"May - Thus Far, Not a Merry Month"

Sydney M. Williams

Thought of the Day

“May – Thus Far, Not a Merry Month”

May 26, 2010

The merry month of May has distinctly gloomy overtones, at least thus far. Unless yesterday’s rally takes traction, it is shaping up to become one of the worst months in the past fifty years. As of yesterday’s close, it is down 9.5%. The five worst months have been: October 1987 (-21.8%); October 2008, (-16.9%); August 1998 (-14.6%); September 1974 (-11.9%), and November 1974 (-11.4%).

With the exception of 1973, in every instance, a year later the market was higher. The record is mixed in terms of the markets’ shorter term performance, though generally it has moved up.

Credit and currency markets have anticipated, and participated with, the sharp decline in stocks over the past several weeks. The yield curve (Ten-Year over Two-Year) has flattened from 282 basis points to 242 basis points. At the end of March the yield on the Ten-Year was 3.83%. Today it is 3.16%. The yield on the Two-Year has declined, in the same period, from 1.01% to 0.74%. The TED spread (LIBOR over Three-Month Treasuries) has widened from 15 basis points to 38 basis points, a significant increase and one worth monitoring, but still below the historically more typical spread of 50 basis points. The spread between Investment Grade Bonds and Ten-Year Treasuries widened as Treasuries rose in price. Reflecting the flight from risk, High Yield Bonds fell in price, as the yield has risen back over 9%. Since the end of the quarter, the Dollar Index has rallied 7.3% since the end of the quarter, 7.9% against the Euro.

Commodities have generally declined as concerns over global growth are fueling whiffs of deflation. The CBOE Index is down 6.3%, principally a function of a 19% decline in oil, offset by a 7% rise in gold. Volatility has returned with a vengeance. The VIX has risen from 17.13 to 34.61 yesterday. And the number of days in May, in which the DJIA has closed +/- 1.5% has been five, the greatest number since last July.

The markets retreat from risk has created an environment which now has an earnings yield for the S&P 500 of 7%, pretty attractive relative to the 4.9% yield for Investment Grade Bonds. And the yield on the 371 dividend-paying stocks in the S&P 500 is 2.5%, which compares favorably with a 3.16% on the Ten-Year.

A market decline that many thought we needed a month ago has, on its arrival, scared the bejesus out of people. The litany of problems is as familiar to investors as the catechism was to parochial school students in my day – uncertainties about the finance reform bill, increased taxes on investments, new regulations, sovereign debt, the balance sheets of FNM and FRE, Greece, California, the oil spill, North Korea, Iran, deflation, inflation, dark pools and high frequency trading.

Investors sense they are being attacked from all sides. What is needed is a re-instillation of confidence – coming from someone in the mold of General Oliver Smith, Commandant of the First Marine Division at the Chosin Reservoir, in northeastern North Korea in late 1950. The Marines were surrounded by Chinese forces, who had crossed the Yalu River, outnumbering them by estimates of up to ten to one. One of his officers radioed him: “Sir, we’re surrounded.” “Excellent,” responded General Smith, “We can attack in any direction.”

Our plight, in capital markets, does not come close to that faced by Marines sixty years ago. But market adjustments, such as we have been experiencing, should be looked upon for the opportunities they offer.