Good morning,

Markets are called lower this morning. This is what'as happening today:

  • Euro finance ministers reached an agreement on March 16 forcing depositors in Cypriot banks to share in the cost of the latest euro-zone bailout. Moody’s Investors Service said today the levy is negative for bank depositors across Europe, while Bill Gross at Pacific Investment Management Co. said it moves “risk-on” trades to the back seat;
  • HSBC Holdings Plc, Europe’s largest bank by assets, led declines in Asian financial stocks after Moody’s Investors Service said the turmoil in Cyprus may have negative implications for bank ratings across Europe;
  • Apple Inc. is poised to boost its dividend by more than a half, according to analysts surveyed by Bloomberg, providing investors hit by a share slump with one of the highest yields in the U.S. technology industry;
  • Netherlands, Norway, France and Malta sell bills.

The markets are trading in negative territory this morning. Cyprus' parliament is due to hold an emergency session to discuss a big bailout, which has angered the public. It is by no means certain that the deal, reluctantly endorsed by the president, will get enough support to pass in parliament. The 10bn-euro ($13bn; £8.6bn) bailout agreed by the EU and IMF demands that all bank customers pay a one-off levy. This led to mass cash withdrawals, and President Nicos Anastasiades later said he wanted to ease the bailout terms.

How the levy is applied:

  • Depositors with under 100,000 euros deposited must pay 6.75%
  • Those with more than 100,000 in their accounts must pay 9.9%
  • Depositors will be compensated with the equivalent amount in shares in their banks
  • The levy is a one-off measure

Cypriot President Nicos Anastasiades, who bowed to demands by euro-area finance ministers to raise 5.8 billion euros ($7.5 billion) by taking a piece of every bank account in Cyprus, appealed to the country’s lawmakers to ratify the levy today.

It is not just the levy on depositors in Cypriot banks thats causing a weakness in the markets. There is another issue. The markets are at an all time high. We have been at this level two other times in history. We were at these levels in 2000 and 2007.

In 2000, we saw the burst of the dot-com bubble. The dot-com bubble (also referred to as the dot-com boom, the Internet bubble and the Information Technology Bubble[1]) was a historic speculative bubble covering roughly 1997 – 2000 (with a climax on March 10, 2000, with the NASDAQ peaking at 5132.52 in intraday trading before closing at 5048.62) during which stock markets in industrialized nations saw their equity value rise rapidly from growth in the Internet sector and related fields. The collapse of the bubble took place during 2000-2001. Some companies, such as, failed completely. Others lost a large portion of their market capitalization but remained stable and profitable, e.g., Cisco, whose stock declined by 86%. Some later recovered and surpassed their dot-com-bubble peaks, e.g.,, whose stock went from 107 to 7 dollars per share, but a decade later exceeded 200.

In 2007, we saw the burst of the housing bubble. The widely watched Dow Jones Industrial Average hit its all-time high on October 9, 2007, closing at 14,164.43. Less than 18 months later, it had fallen more than 50% to 6,594.44 on March 5, 2009. This wasn't the largest decline in history — during the the Great Depression, the stock market took a 90% hit. However, it was more vicious — it took only 18 months, while the fall during the Depression took over three years.

We are back to the highs we have seen in 2000 and 2007 once again. And investors are asking themselves, 'will history repeat itself?' I think the best answer to this question is a JP Morgan report which was issued on 7 March 2013.

Twp weeks ago, we turned short-term cautious on equities on the basis that risk/reward for markets had become balanced—that is, the combination of: (i) bullish positioning by investors, (ii) the underperformance by corporate credit and non-US equities (US stocks are “last man standing”) and (iii) anticipated softening of US economic data in coming weeks, would set the stage for equities to soften. That said, our 2013 big picture view remains that we are in a secular bull market and we recommend that investors overweight equities.

However, equities have since risen further, ending positive for February and up 2% so far in March. What have we overlooked? Multiple factors are likely at work, but 5 notable factors have incrementally supported further gains in stocks:

#1: Performance anxiety by portfolio managers as 63% are trailing their benchmarks this year and 15% by 250bp. The average mutual fund is missing their benchmark this year by around 100bp, with 63% of managers trailing their benchmarks. Thus, dips are going to be used by managers to close the performance gap.

#2: Announced buybacks recently soared to $23b weekly (4-week avg), a $1.2T annualized rate, or nearly 8% buyback yield. This is the highest 4-week average at any time in this bull market and surpasses the June 2012 peak of $17b by 35%. This massive increase in expected inflows is a positive dynamic on equities. For those wondering, historically, 95%-plus of announced buybacks are executed.

#3: Dividend yields of highest payers exceeds investment grade bonds yields by largest margin since 2009. The topquintile of dividend payers in the S&P 500 has a yield of 4.2% compared to 3.5% for investment grade bonds (JULIY Index GP). As shown, in December 2012, this yield exceeded bonds by 123bp, the largest since 2009.

#4: The "fat tails” are shrinking as expectations for shocks diminish. Financial markets confronted two shocks in the past month, the failed Italian elections and US sequestration and after some initial dips, equities have largely shrugged off these events. Over the past few years, we have heard investors argue for lower P/Es given the prevalence of global tail risks—with those diminishing, these argue for equity P/Es to re-rate.

Good day and happy trading!

Kristian Camenzuli