The Cisco Hangover

With little economic news circulating through the markets, the negative comments from Cisco Systems CEO John Chambers appear to be the cause of this morning’s sharp drop in the S&P 500 (down about 1%).  As I mentioned in my comments last night, Cisco’s earnings report was pretty good when viewed in a larger context, but, as is seemingly always the case, the forward-looking comments were of more consequence to investors than the reported numbers.  To be sure, the company’s reduction in revenue growth guidance to 9-12% over the coming year was a sizable reduction from the 13% rate analysts had been expecting.  Having moved up sharply ahead of this earnings release, the shares were certainly primed for disappointment and this simply added fuel to coming fire.  But given investors’ focus on Cisco as a bellwether of economic activity and corporate investment spending, the concerns and challenges outlined on the call have raised real concerns about the economic conditions that will be seen in coming quarters.  Most of this concern is focused on North America, though there was concern about global growth as well, albeit to a much lesser extent.

Putting the equity markets aside, today’s session shapes up as a strange one.  As was the case yesterday, the U.S. Dollar Index (DXY) is continuing to maintain its recent strength, climbing another 0.40% so far this morning.  This resiliency, however, has not seemed to have meaningfully affected either the gold or crude oil markets so far as both are firming up in the early trade.  While I’ve noted that gold and the DXY do not necessarily move in the idyllic inverse correlation that many like to assume, I do find it strange that it hasn’t put any meaningful pressure on commodities during the past week.  Perhaps it's capping the bullish bias of each market, but even that seems to be a stretch.  Furthermore, this strength would imply that Treasury securities should see fairly robust buying, which has clearly not proven to be the case.  Some of this near-term weakness, especially on the long end of the curve, was no doubt influenced by the recent auctions that brought another wave of supply to the market.  However, as I outlined in comments earlier this week, there appears to be a significant shift in investor sentiment towards Treasuries that is more related to default/insolvency risk rather than outright inflation concerns.  If these are, in fact, the concerns at the forefront of investors’ minds, the question becomes why is the DXY appearing to remain well bid while Treasuries are shunned?  It’s a disconnect that certainly bears watching closely since these markets have moved in near lock-step for some time now.

One other thing to keep an eye for the next few weeks will be the VIX.  Despite the recent run up in equity prices, the VIX appears unable to crack below the 18 level, which suggests, to me, that concern is still rife in the marketplace.  Some will claim that presence of concern in the equity markets means that the bullish trade is not yet crowded, thereby opening the door to further gains.  And while there is some logic in this analysis, I sense that this perspective is misplaced in the current environment.  With the Federal Reserve treading in unfamiliar waters with its latest stimulus action and many unanswered questions remaining on the policy front, we are simply in an uncertain economic environment that will cause markets to fluctuate wildly as sentiment and outlooks change.  As a result, rules of thumb and historical ‘norms’ are not likely to prove as useful as they once did in times past.  And as Cisco’s commentary points out, there is still a great deal of uncertainty surrounding our ultimate economic destination; even for a corporate titan of Cisco’s stature.  That is why I still look upon the equity markets with a fair bit of trepidation.  Up 15% in just two months, it’s hard for me to see what could catapult prices even higher, especially with this much uncertainty in place.  It could prove that the markets simply stagnate at these levels and build a base from which to move higher later on.  It’s possible; I just don’t think it’s probable.  Volatility is simply a part of our new paradigm, which suggests that a pullback, whenever it materializes, will be swift and sharp.  That’s the point in time at which I’ll begin backing up the truck to buy shares.  Until then, I agree with Jeremy Grantham’s position that investors should be more inclined to hold cash at this point in the recovery.  It’s not sexy; it’s just prudent.

Until later…..