Monday, June 09, 2014 - Record Highs and a Few Crumbs

Record Highs and a Few Crumbs

by Sinclair Noe

DOW + 18 = 16,943
SPX + 1 = 1951
NAS + 14 = 4336
10 YR YLD + .02 = 2.61%
OIL + 1.73 = 104.39
GOLD - .30 = 1253.00
SILV + .05 = 19.16

The major indices are now up for 4 consecutive sessions. The Dow Industrials hit a record high close for the 10^th time this year. The S&P is now up 14 of the last 17 trading sessions. The last time the Dow experienced a 10% correction was back in October 2011; since then, the Dow has gained almost 60% over 32 months without a 10% correction. Typically, you can expect a correction about every 12 months on average. The longest period without at least a 10% pullback was an 82 month run from 1990-1997. The S&P 500 hit a record high close for the 19th time this year. The S&P bull market is now at 62 months and counting, the best run since 1994 to 2000.

The CBOE Volatility Index moved a little higher today to 11.34. On Friday, the VIX hit a low of 10.73, the lowest level since January 2007. The VIX can go low and stay low for an extended period of time. In 2007, after hitting a low, the VIX steadily rose for the remainder of the year but stock prices didn’t peak until the end of 2007. The VIX measures options trades, but does it really mean investors are dangerously complacent? The Murdoch Street Journal reports: “Last week, 39% of respondents to a long-running weekly survey from the American Association of Individual Investors said they were bullish about stocks. That is well above readings of just over 27% in both February and April, when violence in Ukraine weighed on sentiment. But it is far from giddy. In fact, it is in line with the average since the poll's inception in 1987.”

Today had all the signs of a bull market, in addition to record highs, we had a good old fashioned Merger Monday. Tyson foods agreed to buy Hillshire for $8.5 billion, or $63 a share cash. That follows a bidding war between Tyson and Pilgrim’s Pride that pushed Hillshire from $37 a share on May 23 to the current bid.

Drugmaker Merck paid $3.9 billion, or $24.50 a share in cash for Idenix Pharmaceuticals, a 240% premium to Friday’s close of $7.23. Idenix has three drugs to treat Hepatitis C in clinical trials, but none on the market. Chipmaker Analog Devices agreed to buy Hittite Microwave Corp for $2.5 billion, or $78 a share, a mere 29% premium to Friday’s close.

Depending on the source, deal volume is up about 65% to 70% this year. Worldwide, companies are sitting on about $7.5 trillion of cash. With organic top line growth hard to come by in sluggish economies, many are turning to acquisitions.

You can buy a share of Apple for about $93; that following a 7 for 1 split; the first split for Apple in 9 years. A split is generally a non-event. If you owned 100 shares of Apple on Friday, you now own 700 shares, but the price was divided by 7. The financial structure and value of the company doesn’t change.

The yield on a 10-year US Treasury note was up a couple of basis points today to 2.61%. Meanwhile, the yield on the 10-year Spanish government bonds dropped 5 basis points to yield 2.59%. Normally, you would expect a government bond yield to correspond to demand and overall safety of the bond and the country backing the bond. Things are a little upside down. The good news is that investors aren’t expecting the Eurozone to disintegrate; the bad news is that investors aren’t expecting any growth in the Eurozone.

James Bullard, president of the St. Louis Federal Reserve Bank, speaking at a conference in Florida today, said the US macroeconomy is much closer to a normal state than it has been in 5 years and only weak labor markets and low inflation is keeping the Fed’s accommodative monetary policy in place. Last month, Bullard said that while the housing and labor markets remain weak, he expects recovery through the rest of the year, and said inflation would likely move towards the Fed's desired 2% rate.

Bullard told reporters after his speech: “If you get 3% growth for the rest of this year, if you get unemployment coming down below 6%, if you continue to have jobs growth at 200,000, if you continue to see inflation moving back up toward target, I think if we get to the fall of the year and all of those things are transpiring as I’m suggesting they will, that will change the conversation about monetary policy, and there will be more sentiment toward an earlier rate hike.”

The housing market may not be as strong as some Fed policymakers believe. On Friday, the jobs report showed the economy had regained all the jobs lost in the recession, but that isn’t the case for the home building sector. The number of construction jobs has been climbing, rising about 7% in May from a year earlier, to 2.6 million, including electricians and other specialty trade contractors; but that's way down from the high of 3.45 million in April 2006. While jobs overall are back to their pre-recession peak, residential construction jobs are 34% below their peak.

Even five years after the housing meltdown, a sizeable chunk of homeowners remain underwater. About 6.3 million homes, or 12.7% of all properties with a mortgage, were underwater as of the first quarter.  About 1 in 10 homeowners are almost underwater, with less than 10% equity in their homes, meaning it would probably cost them to sell, when including selling related expenses.

A survey released last week by the MacArthur Foundation found that 43% of those polled said it is no longer the case that owning a home is an excellent long-term investment and one of the best ways for people to build wealth. More than half said that buying a home has become less appealing than it once was. And 70% believe the nation is still in the middle of a crisis and that the worst is yet to come.

One major demographic group that isn’t buying homes is the Millennials; they are just trying to pay off student loans. President Obama announced Monday that he will expand a federal program designed to reduce student loan payments. The program, called “Pay As You Earn”, will give as many as five million more Americans with federal student loan debt the ability to cap their monthly student loan payments at 10% of their income and to have their remaining debt forgiven after either 10 years (for government and some non-profit workers) or 20 years (for other workers).

The current program is only available to Americans who began borrowing after October 2007 and kept borrowing after October 2011; the new order will allow students who borrowed money before October 2007 and those who have not borrowed since October 2011 to participate. The new program will begin in December 2015.

Of course, like so much consumer debt, if you pay the smallest monthly minimum, you just string out the loan and end up paying more over time; so, the new plan might not work for everybody. The best idea is to work some numbers, comparing monthly payments and lifetime costs; there are calculators for this at the Department of Education website.

The housing market is just one factor in an economy that doesn’t seem quite as strong as Fed President Bullard suggests. This was supposed to be a breakout year for economic growth but it started with negative GDP in the first quarter. And even though we have regained the jobs lost in the recession we still have nearly 10 million unemployed, and that’s more than 2 million more than in January 2008; and the quality of the jobs, and the pay has gone downhill for most workers. Income growth is at its lowest point since 2007. When people are shopping, they’re using borrowed money.

Corporations and Wall Street raked in profits unseen in their history. At the end of 2013, corporate profits hit an all-time high of $1.9 trillion. Those profits were largely achieved not by growing, but by cutting jobs and investments; and relying instead on mergers, buybacks, stock splits, QE, and other financial legerdemain.

The economy hasn’t really turned positive. It could change. Maybe the Fed will quit QE and try something that actually helps the economy. Until then, enjoy your milk and cookies, or whatever crumbs might come your way.