It Finally Happenned

It took until the final day of the quarter, but the S&P 500 put in a new all time high closing at 1,569 on March 28th. 



Source: StockCharts



It has taken a while for the S&P 500 to reach these levels again.  This chart from JPMorgan should help put things in perspective.

When the S&P 500 first reached these levels thirteen years ago, it was trading at a forward P/E of 25.6 and competing with a ten year Treasury yield of 6.2%.  Now, the forward P/E is 13.8 and the ten year yield is 1.9%.  So as we have worked through the excesses of the tech, real estate and finance bubbles, overall corporate earnings have continued to grow.  This has made valuations more reasonable and therefore stocks relatively less risky.  At the same time, yields have come down lessening their attractiveness.  With the Fed committed to its current low interest rate policies (think liquidity wave) until unemployment reaches 6.5%, there is no reason to think this relative attractiveness should change any time soon (baring some geopolitical black swan). 

Since making new highs, the S&P500 has since pulled back a little.   While a weaker than expected gain in jobs from the ADP report today was the reason cited for the pullback, a consolidation after reaching new highs is not too surprising.  In addition, investors are anticipating announcements from the Bank of Japan and the European Central Bank Thursday and US employment data on Friday morning.   All potentially market moving events. 

While forecasts of EPS growth have been shrinking, the forward P/E of under 14 does not scream overvalued.  On a positive note, Markit and JPMorgan announced that the JP Morgan Global PMI increased to 51.2 for March from 50.9.

Source Markit JPMorgan

 

Given its large international exposure, the S&P 500 is highly correlated to global growth.  The increase in global PMI is a good sign for better earnings in the future.  While Europe remained a drag, the US continued its growth, the rate of expansion accelerated in China and Japan saw the first growth in ten months. 

Source: StockCharts

While Japanese manufacturing might have seen growth in March, the Nikkei has been consolidating after a large run up since mid November.  Some of this is a function of a short term strengthening of the yen due to increased tensions with North Korea.  In any case, a weaker yen is critical for an export led economy such as Japan's.

New Central Bank Governor Haruhiko Kuroda will lead his first meeting on Thursday.  With the Nikkei approaching its 50 Day moving average the markets will be watching closely for signs of continued commitment from the BOJ to bringing the yen down and bringing inflation up.  A perceived lack of commitment would probably be seen as a time to take profits in the Japanese markets.

Meanwhile in Europe, the resolution of the Cyprus banking crisis, has led to continued talk of contagion by pundits.  So far calm seems to be prevailing as both Italian (4.62%) and Spanish (4.94%) ten year yields closed below five percent.  The pressure seems to be releasing through the decline in the Euro (and drops in the Italian and Spanish stock markets). 

The ECB meeting tomorrow may help shed some light on the situation.

Cyprus??

So a crisis in another small country threatens to take down Europe.  This time auditioning for the role of Serbia,  host country for the assassination of Archduke Ferdinand in 1914, will be Cyprus.  That's Cyprus in the highlighted box in the lower right below Turkey.   Cyprus has a bit over 1 million people and a GDP of $23.5 billion making it a bit smaller than Mozambique, but bigger than Burkina Faso and less than one tenth that of Greece.  However, by dint of being a part of the Eurozone it is certainly punching above its weight in the global economy.

 

Source: CIA World Factbook

News broke over the weekend that for the first time as part of a Eurozone bailout, depositor funds would take a hit through a so called 'bail in' (George Orwell would be proud).  Deposits under the €100,000 guarantee amount would pay a 6.75% tax and those over a 9.99% tax.  Although depositors would get equity in the bank as compensation.  (Links to several posts on the topic are at the bottom)

 

You may ask why would those in charge call all of the deposit insurance programs in the Eurozone into question by having those covered pay?  Well, Cyprus is known as an offshore banking sector with a reputation for laundering money, particularly for the Russian mafia.  As of January 2013, €20 billion of Cyprus' €68 billion in deposits were from the rest of the world, believed to be primarily from Russia. You would think those offshore accounts would be the ones to take the hit.  A German politician's remarks about burning "Russian black money" point in that direction.  So then why hit the locals and little guys?  The financial sector is huge in Cyprus and by not having outside depositors take the full brunt of the pain it appears someone would like to keep the possibility of this business alive at some point in the future.  However, even if that is the case, I am not sure how losing €2 billion will go over in Mother Russia, especially if it is money being laundered.  The Russian mafia does not have a gentle forgiving reputation. 

 

In any case, putting aside the obvious pain being suffered by smaller depositors, the big risk, as it was with Greece, is contagion.  That this idea of covered depositors paying part of the price in a bank bailout, sorry bail in, spreads to other peripheral countries.  Will depositors in Spain or Italy decide they better get their euros out while they still get them at full value?  Or will they be assuaged by the Eurocrats, that Cyprus is a one off case.  We will need to keep track.

 

 

Don't Get Too Excited About Cyprus - Humble Student of the Markets

Report From Paris - David Kotok on The Big Picture

The Cyprus File - Why it Matters Even to Americans - The Big Picture

The War on Common Sense Continues - Tim Duy's Fed Watch