| TSG Weekly Market Watch November 2, 2007 |
|
|
|
| Written by Matt Blackman | |||||||||||||||||||||||||||||||
| Monday, 05 November 2007 | |||||||||||||||||||||||||||||||
|
TSG Stock Market Letter Week Ending November 2, 2007Topics Discussed This Week:
Markets tossed in stormy sea of volatilityIt was another gut wrenching week as stock markets gyrated their way lower. After posting green across the board last week, only the Nasdaq managed to close in positive territory and only by a hair. Financial sector shocks continued to ripple the financial landscape after CIBC analyst Meredith Whitney said that the world’s largest bank, Citigroup needed to raise more than $30 billion and risked cutting its dividend to offset financial losses. The bank reported a 57% drop in earnings two weeks ago but there are fears of further losses ahead. Citigroup stock dropped 2.5% on Thursday and in the process helped erase 362 Dow points on the day. Technically SpeakingMarket leaders still heading higherWhile major indexes struggled, Zanger’s composite of stocks on Wednesday posted a gain of more than 5% even after the brutal drops on Thursday. But given the growing number of foreign issues, this leadership is being increasingly inflation driven by a declining dollar. This week, Zanger’s composite consisted of nine stocks including Apple (AAPL), Bidu.com (BIDU), Mastercard (MA), Ctrip.com ADR (CTRP), Petro Canada (PCZ) and iShares MS Emerging Market ETF (EEM). Their strength is a good thing but it has been a very tough game to play these stocks given the recent volatility.
This week, weekly trading volumes were again below average on the S&P500 and just above average on the Dow Industrial Average. Volume on the Nasdaq was above average for the third week. But the recent divergence between the Dow Industrials and Dow Transports appears to have begun to impact the resilient Industrial Average as both moved lower. As we mentioned last week, the last time the Transports began to fall while the Industrials rallied was in the summer of 1999 eight months before the market began to fall apart. Volatility again jumped as the Market Volatility Index (VIX) surged to 23.01 from 19.56 last week. Given the crumbling support for the dollar by the Fed, it was no surprise that commodities represented by the NYFE CRB Index surged again to close at 455.10 from 450.34 last week. The index remains in nose-bleed territory above its upper 2-standard deviation (2 sigma) trend channel. Ditto for gold as the yellow metal broke through the $800/oz level to close at $809.30 from $787.70 last week and $768.6 two weeks ago. And it was yet another week of new all-time lows as the U.S. Dollar Index dropped to close at 76.30 down from 76.98 last week and 78.16 three weeks ago. The weaker dollar and inventory concerns again helped push oil to another new all-time high as the NYMEX crude oil (continuous) contract closed at $95.93/bbl up from $91.86/bbl last week and $86.95 two weeks ago. Be sure to watch the interview with Boone Pickens who outlined the lopsided oil supply-demand balance. In a nutshell, the world currently produces 85 million barrels per day but current daily demand has grown to 87-88 million barrels according to Pickens, which he sees as bullish for oil prices going forward. (See link at end of newsletter). Fed ‘pumps up the market’ once again…
Figure 2 – Another FOMC meeting and another rate cut, this time a 25 basis-point drop to 4.5%. Bernanke again played Santa to the market on Thursday pumping in another $41 billion in an attempt to stem stock price declines (not shown on this chart). This was more than the $38 billion injection back in August that marked the largest contribution to the market in a single day since 911 according to the Wall Street Journal. (Be sure to watch the Bloomberg interview with Jim Rogers in which he calls Bernanke a nut for dropping rates (and the dollar) to fuel inflation below). Shaken by plummeting U.S. financials Thursday, the MSCI Emerging Market Index ETF (EEM) gave up some ground to close at 161.70 from 163 last week but remained well above its 152.20 close two weeks ago. Like the CRB Index, the EEM is well above its upper 2-standard deviation trend channel. This week, the U.S. prime bank rate dropped to 7.5% from 7.75% last week while the 3-month London Interbank Offered Rate dropped again this week to 4.865% which put it back exactly where it was a year ago from 4.983% last week and 5.15% two weeks ago. LIBOR is used in computing mortgage rates. Fannie Mae 30-year mortgage (30 day) yields moved up to 6.1% (versus 5.912% a year ago) from 6.05% last week. EarningsWith 2205 companies having reported Q3-07 earnings so far this season, earnings were down 4% versus the same quarter last year. This compares to a drop of 5% with 1395 companies having reported last week which is a big drop from an average in earnings improvements last quarter of 13%. Declining earnings is one more sign of a slowing economy. Economic ReportsPending home sales MIAIt was a busy week for economic reports but one that was glaringly absent was the National Association of Realtors (NAR) pending home sales index that has traditionally been reported in the first week of the month. According to the NAR website, pending a housing forecast/pending home sales index will now be released November 13. When contacted for comment, NAR senior public affairs associate spokesperson Walter Molony who heads up statistics said that pending home sales will now be released in the second week of the month and will be combined with the housing forecast, consisting of a variety of data on housing markets. Stay tuned for that report in two weeks.
Chart 1 – Case-Shiller Home Price Index with August data that showed a 4.4% drop in the composite of 20-cities across the U.S. versus August 2006. This index began to register home price drops in January and the size of these drops has increased in each of the eight monthly reports. We expect this trend to continue, especially now that median prices which peaked in June are beginning to drop in earnest. As we discussed in last week’s newsletter, U.S. September median prices have dropped from a high of $229,200 in June to $211,700 in September, a drop of 7.6% in three months (see http://tradesystemguru.com/content/view/100/58/#Median ) It is interesting that according to Molony, the NAR is expecting home prices to drop modestly this year and but recover to flat or slightly positive next year. He also discounted the Case-Shiller index as not being representative of the market. We disagree on both counts. While Molony is critical of the index because it “only” tracks 20 major U.S. cities and believes that it tends to focus on more expensive homes so not representative of a number of smaller markets in his opinion, our view is that the index does a better job of tracking true real estate health because it is not prone to the inaccuracies of median price variations and sampling error. His attempt to discount the Case-Shiller index is understandable. He works for an organization whose job it is to highlight the positive aspects of the market to encourage people to buy and sell. NAR members also blame media coverage for the general negative perception of the housing market. However, I am surprised at how many consumers still believe that now is a good time to buy a home according to the October University of Michigan consumer sentiment survey (64%). Reality check – Aren’t we still at or very near the top of the biggest real estate bubble in U.S. (and probably global) history? If price drops are accelerating on average in the nations’ 20 largest cities, how can this NOT be negative for future prices? Mr. Molony did shed some light on the 17.9 million vacant homes statistic released by the U.S. Census Bureau last week. According to NAR data, there are approximately 125 million dwellings in the U.S. This consists of roughly 75 million owner occupied homes, apartment, condos, mobile homes etc. and approximately 35 million rental units. The question he could not answer was what percentage of vacancies are rental versus owner occupied homes because he is not aware of any organization that tracks it. There are currently 2.2 million vacant homes on the market of the inventory of 4.4 million existing homes listed. There are also new home inventories to consider. Thanks to TSG subscriber Ben R. who did some further research on this question and alerted us to fact that the Census Bureau does not separate out foreclosure data. We will continue researching this question and report our findings (if we get an answer). But one thing is clear – the current mortgage crisis is getting worse. According to First American LoanPerformance, the percentage of sub-prime mortgages more than 60 days in arrears surpassed 20% in August, up from 17.1% in June. Mark Zandi of Economy.com estimates that of the $2.45 trillion in highly risky mortgages (sub-prime and Alt-A) outstanding as much as a quarter could suffer defaults in the months ahead according to a report in the Wall Street Journal. Nationwide, foreclosures in 2007 recently surpassed 250,000 and are rising rapidly according to Bloomberg News. Expectations among mortgage specialists are that approximately 2 million Americans could lose their homes through foreclosure but that assumes that prices don’t continue falling and interest rates remain relatively stable. The challenge is that increasing foreclosures puts further downward pressure on home prices which in turn forces more people into foreclosure in a self-perpetuating spiral. Zandi expects national home prices to drop 10% from their peak (2006) to fourth quarter 2008 which would erase more than $2 trillion in home values. According to the latest Case-Shiller Home Price Index, prices peaked in July 2006 and were down 4.5% a little more than a year later (August 2007). As Chart 1 shows, the price declines are showing no signs of moderating. Manufacturing drops into contraction territory
Chart 2 – The Chicago Purchasing Manager’s Index (PMI) dropped back into contraction territory with a reading of 49.7 in October for only the fifth such reading in the last 39 months. As we see, the trend in the index is strongly negative so we expect to see more sub 50 readings.
Chart 3 – Although construction spending registered a surprise gain of 0.3% in September (expected -0.4%) thanks to a boost in government sponsored projects. But the original gain of 0.2% in August was revised to -0.2%. Residential construction spending fell 1.4% in September after falling 1.4% in August. Ignoring the month-to-month fluctuations, the trend is clearly negative.
Chart 4 – The first estimate of Q3-07 GDP also surprised to the upside with a gain of 3.9% versus an expected 3% gain. This compares to a final GDP for Q2 of 3.8%. This was surprising considering that the housing sector registered a drop of 20.1% in residential investment cutting overall GDP growth by a full percentage point according to the Wall Street Journal. This in turn was offset by a 3% gain in consumer spending that pushed GDP 2.1 percentage points higher. Most economists however, expect growth to slow in Q4.
Chart 5 – Although not in contraction territory, October ISM registered 50.9 on Thursday for the fourth consecutive monthly decline since peaking in June. According to the negative trendline, it’s only a matter of time before it enters contraction territory. 166,000 new jobs… but…
Chart 6 – On Friday, it was announced that there were 166,000 new jobs created in October while the September number was revised down to 96,000 from 110,000 originally reported. Wall Street expected 80,000 new jobs. How realistic was the number and will it too be revised drastically lower in the months to come? The unemployment rate remained steady at 4.7%. In a separate report Thursday, Challenger layoffs dropped 12% in October versus a 9.7% drop in September and huge 85% jump in August. Overall, the trend for layoffs is rising however. And we don’t expect November to be as good in the wake of automobile manufacturing layoffs recently announced. Service sector jobs offset losses sectors like manufacturing and housing with an increase of 190,000 for the largest jump since May. Be sure to read the discussion of the reality behind jobs numbers and brings into this metric into serious question in the latest Frontline Newsletter at http://tradesystemguru.com/content/blogcategory/47/81/#Jobs Next WeekIt’s a slower week for economic reports. Here are the reports we’ll be watching.
SynopsisCitigroup report cardLast week we performed a Countrywide Financial reality check. Were hopes for a turnaround in both the real estate market and company fortunes in Q4-2007 realistic? The evidence was overwhelmingly negative. This week, let’s look at the recent meltdown in Citigroup. Was the fear that drove the stock down this week justified? Here we see a chart of the world’s largest bank showing the break in trend in August and subsequent drop in stock price.
Figure 3 – Weekly chart of Citigroup (C) showing the trendline break in late July (red arrow) and drop from the $50 range to below $38 on Friday taking stock price back to where is way in April 2003. In my research into fundamentals versus technicals, I have found that in most cases when markets reverse direction especially in a correction that fundamentals lag. A price breakdown is the first sign of trouble. As we see from the Citigroup chart, earnings growth (GRT), earnings per share (EPS) of $4.70 and dividend (DIV) of $2.16 have continued to appreciate while price has seriously declined. A trader would have exited in July with the break of the uptrend since waiting for the fundamentals to tell you when to exit is a fool’s game. Regarding market direction, our outlook from last week has not changed. This is a tough environment for traders even as talented and successful as Dan Zanger. Volatility can quickly chew up profits. So unless you are a short-term trader with very fast reflexes and money to burn or a very good handle on emerging markets, cash is a pretty darn good option. Best if you also hold some gold or foreign currencies though while the U.S. dollar continues to drop. Useful Links Bloomberg Jim Roger interview – “Bernanke a nut for continually printing money” Boone Pickens’ Oil and Energy Interview Think that mortgages are only a problem here? UK banks face worse losses (interview). ------------------------------------------------------------------------------------------------------ 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; |
|||||||||||||||||||||||||||||||
| Last Updated ( Saturday, 10 November 2007 ) | |||||||||||||||||||||||||||||||
| < Prev | Next > |
|---|