| TSG Weekly Market Watch September 19, 2008 |
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| Written by Matt Blackman | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Saturday, 20 September 2008 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
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TSG Stock Market LetterWeek Ending September 19, 2008Topics Discussed This Week:
Mother of all short squeezes (part duex) Leaders still struggling Earnings: So what next? U.S. Treasuries flow still falling Permits and starts fall a good thing… But builders still adding to inventories Mother of all short squeezes continued
Last Week
Quote of the week “Senator Schumer speaks about the RFC [solution to hold toxic assets] which was a New Deal creation [from] the Great Depression in which GDP, peak to trough, went down 45% in dollars as the economy was sawed in half. That’s why they had debt problems. Today we have debt problems with what may or may not be a recession and the nominal GDP in dollars is rising. This speaks to an unprecedented calamity of incompetence among people who earn seven and eight and up figures a year. This is the scandal. The talking heads who so blithely talk about the taxpayer’s money and the RFC ought to consider just what a horror show Wall Street and its facilitators have brought us to…What no one has stood up for in the last two frightening weeks is the institution of markets… Maybe AIG could not have been quote “let go.” But let us at least pause over the cadaver of free markets and take off our hats.” – James Grant. (See Jim Grant and Jim Chanos in the Bloomberg interview Thursday (below). It should be required viewing to all investors/traders.) Mother of all short squeezes (part deux) It was another tumultous week on Wall Street punctuated by one of the biggest one day losses in years on Wednesday followed by two days of the largest gains ever Thursday and Friday – due to investor hope that the latest action by regulators and government on both sides of the Atlantic would finally 'fix' financial markets. This time, it was action by the SEC and British FSA to ban short sales in financial companies that did it. Would it be any more successful that past attempts? In the aftermath of the SEC’s last momentus decision to finally start enforcing Regulation Short Sales (RegSHO) on July 15 by banning naked short selling in 19 banking and financial stocks, I wrote the Mother of all short Squeezes? In it I made the following comments. “Not surprisingly given the government bailout plan announced this week, Fannie Mae (FNM) and Freddie Mac (FRE) enjoyed the biggest lift jumping 89.5% and 74.5% between July 15 and July 18. But as of the July 18 close, they were still down 61% and 72% in the last four months (since March 20).” (Note that since then Fannie Mae, Freddie Mac and Lehman have effectively gone to zero.)
“As a group, 17 or the 19 stocks for which naked shorting was banned jumped nearly 20% in the three-day period (July 15-18)!” Unfortunately, this rally was short-lived. In other words, the last SEC action generated nothing more than a short squeeze where prices were temporarily driven higher by short covering. Prices then continued to fall putting in lower lows. In a study of rallies over the last five years, Bespoke Investment Group found that the decile of most heavily shorted stocks (those with the highest short interest as a percentage of their float) led these rallies in each case. The painful downside however, is that the most heavily shorted stocks also led the market to the downside during corrections or bear markets. Early Friday morning we learned that the SEC was joining the British Financial Services Authority (FSA) in banning shorting for 790 financial companies (as opposed to naked shorts which the SEC attacked in January 2005). Problem is, the SEC never really put much effort into enforcing RegSHO that is until this week when it was forced to play catch-up when markets turned truly ugly. (For a list of companies for which the SEC has banned shorting, click here. To see which stocks on the list have been hardest hit as of Sept 19, click here.) These moves in London and Washington follow a similar action in Moscow to ban short selling by the Russian government in an effort to calm panicky markets. Many including yours truly think this move only adds greater credibility to the axiom ‘government intelligence is an oxymoron.’ I can see Russia, part of the Wild and Wooly East when it comes to financial markets and the U.K. run by a Labor government taking such misguided action, but the U.S.? Similar attempts to fix collapsing financial markets have so far failed. Will it work this time? (Continued... See the Synopsis for Mother of all short squeezes continued… ) Technically Speaking Leaders lead lower It was another week in negative territory as Zanger’s Sunday pix. After shedding nearly 1.5% last week, the group lost another 0.19% this week. His week’s list of 10 stocks included Apple (AAPL), Potash Corp (POT), Agrium (AGU), Bank of America (BAC), SunTrust Bank (STI), CF Industries (CF), Fuel Systems (FSYS), US Steel (X), Baidu.com (BIDU) and Goldman Sachs (GS). That these leaders were lagging 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 the highest since August 10, 2007 for the Dow Industrials, Dow Transports, Nasdaq Composite, Russell 2000 and NYSE Index this week which is understandable given the litany of news bytes… and the fact that it was quadruple witching week. But this fact muddies the waters a little since it has all the signs of a capitulation bottom – but its difficult to know how much of the volume was due to options and futures roll-overs. Falling volume is considered mildly bullish when price falls and increasing volume with falling price is considered bearish. The exception to this is if there is a capitulation spike like what happened this week. After spiking at 36.22 on Wednesday, the Market Volatility Index (VIX) settled down to close at 32.07 but it was the highest weekly reading since February 2003. 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 eleven weeks ago, the 19 commodities that make up the NYFE CRB Index dropped some more this week to a low of 451.36 Tuesday before closing at 470.69 up slightly from 470.54 last week. Commodity prices have now fallen more than 23% as a group. Gold finally broke out this week to close at $858.30/oz. up from $755.70/oz and $831 three weeks ago as investors ran for the safety of the yellow metal as financial turmoil roiled over. 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. After falling for the last three weeks, oil firmed up to $102.73/bbl. after closing at $100.99/bbl last week. It is the twenty-ninth consecutive week that oil has remained above $100 and it was the first time that the price dropped below $100 on a daily basis in as many weeks. Normally, oil hits a seasonal high in mid-October so it will be interested to see if it follows through this year. 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) jumped to 3.21% from 2.8187% last week. But Freddie Mac mortgage rates slipped again to 5.78% from 5.93% last week and 6.35% two weeks ago for the 30-year fixed mortgage while the one-year adjustable rate mortgage (ARM) fell to 5.03% from 5.21% last week and 5.15% two 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. About 6 million U.S. mortgages, including the vast majority of subprime home loans as well as 41% of prime ARMs are also linked to LIBOR. EarningsEarnings: Waiting for the next quarter As we wait for the next quarterly results, Q2-08 reporting season continued to wind down, and with a total of 4052 companies (up from 4003 last week) having reported 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 reported. 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. Flow of funds into U.S. Treasuries continues to fall
Chart 1 – The financial crisis is having a long-term effect on the sale of U.S. Treasuries. If you listen to the financial news media, you would think that investors are flocking to Treasuries as a safe haven. But as we see from the chart, there was a net loss of more than $70 billion (net sale of Treasuries) during the July low in stock markets. More concerning, the orange linear regression trend line remains strongly negative and the sales remain below the yellow dashed line that shows the approximate amount that the US Treasury must raise each month just to pay off last year's budget deficit – a deficit that has skyrocketed with all the bailouts announced so far this year! Falling purchases of Treasuries has the potential to put strong upward pressure on interest rates if it continues.
Chart 2 – Homebuilder sentiment ticked up to 18 this month from the all-time low of 16 in August as builders got a little more optimistic about the outlook of their industry. But as we see in the charts below, major challenges remain and it looks like this optimism may be hurting those in the industry. Housing permits & starts take another hit
Chart 3 – Both housing permits and starts resumed their drops in August with permits falling nearly 8.9% and starts down 6.2% from July. But any drop in new homes coming on stream is good news for the industry given that there was a 10.1 month supply (416,000) of unsold homes. Even with the drop, builders are currently building another 895,000 new homes every year for a market that is only absorbing 515,000 new homes per year according to sales figures (see next chart).
Chart 4 – This chart ties together the various parts of the new home market. As we see, permits and starts in July were 937,000 and 954,000 respectively while new home sales were 515,000. But for the first time since the bubble began to pop, the excess of homes being build (red area) exceeded sales. Synopsis The mother of all short squeezes (continued)… Figure 2 below, clearly shows the five-week short-covering rally caused by the decision to ban naked short selling in 19 financial companies July 15 by the SEC.
Figure 2 – Weekly chart of the S&P500 showing short squeeze that resulted in the week of July 18 (green arrow) with sudden action by the SEC to ban naked short selling in 19 banks and financials. Also note that like the Dow Jones Industrial Average and DJ Utilities Average that have both put in bearish head & shoulders chart patterns, the SPX looks its trying to do so too. Chart by GenesisFT.com
Figure 3 – Chart from Bespoke Investment Group as of 9:30AM EDT Friday showing how international markets have fared since the yesterday’s lows in the wake of the short bans. After being down 7% on the week as of yesterday morning, the Dow Industrials had rallied back to even by lunch time Friday which puts it between Germany and Italy on this chart. The S&P 500 Depository ETF symbol SPY experienced its biggest morning gap up ever. As we wait to see how the crew aboard the SEC Titanic will rule on such instruments as put options and how they will deal with inverse or bear ETFs in which money managers short stocks to provide profits, markets will undoubtedly rally and it should be at least as powerful as the one in mid-July. But if we are in a bear market, it's a move that should prove to be short after which stocks are likely to return to their familiar journey to lower prices. However, this action reveals a disturbing global post-bull market reality. Minions at every level of government, from regulator to political candidate, have demonstrated that they share a single belief. And that is that no action, regardless of how disruptive to long term stability, is too drastic or costly in their futile attempt stop the bursting of asset bubbles. And finding a scapegoat is a big part of the larger strategy of trying to gain public approval in a crisis. So is this the bottom financial analysts have been telling us has come each time there has been a rally since October 2007? If past stock market performance, corporate earnings, macro economic fundamentals (like employment, jobs losses, GDP, real inflation, consumer sentiment) are any indication, the answer is probably not. The problem is that fundamentals lag especially at key turning points. But one thing is clear. We cannot assume there has been a real and verifiable change in trend until we see the resumption of a new uptrend in major indexes signified by a series of higher lows and higher highs. And there is also the undeniable litany of failure in past bailout attempts that have at best only generated brief short-covering rallies. Until there is a significant turnaround in earnings, the housing market firms and economies start growing again, any recovery will be short-lived. One definition of insanity is doing the same thing over and over again and expecting a different result. Time will tell if the most recent SEC action at the behest of politicians is any more successful that past similar action at changing the bear market reality. If not, will it then be legally possible to declare our elected and appointed representatives unfit and move them to where they can do no further harm and let this slowdown run its necessary cleansing course? Stories of interest this week… Almost Armegeddon – Financial markets were 500 trades away from meltdown (NY Post) http://www.nypost.com/seven/09212008/business/almost_armageddon_130110.htm Stocks Soar Worldwide on Bank Bailout, Curb on Short Sales http://www.bloomberg.com/apps/news?pid=20601087&sid=ak8MMZSJ.gMQ&refer=home Short Sellers Under Fire in U.S., U.K. After Lehman, AIG Fall http://www.bloomberg.com/apps/news?pid=20601087&sid=aTHLqfgpnFYw&refer=home Treasury, Fed Start Aid, Preceding Broad Crisis Plan (Update1) http://www.bloomberg.com/apps/news?pid=20601068&sid=a0FgZKtE.YFI&refer=home Frank Says Rescue Plan May Make Companies Limit Executive Pay http://www.bloomberg.com/apps/news?pid=20601087&sid=aX4lTr7NWck8&refer=home Backlash Over Bailouts Grows in Congress, Wall Street (Update1) http://www.bloomberg.com/apps/news?pid=20601109&sid=aIaOyCf.U_bU&refer=home U.S. Mortgage Rates May Wreak Havoc After Libor Gain (Update2) http://www.bloomberg.com/apps/news?pid=20601213&sid=aJs41o1Rt_uk&refer=home Washington Mutual Hobbled By Increasing Defaults on Option ARMs http://www.bloomberg.com/apps/news?pid=20601109&sid=aNSwdt57nTBI&refer=home EU Shuns U.S.-Style `Active Role' on Growth, Banks (Update2) http://www.bloomberg.com/apps/news?pid=20601109&sid=aYA5t2oMgPsU&refer=home Lehman Files Biggest Bankruptcy as Suitors Balk; Shares Plunge http://www.bloomberg.com/apps/news?pid=20601087&sid=a6cDDYU5QYyw&refer=home U.S. Stocks Drop, S&P 500 Sinks Most Since 2001 Terror Attacks http://www.bloomberg.com/apps/news?pid=20601087&sid=aiRCWtEfO4Wk&refer=home VIDEOS Grant and Chanos on Bloomberg Thursday Shilling Says Home Price Decline Half-Way Through ---------------------------------------------------------------------------------------------------------------------- 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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