow and orphan" stocks leading the way: Johnson and Johnson (+18.98%), Abbot Labs (+18.04%), Proctor and Gamble (+18.91%), and Duke Energy (+15.64%), to name a few. Other bad news for equity bulls includes the very recent 37 basis point (0.37%) yield rally in the U.S. 10-year Treasury note from its 2013 high yield of 2.07% on March 11, along with lower-than-expected economic data across a number of indicators, including a huge "miss" on the University of Michigan consumer sentiment data. The rationale for the relative year-to-date outperformance of the blue chips includes relative pricing power, global reach, dividend increases, and share re-purchases in an environment that offers few high quality, high income alternatives. Equity bulls are likely to point to the recent announcement by the Bank of Japan on April 4 regarding significant bond purchases and thus potential for global asset price advances. We are carefully monitoring how and where this new source of liquidity will be deployed along with resolution of near-term oil and gold price weakness.
Conditions continue to evolve in Cyprus and Italy
Euro zone officials have confirmed that, when troubled banks require restructuring, non-insured depositors may be required to take haircuts before European Stability Mechanism (ESM) funds are provided. However, they also insist that Cyprus' expropriation of non-insured deposits to repay sovereign debts would not be a template in further sovereign debt restructurings. Share prices of euro zone financials indicate investor queasiness with these statements. In the meantime, negotiations to form a new Italian government continue, as recent data indicate some slippage in Italy's improving fiscal situation.
Surge in Japan, weak performance in China
The Japanese stock market has continued to surge, and the yen to decline, as the Bank of Japan begins to implement massive purchases of long-duration yen-denominated bonds. The yield curve is flattening as long-term bond yields fall. Japanese investors are looking at the "carry trade," borrowing in low-yield yen and investing in higher-yielding dollars or euros. This new round of credit creation and associated leverage is likely to support global asset prices. In the meantime, China is once again implementing administrative measures aimed at controlling non-bank credit issuance and purchases of multiple properties on credit. Chinese stock market performance has been weak: investors are looking for the new Chinese Politburo Standing Committee to clarify its overall economic and financial strategy. Lastly, investors throughout Asia appear to be discounting the threats emanating from the new North Korean leadership.
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