| TSG Weekly Market Watch November 16, 2007 |
|
|
|
| Written by Matt Blackman | ||||||||||||||||||||||||||||||||||||
| Sunday, 18 November 2007 | ||||||||||||||||||||||||||||||||||||
|
TSG Stock Market LetterWeek Ending November 16, 2007Topics Discussed This Week:
Markets get more interesting…Few thought it possible as markets again surprised but this time to the upside. But regarding the bigger picture, here is my favorite quote of the week. In 1929, days after the stock market crash, the Harvard Economic Society reassured its subscribers: “A severe depression is outside the range of probability” In a survey in March 2001, 95% of American economists said there would not be a recession, even though one had already started. Today, most economists do not forecast a recession in America, but the profession's pitiful forecasting record offers little comfort. – Economist November 15. It is a sad reality of markets that at crucial times, the majority (including the professionals) is wrong. It is why bear markets and recessions are so devastating. In markets, especially at major turning points, the few hawks get fat feeding on the many lemmings. Our goal is to help you be a hawk. We have put together a list of some of our favorite indicators and have been working on a new report. To see the ones we have added and updated, please see our Synopsis. To view the report, please see the link at the end of this newsletter. (Ah, ah, ah… no peeking…) Technically SpeakingLeaders still pointing downWhile the large cap indexes managed to hold their own, it was another down week for market leading stocks and trader Dan Zanger is again on the hunt for shorts. “The market remains a treacherous place to consider being long stocks at the moment.” Zanger said in his Wednesday newsletter. Hits picks this week again included past favorites, Research in Motion (RIMM), Apple (AAPL), Bidu.com (BIDU), Mastercard (MA) and back in the fold were ISharesFTSE/China (FXI), Holders Trust Oil-Service (OIH) and Wynn Resorts (WYNN). Except this time he was looking at a number of stocks that had been hit and were getting close to breaking support as short candidates.
Figure 1 – Weekly performance of Zanger’s market leaders compared to the S&P500 (SPX), the Dow Jones Industrial Average (DJX) and Nasdaq Composite (IXIC). Data courtesy of The Zanger Report, performance chart courtesy of VectorVest.com. This week, weekly trading volumes were at or above average for the S&P500, Dow Industrial Average and Nasdaq Composite while markets remained flat. But while the Industrials moved higher, the Transports again fell re-asserting the recent divergence between the two. According to Dow Theory, a trend can only be confirmed when both are moving in the same direction but more about this below. Volatility settled back a little this week as the Market Volatility Index (VIX) closed at 25.49 down from a short-term peak of 28.50 last week. Commodities represented by the NYFE CRB Index dropped somewhat this week to close at 450.11 down from 456.36 last week. The index remained strong but dropped below its upper 2-standard deviation trend channel. Gold experienced a correction this week as the yellow metal closed at $787/oz down from $834.60/oz last week. This was not due to any upside move in the dollar so is probably more related to profit taking following a dramatic move from $668 August 30. Speaking of the dollar, the U.S. Dollar Index recovered slightly to close at 75.84 from 75.39 last week but it is still near all-time lows against a number of major currencies including the euro and Canadian dollar. Oil dropped back a little this week off its all-time high as the NYMEX crude oil (continuous) contract closed at $93.84 from $95.30/bbl last week and $95.93 two weeks ago. Fed ‘helium dollar’ pumping tops previous record
Figure 2 – Not shown on this chart that ends November 14 is the fact that the Fed pumped another $47.25 billion into the banking system (markets) on Thursday (November 15) for the biggest daily injection yet since shortly after 911. But even with this big boost, markets just managed to hold their own. The Fed is betting that buyers will return once the credit crunch ends and by its actions have made it clear that it will act as the bank of last resort in the meantime. Question is, how long can the Fed keep it up? Still suffering from uncertainty in both U.S. and emerging markets, the MSCI Emerging Market Index ETF (EEM) closed at 153.80 up slightly from 153.60 last week and 161.70 two weeks ago. There is concern that the overheated Chinese Shanghai market may be bursting its bubble and that will impact emerging market performance. This week, the U.S. prime bank rate held steady at 7.5% while the 3-month London Interbank Offered Rate moved up this week to 4.948% from 4.879% last week is above where it was a year ago. LIBOR is used in computing mortgage rates. Fannie Mae 30-year mortgage (30 day) yields backed off to 6.095% from 6.168% last week (versus 5.913% a year ago). EarningsWeakness continues…Now that 3638 companies have reported Q3-07 earnings (up from 2991 last week) earnings are still down 19% (versus a 20% average drop last week) compared to the same quarter last year. This is a big drop from -4% with 2205 companies having reported two weeks and an even bigger decline from an average in earnings improvements last quarter of +13% versus the same quarter the year before. It is interesting to note that financials including banks and brokers have seen earnings fall 25% from the same quarter last year versus an increase of 13% in Q2-07. We are very near the end of Q3 reporting season and with the few remaining companies left to report there is little chance of any sizeable overall improvement in results. Not only is earnings weakness troubling, the fact that the financial sector has broken down so rapidly and given its past record of leading markets should be an even greater concern – one that the majority of fundamental analysts (and economist) seem to ignore.
Figure 3 – Chart showing slow but steady deterioration in earnings and negative trendline (black). As earnings have dropped gone is one major reason for bullishness. Economic ReportsThere were just a couple of reports worth including this week. We don’t consider indicators such as consumer price index, producer price index and other inflation metrics used by the Fed to be of much use in helping us anticipate market direction. In line with other reliable indicators of consumer spending, food and retail sales (ex-autos) continues its slow decline. Just flashing across the Bloomberg screen as I write this is that the latest industrial report is showing an unexpected industrial output 0.5% drop as producers from mines to factories reduce output and inventories in an anticipation of economic slowdown. Pending homes sales flat…
Chart 1 – On Tuesday, the National Association of Realtors released pending home sales showing that the number of contracts signed in September rose 0.2%. On a year-over-year basis, the index is down 20.4%. However, the index does not include cancellations which have been running at between 20 and 30%. The NAR still expects a modest recovery in sales for 2008 and prices to stabilize. According to the NAR whose principle task it is to promote real estate to the public, the index is a leading indicator for the housing sector, based on pending sales of existing homes. A sale is listed as pending when the contract has been signed but the transaction has not closed, though the sale usually is finalized within one or two months of signing. Annual changes in the index are more closely related to actual market performance than are month-to-month comparisons. Treasury Flows Remain in Negative Territory
Chart 2 – On Friday, the U.S. Treasury announced that Treasury International Capital (TIC) flows (net purchases of U.S. Treasuries) declined $14.7 billion in September. August figures were revised from -$163 billion originally reported to -$150.7 billion. Considering that Treasury must sell a minimum of $2.1 billion in Treasuries per day to offset the trade gap, a continued decline in TIC flows could force them to raise yields to attract much needed capital. A confirmed bottom in the dollar would certainly help. Stay tuned! Next WeekHere are the reports we’ll be watching next week. U.S. Thanksgiving is Thursday, November 22 so it should be a quieter week as traders try to take some time off.
SynopsisCharts show things getting worse not betterMore indicators are flashing warning signals and as we have seen, weakness has been confirmed by a number of leading economic indicators. This week we update our Dow Jones Industrial versus Dow Jones Transports charts and see how the Transports presaged the bear market in mid-1999 when it diverged with the Industrials...
Figure 4 – Weekly chart of the Dow Jones Industrial Average and Dow Jones Transport Average (purple) showing the reversal of trend. As mentioned above, the last time there was a serious negative divergence between the Dow Transports and Industrials was one that began in May 1999 nearly 10 months before the official start of the last big bear market. ... and as the next chart shows, can see that the same type of divergence between the Industrials and Transports is happening now.
Figure 5 – Here we see the divergence between the Transports and Industrials that started in early August 2007. This divergence continued this week with Industrials gaining 134 points this week while the Transports lost 40. Next, let’s take another look at some of the major sectors in the market – this time we’ll look at Retail, Banks and Financials.
Figure 6 – Last week we looked at how the Financials sector warned of the coming bear market when it broke down in April 2000 a full eight months before the S&P500 and that Financials again started breaking down in February 2007. We have updated the chart this week and it shows continued weakness in Financials (see http://tradesystemguru.com/content/view/109/58/#Bear ). This week, let’s take a broader view showing weekly charts of the Financial sector (blue) together with Retail (cyan), Banks (red) and the S&P500 (black). As we can see, with the exception of the S&P500, these sectors have all broken significant support levels (red arrows), the latest being the Retail sector which broke support in late October. This shows a clear rotation lower and is decidedly bearish for the broad range of stocks. Major sectors are breaking support that while not conclusive, provides more bearish evidence on the health of the overall market.
Figure 7 – In the fall of 2000, the S&P500 Index began dropping but it wasn’t until the first week in January 2001 that the Fed reacted and began dropping the Fed funds rate from 6.5% to 6%. But as we see, even though the rate dropped to below 2% over the next 18 months, stocks continued to plummet with the SPX losing nearly 50% of its value. Chart Metastock.com
Figure 8 – At least this time around the Fed did not take so long to react to financial problems and drop the rates. But as this chart indicates, the Fed's two rate cuts (and huge cash infusions) have failed to help stocks and as we see above, a number of pivotal sectors have rolled over. If the last bear market is any guide, stocks should continue to encounter growing headwinds as the overnight rate declines. Chart Metastock.com Bernanke lowered rates more quickly in response to market weakness compared to the last market melt in 2000 under Greenspan. But will it be enough to re-energize stocks? But Current P/Es Are Reasonable... Isn't that bullish?I heard a lemming analyst on Bloomberg this week claim that because the S&P500 price/earnings ratio was relatively low (around 14), that stocks were fairly valued so should remain strong. This certainly flies in the face of the earnings graph (See Earnings) showing a strong negative trend. But are price/earnings ratios of any benefit in knowing where stocks will go next? The answer is yes but not in the way that many analysts would have you believe.
Figure 9 – Weekly chart of the VectorVest Composite Index (VVC) of more than 8200 stocks trading on US exchanges from 1996 to present showing the correlation between the price of US stocks and the composite price/earnings ratios. At the peak of the market in March 2000, (red arrow) stocks were trading at 32 times earnings. In July 2002 after stock prices had been dropping for more than two years, they were trading at 41 times earnings and just after the market bottomed and had started to recover (May 2003), PEs spiked to more than 60. The moral? It makes at least as much sense to buy PE spikes as sell them. The reason? Stock prices generally lead earnings improvements when looking at the larger indexes. The rate of change of earnings is a more reliable indicator but even this metric tends to lag stock price. PEs rise for two reasons. First, earnings deteriorate (which looks to be occuring now) or investors anticipating higher earnings bid stock prices up. In March 2000 composite P/Es for more than 8000 U.S. stocks peaked at 31.88. P/Es for this index hit 32.66 on October 12, 2007. As of Friday's close, P/Es were 30.4. So what? Peaking PEs mean one of two things. We are at a bottom and a recovery is underway (that if real will be followed by rising earnings), OR we are at a market peak and stocks are getting ready to roll over. I have yet to see any studies showing that PEs provide reliable buying or selling signals. Not much of an indicator in my books. Summing Up Let’s do a tally of what is happening in markets. A growing number of indicators and market sectors are flashing sell signals and an overwhelming majority of economists and analysts believe we will not have a recession (put the odds of recession at less than 50%). Both conditions are bearish. As well, Dan Zanger’s market leading stocks are pointing down and shorts are the preference. It is important to point out that of the major stock indexes we are following (Dow Industrials, Transports, and Utilities, S&P500, Russell 2000, NYSE, Nasdaq and MSCI Emerging Markets), only the Dow Transports have broken significant uptrend support. This means that the rally is still officially in tact. This rally has two other factors in its favor. First, this three month period (November, December and January) has historically has been the best time of the year to be in the market. Second, it is a pre-election year which has been by far the best of the four year election cycle. Since optimism is a most powerful emotion on Wall Street, a rally from here must be considered a distinct possibility. That being said, it remains a very challenging environment in which to make money. At the risk of sounding like a broken record, unless you are a short-term trader with very fast reflexes and money to burn, cash remains a good option. Best if you also hold some gold or foreign currencies though while the U.S. dollar continues to drop. Stories of interest this week… Link to new recession watch report (charts will be updated/added regularly) http://tradesystemguru.com/content/view/113/61/#Recession How do You Spell Stagflation? John Mauldin November 16, 2007 http://tradesystemguru.com/content/blogcategory/47/81/ America's vulnerable economy – Economist Goldman Sees Subprime Cutting $2 Trillion in Lending Tipped Towards Recession – Business Week Chronology – The Credit Crunch of 2007Asia would be hit by a U.S. recession: Morgan Stanley U.S. could face $2 trillion lending shock Countrywide loans drop 48 percent Bank of America sees $3 billion debt write-down Goldman Held Bigger Level 3 Share Than Citi, Merrill Miami condo at ground zero in mortgage fraud Top 100 metro area foreclosures (click “print this” on table half-way down) American Gangster's Wad of Euros Signals U.S. Decline ------------------------------------------------------------------------------------------------------ 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, 24 November 2007 ) | ||||||||||||||||||||||||||||||||||||
| < Prev | Next > |
|---|