| TSG Weekly Market Watch March 21, 2008 |
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| Written by Matt Blackman | ||||||||||||||||||||||||||||||||||||
| Sunday, 23 March 2008 | ||||||||||||||||||||||||||||||||||||
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TSG Stock Market LetterWeek Ending March 21, 2008 Topics Discussed This Week:
Fed efforts again push optimism… Monday – It was another volatile week that got off to a rocky start Monday. After being down more than 190 points intraday, the Dow closed up 21 points partly on news that Bear Stearns would sell itself for $2/share…!? Who says sentiment is bearish. Tuesday – It was another Tuesday 400+ Dow delight brought to you by HeliBen as the Fed cut the Fed funds rate by 75 basis-points. It was the fourth biggest daily Dow gain in history. Last Tuesday it was the more then $200 billion Fed cash injection that had the same effect pushing the Dow to its fifth largest daily gain ever. But the news wasn’t all good. Lehman posted a 57% drop in quarterly net profits but because it was better than expected, LEH rallied 46.5%...!? Wednesday – After Tuesday’s party, it was hangover time for stocks and commodities as the Dow tumbled 293 points. Gold also fell more than $58 in New York and oil dropped nearly $5. Thursday – And for a finale on the last trading day of the holiday-shortened week, the bulls again took over driving the Dow up 262 points on the day. Optimism that stocks were again at a bottom, buoyed by big drops across the board in commodities (see below) led an army of analysts to again conclude for that the bottom for stocks was in. At the head of the pack was Punk Ziegel analyst Dick Bove who confidently declared “the financial crisis over” and that stocks represented “a once in a generation opportunity to buy.” (I wonder if he will one day look back on this comment in the same way Cramer will on his March 11 Bear Stearns advice – see Cramer video link below). But while stock investors remain optimistic, bond traders see further weakness ahead. That was clearly evident as the 3-month T-Bill rate dropped to 0.387% - the lowest level in more than 50 years (see article ‘Treasury’ below). Yield spreads on corporate debt widened to a record high of 305 basis points yesterday which should concern investors but obviously stock analysts weren’t paying attention... Technically SpeakingBut leaders turn down While the major indexes (with the exception of the Nasdaq) ended modestly higher (Thursday to Thursday), after posting a 5% gain last week, Dan Zanger’s Sunday portfolio fell this week losing nearly 9% - another indication of how volatile markets remain. Dan’s 12 picks again included Mosaic (MOS), Transocean (RIG), Devon Energy (DVN), Apache Corp (APA) and EOG Resources (EOG), Apple (AAPL), Research in Motion (RIMM), Baidu.com (BIDU), Mastercard (MA), Mechel Open (MTL) and Potash (POT) as well as Mercadolibre (MELI).
Figure 1 – Weekly five-day performance of Zanger’s market leaders compared to the S&P500 (SPX), the Dow Jones Industrial Average (DJX), Dow Transports (DTX) and Nasdaq Composite (IXIC). Data courtesy of The Zanger Report, performance chart courtesy of VectorVest.com. After losing 2% last week, the MSCI Emerging Markets ETF (EEM) was again the worst performer falling another 2% this shortened trading week as emerging markets continue to feel the pinch. Emerging markets have helped buoy international economic growth but that trend is increasingly looking like it has come to an end. The drop was not enough to confirm the bearish head & shoulders top pattern we discussed last week – it will take another 2-3% drop before we can declare the neckline breach.
Volatility settled down this week as the Market Volatility Index (VIX) dropped to 26.62 from 31.16 last week and 27.49 two weeks ago.
But the 17 commodities that make up the NYFE CRB Index took a major hit this week dropping more than 9% to 523.80 from 563.48 last week and 565.65 three weeks ago. It was the largest weekly drop in at least 34 years. Analysts interviewed for a Bloomberg article credited investors raising cash to buy stocks as the reason for the correction. “Bernanke took care of the commodity bubble,” claimed one analyst which was naïvely optimistic at best given that one week does not a trend change make in either stocks or commodities. Trading volumes on the NYSE, which were only slightly higher than normal, was another reason to question this logic. We simply need more time and data to know whether this is case. After hitting an intraday high of $1033 Monday, gold dropped more than $100/oz. to close the week at $909.90 down from $999.80 last Friday. But gold is still well into its strong seasonal performance period between the end of January and end of June so it remains to be seen if this is the end of the rally. Does this mean that central bankers have suddenly become responsible? It is more likely after the incredible run in commodity and gold prices that traders have decided it a good time to take profits as the economy slows and given how extremely overbought commodity prices including gold had become. After hitting new lows last week, the drop in commodities was good for the dollar this week as the U.S. Dollar Index posted a weekly bounce to close at 72.78 up from 71.66 last week. But it is still below its 73.001 close two weeks ago. Regardless, it was enough reason for analysts to also declare the dollar decline over which was another example of naïve optimism. Meanwhile after the NYMEX crude oil (continuous) also lost ground, it remained above $100 for the fourth consecutive week closing at $101.44 down from $108.66 last week. This week, the U.S. prime bank rate dropped 75 basis points to 5.25% on the back of the same bp decline in the Fed funds rate (to 2.25%). But the 3-month London Interbank Offered Rate (LIBOR) held firm at 2.606% from 2.76375% last week showing that commercial credit markets have not yet bought into the Fed drop. But all efforts by the Fed to ease credit constraints have elicited a muted response in mortgages as Freddie Mac mortgage rates dropped just 26 basis points to 5.87% (from 6.13% last week and 6.03% two weeks ago) for the 30-year fixed mortgage while the rate moved up to 5.15% (from 5.14% and 4.94% two weeks ago) for the one-year adjustable rate (ARM). This is in spite of the fact that Freddie Mac and Fanny Mae got another significant boost from the Office of Federal Housing Enterprise and Oversight (OFHEO) which cut surplus capital requirements for the GSEs to 20% from 30%. The move is expected to pump another $200 billion into the slumping mortgage market. Earnings Earnings still sliding As we come into the Q4-07 earnings reporting season home stretch, a total of 3997 companies have reported so far (up from 3596 last week) and improvements dropped again to -57% (from -56% last week and -55% two weeks ago) leaving little doubt that earnings continue to deteriorate across the board. This compares to a drop of 21% (4205 companies) at the end of Q3-07 reporting season and a 13% jump in Q2-07. Economic ReportsHere are the reports we were following this week. It was a short week but a busy agenda. On Monday, the March New York Fed manufacturing report fell to -22.23 a nearly 50% decline from February. A number below zero signals contraction. Then we got some good albeit expected news given the weakness of the dollar that the current account deficit had fallen again to $172.9 billion for Q4-07. Then on Thursday, the weaker than expected March Philly Fed Business Index reading of -17.4 confirmed New York Fed index weakness Monday. And now even the previously bullish Conference Board index of leading economic indicators has been pointing toward a recession. Here are the charts we are following.
Chart 1 – It is amazing the even in the face of a rapidly falling dollar, foreign interest in US Treasuries has remained for the most part positive. In January this trend continued as net capital flows totaled $37.4 billion. But this was roughly half of the revised December total of $72.7 billion.
Chart 2 – Also on Monday, the National Association of Home Builders housing market index which surveys builders on the health of their industry in three different areas held at 20 in March. Current sales held steady at 20, while the index measuring prospective traffic held at 19. But the index gauging sales expectations for the next six months fell by a single point to 26 so overall the index was down from last month but not enough to drop the overall index.
Chart 3 – However, housing permits and starts both dropped in February – permits down 7.8% and starts down 0.6%. Year-over-year, permits have fallen 33% while starts are down 28.4%. From their peaks in January 2006, they are down 56 and 53% respectively with no bottom yet in sight.
Chart 4 – We’ve included this chart of the effective average Fed funds rate versus the S&P500 to put the recent funds rate drops in perspective. As the chart shows, the Fed dropped the funds rate 85% starting January 2001 last time around while the S&P500 fell more than 50%. So far this cycle, the big Fed funds rate drops have inspired some incredible one to two day rallies in the S&P, but so far they have all died a quick death in the jaws of the bear. At last count the index was down approximately 15% from its 2007 peak in spite of the fact that the Fed has cut rates 55% since September. Will Tuesday’s 75 point drop be the final magic that turns this bear around? Chart by Metastock.com Next Week Here are the reports we’ll be watching. - Monday, February Existing Home Sales (previous -0.4%). - Wednesday, February Durable Goods Orders (previous -5.3%), February New Home Sales (previous -2.8%). - Thursday, Q4-07 Final GDP (previous 0.6%). - Friday, February Personal Income (previous 0.3%), February Personal Spending (previous 0.4%). Which earnings reports should you follow? This week we compare S&P500 earnings results with those of the general market. Figure 2 shows S&P earnings since the rally began in March 2003. Note the successive drops in the slope of trend support lines as the rate of earnings improvements decelerated then the final break as earnings began to weaken in early February 2008.
Figure 2 – Graph of S&P earnings from VectorVest showing earnings peaking in the first week of January. But this chart also exposes the clear deceleration that began to occur in earnings as early as June 2006 when the first trendline (left) was broken. The breach of the next trendline didn’t occur until mid-December but then S&P earnings briefly re-energized only to be broken again in mid-February (third blue trendline) and at orange arrow in lower subgraph. Chart by VectorVest.com Now contrast this performance with quarterly earnings improvements as reported for the more than 4000 companies reporting on Wall Street. We got our first real warning that earnings were dropping way back in Q1-07 with the big decrease in earnings improvements from Q4-06. Improvements then turned negative back in October 2007 and have continued to do so through Q4-07 reporting season.
Figure 3 – Chart showing earnings improvements for more than 4000 companies tracked by the Wall Street Journal. Note that we got the first warning that improvements were declining in Q4-07 in late October – a good four months before S&P earnings in Figure generated a similar warning. This is a clear indication why it is better to follow the broader market versus the cherry picked S&P500 or any major index for that matter since these companies change as the market changes. It is why analysts focusing on S&P earnings have been behind the eight ball when it came to seeing the slowdown. Waiting for “the” bounce On a short-term basis, the probability for a bounce in stocks from here has increased. First, since bottoming on March 10, market breadth on the NYSE has been increasing as advancers/decliners moved higher. Secondly, our Williams Capitulation Index that measures a combination of volume and volatility put in another buy signal this week. Next, after bottoming on February 27, the Williams Relative Strength Index has been moving higher even while the S&P500 fell which is a bullish positive divergence. The positive volume spike on Friday on the S&P500 was also the highest since the last bottom on January 23.
Figure 4 – Daily chart of the S&P500 showing the clear downtrend confirmed by a series of lower highs and lower lows in a 2 standard deviation trend channel. Green arrows show Williams Capitulation buy signals and green lines show positive divergence between price and the Relative Strength Index which is normally bullish, except in bear markets. A word of caution, however. While very tempting, it is very risky habit to try and pick a bottom especially in a bear market. As we see from Figure 4, the S&P500 is in a clearly defined down trend signified by a series of lower highs and lower lows. Yes, there has been a potential buy signal issued this week but in a true bear market, the rallies are short-lived. In other words, when we get indications that a reversal may be in the cards near term, it is better signal for bears to cover short positions than for bulls to load up the truck with long positions. Safer to wait for confirmation in the way of a new confirmed buy signal before getting bullish. Treasury 3-Month Bill Rates Drop to Lowest Since at Least 1954 $200B added to mortgage pipeline Northern Rock, Anatomy of a Bank Collapse - Lessons View of the Day: Lessons from past commodity bubbles An economy undermined? Leading Economic Indicators in U.S. Decreased 0.3% California Leads U.S. in Defaults, Home-Price Declines Cramer’s Bear Stearns advice of March 11 (the day the stock closed at $62.97) - Video ----------------------------------------------------------------------------------------------------------------------------------------- If you find this newsletter insightful, please feel free to forward this newsletter and share it with a friend (or simply have them opt-in free from our home page http://www.tradesystemguru.com/ to be added). DisclaimerTradeSystemGuru.com obtains information from sources deemed to be reliable; |
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