| TSG Stock Market Letter March 28, 2008 |
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| Written by Matt Blackman | ||||||||||||||||||||||||||||||||||||
| Saturday, 29 March 2008 | ||||||||||||||||||||||||||||||||||||
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TSG Stock Market LetterWeek Ending March 28, 2008 Topics Discussed This Week:
Another unimpressive week With all the bullish talk of a market bottom from analysts and money managers over the last few weeks, it was another uninspiring week on Wall Street leaving many to ask, “so where is this bottom?” Monday – Volumes were lower than average on Easter Monday as the Dow rallied more than 200 points on news that JP Morgan had increased its bit for Bear Stearns to $10/share from $2 last week. Fearing that they were being left behind in this much touted bottom, investors joined the party but lower volumes showed that caution still reigns. Better than expected existing home sales and easing oil prices also helped. But as the market approached the close, stocks faded somewhat with the Dow ending the day up 187 points. Tuesday – After two days of stellar gains, the Dow took a break closing down 16 points on the day despite bad news on home prices and more evidence of weaker consumer sentiment. Wednesday – But the bad news on Tuesday combined with disappointing new homes sales figures and falling durable goods orders Wednesday, pushed the Dow down 110 points. Thursday – But counter to the overall market tendency to discount bad news, disappointing news from technology bellwethers Google and Oracle was enough to cause the blue chips to again sink as the Dow Jones Industrial Average lost another 120 points. Further negative impact on stocks came as a result of higher oil prices over the previous two days. Friday – Although stocks got off to a reasonable start and it looked like it would be a flat close, weaker than expected personal spending and retail data late day caused selling to increase toward the close with the Dow ending the week down another 86 points. Technically SpeakingBut leaders hold their own While the large cap indexes rolled over this week, technologies, transports and Dan Zanger’s picks managed to close in positive territory if only just barely. Dan commented this week that these are the wildest and most volatile days he has ever seen as his picks eked out a 0.5% gain. Dan’s 10 Sunday picks again included Devon Energy (DVN), EOG Resources (EOG), Apple (AAPL), Mastercard (MA), Mechel Open (MTL) and Mercadolibre (MELI) as well as past pick Intuitive Surgical (ISRG) but this week a number of financials such as Goldman Sachs (GS), Lehman Holdings (LEH) Merrill Lynch (MER) and Morgan Stanley (MS).
Figure 1 – Weekly five-day performance of Zanger’s market leaders compared to the S&P500 (SPX), the Dow Jones Industrial Average (DJX), Dow Transports (DTX) and Nasdaq Composite (IXIC). Data courtesy of The Zanger Report, performance chart courtesy of VectorVest.com. Volumes on the NYSE and Nasdaq dropped for the third consecutive week, which does not bode well for a strong up-move in stocks from here. To rally stocks need to see steadily increasing volumes and that is simply not happening. And even though the Nasdaq managed a modestly higher close this week, the volume drop in the last two weeks should concern bullish traders. After losing for the last two weeks, the MSCI Emerging Markets ETF (EEM) managed a 4% gain which could be good news if the trend continues. However, that bearish head & shoulders top pattern we mentioned in the last couple of weeks with a neckline support line at 130 is still a very real threat. Volatility settled down this week as the Market Volatility Index (VIX) dropped to 25.76 from 26.62 last week and 31.16 the week before. If you have followed the bulls, another argument for a bottom is that volatility has been dropping and that is bullish. However, while ubiquitous in financial circles, this theory does not prove out in back-testing. After the largest weekly drop in at least 34 years, the 17 commodities that make up the NYFE CRB Index made a comeback of sorts ending the week at 525.56 from 523.80 last week. Gold also made a come modest comeback this week closing at $930.60/oz. up from $909.90 last week. Gold remains in its strong seasonal performance period between the end of January and end of June. Given the last global fad by central bankers at money pumping to keep economies going at all costs, it is highly unlikely that the incredible commodity and gold runs are over. That reality was clearly evident in the moribund performance of the dollar as the U.S. Dollar Index fell again on a weekly basis to close at 72.03 from 72.78 but up marginally from the 71.66 close two weeks ago. For insight into where the dollar may be headed be sure to check out the Jim Grant Bloomberg interview (link below) in which he declares the Fed balance sheet “an economic nightmare.” Always entertaining, Grant also has an enviable track record in spotting credit trouble well ahead of the rest of the Street. Meanwhile after the NYMEX crude oil (continuous) also lost ground, it remained above $100 for the fifth consecutive week closing at $104.95 up from $101.44 last week but down from $108.66 two weeks ago. This week the Fed funds rate held at 2.25% (target). But the 3-month London Interbank Offered Rate (LIBOR) moved up to 2.6975% (from 2.606% last week and 2.76375% two weeks ago) showing that in spite of more than $800 billion in injections from the Fed and U.S. government, commercial credit markets remain tight. Freddie Mac mortgage rates again held steady at 5.85% (from 5.87% last week and 6.13% two weeks ago) for the 30-year fixed mortgage while the rate moved up again to 5.24% (from 5.15% last week) for the one-year adjustable rate (ARM). This is in spite of the $200 billion Fannie Mae and Freddie Mac boost from the Office of Federal Housing Enterprise and Oversight (OFHEO) which cut their surplus capital requirements two weeks ago. So far the move has yet to translate to lower rates for borrowers. Earnings Q4-7 reporting season all but over, earnings down and out But for a few stragglers, it was the end for reporting Q4-07 and with a total of 3870 (3997 companies last week) having reported so far improvements held at a dismal -57% (from -56% two weeks ago) versus the same quarter the year before. This compares to a drop of 21% (4205 companies) at the end of Q3-07 reporting season and a 13% jump in Q2-07. Economic ReportsHere are the reports we were tracking this week. And here are the charts we are following. Housing markets continue to fall as price declines accelerate
Chart 1 – Although stock bullishness on Monday was partly driven by the better than expected existing home sales increase in February of 2.9%, the jump was a result of the largest year-over-year drops in home prices so far this real estate down cycle. As the National Association of Realtors cheerleader Lawrence Yun freely admits, year-over-year changes are far more reliable than monthly changes and existing home sales have fallen 25% since February 2007. The increase in the month-over-month number caused the NAR to revise the inventory of homes to a 9.6 month supply from 10.2 months in January. While Yun tried to put a positive spin on the monthly increase in sales, what he did not say is that foreclosures are a big part of the picture. A glut of foreclosed homes of historic proportions is starting to drive down U.S. home prices faster as lenders put more properties on the markets according to the Wall Street Journal Monday. In beaten down markets like Detroit, home sales jumped 48% in the first two months of the year according to the Detroit Board of Realtors but the average home price has fallen a whopping 54%. Such price declines are having a predictable impact on sales as bargain hunters search for deals. The overabundance of foreclosed homes in the market is likely to push down home prices in much of the country for the next several years, said the CEO of housing-research firm Zelman and Associations Ivy Zelman, in the Wall Street Journal article. Foreclosed properties for sale represent one-in-nine homes on the market nationwide up from one-in-15 a year earlier and this ratio is sure to rise.
Chart 2 – Since peaking in July 2006, median existing home prices have fallen a whopping 14.9% and analysts are saying they expect that prices will fall another 15 to 20%. It is interesting to note that since July 2007, prices have fallen 14.3% in just eight months. On a year-over-year basis, median prices have fallen 8.2% but as we see from the chart, that number is misleading. Charts 1 and 2 have yet to show any indication of a bottom nor is there any such indication in building permits or housing starts. The Case-Shiller home price index (below) provided us with another perspective as did new home sales.
Chart 3 – Then on Tuesday, out came the S&P Case-Shiller home price index report for January showing that average prices in the 20 metropolitan areas tracked by the index were down 10.71% year-over-year, versus 9.01% in December. More importantly it shows that the rate of home prices declines continues to accelerate hitting another new all-time low rate of decline. Since peaking in July 2006, prices have fallen 12.53%. It is interesting to note that it was the thirteenth consecutive monthly decline and that 16 of the 20 areas reported new record low annual declines of which ten were double digit. January saw 19 of the 20 markets post price declines up from 17 in December with Charlotte NC being the lone holdout posting an increase in the last year (1.8%). The same day, an official from the Office of Federal Housing Enterprise Oversight (OFHEO) was on Bloomberg discussing their data showing home prices were down just 3% annually. Perhaps more amazing, monthly OFHEO figures showed the home prices began to decline in July 2007, seven months after the S&P CS index began to show home prices falling. How can these two figures be so different? I put it down to the fact that one is an attempt by a non-governmentally influenced organization (S&P Case-Shiller) to tell it like it is while OFHEO, a government group that like the National Association of Realtors positive propaganda pump with the sole mission of selling homes for its members, is attempting to put a positive (or in this case less negative) spin on the economy. After all, it is an election year and we know how much the government pumps up the economy to make it look as rosy as possible heading into each and every election. One only has to look at the close to $800 billion in Fed and government bailout programs put forward in the last few months…
Chart 4 – On Wednesday, we learned that new home sales continued to fall in February down 1.8% from January and 29.8% from February 2007 to an annual rate of 590,000 homes. There were 49,000 new homes sold in February up from 43,000 in January but since the numbers are seasonally adjusted, the difference was a reported drop. The inventory of unsold homes was 471,000 down from 481,000 in January which represents a 9.8 month supply. The median price of a new home was $244,100 but like re-sale homes, median prices have fluctuated making it of little value in assessing the true situation. The data show that the median price of a new home has fallen just 2.7% in the last year, which given all the credit turmoil and other challenges facing the economy makes little sense. And then there is the issue of builder incentives that are skewing prices higher… Too bad there isn’t a Case-Shiller home price index for new homes.
Chart 5 – Be sure to watch the Bloomberg interview (link below) in which Jim Grant, who accurately warned us of the depth and breadth of the subprime problem more than a year ago, tells us how serious a situation the Fed has gotten itself into. We updated our Markit.com ABX Composite Index which represents the current value of a broad spectrum of subprime mortgages. Valued at 100 in January 2007, the composite of 15 off-the-market bonds is now valued at 35 and the lowest rated bonds at 9 a more than 90% drop. As you can see from the chart, there are scant signs of a bottom in either. But one thing is sure, they can’t drop below zero. Next Week Here are the reports we’ll be watching. - Monday, March Chicago PMI (previous 44.5). - Tuesday, February Construction Spending (previous -1.7%), March ISM Manufacturing Business Index (previous 48.3). - Wednesday, February Factory Orders (previous -2.5%). - Thursday, March ISM Non-Manufacturing Composite Index (previous 49.3). - Friday, March Nonfarm Payrolls (previous -63,000), March Unemployment Rate (previous 4.8%). Synopsis Is the carry trade kaput? New Zealand interest rates have remained stubbornly stuck at 8.25% for months, which while not great for domestic borrowers, have been a boon to carry trade investors who borrow in a low-yield currency to buy debt instruments in a high-yielding economy. Interest rates in Japan have remained near 0.5% making it a cheap source of carry trade funds. As long as this spread remained high and currencies didn’t fluctuate wildly, the investor pocketed the difference between the two as profit. However, if the target currency (NZD) weakens substantially against the base (JPY) it can spell trouble. As we see from Figure 2, the NZD has weakened versus the JPY substantially since mid 2007. This currency pair is an excellent proxy for the health of the carry trade.
Figure 2 – Weekly chart of the New Zealand dollar/Japanese yen currency pair that is an excellent proxy for the carry trade. Chart by GenesisFT.com Another popular target of carry trade investors has been the Icelandic krona, which was the biggest loser against the dollar among the 177 currencies monitored by Bloomberg Friday on concern financial firms will suffer from the global credit freeze. The risk of Iceland's biggest banks defaulting rose above 49% based on credit-default swap (CDS) premiums. Since November 6, the krona has fallen more than 40% against the euro, dropping to a record low against that currency putting carry trade investors seriously underwater. It is down 32% against the beleaguered dollar since November. The Icelandic central bank unexpectedly raised interest rates to 15 percent this week and sold 7.15 billion krona ($93 million) of debt Friday in attempts to shore up the currency. Credit-default swaps on the Icelandic banks are more than 10 times higher than the average for European lenders as the credit market freeze prompted investors to shun all but the safest assets. Premiums on the krona indicate very distressed levels according to Matthew Hegarty, a credit analyst at Barclays Capital in London. “Credit spreads are implying there's a chance of default over the next five years. Not a probability, but a real possibility,” according to Bloomberg. Why is this important? The carry trade has generated a cheap source of funds for global investors including hedge funds and institutions which have been an important driver behind both equities and commodities markets in the last few years. As the damage swath cut by the credit crunch widens, it is having many unanticipated repercussions. A squeeze of the carry trade is one clear example. But just how much it will impact other markets remains to be seen. However, one thing is clear. Events across the Atlantic and South Pacific this week showed that a final end to the credit crisis is anything but near at hand. Stories of interest this week… Jim Grant on Bloomberg - Fed Balance Sheet "An economic nightmare." Wave of Foreclosures Drives Prices Lower And the award for the worst forecaster ever goes to.... (oldie but goodie) Taxpayers May Be Liable For Bear, Mortgage Rescue http://www.bloomberg.com/apps/news?pid=20601109&sid=aN.cnCGH92GQ&refer=home Lunch Lady Suffers as Banks Prepare $2 Trillion in Lending Cuts ----------------------------------------------------------------------------------------------------------------------------------------- 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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