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TSG Stock Market Letter Week Ending January 2, 2009 Topics Discussed This Week: New Feature - The TSG Weekly Now in Audio Off to a good start Leaders flying high Q3 earnings – down and out Investors ignore bad news over Christmas & first trading day So is the worst really over? | INDEX | Jan 2-09 | Dec19-08 | Change | Change% | | INDU | 9,034.69 | 8,579.11 | 455.58 | 5.31% | | DJT | 3,651.02 | 3,389.47 | 261.55 | 7.72% | | SPX | 931.80 | 887.88 | 43.92 | 4.95% | | COMPX | 1,632.21 | 1,564.32 | 67.89 | 4.34% | | RUT | 505.84 | 486.26 | 19.58 | 4.03% | | EEM | 26.16 | 25.44 | 0.72 | 2.83% | Last Year | INDEX | Jan 2-09 | Jan 4-08 | Change | Change% | | INDU | 9,034.69 | 12,800.18 | -3,765.49 | -29.42% | | DJT | 3,651.02 | 4,260.39 | -609.37 | -14.30% | | SPX | 931.80 | 1,411.63 | -479.83 | -33.99% | | COMPX | 1,632.21 | 2,504.65 | -872.44 | -34.83% | | RUT | 505.84 | 721.60 | -215.76 | -29.90% | | EEM | 26.16 | 145.01 | -118.85 | -81.96% | Quote of the week “We’re seeing a more statist world economy. That’s not good for growth in the longer run.” – Ken Rogoff, former IMF chief economist and current Harvard professor. Now - Listen to this newsletter in audio We've added a new feature this week that allows you to listen to this newsletter in a mp3 audio file so you can listen to it in your favorite audio device such as an iPod. Click this link to download this audio file - size 3 megs Off to a good start Anyone who has been reading the newspapers already knows just how brutal 2008 was so we won’t re-hash it here. For those who are interested, we have included some good summaries in our Suggested Reading section at the end of the letter. Traders and investors worth their salt are now focused on what happens in the next few weeks. Two reliable indicators, The First Five Days (FFDs) and the January Barometer, are described in the 2009 Stock Traders Almanac. An early indicator of what lies ahead is the FFD that says that as go the first five trading days in January, so goes the rest of the year. According the Almanac, the last 36 positive FFDs of January were followed by full year S&P500 Index gains 31 times for an accuracy of 86% posting an average 13.7% gain in all 36 years. However, in the last 22 negative FFD periods, 11 years ended up and 11 down so it is a less reliable indicator of whether the year will be negative. More reliable is the January Barometer developed by Yale Hirsch in 1972 that says as goes January, so goes the rest of the year, but more about that next week. January 2 was the first trading day and it registered impressive gains of 2.9%, 3.5% and 3.2% respectively for the Dow Industrials, Nasdaq Composite and S&P500 but one good day does not a week or month make. But assuming volume returns to normal Monday, by this time next week we should have our first real indication of what the year holds. Technically Speaking Leaders flying high Two weeks ago, Dan Zanger’s Sunday pix barely broke even with a 0.7% gain. This week, as we see from the chart the only major indexes to outperform Zanger’s portfolio was the emerging market ETF (EEM) and the Dow Transports (DJT). Rapidly falling energy prices helped propel the Dow Transports to second place again this week. That emerging markets and the transports lead is bullish but that Dan’s market leaders are leading stocks is even more bullish. This week Dan’s portfolio of 8 stocks included Hess Corp (HES), Bunge (BG), Potash (POT), Sohu.com (SOHU), First Solar (FSLR), Holders Oil Serv (OIH), Energy Conv (ENER), and ProShares UltraShort Financial (SKF). 
Figure 1 – Five-day performance of Zanger’s last Sunday pix (green) compared to the S&P500 (SPX), the Dow Jones Industrial Average (DJX), Dow Transports (DTX), Nasdaq Composite (IXIC), Russell 2000 (RUT) and MSCI Emerging Market ETF (EEM). Data courtesy of The Zanger Report, performance chart courtesy of VectorVest.com. Not surprisingly given the time of year, weekly volumes have been well below average and that means that this week’s rising prices are less bullish. Rising prices on falling volumes shows fewer buyers entering the market and that spells trouble in a rally. To be convincing, rising prices need to be accompanied by rising volume if the rally is to be sustained. And not surprisingly, after slipping to 45 two weeks ago, the Market Volatility Index (VIX) continued to drop closing at 39.19 Friday as fear continued to seep out of markets. After surging over the last three weeks, the 19 commodity NYFE CRB Index continued to recover this week to close at 370.68, up from 351.81 two weeks ago. Since hitting a high of 611.51 three months ago and losing nearly 50%, the CRB Index has pared its loss to 40% from its peak. Gold continued to rally this week to close at $879.20/oz. from $837.00 two weeks ago amid all the money being pumped into the economy. Although we are still in a deflationary period, investors continue to seek a haven in gold. Although the dollar has struggled amid the drop in the Fed funds rate to zero, the U.S. Dollar Index managed to mount a rebound this week hitting 81.84, up from 81.10 two weeks ago. Since bottoming in July, the U.S. Dollar Index has seen its gain pared from 22 to 13.6%. And after a five month slide, crude rebounded this week to close at $50.31/bbl. up from $42.91 two weeks ago amid tensions in the Middle East. However, volume was again well below average so we will need to see more commitment before the move is confirmed as bullish. Oil is still down 66% from its halcyon mid-summer high of $147.20. After falling 75 basis-points in early December, the U.S. bank prime rate and the Fed funds target rate held steady at 3.25% and 0.00% - 0.25% respectively with the effective Fed funds rate falling to 0.13% (from 0.15% two weeks ago). Meanwhile, credit markets continued to loosen as the 3-month London Interbank Offered Rate (LIBOR*) slipped again to 1.4125% (from 1.4975% two weeks ago and 2.1856% four weeks ago). Freddie Mac mortgage rates slipped again to 5.10% (from 5.19% two weeks ago and 5.97% four weeks ago) for the 30-year fixed mortgage while the one-year adjustable rate mortgage (ARM) slipped to 4.85% (from 4.94% two weeks ago). *LIBOR is the benchmark for $900 billion in subprime mortgage loans which typically adjust to it every six months. Corporations around the world have the interest rates on roughly $9 trillion in debt pegged to LIBOR and rates on more than $380 trillion in derivative interest rate swaps also are based on LIBOR. About 6 million U.S. mortgages, including the vast majority of subprime home loans as well as 41% of prime ARMs are linked to LIBOR. Earnings Q3 Earnings – Down for the count In the last week of Q3-08 reporting season with a total of 4004 companies having reported (up from 3990 companies two weeks ago), average earnings ticked one point better to -61% (from -62% two weeks ago, -63% four weeks ago, and -13% in the season opener) versus Q3-07. Earnings experienced their biggest drops since first turning negative in Q3-07 and there are few signs that this situation will improve in Q4. 
Economic Reports Investors ignore bad news in first trading day Although a holiday-shortened week, there was no break from bad news. We got further confirmation Tuesday that home prices are still collapsing with an 18% annual drop in the October Case-Shiller 20-City Composite Home Price Index, another new record. Since their peak in July 2006, existing home prices have now fallen 23.42% with no end in sight. This followed last week’s revelation that both new and existing home sales were still falling rapidly. We also learned Tuesday that the Chicago Purchasing Manager’s Index remained weak with a 34.1 reading in December up marginally from 33.8 in November as well as a weaker than expected reading of 36.2 in December for the Institute Supply Management Manufacturing Index. In both indexes a reading below 50 indicates contraction. We learn Tuesday if the broader-based indicator of business health, the Non-manufacturing (service) ISM, fared any better. 
Synopsis Is the worst over? History says it's not… This week’s market rally occurred in spite of more grim economic news and that is bullish. There is a significant lag between a market recovery and an improving economy but the question remains will this be yet another false start? Anyone who has watched any financial channel has heard the parade of analysts singing the familiar tune, ‘the correction is over, let the rally begin.’ But as referenced in our opening quote, all is not well according to Dr. Ken Rogoff. In a paper he and authored with Carmen Reinhart entitled The Aftermath of Financial Crises, presented to the American Economic Association January 3, 2009, the authors outline the pivotal differences between a recession and crisis in 66 nations over 200 years. They express little doubt that it is the latter through which we now wade. In the following quote, their findings are summarized. “Broadly speaking, financial crises are [more] protracted affairs [than recessions]. More often than not, the aftermath of severe financial crises share three characteristics. First, asset market collapses are deep and prolonged. Real housing price declines average 35 percent stretched out over six years, while equity price collapses average 55 percent over a downturn of about three and a half years. Second, the aftermath of banking crises is associated with profound declines in output and employment. The unemployment rate rises an average of 7 percentage points over the down phase of the cycle, which lasts on average over four years. Output falls (from peak to trough) an average of over 9 percent, although the duration of the downturn, averaging roughly two years, is considerably shorter than for unemployment. Third, the real value of government debt tends to explode, rising an average of 86 percent in the major post–World War II episodes. Interestingly, the main cause of debt explosions is not the widely cited costs of bailing out and recapitalizing the banking system. Admittedly, bailout costs are difficult to measure, and there is considerable divergence among estimates from competing studies. But even upper-bound estimates pale next to actual measured rises in public debt. In fact, the big drivers of debt increases are the inevitable collapse in tax revenues that governments suffer in the wake of deep and prolonged output contractions, as well as often ambitious countercyclical fiscal policies aimed at mitigating the downturn.” In summing up, the authors concluded that “recessions surrounding financial crises have to be considered unusually long compared to normal recessions that typically last less than a year. Indeed, multiyear recessions typically only occur in economies that require deep restructuring.” Without a doubt, the aspect given shortest shift today is the severe impact past crises have had on public debt. If, after this crisis has come to its final end, we suffer the average increase in government debt, it will mean that the current $10 trillion will be nearly $19 trillion. But such a situation would also see total credit market debt, currently at 350% of GDP nearly double as well to new uncharted territory, debt that could well take decades after the recovery has arrived to finally bring back under control. That is certainly not the kind of legacy baby-boomers intended to leave their children and children’s children… Dr. Copper Finds Some Support Copper has often been referenced as a good indicator of economic strength earning it the euphemism Dr. Copper. Used in everything from home construction to electrical fixtures, when it’s in demand, the economy is usually cooking. 
Chart by TradeGuider.com Data by RealTimeData.com As we see from the next chart, it’s been a tough eight months for the metal. After touching $4 in June, it dropped to a low of $1.25 last week. But as this chart also shows, there is evidence that someone was again buying (green rectangle) last week. This week, the green rectangle indicates a smart money shakeout – professionals pushing the price around to see what selling or buying follows. This could be a bottom for Dr. Copper but we will have to see solid support here and increasing volume on up-moves if this rally is to have staying power. Stories of interest this week… The Aftermath of Financial Crises – Rogoff and Reinhart http://ws1.ad.economics.harvard.edu/faculty/rogoff/files/Aftermath.pdf Friedman Would Be Roiled as Chicago Disciples Rue Repudiation http://www.bloomberg.com/apps/news?pid=20601109&sid=a3GVhIHGyWRM&refer=exclusive Saving Capitalism No Sure Thing as Statism Undermines Economy http://www.bloomberg.com/apps/news?pid=20601109&sid=aDjmuEpDoctc&refer=exclusive U.S. Stocks Post Steepest Yearly Decline Since Great Depression http://www.bloomberg.com/apps/news?pid=20601087&sid=a5RkfQG30k1k&refer=home U.S. Economy: Home Prices Fall Near Depression Pace http://www.bloomberg.com/apps/news?pid=20601213&sid=adkUcqYlJVRA&refer=home U.S. Treasuries Rally Most Since 1995 as Investors Seek Safety http://www.bloomberg.com/apps/news?pid=20601087&sid=aQPL__I0I11c&refer=home U.S. Mortgage Rates Fall to Lowest in Three Decades http://www.bloomberg.com/apps/news?pid=20601110&sid=arhNqri04_XI Iceland ‘Like Chernobyl’ as Meltdown Shows Anger Can Boil Over http://www.bloomberg.com/apps/news?pid=20601109&sid=a2gMphgAVl3U&refer=exclusive Japan Stocks Finish Worst Year on Global Recession http://www.bloomberg.com/apps/news?pid=20601110&sid=aYYGeFM6fx88 Emerging-Market Bonds Cap Worst Year in Decade Amid Crisis http://www.bloomberg.com/apps/news?pid=20601110&sid=a9OFrCToh4Zw Copper Heads for Biggest Drop in 21 Years as World Growth Slows http://www.bloomberg.com/apps/news?pid=20601110&sid=a6AJJAfqkPCI Merrill’s Rosenberg Inspired by Farrell in Foreseeing Crash http://www.bloomberg.com/apps/news?pid=20601109&sid=a8KK_pGpxqL4&refer=exclusive Commodity Boom Turns Bust in 2008 as Worldwide Economy Crumbles http://www.bloomberg.com/apps/news?pid=20601087&sid=a_oih_J0oMWg&refer=home Journal of a Plague Year: Faith in Markets Cracks Under Losses http://www.bloomberg.com/apps/news?pid=20601109&sid=ataVotdLreS0&refer=home Stocks in U.S. Advance in Best Start to Year Since 2003 http://www.bloomberg.com/apps/news?pid=20601087&sid=aVHZBX7xtycs&refer=home Buffett Has ‘Nowhere to Hide’ Amid Berkshire’s Plunge http://www.bloomberg.com/apps/news?pid=20601109&sid=aVs.jRV4UDWA&refer=home VIDEOS The Mortgage Meltdown - It's Just Getting Started - 60 Minutes http://www.cbsnews.com/video/watch/?id=4668112n --------------------------------------------------------------------------------------------------------------------- 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 have it sent to them each week). Disclaimer TradeSystemGuru.com obtains information from sources deemed to be reliable;
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