Blue Chips Now Yield More Than Treasuries

Last week, the market fell less than 1% on the Nasdaq, 1.5% on the Dow and 1.7%
on the S&P 500, but we saw four straight days of alternating gains and losses of
400 or more points on the Dow. In retrospect, this volatility looks a lot like
Shakespeares line about sound and fury, signifying nothing. The market bottom
came early last week, on high volume, in a panicky Monday capitulation, when the
S&P 500 closed at 1,119. Then we saw a successful retest last Wednesday with the
S&P closing a notch higher, at 1,120, followed by an impressive rally Thursday
and a solid high-volume gain Friday. The S&P 500 now yields 2.24%, which is more
than most Treasury securities. With earnings rising so sharply, the S&P sports a
14.5 trailing P/E, down from 17.7 a year ago. This tells me that last weeks
panic was exciting but relatively meaningless in the long term. This latest dip
makes high-quality big-cap stocks look especially attractive. We may retest our
recent lows, but I expect most Blue Chips to hold up well, even though some
small-cap stocks might feel more like hot potatoes during the next few weeks.
Computerized trading programs ran wild last week, especially during the last
hour of trading. Speculation in financial derivatives also hit a record high
last week. Gold shot up to $1,819 per ounce Wednesday before the CME Group
(parent of the COMEX commodity exchange) raised the collateral requirements for
gold, effective at Thursdays market close. That helped to prick the gold bubble
a bit. The Swiss franc also settled down in the last two days of last week as
investors turned to higher-yielding big-cap stocks. In the meantime, Ben
Bernanke emerged as a market savior last Tuesday when the Federal Open Market
Committee boldly proclaimed the Fed would hold key interest rates at ultra-low
levels through at least mid-2013. The FOMC essentially told investors they need
to look elsewhere (i.e., to blue-chip stocks) for higher yields than Treasury
securities. The bad news was the FOMC statement said the downside risks to the
economic outlook have increased. This new language might have contributed
somewhat to greater market uncertainty, fueling last Wednesdays retest of
Mondays lows. The Fed also indicated it had discussed a wide range of policy
tools available to promote a strong economic outlook recovery. Translated from
Fedspeak, that means the Fed discussed the possibility of buying more bonds. The
Feds balance sheet is now nearly $4 trillion (up from less than $1 trillion
before the financial crisis of 2008). The Fed gave no signal that it wanted to
start another round of quantitative easing (QE3), so Fed watchers now will focus
on Bernankes speech at the Feds upcoming retreat in Jackson Hole, Wyo., on Aug.
26 and on the release of last Tuesdays FOMC minutes Aug. 30. Not surprisingly,
the U.S. dollar tumbled after the Fed said that its zero-interest-rate-policy
will last until 2013. (A weak dollar has helped fuel rising profits among many
multinational companies.) Interestingly, of the 447 S&P 500 stocks that have
announced their second-quarter results so far, sales are up 15.3% (excluding the
troubled financials), while earnings are up a very healthy 22% and the average
earnings surprise was +5.5%. The second quarter is shaping up to be the 10th
quarter in a row in which earnings have exceeded analysts expectations. It might
come as a surprise to many investors (since the financial press ignores these
facts), but corporate profits are at a record high and P/E ratios are shrinking!
Whats next? First, we need so see the VIX subside in the upcoming weeks, and
then we need to see some serious trading volume pick up after Labor Day, when
institutional managers return from their summer hiatus. Then, I expect to see
domestic stocks firm up no later than Sept. 30, in time for quarter-ending
window dressing and corporate stock buybacks. I expect well see another
late-September rally, much like the sudden rally that we saw in late June, at
the end of the second quarter.