| TSG Weekly Market Watch October 10, 2008 |
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| Written by Matt Blackman | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Sunday, 12 October 2008 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
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TSG Stock Market LetterWeek Ending October 10, 2008Topics Discussed This Week:
Leaders pulling out? Earnings still falling in Q3 Pending home sales show surprising strength But import prices falling fast Everything you wanted to know about derivatives…
Last Week
Quote of the year “As a student of bubbles and crashes, I can tell you that I have never seen a bubble in equities unwind without an unwind in property. For example, Japan, Korea, Hong Kong, the Philippines, Thailand, Indonesia, Mexico, and Brazil. And the unwind generally begins when credit goes south, which happens shortly after an overvalued currency begins to fall, which follows the first leg down of a big, ugly bear market.” Richard Russell The week that was…. There are few words in the English language to describe the carnage that occurred in markets this week in which U.S. stocks lost another $2.4 trillion. So far, stocks have fallen $8.4 trillion in the past year according to the Dow Jones Wilshire 5000. The global tally is far higher. But as bad as it was for U.S. markets, others were hit harder. The Japanese Nikkei 225 fell 24.3% which is the worst weekly drop on record. Ditto for the Dow Jones Industrial Average. Here is a sobering quote from Bespoke Investment Group this week. "Most Dow stocks were down more this week than during the week of the '87 crash. As shown, GM was down 45%, AA was down 41%, BAC was down 39%, CVX was down 27%, and AXP was down 25%. Only two Dow stocks were down less than 10% this week: JPM (-9%) and GE (-0.32%). Maybe the most important takeaway is the returns these Dow stocks have had since the '87 crash. Who knows when, but we will go up again." (See link to table below.) Exactly a year ago Thursday (October 9), the Dow hit its all-time high of 14,164.50. Since then it has lost 40.36% taking it back to where it was during the first week in May 2003 and erasing nearly all the gains since the rally began. An interesting article in this weekend’s Wall Street Journal discussed a useful measure of value used by Dr. Robert Shiller; the trailing 10-year price/earnings ratio for the S&P500 which he has tracked back to 1881. This metric’s long-term average is 16.3 times earnings. As of Friday’s close, it was 15. Does it mean the worst is over? Probably not if history is any guide. In every major recession since World War II, the PE has dropped below 10 which would take the SPX back down to 600 and the Dow below 6,000. To get back to a PE of 6.6 in the depths of the 1982 recession, the SPX would need to fall to 400. It is a sobering reminder to those glib analysts who would have us believe that a situation similar to the Great Depression or Japanese collapse that has persisted since 1990 is not possible today. Could we see the Dow drop 91% from its peak like it did from 1929 to 1932? Things would have to deteriorate significantly. Granted, there is more government oversight and market mechanisms in place to prevent such a meltdown and aren’t we a lot smarter now? But the flip-side is that the financial world was not plagued with the vast array of financial instruments like derivatives, which Warren Buffett has labeled financial weapons of mass destruction. With approximately $600 trillion in existence today, one major multi-trillion dollar hiccup would be beyond the ability of any group of government wizards to repair. In the final analysis, we will only know when it’s over well after the fact. Technically Speaking Leaders pulling out of dive? After shedding 18% last week, Dan’s Sunday pix lost another 12% this week. But as you can see, every major index with the exception of the Dow Transports performed worse. So is a 12% drop a good sign? It could portend some sort of bounce ahead. This week’s list was comprised of 10 stocks including Apple (AAPL), Apache (APA), Potash Corp (POT), sTracks Gold (GLD), Google (GOOG), Mosaic (MOS), CF Industries (CF), Research in Motion (RIMM), Wells Fargo (WFC), Amgen (AMGN) 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 back at extremes not seen since the third week in September for the major indexes. Falling volume is considered mildly bullish when price falls while increasing volume with falling price is considered bearish. The exception to this is if there is a capitulation spike like what happened again this week but the normal bounces we get at times like this have been suspended. Indexes and stocks alike remain extremely oversold but as we said last week this situation can persist for weeks in a strong bear market. We would have expected a bounce two weeks ago given high volumes and VIX reading but then again, no one expected the VIX to put in a new all-time high this week. Speaking of the Market Volatility Index (VIX), after peaking a week ago Monday at 48.4 which was the highest daily reading going back to at least 1990, it took off to close at a new high of 69.95 this week. 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 but so far it hasn’t happened. After staging a small comeback two weeks ago, the 19 commodity NYFE CRB Index dropped again to 392.80 from 430.43 last week. Since hitting a high of 611.51 four months ago, the CRB Index has now fallen nearly 36%. It was another volatile week for gold as it see-sawed around to close at $856.60/oz up from $831.20 last week and $883.70 two weeks ago. With the financial turmoil, gold could head in two directions. Bearish for the precious metal is the continuing decline in commodity prices, especially oil which indicates deflationary pressure. But panicked investors run to gold in times of trouble and if central banks and governments get more focused on inflating their way out of this mess, gold will benefit. . Surprisingly, the dollar rallied strongly again this week as the U.S. Dollar Index climbed to 82.41 from 80.60 as other currencies, especially those commodity-based in Australia, New Zealand and Canada really took in on the chin this week. Apparently, forex investors believe the greenback is the safest place to be given the dauntless efforts of the federal government to try to fix the financial mess. Unfortunately, foreign investors don’t hold the same view of U.S. Treasuries which if this loss of popularity persists, could mean higher interest rates ahead. Crude oil continued to collapse this week, dropping below $80 before strengthening to close at $80.15/bbl. This is down from $92.11 last week and $106.96 two weeks ago. Normally, oil hits a seasonal high in mid-October but the trend failed to materialize this year. The U.S. bank prime rate fell to 4.5% and the Fed funds target rate dropped 50 basis-points to 1.5%. But unfortunately for borrowers, the 3-month London Interbank Offered Rate (LIBOR) moved in the opposite direction again jumping to 4.819% from 4.33% last week and 3.76% two weeks ago as credit spreads continued to soar amid bank credit constipation. But Freddie Mac mortgage rates eased somewhat to 5.94% for the 30-year fixed mortgage versus 6.10% last week while the one-year adjustable rate mortgage (ARM) firmed to 5.15% from 5.12% 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 linked to LIBOR. Earnings Earnings still falling in Q3… It was the first week of Q3-08 reporting season and with a total of 390 companies to have chimed in so far, average earnings are down 13% from Q3-07 for which earnings had fallen 21% from Q3-06. This compares to a 36% drop in Q2-08 earnings, a 30% decline for Q1-08, a fall of 57% for Q4-07, a 21% drop for Q3-07 and a 13% jump for Q2-07 versus the same quarter the year before. Q2-08 also marked the fourth quarter than earnings showed a trend to deteriorate as the season matured. Economic Reports With what was happening in markets this week, economic news took a back seat. On Wednesday, central banks around the globe cut their overnight lending rates with the Fed shaving another 50 basis-points to a meager 1.50%. But that and the surprising upsurge in pending home sales that posted a 7.4% rise in August did little stop markets from sliding. On Friday, we learned that September import prices registered drop of 3% down from -3.7% in August, which is further confirmation that the consumer is curtailing spending but the market was focused on the Lehman Brothers derivatives auction that priced these instruments at an average of 8.625 cents on the dollar which has dire implications for the $55 trillion credit swap market and hence the attention.
Chart 1 – We got some potentially good news in Wednesday with the release of the August pending home sales figures from the National Association of Realtors. On a month-over-month basis pending home sales jumped 7.4% from July but this metric is not all that reliable. Much more useful is the year-over-year rate because it removes seasonality from the equation. As we see from the chart, August was the first increase we have seen since 2005 with an impressive 8.8% jump from August 2007. While it is too early to celebrate the end of the housing bear market, this uptick could portend at a minimum a bottom in sales. But sales lead home prices by approximately one year or more, so home price declines should continue for some months yet. But this good sales news has an ally in the Case-Shiller home price index which showed a moderation in the rate at which home prices are falling in the latest figures. To confirm this trend, we need to see a moderation in new home sales declines followed by an increase which tends to lead the existing home market in a sustainable rally. Pending sales are still down 27.1% from their peak in August 2005.
Chart 2 – Import prices had another bad month in September falling 3% versus 3.7% in August. It is a clear indication of how much the consumer is being impacted by the economic slowdown but the strengthening US dollar is also a factor. Synopsis Everything you wanted to know about derivatives but were afraid to ask… Be sure to read our special report this week entitled “The Mother of All Bubbles that Ate Wall Street,” an incisive look into the risks contained in the $600 trillion dollar derivatives markets and how troubles in this market are a contributing factor to the current market malaise. Please see http://tradesystemguru.com/content/blogcategory/47/81/ Stories of interest this week… Comparing This Past Week to the '87 Crash (Table) http://static.seekingalpha.com/uploads/2008/10/12/saupload_dowmembers101008.png Cost of U.S. Crisis Action Grows, Along With Debt http://www.bloomberg.com/apps/news?pid=20601109&sid=anUDEEEP1_M0&refer=exclusive Lehman Credit-Swap Auction Sets Payout of 91.38 Cents http://bloomberg.com/apps/news?pid=20601087&sid=aLkOZnNcDmSQ&refer=home Lehman Auction Yields Little Guidance for Bondholders http://www.bloomberg.com/apps/news?pid=20601087&sid=aTFpC.9DW5RQ&refer=home Details on Lehman Auction from Markit http://www.creditfixings.com/information/affiliations/fixings/auctions/current/lehbro-res.shtml Cox's SEC Censors Report on Bear Stearns Collapse http://www.bloomberg.com/apps/news?pid=20601109&sid=a572cxH2Or8E&refer=exclusive Harvard's Feldstein Says U.S. Recession to Be Longer Than Usual http://www.bloomberg.com/apps/news?pid=20601087&sid=acjCtcxT4Lrc&refer=home MetLife Says Ratings Review May Have `Material Adverse Effect' http://www.bloomberg.com/apps/news?pid=20601110&sid=aKKiSyQhdaJs Meridian Bank of Illinois Fails, 15th Bank to Close This Year http://www.bloomberg.com/apps/news?pid=20601110&sid=aZPy7tCZR7YA Subprime Devastation Retraces Path of S&L Crisis in U.S. States http://www.bloomberg.com/apps/news?pid=20601109&sid=axi7wgOziH00&refer=home Fed, ECB, Central Banks Cut Rates in Coordinated Move http://www.bloomberg.com/apps/news?pid=20601068&sid=aq.Ta5bnl.wU&refer=home Buffett's Goldman, GE Warrants Worthless for Now as Shares Drop http://www.bloomberg.com/apps/news?pid=20601109&sid=aq1o3bykoCNU&refer=exclusive Iceland Premier Tells Nation to Go Fishing After Banks Implode http://www.bloomberg.com/apps/news?pid=newsarchive&sid=azZ189JG.1S8 Pound Falls on Concern U.K., Iceland Assets Row May Escalate http://www.bloomberg.com/apps/news?pid=newsarchive&sid=afF1b1Fw4RxQ Libor Holds Central Banks Hostage as Credit Freezes http://www.bloomberg.com/apps/news?pid=20601109&sid=a6.wGKIe.RGg&refer=exclusive ---------------------------------------------------------------------------------------------------------------------- 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 have it sent to them each week). DisclaimerTradeSystemGuru.com obtains information from sources deemed to be reliable; |
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