| TSG Weekly Market Watch November 21, 2008 |
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| Written by Matt Blackman | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Sunday, 23 November 2008 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
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TSG Stock Market LetterWeek Ending November 21, 2008Topics Discussed This Week:
Another week of living dangerously Looking down the throat of a structural bear Leaders head up Q3 earnings – rig for deep dive! CPI, builder sentiment & starts drop, Treasury sales jump Fed – A year late and a few trillion short?
Last week
Quote of the week“A lesson I take from the Japanese experience is not to let that get ahead of us, to be aggressive. Whatever I thought that risk was four or five months ago, I think it is bigger now even if it is still small.” Donald Kohn – Federal Reserve Vice Chairman and deputy to Ben Bernanke in a speech in Washington this week. (More on this quote in the Synopsis.) Another week of living dangerouslyIt was another ugly week on Wall Street as the S&P500 Index fell to a level not seen since 1997 on Thursday, extending its 2008 loss to 49%. As an indication of just how brutal the day in which the Dow Jones Industrial Average dropped another 444.97 points was, seventeen S&P500 Index companies lost more than 20% of their value with Citibank falling 26% and JP Morgan Chase dropping 18% on Thursday alone. Markets then waffled around Friday until it was announced in the last hour of trading that the head of the Federal Reserve Bank of New York’s Tim Geithner had been tagged by Obama as the next Treasury Secretary. Investors obviously liked the choice pushing the Dow to close up 494 points on the day. But all this accomplished was to lessen the carnage on the week with small caps losing another 11% and transports down 10.6% over the last five days. This bear market has been toughest on a buy and hold strategy as highlighted by the portfolio of “the Warren Buffett of the Gulf,” Prince Alwaleed bin Talal. Alwaleed’s motto is “never sell” and he bought more Citibank stock Thursday amid the carnage, according to Bloomberg. It’s been a tough year for the Prince. His Kingdom Holding Co. of which he owns 94%, has fallen 63% so far this year compared to a drop of 41% for Berkshire Hathaway managed by the world’s most famous buy and hold investor Warren Buffett. Investors who scrambled to get in on the Kingdom Holding Initial Public Offering in July 2007 have seen the value of their investment fall 55% so far. What sort of returns do these investors need just to get their money back? Assuming we have hit bottom (and that is a big leap given the current environment), Kingdom Holdings IPO investors will need to generate 122% and the Prince will need to see his investments grow more than 170% just to get back to flat. Structural bear market – What we can look forward to?But a bigger challenge faces the Prince, the Oracle and the buy & hold approach based on the growing body of evidence that we are in structural or secular bear market. According to respected technical analyst Louise Yamada interviewed by Bloomberg this week, the current secular bear market began in 2000 following the bursting of the tech bubble and resumed last year following the bursting of all the other bubbles. Such bear markets tend to last from 13 to 16 years.  Figure A – Weekly chart of the Dow Jones Industrial Average structural bear market showing the price declines from their peak in September 1929 to the July 1932 low in which prices dropped 90%. The market did not begin a sustained recovery until 1942. Chart by Metastock.com Other structural bears occurred between 1966 and 1982 and before that, from 1929 and 1942. Yamada also discussed the Elliott Wave theory of alternation of cycles that basically says that secular markets do not repeat the past cycle (1966-82) but the one two cycles back, suggesting were are in a 1929 style meltdown. Both periods experienced volatile price swings but overall, markets declined for years to put in significant lows. Prices began declining in August 1929 and did not bottom until July 1932 in which the Dow lost nearly 90% of its value. (See link to the Bloomberg interview video “Yamada…” below). Technically SpeakingLeaders head higher After falling 7% last week, Dan Zanger’s Sunday pix was the only group to gain ground rising 6.1% compared to across the board losses for the major indexes This week Dan was waxing bearish about the number of descending triangle patterns and on his list were two contra ETFs (that go up when stocks go down) that included Proshares Ultrashort Russell (TWM) and ProShares Ultrashort Real Estate (SRS). Others on his list were Mosaic (MOS), Apple (AAPL), CF Industries (CF), Visa (V) and Holders Oil Services (OIH).
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 for the major indexes rose to their highest levels since the October 10 capitulation as markets broke below key support levels put in that week. But so far, 8000 has acted like concrete support and while it was breached mid-week, the Dow managed to close above it by Friday. But stocks dropped on rising volume this week and that is bearish. Although news that Geithner will head Treasury really makes no fundamental difference to the economy, it shows that investors still respond to news positively and that is good short-term. But while markets may mount a rally from here, it should prove temporary. And history tells us that while bullishness is alive and well, markets rarely hit a significant bottom. After surging to 81.65 three weeks ago the Market Volatility Index (VIX) again surged above 80 Thursday before settling to end the week at 72.67, up from 66.31 last week. Usually extreme VIX readings presage at least a temporary market bottom but so far the much hoped for bounce has failed to materialize and that is decidedly bearish. After falling last week, the 19 commodity NYFE CRB Index slipped again to close at 344.02 down from 357.92 last week week. Like a number of stocks, the bottom for commodities has proven elusive. Since hitting a high of 611.51 three months ago, the CRB Index has fallen 44% and volatility has remained high. But gold surged to close at $791.80/oz up from $742.70/oz. last week that is puzzling. We are clearly in a deflationary period but investors appear to still be seeking a haven in gold amid the economic turmoil even though the U.S. dollar has strengthened. And speaking of the dollar, the U.S. Dollar Index continued to enjoy its false rally based the misguided belief the bailouts will provide a quick fix to bursting asset bubbles. The dollar firmed to close at 87.66 up from 87.39 last week. Since bottoming in July, the index has gained 22%. But this combined with weakening demand continues to depress energy prices as a barrel of crude closed the week at $50.36 down from $57.11 last week. Oil is now down more than 65% from its mid-July high. This has been the most volatile year for crude in nearly two decades when it dropped from a high of $40.10 to a low $17.61 between September 1990 and February 1991. The U.S. bank prime rate and the Fed funds target rate held at 4.0% and 1.0% respectively but the effective Fed funds rate rose marginally again to 0.65% (from 0.42% last week and 0.24% three weeks ago). Credit markets have leveled off as the 3-month London Interbank Offered Rate (LIBOR) firmed to 2.477% (from 2.23625% last week and 2.29% two weeks ago). But the Freddie Mac mortgage rates slipped again to 6.04% (from 6.14% last week and 6.20% two weeks ago) for the 30-year fixed mortgage while the one-year adjustable rate mortgage (ARM) slipped to 5.29% (from 5.33% 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. EarningsEarnings – Rig for deep dive!In the seventh week of Q3-08 reporting season with a total of 3719 companies having reported (up from 3366 companies last week), average earnings dove to -62% (down from -47% last week, -38% two weeks ago, -42% three weeks ago and well down from -13% in the season opener seven weeks ago) versus Q3-07. This compares to a year-over-year 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. Q3-08 also marks the fifth quarter that earnings have deteriorated as the season matured. This is the worst earnings decline since earnings began to fall out of bed last year!
Figure 2 – Chart showing year-over-year changes in earnings for the more than 4000 Wall Street companies since Q2-04. Insert (red) shows the weekly declines in earnings as Q3-08 reporting season has progressed. We have found that results from a broad range of companies are much more reliable than analysts’ earnings forecasts, S&P500 earnings, earnings surprises and month-to-month changes in seeing the true earnings picture. When earnings are falling for the broad range of companies, it’s a negative indicator of market and economic strength. When they hit a solid bottom and start to rise, it’s very good for both. Economic ReportsCPI, builder sentiment & housing starts drop, Treasury sales jumpSeptember Treasury international capital flow figures released Tuesday were surprisingly strong given the negative trend since last year. In total, $143.4 billion in U.S. Treasuries were purchased, up from a revised increase of $21.4 billion in August as investors ran for the cover of government bonds amid the expanding credit crisis and falling stock prices. We don’t normally pay much attention to the consumer price index (CPI) because of the strong ‘fudge factor’ present in the data but the 1% drop in October was exceptional – it was the largest drop since February 1947 demonstrating just how quickly consumers are cutting their spending. On the housing front National Association of Home Builders (NAHB) housing market index fell to another all-time low, hitting 9 in November as builders got more pessimistic on the outlook of their industry. We also learned that housing starts fell to a new low in October, down 4.5% from September.
Chart 1 – The National Association of Home Builders housing market index suffered a big drop in November, falling to another all-time low of 9 from 14 in October as builders got more pessimistic on the outlook of their industry.
Chart 2 – And then we got more bad home-construction news as we learned that housing starts fell another 4.5% in October to a seasonally-adjusted 791,000 annualized, the lowest level of construction since the indicator was initiated 1947 according to the Wall Street Journal. What should be of greater concern is that housing permits, a leading indicator of starts, fell more than 12% to 708,000 (annualized). However, the overriding reality is that these numbers are still far too high. Just 464,000 new homes sold in September and that reality will exert further downward pressure on construction. Chart 3 – A volatile statistic, net Treasury international capital flows surged strongly in September to $143.4 billion as investors sought the relative security of Treasuries amid the stock and commodity meltdown (see article “Treasuries…” below). But is this just a short-term bounce or a sustained recovery for Treasuries? Let’s hope it’s the latter because the government will need money like never before in the coming years as spending soars and revenues shrink. SynopsisFed – A year late and a few trillion short?Amid another brutal week on markets, Don Kohn’s quote (see Quote of the Week above) offers cold comfort as minions in the Fed and government continued to try and stop the myriad of asset bubbles from breaking. Kohn’s quote shows just home much the Fed continues to underestimate the severity of the credit crisis. It is certainly not the first instance. Until this year Ben Bernanke was downright cavalier about deflation risks (remember his ‘why worry about deflation when you have helicopters and printing presses’ speech?). By its actions that of late verge on outright panic, we clearly see just how myopic and woefully behind the curve the Fed has been in recognizing and addressing the current crisis. So far, government has had to inject ship-loads of cash to bolster the Fed balance sheet from what they previously considered more than adequate at $800 billion to nearly $2 trillion and counting. This is more troubling when we consider that other than to torpedo government balance sheets, the impact of the global cash blizzard has so far at least been minimal at best. And now Team Fed would have us believe that the risks of a two-decade long Japanese meltdown “still small”?  Figure 2 – We updated our monetary base graph (money in circulation in the U.S.) this week and see that since the end of August 2008, money in circulation has grown an eye-popping 72.24%. On a year-over-year basis it works out to an increase of 75.5%. This compares to an annual average growth rate between 1986 and 2007 of 6.6%. Since the Fed clearly acknowledges the failure in Japan’s approach in dealing with their meltdown in 1990, why are they making the same mistake of keeping technically insolvent companies on life support? Maybe Mr. Bernanke should have spent less time studying the Great Depression and a little more time studying the mistakes made in the land of the rising sun? Seems that the longer this crisis lasts, the more frightening the similarities with Japan get. What the government and Fed are doing now would have been like a group commandeering the Titanic after it hit the iceberg and forcing the crew to break up the lifeboats and use the pieces as well as all the lifejackets to try and plug the gash in the ship’s hull. Fine if it works, but if not, everyone on board would have gone down with the ship!
If we are in a structural bear market as Louise Yamada suggests, not only will buy & hold investors be broke, so will governments that threw tons of cash at the problem based on the assumption that the correction would be swift and short. Stories of interest this week…
The Next Subprime Crisis Looms http://www.spiegel.de/international/business/0,1518,druck-591613,00.htmlObama Targets 2.5 Million Jobs With Stimulus Plan http://www.bloomberg.com/apps/news?pid=20601087&sid=aip_MC9nX0M0&refer=home Reason for Friday’s Pop - Obama Taps Fed's Geithner for Treasury http://www.bloomberg.com/apps/news?pid=20601087&sid=a2x_bZrE_VrY&refer=home S&P 500 Index Drop Leaves 64 Industries With Losses http://www.bloomberg.com/apps/news?pid=20601213&sid=am1FNznC.tNE&refer=home U.S. Needs to Pump $1.2 Trillion Into Banks, FBR Says http://www.bloomberg.com/apps/news?pid=20601110&sid=a2TA9gT_XOX4 U.S. Economy: Jobless Claims Approach Highest Level Since 1982 http://www.bloomberg.com/apps/news?pid=20601110&sid=anVS4Mooik1I Alwaleed Position Highlights Major Buy & Hold “Never Sell” Challenge http://www.bloomberg.com/apps/news?pid=20601109&sid=a3pNjAm3wGxM&refer=home Treasuries Surge Triggers Squeeze Concern in Futures Market http://www.bloomberg.com/apps/news?pid=20601087&sid=a8koj6NxRrOk&refer=home `Unprecedented' Biotech Bankruptcies Erupt Amid Finance Crisis http://www.bloomberg.com/apps/news?pid=20601109&sid=a55.vWF5YPhA&refer=home Solution to a slow economy: Less work and more sex? http://www.bloomberg.com/apps/news?pid=20601109&sid=a6qq53CVLzUg&refer=home San Francisco Bay Area Home Prices Fall Record 41% http://www.bloomberg.com/apps/news?pid=20601110&sid=ayS7TXEg_e4I Ben Bernanke’s ‘Printing Presses’ Speech http://www.federalreserve.gov/boarddocs/speeches/2002/20021121/default.htm Goldman, GE, GM Invite Us to Play a Rigged Game http://www.bloomberg.com/apps/news?pid=20601039&sid=at5FqZ7Gr0nw&refer=home Copper Drop Deepens as China Growth, Housing Falter http://www.bloomberg.com/apps/news?pid=20601109&sid=a_6mdiIJ8.Rs&refer=home In Spite of All the Stimuli Deflation Remains Fed Concern http://www.bloomberg.com/apps/news?pid=20601109&sid=awlaebKn1pSQ&refer=home FDIC May Alter Guarantee Plan After Banks Complain http://www.bloomberg.com/apps/news?pid=20601109&sid=akfnpgG_lK7c&refer=home ABCPMMMFLF Spells Fed Relief for JPMorgan, Citi Shadow Banking http://www.bloomberg.com/apps/news?pid=20601109&sid=aAmfkLEyMPYM&refer=home Commodity Collapse: Hammer to Fall on Canada (Report in pdf) http://www.bmonesbittburns.com/economics/focus/20081114/feature.pdf Defensive Play? Campbell Beats Bear Market as Consumers Cut Back http://www.bloomberg.com/apps/news?pid=20601109&sid=aLSl5Zol_6bk&refer=home VideosYamada Sees U.S. in `Structural Bear Market' for Years So how bad will it get? Nouriel Roubini interview http://www.bloomberg.com/avp/avp.htm?clipSRC=mms://media2.bloomberg.com/cache/vC6A2kpBh6Ts.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 have it sent to them each week). DisclaimerTradeSystemGuru.com obtains information from sources deemed to be reliable; |
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