| TSG Stock Market Letter February 15, 2008 |
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| Written by Matt Blackman | ||||||||||||||||||||||||||||||||||||
| Saturday, 16 February 2008 | ||||||||||||||||||||||||||||||||||||
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TSG Stock Market LetterWeek Ending February 15, 2008Topics Discussed This Week:
Miscues leave stocks mired in no-man’s landThat stocks registered mediocre performances this week is not the issue. What is amazing is that with all the cracks spreading through credit markets, stocks didn’t fall out of bed. This was clearly evident Tuesday as the Dow rallied more than 130 points on Warren Buffett’s $800 billion municipal bond reinsurance (bailout) plan – a plan that would allow the Sage to reinsure monoline insurers’ safest bonds for a hefty $4.5 billion fee. But municipal bonds aren’t the problem; it’s the more than $1 trillion of asset-backed securities (including mortgage-back securities and collateralized debt obligations) bond insurance issued since 2001 that represent the real risk to credit markets. In other words, stocks rallied on a plan that even on the miniscule chance it is consummated, would do little to reduce the risk of a systemic failure. (If Mr. Buffett isn’t already a member of the mystery-shrouded Plunge Protection Team, he should be.) This optimism was further evidenced by the nearly 180-point Dow rise in spite of the failure of municipal bond auctions and skyrocketing rates Wednesday for the biggest Dow gain since the year began. In one case, rates on $100 million of bonds sold by the Port Authority of New York and New Jersey, soared to 20% from 4.3% just one week before due to an absence of buyers (see Auction-Bond Failures Roil Munis, Pushing Rates Up in reading list). But stock investors instead gleefully focused on the January retail sales 0.3% increase versus the expected 0.4% drop (ignoring the fact that core retail sales excluding autos, gas and food, fell in real terms.) Then on Thursday, news from UBS exposed a new crack forming in credit markets – losses in Alt-A markets originally deemed more secure than subprime. These losses are based on no write-downs in monoline bond insurers’ (like Ambac and MBIA) ratings – an assumption that requires a huge leap of faith. Stocks did fall 175 points (Dow) Thursday but only after rallying nearly 180 points in the morning. In the face of rapidly deteriorating fundamentals, the obvious question remains. What is keeping stocks up? I put it down to misplaced hopes by investors that a variety of bailouts will prove successful in negating the long-term fallout from the bursting bubbles around the globe. From where I stand, stocks are priced for the best case scenario in credit markets and the economy. Students of history know better. Technically SpeakingLeaders resume surgeAfter a tough week last week, Dan Zanger’s Sunday portfolio led the pack with a gain of more than 4% compared to 1.4% for the S&P500 and Dow. His 9 picks this week again included Apple (AAPL), Mosaic (MOS), Mastercard (MA), Research in Motion (RIMM), Baidu (BIDU), Petro Bras (PBR) as well as Hess Corp (HES), DB Commodity (DBC) and EOG Resources (EOG).
This week the major indexes rose, except that this time it was the turn of the Dow Transports Average as worst performer. On the weekly charts, the Dow Industrials failed to break down through key support at 12,100 but like the S&P, looked to be in the process of forming a bear flag that often implies much lower prices if support is broken.
Volatility dropped this week as the Market Volatility Index (VIX) fell to 25.02 from 28.01 last week. But it was another strong week for the 17 commodities that make up the NYFE CRB Index, which soared to close 526.28 from 518.47 last week. It pushed the index further above its upper 2-standard deviation trend channel, a level it has closed above for nine consecutive weeks. But gold dropped to close at $906.10 from $922 last week as the yellow metal continued to consolidate. It is well into its strong seasonal performance period between the end of January and end of June but resistance at $930 will be its next major barrier. But the dollar also dropped with the U.S. Dollar Index dropping to 76.21 from 76.82 as the dominant downtrend resumed. Meanwhile the NYMEX crude oil (continuous) contract moved higher closing at $95.45/bbl from $91.77/bbl last week and $88.96/bbl two weeks ago. This week, the U.S. prime bank rate held steady at 6.00% as did the Fed funds rate at 3.0%. The 3-month London Interbank Offered Rate (LIBOR) slid to 3.07% from 3.088% last week and 3.3% three weeks ago. Although LIBOR dropped, Freddie Mac mortgage rates rose to 5.72% (5.67% last week) for the 30-year fixed mortgage while the rate fell to 5.0% (from 5.03% last week) for the one-year adjustable rate (ARM) – evidence that lending standards remain tight. EarningsEarnings still trending lowerThree weeks ago, Q4-07 earnings had fallen 73% from the same quarter a year ago, two weeks ago they were down 52% and last week that deficit was 37%. And that is where it stayed this week. With 2474 companies having reported so far (1968 companies last week) average earnings were again down 37% from the same quarter the year before. As the season approaches an end (final week of March) this number probably won’t change all that much. This compares to a drop of 21% (4205 companies) at the end of Q3-07 reporting season and a 13% jump in Q2-07. As we can see from the chart below, Wall Street earnings continue to decelerate at a rapid rate.
Figure 3 – Chart showing changes in earnings from the same quarter the year before. Q4-07 reporting season has just passed the half-way mark with earnings down 37%. Economic ReportsHere are the reports we were following this week. Credit markets still deteriorating
Chart 1 – We updated our ABX indexes this week. Here is the composite of 15 different asset-backed credit default swap indexes from AAA prime to BBB minus sub-prime mortgages (blue line) compared to the lowest grade (BBB minus) monitored by Markit.com. Set at a value of 100 in January 2007, the bonds have fallen nearly 60% and 90% respectively. The best performer of the group (ABX AAA-07-02) is down more than 30% (see next graph). Until these trend reverses, expect to see credit markets, especially for mortgages and refinancings, and the housing market continue to contract. (The group now has 20 indexes but the latest five on-the-run indexes are new = less historical data). Chart 2 – The best performer index is off more than 30% while double AA index has fallen more than since 60% since January 2007 according to Markit.com.
Trade gap narrows…
Chart 3 – The trade deficit dropped to $58.8 billion in December from $63.1 billion in November due to a weakening economy and falling dollar, led by drops in auto sales and consumer good – further signs of weakening consumer spending. Meanwhile, the deficit with China fell slightly to $18.8 billion in the month. Overall, the trade gap with China hit a record $256.3 billion in 2007, despite the late year poor showing in same-store-sales from Wal-Mart, the largest single seller of Chinese goods in America.
Chart 4 – Net capital flows into US Treasuries fell to $60.4 billion in December from a revised $150.8 billion in November. That the number remains positive shows that the weak dollar hasn’t yet scared away investors. Net purchases by foreign official institutions were $35.8 billion and net purchases by private foreign investors were $33.3 billion. U.S. residents purchased a net $12.6 billion of long-term foreign securities. Next WeekHere are the reports we’ll be watching.
SynopsisStocks walk the lineAction this week again revealed the flaws in the efficient market hypothesis theory. Markets are only as efficient as sentiment allows and this week that sentiment was downright buoyant. But this optimism can only last so long in the face of deteriorating earnings and credit markets. This next week will be pivotally important. Technically, if key S&P and Dow support levels are not broken they have the potential to provide a stepping stone to higher prices… as long as more bad credit news doesn’t undermine it. But from 30,000 feet, although rallies will come, they will be short-lived as long as this bear controls the forest. Requiem on the Carry Trade?Much has been written about the carry trade that relied on cheap Japanese interest rates and high-yield returns on New Zealand, Australian or other bonds to reap handsome profits. How is the trade doing? Its best days appear to be behind it if the New Zealand dollar-Japanese yen currency cross is any indication.
Figure 4 – Weekly chart of the New Zealand dollar – Japanese yen cross, a barometer of the carry trade. After peaking in late July 2007, the value of the cross has fallen nearly 15%. Chart by GenesisFT.com However, until the uptrend that began in 2001 is decisively broken as evidenced by a major breach in the 100-week moving average (red line), the trade is still technically alive. Why is it important? The carry trade is a proxy of sorts for global credit markets and when it breaks down, not only is it bad news for global liquidity but for commodity-based economies as well that have benefited from the steady supply of easy money. Whatever the outcome, it promises to be an interesting story. Stay tuned!
Stories of interest this week… Third of recent buyers owe more than home's value Government, Banks Forge Foreclosure-Freeze Deal Buffett Bids for MBIA, Ambac Municipal Bond Contracts Fed Interest-Rate Cuts Fail to Lower Borrowing Costs Global Confidence Weakens for Third Month on Slowdown Europe Economy May Stay Sick After Catching U.S. Cold UBS reveals new U.S. loans exposure UBS Won't Support Failing Auction-Rate Securities Home Prices Fall in 77 U.S. Metro Areas Sacramento: Foreclosures Nearly Equal Home Sales Auction-Bond Failures Roil Munis, Pushing Rates Up
U.S. Economy: Confidence Drops, Manufacturing Fails to Increase Banks at Risk From $203 Billion Writedowns, Says UBS ------------------------------------------------------------------------------------------------------ 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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