| TSG Weekly Market Watch October 3, 2008 |
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| Written by Matt Blackman | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Sunday, 05 October 2008 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
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TSG Stock Market LetterWeek Ending October 3, 2008Topics Discussed This Week:Another heart-stopping weekLeaders nosedive Earnings: Waiting for Alcoa Paired existing home prices still falling fast but looking up? Mixed manufacturing signals… sort of But jobs casualties mounting fast
Last Week
Quote of the week “Nobody trusts anyone any more, and in banking trust is everything. As long as people trust you, you can build a very long domino chain. But once that trust is gone things start falling.” – Arni Einarsson, owner of the Atlantic Ocean Reykjavik in Iceland after the government bailed out Glitnir Bank hf which recently failed. It was the third biggest banks in the country. It also succinctly sums up the situation for international banking. Another heart-stopping week on Wall Street It was a defibrillator-necessitating wild bull-ride this week with investors doing bi-polar flips and legislators playing bailout buffoonery around the financial black hole. Stocks experienced their worst week since 911 amid bailout blues and more troubling economic signs. In the process, the Dow Industrials dropped back to where it was in October 2005 while the S&P500 sunk back to where it was in October 2004. Ouch. Meanwhile, an interesting theory emerged for Nancy Pelosi’s highly partisan acerbic diatribe on Monday that effectively put the kibosh on any hopes for a yes in the bailout’s its first Congress vote. Chaos favors the Democrats so it was in their best interests to create further uncertainty and killing the vote was the perfect vehicle. A few days later, with Pelosi safely muzzled and ensconced to a low-profile location, both parties were finally able to pull together to pass the bill. However, when all was said and done the market had already discounted the decision and sank on the news – Pelosi’s mission accomplished. Whether the theory is fact or fiction has yet to be proven. But there is little doubt that bad economic news favors an Obama victory, if history is any guide. It is this undeniable reality that motivates incumbent administrations to exert so much effort in spending taxpayer money on juicing the economy leading into each election. But now, the bigger the problem grows the more heat the next president will face on the White House hot-seat in January. But this week’s political wrangling have further shaken confidence in our elected officials, and in the process made a bad economic situation worse. After the biggest point sell-off day in history on Monday, the major indexes rallied on Tuesday but then spent rest of the week retreating. It was ‘buy the rumor, sell the news’ as the Dow lost another 157 points to end the week below Monday’s low. On the week, U.S. equities lost more than $1 trillion dollars in value (they did that on Monday alone) and home values have shed roughly $3 trillion this year alone, exposing just how small the size of the bailout is when compared to the losses. Be sure to read the Synopsis below as we chart the effect bailouts and interventions have had on the Dow over the last nine months. Technically Speaking Leaders nosedive After shedding 7.92% last week, Dan’s Sunday pix were again the worst performers losing more than 18% versus more modest losses for the major indexes. Runner-up worsts were the Emerging Markets ETF (EEM), the Dow Transports and the Russell 2000 small cap index. At the risk of sounding inanely banal, this is not a good omen for markets. This week’s list was comprised of 11 stocks including Apple (AAPL), Baidu.com (BIDU), Apache (APA), Potash Corp (POT), Agrium (AGU), Fuel Systems (FSYS), Agnico Eagle (AEM), Devon Energy (DVN), Rangold Resources (GOLD), sTracks Gold (GLD) and re-addition Google (GOOG).
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 a little higher than last week but still well off their highs two weeks ago which is mixed blessing for the Dow Industrials, Dow Transports, Nasdaq Composite, Russell 2000 and NYSE Index since they were all strongly down again 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 but the expected bounce can be delayed for a while especially in this kind of market. Indexes are getting extremely oversold which can last for weeks in a strong bear market but this fact combined with the VIX spike changes the outlook somewhat (see below). After hitting 36.22 last Wednesday, the Market Volatility Index (VIX) spiked Monday to 48.4, which is the highest daily since at least 1990. For the week the VIX was 45.14 which is an extreme value. This compares to 34.74 last week which 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. Extreme VIX readings can often presage at least a temporary market bottom especially when it follows a high volume capitulation reading like we saw last week. After staging a small comeback last week, the 19 commodity NYFE CRB Index dropped again to 430.43 from 476.33 last week. And after hitting a high of 611.51 three months ago, commodity prices have now fallen nearly 30% as a group. Gold had another tough week closing at $831.20/oz. after last week’s close at 883.70/oz. It takes the yellow metal below its $858.30 close two weeks ago. But it is still well above its $755.70 close four weeks ago. Gold’s strong seasonal period from the end of July to the end of September is over but this has done little to help it this year. With the continuing financial turmoil however, it has made a comeback as a safe haven but this situation may be challenged in the coming weeks if commodity markets continue to crater. The dollar rallied through July and August and then dropped for the last two weeks. However this week, the U.S. Dollar Index took off bolstered by hopes that the latest $700 billion bailout would end credit woes causing the index to surge to 80.60. This is up from 77.20 last week. Traders have been seeking the relative safety of dollar denominated assets like Treasuries but this trend may be short-lived as the federal government continues to take on mounting Wall Street liabilities. After putting in a two week bounce, crude oil resumed its downtrend dropping to $92.11/bbl this week compared to $106.96/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 4.33% from 3.76% last week as credit spreads continued to soar amid bank credit constipation. Freddie Mac mortgage rates moved higher to 6.10% from 6.09% last week for the 30-year fixed mortgage while the one-year adjustable rate mortgage (ARM) slipped to 5.12% from 5.16% 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. 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. Impact of the Credit Crunch in the U.K. Would you like fries with that? Earnings: Waiting for Alcoa As we wait for the next quarterly results next week with Alcoa first off the mark, reports continue to trickle in. With a total of 4096 companies having reported (up from 4085 companies last week) average earnings again got a little better at -36% (versus -38% last week and -39% two weeks ago) but down from -22% near the beginning of reporting season versus Q2-07. Be that as it may, Q2-08 was a brutal one for earnings. 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 ReportsThis week we saw August personal income add 0.5% while personal spending was unchanged. The September Chicago Purchasing Managers’ Index (PMI) came in higher than expected at 56.7 while the September Institute of Supply Management manufacturing index (ISM) fell more than expected to 43.5 from 49.9 in August and the ISM service index slipped to 50.2 from 50.6 in August. After dropping 1.4% in July, construction spending was unchanged in August. Finally payrolls dropped more than expected in September with the loss of another 159,000 jobs from a loss of 73,000 (revised) in August. Case-Shiller – Prices still falling but a landing in sight?
Chart 1 – Most recent chart of the S&P Case-Shiller home price index for the 20-city composite which showed a 16.35% drop in July from July 2007. But it was a good news-bad news story (red arrows). The good news is that both the index and the annual rate of change appear to be leveling off. The bad news is that even if the second chart levels off, it will mean home price will continue falling at a rate of more than 16% per year. Those analysts who think that home prices nationally are near a bottom are either intellectually impaired or have discovered a new type of hallucinogenic drink that has yet to be detected by their employers.
Chart 2 – The September Chicago Purchasing Managers Index came in surprisingly strong with a reading of 56.7 versus the expected 53.0. Chart 3 – However, the broader measure of national manufacturing, the Institute of Supply Management manufacturing index disappointed with a reading of 43.5 in September, well below the contraction threshold of 50. Meanwhile, the ISM service index settled to 50.2 in September from 50.6 in August but as we see from the chart, came up and just touched the red-dashed trendline which remains clearly negative. As we see from both this and the PMI (chart 2), the trends remains strongly negative for all three measures.
Chart 4 – September non-farm payrolls came in well below the expected -105,000 with a reading of -159,000 as this lagging economic indicator continued to worsen, down from the upwardly revised -73,000 in August. Since January, the economy has lost a total of 760,000 jobs. Dress up it in designer clothes, give it a body makeover, paints its face and have a few drinks to make everything look a little prettier, but at the end of the day this statistic is still coyote ugly.
Chart 5 – Now that is one bearish looking chart with a significant double top in September 2007 and May 2008 above 10,000 after which the index cratered to 3205 as of Friday’s close. The Baltic Dry Index (BDI) represents the cost for shipping dry goods by sea around the world. When demand for goods is high (and the economy good) rates go up and when demand is low, they fall. What makes the BDI an interesting economic indicator is that there is virtually no speculation – the cost of shipping is driven by real demand so it is therefore not subject to trader fear and greed emotional swings. It also supports the theory that the bubbles in commodity and stock markets were not significantly driven by speculators as many politicians and regulators have charged. This index climbed from around 4,000 in early 2007 to over 10,000 in May 2008 based on pure demand. Data – Capital Link Shipping. Synopsis Friday’s $700 billion bailout was the latest in a string of attempts to address credit constipation. So what impact has it and past efforts had on markets? We compiled a chart showing when the bailouts were initiated and what happened to the Dow Jones Industrial Average afterwards. As we see from Figure 2, the first time the Fed and government intervened was when Bear Stearns got into serious trouble in the second week of March. The Fed provided guarantees to JP Morgan so a quick deal could be done after close of markets on March 14 - 15 thereby averting what many felt could have caused a financial meltdown. As we see from the chart, it helped the Dow mount a two month rally that ended in the third week of May.
Figure 2 – Daily chart of the Dow Jones Industrial Average showing the impact of each successive attempt to rescue beleagured companies or stop the carnage on Wall Street culminating with the passing of the latest $700 billion bailout Friday. Chart by Metastock.com Next, the Indy Mac takeover was announced July 11, followed by the SEC naked short ban announcement July 15 and action July 21. That intervention triple play had the affect of buoying the Dow until the end of August. Right after Labor Day, we learned that Fannie Mae and Freddie Mac needed a federal bailout. Obviously the short ban hadn’t helped them but immediately instead of rallying, stocks dropped. Then the Fed had to step in to rescue AIG September 16 which caused markets to drop. After the SEC decision to stop naked short selling did little to stop the drop in stocks, it announced a short selling ban for 799 financial companies September 17. A few days later that was extended to include companies like General Electric. As we see from the chart, that caused a two day blip then the carnage resumed. The collapse of Washington Mutual and subsequent bailout caused a smaller blip that lasted just two days. Finally, we see the impact of the passage of the $700 billion bailout Friday which caused the Dow to drop by 157 points after rallying more the 300 points earlier in the day. As we pointed out last week, the ban on naked shorting was long overdue if only because it allowed a select group of players to effectively counterfeit shares. Why it has been tolerated for so long is beyond comprehension. But the outright ban on short selling of any kind on more than 800 companies is ludicrous. And bailouts, while seemingly well-intentioned, appear to be having a diminishing impact with the latest bailout actually having the opposite of the desired effect on stocks. Question is, will it be any more effective than past bailouts for the economy? We mentioned above that U.S. stocks lost more than $1 trillion this week and homeowners have lost roughly $3 trillion this year (according to the Case-Shiller Index) exposing the relative insignificance of recent government and Fed bailouts – kind of like throwing a pail of water on a house fire. Here is another chart that shows just how bad our debt situation has grown in the last two decades. It shows the ratio of total credit market debt (debt at all levels from household and corporate to government) to GDP. Since 2000 Debt/GDP has grown 25% faster than our economy. The ratio has doubled since 1982.
Figure 3 – Total credit market debt to GDP percentage showing that we hit nearly 350% in Q1-2008. This rate of debt increase is clearly unsustainable but more alarming is what will happen when we have a significant economic slowdown. As of the first quarter 2008, U.S. debt was nearly 350% of GDP but that’s not the scary part. Look what happened the last time we had a really serious slowdown in the early 1930s. GDP fell by 45% pushing the ratio Debt/GDP from 155% in 1929 to 260% by 1932 as the economy worsened – a 67% increase in just three years. A similar economic meltdown again, which is now looking increasingly possible, would push our total debt to GDP ratio to nearly 600%! Now go back and take a look at our chart in our Sept 19 newsletter showing U.S. Treasury Income Flows, see http://tradesystemguru.com/content/view/214/58/#TIC. As you can see, Treasury is having a hard time selling enough Treasury instruments to pay the $33 billion/month our current $400 billion deficit represents. Now add the cost of a host of bailouts combined with falling revenues a recession would cause and imagine what that combination would do to interest rates… and at the worst possible time. I don’t mean to scare anyone but forewarned is forearmed. Better to hope for the best but plan for the worst than get broadsided if it happens. Also be sure to check our 'Columns' (move your mouse over the 'Market Commentary' button on the lower landscape bar from our home page ) for our next report covering the derivative bubble on Wednesday. I’ll put a link from this newsletter if you check back then. Trade safe! Stories of interest this week… High-Yield Bond Spreads Widen to Record 12 Percentage Points http://www.bloomberg.com/apps/news?pid=20601110&sid=aGj1ZcJEaJNA Bond Dealers Ogle Spreads in Trading Off Wall Street http://www.bloomberg.com/apps/news?pid=20601109&sid=av.1oNLliTgQ&refer=home Short-Selling `Math Geek' Not Naked, Covered in Blame http://www.bloomberg.com/apps/news?pid=20601109&sid=a4JOcJNafRyQ&refer=home Cash-Starved Companies Scrap Dividends, Tap Credit http://www.bloomberg.com/apps/news?pid=20601109&sid=aLnv4NhdZ3Hs&refer=exclusive Long wait for next big bubble – Shiller http://www.financialpost.com/story-printer.html?id=854398 Time Cover – How Financial Madness Overtook Wall Street (A contrarian indicator?) http://www.time.com/time/business/article/0,8599,1842123,00.html EU’s Trichet Says U.S. Must Rescue ‘Global Finance’ http://www.bloomberg.com/apps/news?pid=20601109&sid=aAYDiHZzyzD0&refer=exclusive Europe's Real Estate Slump May Spark Wave of Local Bank Mergers http://www.bloomberg.com/apps/news?pid=20601110&sid=awoHYkxiRsIE Latin America Economic Boom Threatened as Credit Freeze Deepens http://www.bloomberg.com/apps/news?pid=20601109&sid=aeWRhkAoaDlE&refer=home Icelanders Worry `House of Cards' May Collapse After Glitnir http://www.bloomberg.com/apps/news?pid=20601110&sid=ay0IzIsFB5gw Australia, New Zealand Dollars Drop as Commodities, Stocks Fall http://www.bloomberg.com/apps/news?pid=20601110&sid=ak8xWIQu35sU ----------------------------------------------------------------------------------------------------------------------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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