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TSG Stock Market Letter Week Ending July 11, 2008 Topics Discussed This Week: * Stock performances mixed amid deteriorating credit news * Inflationary pressure continues to mount * First earnings reports for Q2-08 show more bad news * Pre-election period on track to make history (of the unimpressive kind) | INDEX | Weekly Close | Last Week | Change | Change% | | INDU | 11,100.54 | 11,288.54 | -188.00 | -1.67% | | DJT | 4,776.74 | 4,678.75 | 97.99 | 2.09% | | SPX | 1,239.49 | 1,262.90 | -23.41 | -1.85% | | COMPX | 2,239.49 | 2,245.38 | -5.89 | -0.26% | | RUT | 674.95 | 665.78 | 9.17 | 1.38% | | EEM | 129.29 | 128.46 | 0.83 | 0.65% | Last Week | INDEX | Weekly Close | Last Week | Change | Change% | | INDU | 11,288.54 | 11,346.51 | -57.97 | -0.51% | | DJT | 4,678.75 | 4,909.12 | -230.37 | -4.69% | | SPX | 1,262.90 | 1,278.38 | -15.48 | -1.21% | | COMPX | 2,245.38 | 2,315.63 | -70.25 | -3.03% | | RUT | 665.78 | 698.14 | -32.36 | -4.64% | | EEM | 128.46 | 134.29 | -5.83 | -4.34% | Quote of the week “June was the second straight month with more than a quarter million properties nationwide receiving foreclosure filings. We have not yet reached the top of this foreclosure cycle.” – James J. Saccacio, chief executive officer of RealtyTrac. Mixed bag of a week for stocks It was a week of more you-know-what hitting the fan for credit markets as IndyMac, the second largest federally insured finance company, was seized by regulators. To make matters worse, more insolvency rumors circulated about Fannie Mae and Freddie Mac that guarantee approximately half of the $12 trillion in mortgages across the country. But it spite of this fact stocks attempted to stage a comeback with mixed success as the Dow Industrials, S&P500 and Nasdaq Composite again lost ground for the fourth consecutive week. Looking at the bigger picture, it was a bad week for a number of indexes as more key support levels were broken even though many are extremely oversold. According to one rather somber analyst interviewed on Bloomberg this week, a big reason why stocks have held up in spite of worsening credit news is that sovereign wealth funds have been on the long side of the market presumably to take advantage of attractive valuations. But this strategy will backfire if we are in a true bear market and asset bubbles, especially in real estate and credit, continue to implode. Technically Speaking Leaders struggle Dan Zanger’s Sunday list was composed of 10 stocks this week including Agrium (AGU), Potash (POT), Murphy Oil, (MUR), Whiting Petro (WLL), PetroBras ADR (PBR), Apache Corp (APA), Energy Conv (ENER), Apple (AAPL), Baidu.com (BIDU) and Visa (V). After falling more than 7% last week, Dan’s portfolio of stocks fell a percent this week, about the same as the Industrials and S&P500 while the Dow Transports gained nearly 2%. 
Figure 1 –Four-day (actually 3.5) performance of Zanger’s market leaders (green) 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. Weekly volumes on the NYSE, Dow Industrials, Dow Transports and Nasdaq were back above average which for the Dow, S&P500 and Nasdaq was bearish. Stocks can fall of their own weight but need steadily increasing volume to drive them higher but that fact that volume increases on down days is bearish as it signals that sellers are in control. The market is still looking for a capitulation bounce and each week gets more oversold. Meanwhile, the Market Volatility Index (VIX) climbed again to 27.49 from 24.80 last week and 21.22 four weeks ago. This compares to a VIX north of 31 when the Dow last bottomed during the week of March 14 and shows that fear has so far remained muted during this recent decline. After hitting another high of 611.51 last week the 19 commodities that make up the NYFE CRB Index gave up some ground this week to close at 594.13 down from 596.79 two weeks ago and 571.90 four weeks ago. Moving in the opposite direction of stock indexes, the CRB Index keeps getting more overbought every week supercharged by a weakening dollar. Gold continued to make gains this week to close at $960.40/oz. from $935.90/oz last week and $873.40 four weeks ago as it approached the beginning of a strong seasonal period from the end of July to the end of September. But after making gains last week the U.S. Dollar Index closed at 71.92 down from 72.74 last week getting dangerously close to its all-time daily low of 71.33 put in on April 22. And as the economy continues to weaken and an election approaches, it is looking increasingly unlikely that the Fed will raise rates to try to support it. After a brief break earlier this week, oil put in another high as a barrel of NYMEX crude oil contract closed at $145.15 Friday up from $144.46/bbl last week. It was the nineteenth consecutive week that oil has remained above $100. Based on the seasonality of oil with a peak in mid-October, this rally could continue for a few months yet. The U.S. bank prime rate held again this week at 5% and the Fed funds target rate remained at 2%. The 3-month London Interbank Offered Rate (LIBOR) held at 2.790% (from 2.791% last week and 2.8% three weeks ago). Freddie Mac mortgage rates rose slightly this week to 6.37% from 6.35% last week and 6.45% weeks ago) for the 30-year fixed mortgage while the one-year adjustable rate mortgage (ARM) held at 5.17% (from 5.27% two weeks but up from 5.09% four weeks ago). LIBOR is the benchmark for $900 billion in subprime mortgage loans which typically adjust to it every six months. Corporations around the world have the interest rates on roughly $9 trillion in debt pegged to LIBOR and rates on more than $380 trillion in derivative interest rate swaps also are based on LIBOR. Earnings Earnings still falling as new season begins It was the first week of Q2-08 reporting season and with a total of 422 companies having reported earnings fell 22% versus Q2-07 (when earnings were up 13% from Q2-06). This compares to a 30% drop for Q1-08 earnings season with a grand total of 4214 companies having reporting. But as we have seen in the last two quarters earnings have shown a consistent trend to fall as more companies have reported. Looking at past seasons, there was a drop of 57% for final Q4-07 (3900 companies), a 21% drop (4205 companies) for Q3-07 and a 13% jump for Q2-07. Economic Reports Here are the charts we were watching this week. 
Chart 1 – The National Association of Realtors pending home sales index, a supposed leading indicator of existing housing demand fell 4.7% in May. But it’s not really very accurate for two reasons. First, although it’s supposed to lead, the number is not reported for nearly two months and since most homes complete in 30 to 60 days, the data comes out as the homes are completing. (Pending home sales data reports contracts signed but that have not yet completed). But the biggest challenge with this metric is that it does not include cancelled contracts or those that fail to complete and the number of cancelled contracts which become more common in falling markets. Cancellations have been running north of 30% over the last two years. So like existing home sales, this is a statistic that should be taken with a big grain of salt and is in reality not really leading at all, especially considering that the data are almost continually revised. 
Chart 2 – Import prices continue to swell thanks to a falling dollar as prices increased another 2.6% in June (annualized), a clear indication of inflationary pressure. Oil import prices have risen an average 8.5% annualized over the last four months. 
Chart 3 – And we will continue to see import prices rise as long as consumers can continue to obtain credit which continues to grow in May. But this will also put more pressure on consumers as evidenced by the rapidly rising foreclosures and credit card default rates. Next Week Here are the reports we’ll be watching next week. The ones emboldened are leading or useful indicators, the others have the potential to impact markets short-term. - Tuesday, June Producer Price Index (previous 1.0%), June Retail Sales (previous 1.0%). - Wednesday, June Consumer Price Index (previous 0.6%), May Treasury International Capital Flows (previous $60.6 billion), July NAHB Housing Market Index (previous 18). - Thursday, June Housing Starts (previous -3.3%), June Philadelphia Fed Business Index (previous -17.6). Synopsis Technically troubled and cyclically challenged While the Dow Jones Industrial Average broke major support two weeks ago on the weekly chart, the same thing occurred for the S&P500 Index and the NYSE Index which broke bearish head & shoulders top neckline support this week. Meanwhile, the MSCI Emerging Markets ETF (EEM) which broke neckline support last week failed to break back above it and even more bearish is the fact that this failure came on significantly increased volume and that the EEM is now what looks to be a bearish flag on the daily chart. Just how challenging this market has been is becoming clear in examining a long-term chart of the S&P500. We compared other two-year pre-election periods, traditionally the best time to be in the market for more than a century and discovered that unless we see a 96 or more point (7.7%) rally on the index, it will be the first time this historically stellar period consisting of the 26-months leading up to each election has ended down since 1948 following World War II. If the SPX were to end where it is this week, it will be the worst per-election performance since 1940 when the world was preparing for war, a period in which the SPX fell 11.8%. It is also amazing that even though stocks remain extremely oversold this market has been unable to manage some sort of bounce. This is bearish but also requires great caution to trade. Those on the short side of the market require a high pain threshold or risk getting shaken out of short trades when these powerful rallies do finally appear. And that usually occurs when they are least expected. Stories of interest this week… Second Biggest U.S. Finance Company Seized by U.S. Regulators http://www.bloomberg.com/apps/news?pid=20601087&sid=aAYLeK3YAie4&refer=home Fannie Mae, Freddie Mac Tumble on Takeover Option http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aIePshn7LFOM Fannie Mae, Freddie Mac Turmoil Pose New Economic `Headwind' http://www.bloomberg.com/apps/news?pid=20601087&sid=a1awX5uIRoFA&refer=home Toxic CDOs Given Up for Dead Coming to Life With Pension Funds http://www.bloomberg.com/apps/news?pid=20601109&sid=a0TGMrBy2PyE&refer=exclusive June home foreclosures up 53 percent http://www.reuters.com/articlePrint?articleId=USN0945481320080710 Lehman shares plunge amid market distress http://www.reuters.com/article/ousiv/idUSN1135994720080712?sp=true U.S. bank earnings fraught with pain, uncertainty http://www.reuters.com/article/ousiv/idUSN1048551720080710?sp=true Airbus Says One-Third of Backlog Is Threatened by Oil http://www.bloomberg.com/apps/news?pid=20601087&sid=a3jsVuhIAvFY&refer=home ---------------------------------------------------------------------------------------------------------------------- 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). Disclaimer TradeSystemGuru.com obtains information from sources deemed to be reliable;
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