| TSG Weekly Market Watch January 25, 2008 |
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| Written by Matt Blackman | ||||||||||||||||||||||||||||||||||||
| Sunday, 27 January 2008 | ||||||||||||||||||||||||||||||||||||
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TSG Stock Market LetterWeek Ending January 25, 2008Topics Discussed This Week:
Band-aid bailoutMore details of the Bush bailout were released this week and another bailout for bonds was hinted at in New York. Not to be left out of the fiscal frivolity, the Fed issued a surprise 75 basis-point rate cut on Tuesday more than a week ahead of the scheduled rate announcement on January 30. But there are two glaring questions about the Bush plan finalized this week with the blessing of the Democrats. 1) Does the government actually believe that the biggest set of bubbles in history will be magically cured by shelling out one-time tax rebates of $600 to individuals, $1200 to couples and cash payments of $300-$600 to the unemployed in June or July at the earliest? 2) What happens the month after the money is gone? But it wasn’t the Bush bailout or Bernanke surprise 75-basis point rate cut, it was news that New York was looking into a plan to bailout bond insurers that really gave stocks a boost. More about that in our Synopsis. Technically SpeakingLeaders turn upAfter three losing weeks for Dan Zanger’s Sunday picks, they moved into positive territory for the week gaining nearly 2%. But that performance was dwarfed by the Dow Transports that gained more than 7%. Both are bullish signs and add further credence to the theory that we are at a market bottom of sorts (see below). His 10 picks this week included Baidu (BIDU), CF Industries (CF), Monsanto (MON), Petro Bras (ADR) (PBR), FirstSolar (FSLR), Oil Holders (OIH) and SolarFun (SOLF).
Major indexes are trying to put in some sort of bottom. After putting in a bullish tweezers bottom chart pattern on Tuesday and Wednesday (in which the lows are nearly identical), the Dow managed to hold on support at 12,100. A similar pattern occurred on the S&P500 with weekly support at 1310. There was a volatility spike that occurs at bottoms as the Market Volatility Index (VIX) surged above 30 before settling down slightly Thursday and Friday. After retracing Monday thru Wednesday the 17 commodities represented by the NYFE CRB Index surged again to close at 492.02 up from 490.37 last week. This index remains above its upper 2-standard deviation trend channel making it very overbought – a position it has held for the last seven weeks straight on the weekly chart.
Figure 2 – Weekly chart of the Dow Jones Industrial Average showing major support at 12,100 holding and a spike in the volume, volatility-based Williams Capitulation Index (middle subgraph) which has coincided with bottoms in the past. The latest WCI reading is the highest since October 2002. Finally, the channel bordered by the two blue dashed lines is the 2-standard deviation linear regression channel that began in early 2003. Chart by GenesisFT.com After taking a breather for a couple of days, gold took off again closing the week at $910.70 up from $881.40 last week. Given the increasing downward pressure on the U.S. dollar, I don’t expect gold to drop anytime soon. Not surprisingly with all the money being given away, the U.S. Dollar Index fell again losing nearly a percent on Tuesday. It closed the week at 76.11 from 76.50 last week. The NYMEX crude oil (continuous) contract held the double top neckline support we discussed last week as Texas tea moved up to close at $90.71/bbl from $89.92/bbl last week. With the giveways getting bigger and more inventive as the election approaches, we don’t expect to see the US dollar gain strength anytime soon. Contrast this with a weakening economy and you have a unique tug-of-war on the price of oil. This week, the U.S. prime bank rate dropped to 6.50% thanks to Santa Ben’s surprise 75 basis-point cut in the Fed funds rate to 3.5% Tuesday. Meanwhile, the 3-month London Interbank Offered Rate (LIBOR) fell in sympathy to 3.3% from 3.894% last week and 4.2575% two weeks ago. The LIBOR drop is good news for credit markets and mortgage rates. However, Freddie Mac mortgage rates remained stubbornly high ranging from 5.48% the 30-year fixed mortgage (5.69% last week) to a low of 4.99% (5.26% last week) for the one-year adjustable rate (ARM). EarningsEarnings remain weakWhile earnings for S&P500 companies having reported so far appear to be hanging in, not so for the broader range of more than 4000 companies covered by the Wall Street Journal. Last week we reported that with 573 companies having reported for Q4-07, earnings were down 73% from the same quarter last year. With a total of 883 companies having reported this week, average earnings were still down 52%. This compares to a drop of 26% in the first week with 415 companies reporting. Some of the worst hit industries were semiconductors down 88% and the consumer good group down 92% (versus -88% last week). However, since less than 25% of companies have reported so far, the headline number could change significantly. A total of 4205 companies reported Q3-07 results and average earnings fell 21% from the same quarter the year before compared to a 13% jump in Q2-07. Economic ReportsIt was holiday shortened week this week with just a few reports. But there was some big unscheduled news in the way of a surprise 75 basis-point cut in the Fed funds rates, more details on the Bush bailout plan and discussions by New York on a bond bailout plan. Existing Homes Sales and Prices Fall
Chart 1 – Existing home sales fell 2.2% in December to an annual rate of 4.89 million homes and median home prices dropped 1% from November. In the last year, median home prices have fallen 6% nationally. Some good news came as the inventory of homes on the market dropped to 3.9 million from 4.2 million in November. At the current rate of sales, that represents a 9.6 month supply, down from 10.1 months last month and 10.7 months in October. Next WeekIt will be much more active next week. Here are the reports we’ll be watching.
SynopsisOf bonds, bailouts and billion dollar betsThis week, the spread between 10-year Treasuries versus AAA-rated commercial mortgage-backed securities jumped 32% to 244 basis points, according to a Morgan Stanley index. The extra yield over 10-year swap rates rose 48% to a record 185 basis points according to Bloomberg, which was the biggest increase since October 1998 when Long Term Capital Management was collapsing and the Russian ruble crisis came to a head. It is further confirmation of rising credit nervousness. That nervousness has clearly spread to governments and the Fed if this week’s news is any indication. But while the Fed’s surprise rate cut and details about the Bush bailout failed to impress equity markets, news that New York regulators were considering a plan to help beleagured bond insurers had better effect causing the Dow Industrials to rally more than 600 points Wednesday. So why would this news have such a positive impact? Banks have so far had to come up with $72 billion to shore up capital requirements as a result of subprime losses. This has caused no end of headaches for bankers who have had to literally go to the ends of the earth (mostly eastward) to raise the necessary capital. But according to a report by Barclays Capital analyst Paul Fenner-Leitao, another $143 billion would have to be raised should bond insurers suffer credit downgrades. Barclay’s estimate is based on banks holding 75% of a total of $820 billion in structured securities (structured investment vehicles) guaranteed by bond insurers. In total, the credit quality on a total of $2.4 trillion of bonds could be in doubt according to Bloomberg.In comparison, banks would need a more manageable $22 billion if bonds covered by insurers like MBIA Inc and Ambac Assurance Corp are cut one level from AAA and six times this figure if downgraded four levels to an A rating. So it makes more sense for banks to bailout bond insurers than face the nearly impossible task of raising another $143 billion. Is it any wonder that stocks rallied on news that New York’s Insurance Superintendent Eric Dinallo is working to arrange a bank-led bailout of bond insurers? Hopefully Dinallo et al can come up with a more permanent solution than the latest Bush bailout. Median home prices have fallen 6% in the last year which equates to a total of $1.2 trillion in real estate equity lost in the last twelve months and this correction is far from over. The loss in equity to stock investors since global markets peaked last year amounts to $5 trillion worldwide. But even this amount pales in comparison to the 36% drop in buying power for every U.S. dollar and financial instrument denominated in dollars since the beginning of 2002. So tell me again how a one-time $150 billion giveaway to those making less than $75,000 will miraculously fix this situation? And where does the $7.2 billion that trader Jerome Kerviel lost for Societe Generale come from? Finally, how many other nasty surprise losses on this and the other side of the Atlantic await revelation? As if this wasn’t enough, in the last year the credit default swap (CDS) market has doubled in size to more than $40 trillion. Given that the creditworthiness of $2.4 trillion of bonds may be in doubt, how sure can we be that the other nearly $40 trillion is safe from default? And considering that there are more than $500 trillion in derivatives worldwide, are CDSs the only derivative class in trouble? Short-term stock outlook brightensLooking at the shorter-term, the probability of a rally has increased if the jump in volatility as expressed by the volatility index (VIX) as well as the Williams Capitulation Index (see Figure 2) and spikes in volume are any guide. Some of the worst hit so far, such as banks and homebuilders, began rallying a few days ago. Let’s not forget the Zanger composite of leading stocks that are pointing higher. Finally, the rally in the Dow Transports brings the current downtrend into question according to Dow Theory since now the Transports and Industrials are heading in opposite directions. But if we don’t get at least a short-term rally from here given deeply oversold conditions in the major indexes, it will be very bearish indeed. Stories of interest this week… Commercial Mortgages Next in Delinquency Firing Line Bernanke Earns Cheers and Jeers for Emergency Cut More Troubles for Citigroup Banks May Need $143 Billion for Insurer Downgrades A Monty-Pythonesque Look at the Credit Mess (Video) Pressure grows for SocGen answers on trader scandal China's Growth Likely Slowed on Weaker Export Demand Countrywide's Underwriters Sued for Fraud by New York ------------------------------------------------------------------------------------------------------ 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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