| TSG Weekly Market Watch August 1, 2008 |
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| Written by Matt Blackman | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Monday, 04 August 2008 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
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TSG Stock Market LetterWeek Ending August 1, 2008Topics Discussed This Week: Rally goes nowhere Leaders on the upswing Q2-08 earnings show slight improvement Exports driving GDP growth, downward revisions turn Q4-07 negative Existing home prices down 16%Jobs still MIA Is the commodity bubble over?
Last Week
Quotes of the week “I thought things would be bad enough but they turned out to be a lot worse. I thought a year ago we were looking at the “first truly global bubble” in asset prices. The credit crisis looked to be so predictably powerful and unstoppable then that I likened the experience to “watching a slow motion train wreck,” and I predicted that “one major bank will fail within 5 years,” for which I got considerable grief as a doomsayer, as the less optimistic strategists usually do. Well a year later one bank failure looks positively quaint as a prediction. Ironically for a “perma bear,” I underestimated in almost every way how badly economic and financial fundamentals would turn out.” Jeremy Grantham – GMO Newsletter Q2-08 Rally goes nowhere It was a week of big stock see-saws as the Dow experienced big down days, followed by up days in alternate fashion with a loss of 52 points Friday. Overall, the index went nowhere on the week. Similar moves occurred in the other major indexes as investors went through bi-polar mood swings from one day to the next – first depressed by bad news then euphoric when some earnings reports came in better than expected. They even celebrated when reports were not as bad as expected. But in the final analysis, the housing market is showing little signs of a bottom and it continues to exert a major drag on both the economy and markets. As we learned this week, it is exports that have so far prevented the economy from entering an official recession. But this is due to a weakening dollar prompting the obvious question. What happens when the dollar begins to gain strength in earnest? Technically Speaking Leaders move higher Dan Zanger’s Sunday list was composed of 12 stocks this week again included Potash (POT), Energy Conv (ENER), Apple (AAPL), First Solar (FSLR), Google (GOOG), and Baidu.com (BIDU) was back on the list. Added were VisionChina (VISN), NII Holdings (NIHD), United Therapeutic (UTHR), US Steel (X) and Continental Air (CAL). After dropping 3% last week, Dan’s Sunday portfolio of stocks led the market higher with a gain of 1.4%. Second best performer was the Russell 2000 small caps. The rest of the indexes were flat to down.  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), Nasdaq Composite (IXIC), Russell 2000 (RUT) and MSCI Emerging Market ETF (EEM). Data courtesy of The Zanger Report, performance chart courtesy of VectorVest.com. Weekly volumes on the NYSE, Dow Industrials and Dow Transports were again below average this week which is bearish since it shows a lack of commitment from buyers. But it also shows that the bears are undecided. Nasdaq Composite volume was more positive and showed that buyers were indeed taking a chance while the NYSE Index has now spent the last four weeks below the critical head & shoulders neckline resistance level. Falling volume is decidedly bearish and shows that buyers aren’t joining the rally. Stocks can fall of their own weight but need steadily increasing volume to drive them higher. That volume increases on down days is bearish as it signals that sellers are in control. Most of the reliable technical indicators are saying we should be rallying but the volumes so far show a decided lack of commitment from buyers. Meanwhile, after spiking to 27.49 two weeks ago, the Market Volatility Index (VIX) settled down for a third week to 22.57 from 22.91 last week and 24.04 two weeks ago) which is just below the 52-week moving average. 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. But after hitting a high of 611.51 four weeks ago the 19 commodities that make up the NYFE CRB Index firmed this week to close at 546.67 (from 544.48 last week and 562.86 two weeks ago). Moving in the opposite direction of stock indexes, the CRB Index had gotten very overbought and it will be interesting to see if this is a temporary recovery or if the weakness will resume. But gold dropped again to close the week at $912.80/oz (from $926.90 last week and $957.50 two weeks ago). However, it has begun a strong seasonal period from the end of July to the end of September so we expect to see some strength in the coming weeks. It was the third consecutive week that the U.S. Dollar Index gained, closing at 73.36 up from 72.81 last week and 72.17 two weeks ago. 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 even though inflation is becoming a bigger global problem. Oil recovered this week as the price of a barrel of NYMEX crude oil contract firmed to $125.69/bbl from $123.43/bbl last week and $129.10 two weeks ago after hitting a weekly high of $145.15 July 11. However, it was the twenty-second consecutive week that oil has remained above $100. Normally, oil hits a seasonal high in mid-October so it will be interesting to see if this correction is just temporary or another indication of the weakening economy. 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) ticked up to 2.794% (from 2.793% last week). Freddie Mac mortgage rates slipped this week to 6.52% (from 6.63% last week) for the 30-year fixed mortgage while the one-year adjustable rate mortgage (ARM) dropped to 5.27% (from 5.49% last week). 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. But even with this recent slide, there has been a disturbing trend toward higher mortgage rates despite the Fed’s determined and significant efforts to flood the market with liquidity over the last nine months. Earnings Earnings tick up? It was the fourth week of Q2-08 reporting season and with a total of 1976 companies having reported (up from 1199 companies last week) average earnings losses moderated to -22% (from -33% last week and -22% three weeks ago) versus Q2-07. This compares to a 30% drop at the end of Q1-08 earnings season with a grand total of 4214 companies having reporting. This marks the third quarter that earnings have shown a consistent trend to drop 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 ReportsThis was as active week for reports. GDP growth driven by exports, downward revisions turn Q4-07 negative  Chart 1 – Chart showing the most recent revisions to GDP growth. As we see, Q4-07 was revised down from +0.6% to -0.2% while the latest estimate for Q2-08 GDP is 1.9%. The Commerce Department also revised growth from 2005-2007 downward, lowering overall growth for 2007 to 2% (from 2.2%) and average growth over the three-year period to 2.6% (from 2.7%). It is only logical to expect further downward revisions. In the final analysis it may take 18 months or more to confirm a recession thanks to revisions. The National Bureau of Economic Research, the official arbiter of the economy, defines a recession as “a significant decline in economic activity spread across the country, lasting more than a few months.” The good news is that exports rose 9.2% in Q2, strength that was responsible for 84% of the quarter’s GDP growth according to UniCredit economist Harm Bandholz. Democratic candidate Barack Obama should take note. He is promising to re-write NAFTA and other trade agreements increasing the chances for a trade war with those buying U.S. exports, the main driver of current economic growth.
Chart 2 – While the National Association of Realtor existing median price chart last week showed a rather mixed picture with prices moving up since February, the latest S&P Case-Shiller home price index is less murky. May marked the second consecutive month that all 20 cities showed annual declines with dropping an average 15.8% from May 2007. However, on a month-over-month basis, 8 cities showed increases with Cleveland showing the biggest increase at 2.9%. For more info click here. ( http://www2.standardandpoors.com/portal/site/sp/en/us/page.article/2,3,1,0,1204838123979.html )  Chart 3 – We got some hope Wednesday on the jobs front with the ADP Employment Report that showed an increase of 9,000 jobs versus the expected drop of 65,000. Instead non-farm payrolls came in on Friday with a drop of 51,000 jobs in July for the seventh consecutive monthly drop. Meanwhile the unemployment rate increased again to 5.7% from 5.5% in June. Unfortunately, we’ll have to wait for the inevitable revisions to know what really happened on the jobs front but one thing is clear. The trend remains strongly negative. 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. - Monday, June Personal Income (previous 1.9%), June Personal Spending (previous 0.8%), June Factory Orders (previous 0.6%). - Tuesday, July ISM Non-Manufacturing Composite Index (previous 48.2). - Thursday, June Pending Home Sales (previous -4.7%), June Consumer Credit (previous $7.78 billion). - Friday, June Wholesale Trade (previous 0.8%). Synopsis Commodity bubble nearing an end? Commodities have been on a tear since the beginning of 2002 driven by global demand and a cheap money policy. After beginning a parabolic move in August 2007, the CRB Index enjoyed an incredible 150% move as it peaked four weeks ago. However, since then commodities have experienced a 10% correction which is the second largest drop in commodity prices in the CRB Index’s history. So is this the end of the commodity run? It is interesting to note that the worst month for the CRB occurred in March 1980 and it, too came after a significant run-up in commodity prices. Did it market the end? According to Bespoke Investment Group, the index moved up another 24% over the next six months before putting it a multi-year high in September. Over the next 20 years however, the CRB Index fell before putting in a multi-year low in late 2001. Are we near the top of another super-cycle high? There are some indications that this could be the case. As we see from the chart below, emerging markets Brazil, Russia, India and China (BRIC) which have been responsible for drastically increasing global commodity demand have seen their markets drop significantly over the last nine months, falling further than moribund U.S. stocks.
Figure 2 – Chart showing relative performance of BRIC stocks indexes versus the U.S. since late October 2007. This is a good-new, bad-news story. Commodity growth has been responsible for strong demand of U.S. goods abroad which has been the major GDP driver and why growth in the U.S. has not yet turned negative. But rising commodity prices have also been responsible for rising inflationary pressures, especially in energy and food. Higher commodity costs have also been putting relentless pressure on manufacturers to raise prices or lose money. Falling commodity prices will be decidedly good news for consumers but falling prices could also indicate further economic weakness. What is better for stocks?
Figure 3 - Relative strength chart of the Dow Jones Industrial Average divided by the CRB Index. From 1980 through 2001, the CRB Index trend was generally negative as stocks experienced their longest and most powerful rally in history. Since 2001 however, commodity prices have been on a tear outperforming stocks. Chart by Metastock.com When commodity prices were trending lower from late 1980 through 2001, the Dow Jones Industrial Average performed strongly. As commodity prices rebounded, stocks languished and the U.S. economy experienced weakness. Stocks did recover in 2003 but in real terms (compared to gold) the Dow has performed very poorly indeed since peaking in 1999 against the yellow metal. If history is any guide, falling commodity prices should be good for stocks. Stories of interest this week… U.S. Economy: Unemployment Rate Increases to Four-Year High http://www.bloomberg.com/apps/news?pid=20601087&sid=apPnyEIjZJ5Q&refer=home U.S. Recession May Have Begun in Last Quarter of 2007 http://www.bloomberg.com/apps/news?pid=20601068&sid=axADxPkA6IA8&refer=home Soros Successors Thiel, Howard Prove Global Bears Rule Markets http://www.bloomberg.com/apps/news?pid=20601109&sid=aimTNk3q6IzE&refer=home IMF Says End of U.S. Housing Slump `Not Visible' http://www.bloomberg.com/apps/news?pid=20601110&sid=ao8IfKzWFWwQ U.S. Driving Falls Again, Heralding 1st Annual Drop Since 1980 http://www.bloomberg.com/apps/news?pid=20601110&sid=aLQ2SX0k5sN0 U.S. Deficit to Reach Record $490 Billion in 2009 http://www.bloomberg.com/apps/news?pid=20601068&sid=aZ4UCHX9tUbM&refer=home Mortgage Debt Least of Bad Bets as Investing Sinks http://www.bloomberg.com/apps/news?pid=20601213&sid=aoVek8MgifKE&refer=home California's Discount Foreclosure Sales Point to Housing Bottom http://www.bloomberg.com/apps/news?pid=20601109&sid=aAL047pyn7t4&refer=home Housing Slump Hits Northern Ireland Economy Harder Than Bombs http://www.bloomberg.com/apps/news?pid=20601109&sid=aATDeqyvwJkc&refer=home Struggle to Avoid Foreclosure in Spain– Majority of Mortgages are Variable Rate http://www.bloomberg.com/apps/news?pid=20601170&refer=home&sid=aVed.B_0LtRI GM's $15.5 Billion Loss Is Third-Biggest in a Century http://www.bloomberg.com/apps/news?pid=20601087&sid=au.TL_ofjGuM&refer=home OPINION Mad Men of Washington Cheat Voters on Housing Law http://www.bloomberg.com/apps/news?pid=20601039&sid=aBg1E6jaxSGY&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). DisclaimerTradeSystemGuru.com obtains information from sources deemed to be reliable; |
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