| TSG Weekly Market Letter July 18, 2008 |
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| Written by Matt Blackman | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Saturday, 19 July 2008 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
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TSG Stock Market LetterWeek Ending July 18, 2008Topics Discussed This Week:
Stock rally – a real reversal or a dead-cat bounce? Leaders take big hit Earnings for Q2-08 deteriorate Builders get more pessimistic, starts get NYC spike The mother of all short squeezes Snapshot of the larger picture or making sense of the rally
Last Week
Quotes of the week “We're trading purely on emotion right now. There is rife speculation on where we are fundamentally, but the truth is no one knows [the true state of many financial firms' books, which remain laden with complicated, difficult-to-value credit instruments]." - Peter McCorry, senior equities trader for Keefe, Bruyette & Woods. "This is a very serious financial crisis and it is the most serious financial crisis of our lifetime. It is an idle dream to think that you could have this kind of crisis without the real economy being affected." George Soros in Bloomberg interview, July 14-08. Rally real or short covering bounce? Stocks rallied this week and it was the first time we have seen all green on the index table since May 30. But stocks were way overdue for a bounce and the question remains, how much of this week’s rally was driven by short covering (see below)? But at least some of the power of the stock rally was powered by falling oil prices, as a barrel of black gold dropped below $130/bbl this week for the first time since May 30. Technically Speaking Leaders struggle Dan Zanger’s Sunday list was again composed of 10 stocks this week that included Potash (POT), Agrium (AGU), Murphy Oil, (MUR), Whiting Petro (WLL), PetroBras ADR (PBR), Apache Corp (APA), Energy Conv (ENER), Apple (AAPL), Baidu.com (BIDU) and Visa (V), the list pretty much unchanged from last week. After falling a percent last week, Dan’s portfolio of stocks led the market to the downside with a drop of nearly 7% compared to gains for the Dow Industrials, S&P500, Dow Transports, Nasdaq and Emerging Markets ETF (EEM). In my books this is bearish and shows that while the most heavily shorted stocks in the market rallied strongly (see below), the strongest stocks over the last few weeks were weak and that is a bad sign.
Figure 1 –Five-day 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. Not surprisingly weekly volumes on the NYSE, Dow Industrials, Dow Transports and Nasdaq surged back above average for the second week (and higher than last week) which for the Dow, S&P500 and Nasdaq is bullish. 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. But will this capitulation short rally bounce have any staying power (see below)? Meanwhile, after spiking to 27.49 last week the Market Volatility Index (VIX) settled down this week to 24.04 which is still above the 52-week moving average of 23.32 and 21.22 VIX reading five 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. But after hitting another high of 611.51 two weeks ago the 19 commodities that make up the NYFE CRB Index took a big hit this week to close at 526.86 down from 594.13 last week. Moving in the opposite direction of stock indexes, the CRB Index had gotten very overbought and now some of the air has come out of the bubble. But surprisingly gold held its ground to close the week at $957.50/oz versus $960.40 last week and $935.90 two weeks ago. Part of the reason for its strength in the face of falling commodity prices is the fact that it’s approaching the beginning of a strong seasonal period from the end of July to the end of September. But after losing ground last week to near record lows of 71.92, the U.S. Dollar Index closed at 72.17 this week. Its daily all-time low of 71.33 was 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.Oil also took a big hit this week as the price of a barrel of NYMEX crude oil contract dropped to $129.10/bbl down from $145.15 last Friday. However, it was the twentieth consecutive week that oil has remained above $100. Based on the seasonality of oil with a peak in mid-October, this correction may just be temporary unless the economy continues a rapid decline. 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) was unchanged at 2.790% (from 2.791% two weeks ago and 2.8% four weeks ago). Freddie Mac mortgage rates slid this week to 6.26% (from 6.37% last week, 6.35% two weeks and 6.45% three weeks ago) for the 30-year fixed mortgage while the one-year adjustable rate mortgage (ARM) dropped to 5.10% from 5.17% last week, 5.27% three weeks ago but up from 5.09% five 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 drop harder The second week of Q2-08 was even more brutal than the first and with a total of 631 companies having reported (up from 422 last week), earnings fell a whopping 31% (-22% last week) versus Q2-07. This compares to a 30% drop for Q1-08 earnings season with a grand total of 4214 companies having reporting. We are now into the third quarter in which 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 ReportsHere are the charts we were watching this week. Homebuilder pessimism grows and a NYC housing start spike
Chart 1 – July marked a new low for the National Association of Home Builders Housing Market Index with a reading of just 16. The survey of home builders showed that present single family homes dropped 17 in June to 16 while the expectation for sales of single family homes in the next six months from 27 to 23 and the traffic of prospective buyers through show homes fell from 16 to 12.
Chart 2 – Call it the New York bounce as both housing permits and starts took a big jump in June up 11.6 and 9.1% respectively month-over-month. The big gains were due to a last minute dash for both resulting from a change in New York City’s building code as builders rushed to get their starts and permits before the deadline. But if you exclude the multifamily jump, starts dropped 4% according to Bloomberg. Permits would have presumably also been negative. Even with the jump, permits are down 25.6% and starts down 26.9% year-over-year.
Chart 3 – Net Treasury International Flows fell $2.5 billion in May for the fourth monthly drop in the last ten months. Why is this important? Given the huge U.S. budget (and current account) deficits means this country is beholding to foreigners to lend them money. Treasury must sell more than $30 billion in U.S. Treasuries each month just to pay the budget deficit (dashed yellow line). It is not a matter of if but when foreigners finally will get tired of earning low returns in a weakening currency and means that when that day comes, interest rates will have to rise to attract the requisite capital (see declining trend line). Next Week Here are the reports we’ll be watching next week. The ones emboldened are leading, useful or indicators we are tracking, the others have the potential to impact markets short-term. - Thursday, June Existing Home Sales (previous 2.0%). - Friday, June Durable Goods (previous 0%), June New Home Sales (previous -2.5%), July Reuters/U Mich Sentiment Index Synopsis Tuesday’s action by the SEC in amending Regulation Short Sales (RegSHO) listed 19 banks and financials companies for which naked shorting was effectively banned for 30 days. Such a limit was long overdue but why limit the restriction to just 19 companies and just 30 days? Naked short selling (selling shares short that are not first borrowed which is required to execute a legal short) is endemic and the SEC has turned a blind eye to it since the agency was created. This recent action is a knee-jerk reaction but a clear example of too little way too late. The question is will they have the stomach to do what it necessary and give all stocks the same naked short protection? But like anything else, the devil is in the detail. As you can see from the chart below, the ban and rally created one mother of a short squeeze this week with the 17 companies trading on the NYSE rallying nearly 20% in just three days. However, since May 1, 2008 this group is still down 24.8%. (Before this week’s rocket ride, the group was down 37.2%) Not surprisingly given the government bailout plan announced this week, Fannie Mae (FNM) and Freddie Mac enjoyed the biggest lift jumping 89.5% and 74.5% between July 15 and July 18. But as of the July 18 close, there were still down 61% and 72% in the last four months since (March 20). In their monthly Short Interest Report on July 16, Bespoke Investment Group updated their short interest numbers showing that short interest as a percentage of the float continued to increase during the second half of June with the average short interest hitting 6% for the S&P500. Over the last year, short interest has increased 48% for the 500 stocks. Bespoke also found that the 10 percent of stocks in the S&P1500 with the highest short interest (150 stocks) gained 15.1% in the two day period ending July 17, 2008 compared to just 2.2% for the 150 stocks with the lowest short interest. Now that’s a short squeeze rally!
Figure 2 – Chart showing three-day stock performance for 17 of the 19 stocks that the SEC identified in its naked-short prohibition order amendment to the Regulation Short Sale (RegSHO) rules Tuesday. Two of the companies trade on the pink sheets so we graphed the other 17 that trade on the NYSE. As a group, these stocks jumped nearly 20% in the three-day period! Chart by VectorVest.com We checked Buyins.net, a website that tracks naked short selling statistics that became available as the result of RegSHO that became law on January 1, 2005. Buyins.net has to contend with a regular barrage of hack attacks presumably from short sellers who don’t like what they are doing We looked at their list of stocks that are fail to delivers (FTDs) (stocks shorted without first having to borrow the same number of shares, which is what you and I have to do before executing a short sale). Top of the list is Medis Technologies (MDTL), which has remained on the SEC’s fail to deliver threshold list for 742 days. In other words, it has been the target of naked short attacks and these shorts have not had to deliver shares that they have shorted for a total of 742 days! We counted a total of 244 stocks that have stocks that are classified as fail to delivers in excess of the maximum supposedly allowed by the SEC of 13 days. Brokers, market makers and some other big players have found ways around this inconvenient rule. Brokers and money-makers should have some time to deliver borrows but 742 days? There is something seriously wrong in stock regulation/enforcement land and as long as it is allowed to continue, stock markets will experience increased short-driven volatility. Larger Picture Looking at the broad market, stocks were way oversold and overdue for a bounce. But this doesn’t mean the rally is back to stay. It’s a time to exercise extreme caution. That being said, this rally could last for days or even weeks so if you are a trader, by all means go ahead and play the upside but be sure to set your stops very tight.
Figure 3 – Weekly chart of the S&P500 showing this weeks rally touching the bottom of the neckline of the bearish head & shoulders top pattern. If price breaks above the neckline watch for the fakeout – a break above the neckline to fool you into thinking the worst is over. It will need huge volume to be sustained and when volume begins to dry up, look out below. Chart by GenesisFT.com Stories of interest this week… Citigroup's $1.1 Trillion of Mysterious Assets Shadows Earnings http://www.bloomberg.com/apps/news?pid=20601109&sid=a1liVM3tG3aI&refer=home Global Economic Confidence Drops on Market Turmoil, Oil Surge http://www.bloomberg.com/apps/news?pid=20601068&sid=a25Jf4sXEt70&refer=economy Fannie Plan a `Disaster' to Rogers; Goldman Says Sell http://www.bloomberg.com/apps/news?pid=20601087&sid=a5GYUti82O0s&refer=home SEC to Limit Short Sales of Fannie, Freddie, Brokers http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aQro9RDFCne4 SEC Poised to Exempt Market-Makers From `Naked-Short' Sale Ban http://www.bloomberg.com/apps/news?pid=20601087&sid=a6vYdD7V5sB4&refer=home U.S. `Misery Index' Climbs to 15-Year High on Prices http://www.bloomberg.com/apps/news?pid=20601087&sid=aHXJY.fS72Ss&refer=home U.S. Economy: Consumer Prices Up 5%, 17-Year High http://www.bloomberg.com/apps/news?pid=20601087&sid=aytt_8EhMyRE&refer=home Europe Inflation Accelerates to Fastest in 16 Years http://www.bloomberg.com/apps/news?pid=20601068&sid=aInGe5pMXnAo&refer=economy Mexico Bank May Raise Rate for Second Month as Inflation Mounts http://www.bloomberg.com/apps/news?pid=20601110&sid=aoYIfanjnzZI BOJ Cuts Economic Assessment, Says Growth Is Slowing `Further' http://www.bloomberg.com/apps/news?pid=20601068&sid=adagXFEX7tko&refer=economy Interesting articles from the archives Tice Proves Every Bear Has a 9.5% Return as He Invokes `D' Word http://www.bloomberg.com/apps/news?pid=newsarchive&sid=a8qiQmY7BEPc OPINION The Lost Decade: How the U.S. Financial Crisis Resembles Japan’s Ten Years of Misery - And How to Play it http://www.moneymorning.com/2008/07/17/the-lost-decade/ The Lost Decade: Part 2 http://www.moneymorning.com/2008/07/18/lost-decade/ VIDEOS Arthur Levitt on SEC Short-Selling Limit and "Bizarre" GSE Accounting Rules ----------------------------------------------------------------------------------------------------------------------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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