| TSG Weekly Market Watch September 12, 2008 |
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| Written by Matt Blackman | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Saturday, 13 September 2008 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
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TSG Stock Market LetterWeek Ending September 12, 2008Topics Discussed This Week:Five challenges ahead as corporate soup lines grow Leaders drop further Earnings: So what next? Consumer credit, import prices still trend higher But retail sales post largest drop in years Global market challenges build
Last Week
Quote of the week “The best thing to do is to let housing prices reach their natural level as soon as possible, so people know what's real and what's not.” Daniel Mitchell, Senior Fellow Cato Institute Five challenges ahead as corporate soup lines grow Like rescuers rushing to help Darwin-award wannabees who ignored dire warnings to evacuate Galveston in the path of Hurricane Ike, federal officials and Wall Street execs worked feverishly Saturday in an attempt to resolve the financial crisis now facing Lehman. It is the second ‘big five’ Wall Street brokerage to succumb to the financial tsunami after Bear Stearns which took $29 billion in federal assistance to make the JP Morgan purchase of the company work. But this time officials are doing their level best to convince potential buyers that no bailout should be expected. It remains to be seen if officials can make this condition stick but if no buyer steps up to the plate, the government will again have to act as buyer of last resort. Chances for a deal devoid of government-backed guarantees dimmed significantly Sunday when Barclays Bank, the last remaining bidder, walked away from negotiations increasing the chances of a Lehman bankruptcy. But even if a deal is made, there is little doubt that this will be the end of the crisis prompting financial industry experts and investors to ask the all-too-obvious question, whose next? And then there are the banks... So far this year there have been a total of eleven bank collapses which the bulls say is small potatoes considering that the Federal Deposit Insurance Corporation currently insures 8,451 banking institutions. But what resources does the FDIC have at its disposal and what happens if collapses start to mount? According to its website, the FDIC insures up to a maximum of $100,000 per account or $200,000 per individual (up to 2 accounts) in the event of bank failure. At the end Q1-2008, the Deposit Insurance Fund, monies used in the event of bank failure to repay depositors, totalled $52.8 billion – not very much when you consider this has to insure a total of more than $4 trillion which works out to a ratio of 1.3%.
Figure A – Performance chart over the last six months showing how financial stocks Lehman Bros. (LEH), Merrill Lynch (MER), AIG Group (AIG), Freddie Mac (FRE) and Fannie Mae (FNM) have performed. As we see, FRE and FNM are essentially bankrupt as far as shareholders are concerned and there is little hope that stockholders of Lehman Bros and AIG will fare any better. Chart by VectorVest.com The IndyMac Bank failure cost the FDIC $8.9 billion, wiping out more than 16% of the fund, helping to push the reserve ratio down to 1.19%. Eleven failures have put the agency very close to the brink and once reserves fall below 1.15%, the FDIC will need more cash according to its charter. Other potential problems include Washington Mutual bank as well as insurer AIG Group as the ripples continue to build with little end in sight.
Figure B –Six month performance comparison between Financials and Banks. As we see, they have performed similarly through this crisis. As long as the economy deteiorates and housing prices fall both sectors will suffer and more banks will collapse. Chart by VectorVest.com So what happens if we get a situation like the Great Depression or S&L Crisis in the 1980s, when thousands of banks failed, which in both cases bankrupted the FDIC? The Fed has already been forced to rescue failed mortgage companies Fannie Mae and Freddie Mac, assuming more the $5 trillion in potential liabilities “for the greater good.” And with each failure and rescue, hopes run high that this will be the end of the troubles. But each time, the situation continues to deteriorate and credit spreads rise. For example, a 6.25% AIG bond due 2037 recently yielded 17% which means investors are selling them at a huge discount according to the Wall Street Journal. The cost to insure Washington Mutual bonds have skyrocketed – it now costs approximately $3.7 million up front and $500,000 annually to protect $10 million in WaMU bonds. Another few bank failures and the FDIC will also be forced hat in hand to the Fed and Treasury Department for cash. As if this wasn’t enough to keep investors from becoming complacent, we got news that at least one auto giant is also in trouble. GM’s Rick Wagoner was in Washington this week looking for a minimum $25 billion handout in the way of government-backed loans. Detroit is looking for a bigger $50 billion package according to WSJ. All this with a recession that has yet to be confirmed by the NBER? It doesn’t take a rocket scientist to see what will happen as the economy deteriorates further. Here are the realities we face, as I see them. 1) Although house prices appear to be falling more slowly, they are still dropping and this trend will not reverse tomorrow, next week or next month. And as prices fall, more mortgages will fail pulling more banks and lenders down with them. For example, foreclosures are still rapidly rising according to RealtyTrac which reported this week that 303,879 properties went into foreclosure in August, well up from the average Q2 rate of 247,000 foreclosures per month. At this rate, the final tally for Q3-08 could be more than 900,000 foreclosures! This is also decidedly bearish for home prices and the banks holding the mortgages. (See Figure 7 at http://tradesystemguru.com/content/view/209/58/#Homes ). As of the latest inventory figures from the National Association of Realtors, there are 3.9 million unsold existing homes which represents an 11.1 month supply using the latest sales data. Add to this another approximately 500,000 unsold new homes. But foreclosures are clearly the housing market dark horse expected to total more than 3.6 million more homes in the next twelve months at the current failure rate to already high inventories! 2) We are in a bear market and retail trading volumes (and commissions) will continue falling which will negatively impact brokers and others in the finance industry food chain. Two years from now the landscape for financial companies on Wall Street will look vastly different than it does today and it will be a tough period all round. 3) Even if Obama gets elected and follows through on his promise to raise corporate, personal (for the 5% of the population that currently pay 70% of the total tax burden), capital gains and dividend taxes, federal deficits will continue to rise and revenues fall. This is the reality in a deteriorating economy and the more rapidly this occurs, the farther revenues will fall. As deficits rise, demands for Treasury bonds to foreigners will jump. Given the amount of debt in the U.S., how long will foreigners continue to finance it for rates below the real rate of inflation? 4) Baby boomers begin to retire en mass in 2009 when the median age of the biggest spenders (45 to 54 year olds) pass the median age of 50. This is creating a whole raft of problems which we are just beginning to see but at the present rate, our social security and pension system is in serious trouble if not already technical broke. 5) Last but not least, in good times or bad, the two post-election years have been the hardest on economies/markets and with the sole exception of the short-lived 1987 melt, every single bear market and recession since World War II occurred in the 24-month period after an election. There is no reason to expect a difference this time around. Realistically, it will probably be worse given that momentum is slowing and in spite of Houdini-tricked government stats to the contrary, a recession it already here. I don’t care how optimistic you are, there is no way of putting lipstick on these market pigs! Technically Speaking Leaders lead lower It was another week in negative territory as Zanger’s Sunday pix. After shedding nearly 10% last week, they lost another 1.5% this week. His week’s list of 11 stocks included Research in Motion (RIMM), Apple (AAPL), First Solar (FSLR), MBIA (MBI), Ambac Financial (ABK), SunTech Power (STP), Potash Corp (POT), Suntech Power (STP), Continental Airlines (CAL) and United (UAUA). That these leaders were the worst performers again is bearish.
Figure 1 –Five-day performance of Zanger’s last Sunday pix (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 were above average this week for the Dow Industrials, Dow Transports, Nasdaq Composite, Russell 2000 and NYSE Index this week which is bullish since most (with the exception of the EEM) moved higher. Falling volume is considered mildly bullish when price falls but that’s not what happened. Increasing volume with falling price is considered bearish. The exception to this is if there is a capitulation spike similar to what happened with crude oil (see below). The Market Volatility Index (VIX) moved up again this week to 25.66 from 23.06 last week and 20.65 two weeks ago. This compares to a VIX north of 31 when the Dow last bottomed during the week of March 14. After hitting a high of 611.51 ten weeks ago, the 19 commodities that make up the NYFE CRB Index settled some more this week to close at 470.54 from 489.24 last week and 516.47 two weeks ago. Commodity prices have now fallen more than 23% as a group. Gold also had another challenging week as the yellow metal fell to $755.70/oz from $799.30 last week and $831 two weeks ago. Gold’s strong seasonal period from the end of July to the end of September is nearly over but this has done little help it this year. And the U.S. Dollar Index continues to rally and is now up nearly 10% from its mid-July low as it closed at 78.93 from 77.88 last week. Traders still believe that the greenback is a safer place to be than in most other currencies given the declining global economy. But is it? As we mentioned last week the dollar move has been due to apparent stronger U.S. GDP growth but the numbers are deceiving.
Figure 2 – Weekly chart of crude oil showing major support at $98 together with the more than 30% drop since the July peak. Notice the big volume spike that was a capitulation according to the Williams Capitulation Index which often warns of approaching bottoms (temporary or longer-lasting). If there is no bounce around this support level, it will be very bearish for crude but chances are that there will be. Chart by GenesisFT.com Oil continued to drop of a barrel of crude closed at $100.99/bbl. It is the twenty-eighth consecutive week that oil has remained above $100 but this stretch looks about to be broken. Normally, oil hits a seasonal high in mid-October. 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 again to 2.8187% from 2.8144% last week. But Freddie Mac mortgage rates fell again to 5.93% (from 6.35% last week) for the 30-year fixed mortgage while the one-year adjustable rate mortgage (ARM) inched up to 5.21% from 5.15% 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. Earnings Earnings: Q2 was bad, will Q3 be any better? As we wait for the next quarterly results, Q2-08 reporting season continued to wind down, and with a total of 4003 companies having reported (from 3923 last week) average earnings held steady at -39% (down from -22% six weeks ago) versus Q2-07. This compares to an overall 30% drop at the end of Q1-08 earnings season with a grand total of 4214 companies having reporting. This also 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. Meanwhile, the Commerce Department also reported a durable goods increase 1.3% in July versus an expected drop of -0.3% due in part, the agency said, to stronger demand for aircraft. But even without this metric, durable goods increased 0.7% again thanks to stronger exports. Economic ReportsHere are the reports we were watching this week. Consumer credit slips but still trending higher
Chart 1 – Consumer credit slipped to $4.6 billion in July but the trend in consumer borrowing remains strongly positive.
Chart 2 – Import prices have also been in an uptrend but took a big hit in August dropping 3.7% from July as prices took their biggest hit in three years. Jobs losses, unemployment jump
Chart 3 – Although the trend in import prices is up, the same cannot be said about retail sales, which dropped 0.7% in August. Next Week Here are the reports we’ll be watching next week. The ones emboldened are leading or useful indicators we are tracking, the others have the potential to impact markets short-term. And then there is the fact that most government-back statistics that should not be taken too seriously. When in doubt, use market direction as an indicator. - Tuesday, August Consumer Price Index (previous 0.8%), ex-food & energy (previous 0.3%), July Treasury International Capital Flows ($36.6 billion), September NAHB Housing Market Index (previous 16), FOMC Fed funds rate decision. - Wednesday, August Housing Permits and Starts (previous -11.0%), Q2-08 Current Account Balance (previous -$176.4 billion). - Thursday, September Philadelphia Fed Business Index (previous -12.7). Synopsis Global market challenges build Last week we included a link to the Bespoke Investment chart showing how much global indexes had dropped from the 52-week highs. Here is the chart to September 5. Figure 3 – Chart showing percentage performance from the 52-week highs of the above global indexes. As we see, North American markets have so far held up best with Canada at the top of the list. But a quick look at the chart should give international and Canadian investors cause for concern. A market that has been strongly impacted by commodity prices, the Toronto TSX has strongly outperformed its US counterparts in the last five years in both real and nominal terms. But as we see from the next chart, the good times look to be in the process of ending. This does not bode well for the TSX or the Canadian dollar. Since peaking in November, the Canadian ‘loonie’ has fallen more than 12% and there is no end in sight as long as commodity prices and the Canadian economy continues to weaken.
Figure 4 – The drop in commodity prices has had a very real impact on Canadian stocks as evidenced by this very bearish double top chart pattern on the iShares Canadian ETF (EWC) on the weekly chart. Note the breach of both the four-year uptrend line and the double top neckline with a retest and failure this week (see top purple arrow) on spiking volume (see lower arrow). This does not bode well for the Toronto Stock Exchange market or the Canadian dollar. Chart by Metastock.com Is it any wonder that movies like the new Batman movie Dark Knight are doing so well? It’s certainly a cheaper way of dealing with the stress than getting a valium prescription! Stories of interest this week… U.S. Foreclosures Hit Record in August as Housing Prices Fell http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aWKdjgdwQZQI US May Be Running Out Of Options To Stop Recession http://www.cnbc.com/id/26563570 Credit Suisse Says Stock-Market Advance Won't Last http://www.bloomberg.com/apps/news?pid=20601213&sid=a0hbYoiYVsXc&refer=home More `Chaos' Ahead for U.S. Banks, Investor Jim Rogers Predicts http://www.bloomberg.com/apps/news?pid=20601087&sid=avO28IC.6pa4&refer=home Surge in Joblessness May Deepen US Housing Slump http://www.cnbc.com/id/26560917 Alt-A Mortgages Next Risk for Housing Market as Defaults Surge http://www.bloomberg.com/apps/news?pid=20601109&sid=arb3xM3SHBVk&refer=home Wall Street Trading Gets Zero Value From Lehman, Merrill Owners http://www.bloomberg.com/apps/news?pid=20601109&sid=aPBMl6mTFuks&refer=home Government Payments to Wall Street for Auction-Rate Wreck Climb http://www.bloomberg.com/apps/news?pid=20601109&sid=aNRhA7QuyCC0&refer=home Oil Investors Pulled $39 Billion in Futures Contracts http://www.bloomberg.com/apps/news?pid=20601110&sid=agQ7prrjwiuU Bond Traders Lose `One-Night Stands' in Credit Crunch http://www.bloomberg.com/apps/news?pid=20601109&sid=apx7VaSD28lU&refer=home Borrowing Binge Weakens Europe's Companies as Recession Looms http://www.bloomberg.com/apps/news?pid=20601109&sid=a3iml0OJI0w0&refer=home Pound Near 2 1/2-Year Low as Report Shows U.K. Economy Shrank http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aPzfB8U6igLg `Overvalued' Pound to Fall 20% as Darling Despairs http://www.bloomberg.com/apps/news?pid=20601109&sid=awGegoQkVuU4&refer=home Bollard Cuts New Zealand's Key Rate to 7.5%; Currency Tumbles http://www.bloomberg.com/apps/news?pid=20601087&sid=a8_RZFZG5JGQ&refer=home Japan Economy Shrank 3% Last Quarter as Exports, Spending Fell http://www.bloomberg.com/apps/news?pid=20601110&sid=aM60Fs.jbT2k Icelanders Tighten Belts, End Spending Spree as Recession Looms http://www.bloomberg.com/apps/news?pid=20601109&sid=aQRrb_mC18pw&refer=exclusive WaMu Sees $4.5 Billion Loan-Loss Provision in Quarter http://www.bloomberg.com/apps/news?pid=20601110&sid=ab7A9dOdzUGY VIDEOS Roubini Says U.S. at Start of `Very Severe' Bank Crisis http://www.bloomberg.com/avp/avp.htm?clipSRC=mms://media2.bloomberg.com/cache/vmUV7PR4JGX8.asf ---------------------------------------------------------------------------------------------------------------------- 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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