| TSG Weekly Market Watch September 26, 2008 |
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| Written by Matt Blackman | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Saturday, 27 September 2008 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
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TSG Stock Market LetterWeek Ending September 26, 2008Topics Discussed This Week: Fooling around near a financial black hole Leaders lead market lower again Earnings: Waiting for October… New home sales falling but hope for existing homes Stock sector stress still building Crisis in confidence forces credit spreads higher
Last Week
Quote of the week “Clowns to the left of me, jokers to the right, here I am stuck in the middle with you.” – Song lyrics by Stealers Wheel that very aptly describe the rare breed of politician opposed to the bailout. Fooling around near a financial black hole Trying to find a politician who thinks the next bailout is a bad idea is like looking for the CEO of a bankrupt company willing to forfeit his fat severence package – they are a rare breed indeed. And this time around that rare breed is someone like Alabama Senator Richard Shelby. In an interview on Bloomberg this week he described the situation, admitting that he is popular on neither side of the isle. What has made him so unpopular? He refuses to sign on to the $700 billion bank bailout and believes it is a sellout of the American taxpayer. A credit crisis is never pleasant. It’s kind of like having a national root canal. But having a credit crisis on the eve of an election is dangerous indeed. Why? Politicians on both sides of the fence have agendas that they generally keep to themselves. But throw them into an election and we quickly learn that these agendas serve one purpose and that is to get elected at all costs. As the world waited for the clowns and jokers on Capital Hill and Wall Street to finally agree on who gets what in the latest $700 billion bailout, one only had to watch the financial news this week as Barney Frank and company did their best to discredit the current administration. They went as far as issuing the implicit threat that if the government delayed, people on Main St. would suffer greater hardship. It was a shameless display of politicking to exploit the situation. Next will come another bailout out for beleagured homeowners who paid too much for their properties and now 11 million of them have mortgages worth more than the value of their properties. So now the taxpayer must pick up the tab "for the common good"? The dismal truth is that so far, bailouts have failed to work. Will this one be any different? Undoubtedly, it won’t be the last. But this situation reveals a disturbing trend. In an election year, politicians will stop at nothing to gain public approval even though it means sticking their constituents with the ultimate exorbitant bill for their short-sighted and expensive "fixes." Such policies do not solve the problem, they only prolong the pain. They are highly inflationary and even if they do temporarily work, result in rapidly eroding buying power as government deficits soar and the value of the dollar plummets. Throughout history, such efforts by government have an abysmal record. Yes, such policies are temporarily popular and win votes from those looking for a quick and painless fix at election time. But the price we all must pay goes up substantially and only serves to prolong the agony. Banning short sales is a classic example. Until the recent action by Russia, the U.K. and the U.S., the only countries to have banned short selling in recent memory were China and Zimbabwe according to Larry Williams. Are you kidding? So now the U.S. is taking the lead of a communist state and the world's economic basket case with a 19 million percent annual inflation rate (and the most corrupt political leader in Africa)? I wonder how many legislators or regulators have studied history? The answer seems obvious – no one. If they had, would they knowingly push measures that have clearly failed in the past? Every time short sales have been either banned or restricted, the effect has been the opposite of what was intended – after a temporary lift stocks continued to fall as confidence in markets and the financial system was eroded. We have to go all the way back to 1930 to see when similar action was taken by government in the U.S. According to Williams, in the wake of the 1929 stock market crash on April 1, 1930 a new exchange rule put curbs in place on short selling that required brokers to first obtain written consent from clients to borrow stock. Markets rallied on the rumor but look what happened to the Dow Jones Industrial Average shortly afterward (see Figure A).
Figure A – Weekly chart of the Dow Jones Industrial Average showing the temporary impact of the last time restrictions were place on short selling following the 1929 correction. Chart by Metastock.com These misguided bailouts and bans may seem like a good idea at the time and appear to have gained public support if recent election polls are any indication. But this action does not change the inevitable albeit painful reality. Recessions are a necessary part of maintaining healthy capital markets longer-term. They remove excesses that have been built up over years of easy money and rapidly appreciating asset prices as the inevitable bubbles build. To try to interrupt this cycle makes about as much sense as trying to suspend the law of gravity. The problem is that such action only extends the pain that in its worst form turns into a Japan-style economic recession that lasts decades instead of a year or two. Technically Speaking Leaders lead lower After shedding 0.19% last week, Dan’s Sunday pix were again the worst performers versus the major indexes except that this time, the Dow Transports and Emerging Market ETF (EEM) also got creamed making the overall picture even more bearish. This week’s list was comprised of 16 stocks including Apple (AAPL), Baidu.com (BIDU), Apache (APA), Potash Corp (POT), Agrium (AGU), Bank (BKX)), SunTrust Bank (STI), Fuel Systems (FSYS), Agnico Eagle (AEM), Chicago Mercantile Exch (CME), Devon Energy (DVN), Massey Energy (MEE), sTracks Gold (GLD), Wells Fargo (WFC) and Goldman Sachs (GS).
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 well off their highs of last week which is a good thing for the Dow Industrials, Dow Transports, Nasdaq Composite, Russell 2000 and NYSE Index since they were all strongly down this week. 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 last week. However, we have yet to see any expression of that bullishness. After spiking at 36.22 on Wednesday, the Market Volatility Index (VIX) remained elevated this week to close at 34.74 up from 32.07 last week for 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 three months ago, the 19 commodities that make up the NYFE CRB Index staged a modest comeback this week to 476.33 from 470.69 last week. Commodity prices have now fallen more than 22.5% as a group. Gold had another good week closing at 883.70/oz up from $858.30 last week and $755.70 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 to help it this year. With the continuing financial turmoil however, it looks to be making a comeback as a safe haven. And after strengthening through July and August, the U.S. Dollar Index entered its third week of negative performance dropping to 77.20 from 78.93 last week and 77.88 two weeks ago. Traders had been seeking the relative safety of dollar denominated assets like Treasuries but this trend may be coming to an end if the dollar is any indication. After falling for the nearly three months, oil spent its second week firming as crude closed at $106.96/bbl up from $102.73/bbl last week. It is the thirtieth consecutive week that oil has remained above $100. 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 again to 3.76% from 3.21% last week as credit spreads continued to soar amid bank credit constipation. Freddie Mac mortgage rates jumped to 6.09% from 5.78% last week for the 30-year fixed mortgage while the one-year adjustable rate mortgage (3-1 ARM) rose to 5.86%. 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. Earnings Earnings: Waiting for the next quarter As we wait for the next quarterly results in the first week of October, Q2-08 reporting season continued to wind down, and with a total of 4085 companies having reported average earnings (up from 4052 companies last week) got a little better having reported average earnings at -38% (up from -39% last week but 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 ReportsOther than existing and new home sales, reports we were following included durable goods, which fell 4.5% in August with the chart showing a mildly negative sloping trendline over the last three years. Final Q2-08 GDP came in at 2.8% down from the previous estimate of 3.3% but as we have discussed before, this statistic is a joke as is CPI. We learned Thursday that New Zealand has now officially entered recession as it experienced its second quarter of GDP contraction in Q2. Here are the reports we were watching this week. No improvements in new home sales but a possible floor in existing homes sales
Chart 1 – This chart says it all. August new home sales fell 11.54% from July and are now down 34.4% year-over-year. All the bailouts and money pumped into markets have yet to have any impact on sales according to the latest Census Bureau data. From their peak in December 2006, new home sales are down a whopping 57%. Meanwhile new home median prices have fallen 6.2% year-over-year and are off 15.5% from their peak. But it is important to remember that prices are artificially inflated by generous builder incentives. Chart 2 – Meanwhile, existing home sales seem to have hit some sort of bottom as this chart shows. The question remains as to whether it is temporary or not. A total of 4.91 million homes (annualized) sold in August down from 5.02 million (revised) in July but it was the same number of homes that sold in December 2007. Unsold existing home inventories slipped to 10.4 months from 10.9 in July according to the National Association of Realtors. The median price of an existing home was $203,100 down 9.5% from August 2007 but up from $195,900 in February. However, median prices can be very misleading and we defer to the Case-Shiller home price index on Tuesday for the a more accurate take on prices. Rapidly rising foreclosures represent the biggest threat to existing home prices in the next one to two years. Chart 3 – We updated our composite chart of housing permits, starts and new home sales this week which ties together the various parts of the new home market. In August, permits and starts were 854,000 and 895,000 respectively while new home sales were 460,000 (down from 515,000 in July). July marked the first time since the bubble began to pop that the excess of homes being build (red area) exceeded sales and as we see from the chart, this situation continues to plague builders. Synopsis Stock sector stress still building Here is a chart that will help us step back and look at the bigger picture of how those sectors more severely impacted by the credit crunch have been faring of late. We have seen an anemic recovery off the July lows but these sectors remain weak. The lack of confidence among investors is clearly shown in widening credit spreads as investors and banks continue to shun stocks in favor of lower risk instruments like bonds while demanding a high price for credit default swaps.
Figure 2 – Weekly chart of some of the sectors we’ve been tracking that have led this market lower. What we are looking for is signs of recovery. As we see, banks (gold) and financials (blue) are still higher than they were during the mid-July lows as is the building and retail sectors but auto & truck manufacturers continue to suffer. But as you can see from the chart, every sector remains in a technical downtrend demonstrated by a series of lower highs and lower lows. Chart by VectorVest.com Credit spreads still widening
Figure 3 – Chart from Bespoke Investment Group showing that while the “scarecrows” (“if I only had a brain”) squabble in Washington over the size of the next bailout, credit markets remain seized. This index shows the risk of default of major banks in the Bespoke credit default swap (CDS) Index which hit another new high this week of 428.68 showing that investors are demanding vary high prices for CDS-type of insurance even if they can’t in stocks. Other credit spreads such as the TED spread (difference between three-month Treasuries and LIBOR) show similar stress levels. Chart Bespoke Investment Group. What does this mean? Confidence by banks in one another has sunk to new lows if the prices they are charging each other and the LIBOR are any indication. We will have to wait to see if the bailout has a positive impact on this but as we have said in the past, this is not a liquidity problem, its is a solvency crisis that no amount of liquidity will cure. Stories of interest this week… Hundreds of Economists Urge Congress Not to Rush on Rescue Plan http://www.bloomberg.com/apps/news?pid=20601110&sid=au2e.vPTWKK8 Bailout May Be Granddaddy of All Carry Trades http://www.bloomberg.com/apps/news?pid=20601110&sid=aBEM0cTTdBmA New Zealand Economy Shrank 0.2%, Confirming Recession http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aIQfRV6AYbfk Shipping Market Sinks Most in 9 Years on Steel Output http://www.bloomberg.com/apps/news?pid=20601110&sid=awRp8nRn8_YM London Turns Against Hedge Funds in Hunt for Culprit http://www.bloomberg.com/apps/news?pid=20601109&sid=aaJOwRDVsDIE&refer=exclusive WaMu Assets Sold to JPMorgan in Record Bank Failure http://www.bloomberg.com/apps/news?pid=20601087&sid=acBgLSSWN0.8&refer=home WaMu to Have `Significant' Effect on CDOs, S&P Says http://www.bloomberg.com/apps/news?pid=20601087&sid=aabOYF5xOpSs&refer=home Bond Risk Rises on U.S. Bailout Delay Concern, Asia Bank Run http://www.bloomberg.com/apps/news?pid=newsarchive&sid=ajT6DVDtlMZM ---------------------------------------------------------------------------------------------------------------------- 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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