| TSG Weekly Market Watch December 19, 2008 |
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| Written by Matt Blackman | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Sunday, 21 December 2008 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
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TSG Stock Market LetterWeek Ending December 19, 2008Topics Discussed This Week:Stocks up but so are yield spreads… Leaders flat Q3 earnings – down for the count Turbo-charged Fed cash machine yet to yield benefits
Last week
Quote of the week “The reason there is very little support for the gold standard is the consequences of those types of market adjustments are not considered to be appropriate in the 20th and 21st century. I am one of the rare people who have still some nostalgic view about the old gold standard, as you know, but I must tell you, I am in a very small minority among my colleagues on that issue.” Alan Greenspan Stocks up but so are yield spreads In their weekly review Friday, Bespoke Investment Group asked the question on every investor’s lips – is the storm subsiding or is this just the eye of the hurricane? Volatility continues to fall as trading ranges narrow with the S&P500 trading in its narrowest weekly range since September. However, there was evidence that the dollar is now taking the brunt of corrective action and is down nearly 7% in the last ten trading days as the Fed cut the Fed funds rate to between 0 and 0.25% pushing it down to its lowest rate in more than a half a century. Record low interest rates have pushed bonds to record high prices with 30-year Treasuries hitting 140^25 Friday. But the undeniable reality remains. According to Merrill Lynch’s High Yield Master Index, the spread between high-yield bonds and comparable Treasuries has increased from roughly 600 basis-points to 2,072 bps since June according to Bespoke. This means that companies in the high yield bond category still face interest rates north of 22% to borrow – not a situation conducive to healthy balance sheets, especially in a deteriorating economy.  Figure 1 – Chart showing spreads between high-yield corporate bonds and comparable Treasuries showing the premium these companies must pay in basis-points to raise cash. The good news is that lower risk investment grade bonds have rallied 30% since their October 10th low which means that borrowing for less risky companies has gotten a lot more reasonable. Now if only the riskier bonds would follow suit. Technically Speaking Leaders flat After gaining 3.3% last week, Dan Zanger’s Sunday pix barely broke even this week with a 0.7% gain. As we see from the chart, the only major index to underperform it was the Dow Jones Industrial Average. Meanwhile, rapidly falling energy prices helped propel the Dow Transports into top spot this week. This sends a mixed message. It’s bearish when Dan’s pix don’t lead the market higher but the fact that Transports are leading is bullish. This week Dan’s portfolio of 11 stocks included Apple (AAPL), Baidu.com (BIDU), Fluor Corp (FLR), Google (GOOG), MasterCard (MA), Noble Energy (NBL), Nucor Corp (NUE), PetroBras (PBR), Research in Motion (RIMM), Rio Tinto (RTP), US Oil Fund ETF (USO) and US Steel (X). When both stock and commodity markets do finally take off, these stocks stand a very good chance of leading the pack.
Figure 2 – 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 moved up this week which is mildly bullish for markets since only the Dow Industrials dropped. Rising prices on rising volumes, even when modest, show buyers increasingly entering the market while falling volume shows that buyers are not participating in the game. Could the waterfall of money courtesy of the Fed finally be having an impact? After slipping to 54.28 last week, the Market Volatility Index (VIX) spent the week losing more ground to close at 44.93 Friday. Markets appear to be settling down due in a large part to the Fed’s cash snowfall. After surging last week, the 19 commodity NYFE CRB Index continued to recover this week to close at 351.81, up from 345.17 last week. Since hitting a high of 611.51 three months ago, the CRB Index is now down 42% from its peak. Gold continued to rally this week to close at $837.00/oz. up from $820 last week and $752.30 two weeks ago. Although we are clearly in a deflationary period, investors are still seeking a haven in gold. For a second week, the gain was due to big drop in the dollar. As we mentioned in the introduction, the dollar has had a tough time and the drop in the Fed funds rate to zero didn’t help as the U.S. Dollar Index dropped to a low of 77.69 Thursday before coming back to close at 81.10 Friday. This is down from 83.68 last week and 86.87 two weeks ago. Since bottoming in July, the U.S. Dollar Index has seen its gain pared from 22 to less than 13%. Crude slipped again to close at 42.91/bbl down from $49.43 last week and $42.93 two weeks ago on another week of significantly higher volume. Oil is still down 66% from its halcyon mid-summer high of $147.20. The U.S. bank prime rate and the Fed funds target rate dropped 75 basis-points to 3.25% and 0.00% - 0.25% respectively with the effective Fed funds rate falling to 0.15% (from 0.21% last week). Credit markets continued to loosen as the 3-month London Interbank Offered Rate (LIBOR) slipped again to 1.4975% (from 1.9213% last week and 2.1856% two weeks ago). And thanks to continued help from the Fed in buying at the long end of the yield curve, Freddie Mac mortgage rates slipped again to 5.19% (from 5.47% last week and 5.97% three weeks ago) for the 30-year fixed mortgage while the one-year adjustable rate mortgage (ARM) slipped to 4.94% (from 5.09% 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 Q3 Earnings – Down for the count In the eleventh week of Q3-08 reporting season with a total of 3990 companies having reported (up from 3950 companies last week), average earnings held steady at -62% for the third week (from -63% three weeks ago, -38% five weeks ago and -13% in the season opener) versus Q3-07. But for a few late reporting stragglers (and the crying), this earning season is over and we don’t expect this number to change. 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. Earnings are now experiencing their biggest drops since first turning negative in Q3-07. Economic Reports Fed’s turbo-charged cash machine yet to yield tangible benefits U.S. Treasury international capital flows, which tell us how interested foreigners are in continuing to finance our spending ways, spiked again in October jumping $286.3 billion, up from $142.6 billion in September. The return on three-month U.S. Treasuries dropped to negative last week for the first time since 1941 as domestic and international investors alike paid to have their money in what they considered safe investments. But the problem is that these investors will redeem their Treasuries faster than iron filings to a magnet once the perceived threat has passed and they realize just how vulnerable the dollar really is. The current account deficit also dropped in Q3 to $174.1 billion from $183.1 billion in Q2, one of the small benefits of a declining economy. We took a look two weeks ago at the monetary base (money in circulation) which was up 75% as of the November 19 from a year ago according to the Federal Reserve. Well, we checked again this week and as of December 17, on a year-over-year basis, monetary base is now up a mind-numbing 97%! This compares to an annualized rate of 2.5% just four months ago. Monetary base has risen more than 91% from July 30 this year when the Fed kicked the money printing machine into warp speed.
Chart 1 – The money flowing into Treasuries spiked up again hitting $286.3 billion in October up from $142.6 (revised) in September. As the chart shows, it was the biggest flow of funds in at least three years as foreigners sought the refuge of short-term Treasuries in the financial storm. The yellow dashed line shows the approximately value of Treasuries that must be sold every month to finance the current budget deficit but this will more than double as the deficit soars north of a trillion next year.
Chart 2 – We learned this week that November was another challenging month for housing permits and starts as permits dropped 15.6% and starts fell 18.9% from October. The chart continues to look like a ski slope into oblivion. Since peaking in January 2006, building permits and starts have fallen more than 72%.
Chart 3 – Here is our updated monetary base chart (money in circulation) showing the massive increase in dollar bills in circulation in the last year. Monetary base is defined as the currency in the money stock plus reserves of depository institutions, adjusted for changes in reserve requirements. Data – St. Louis Fed A more accurate picture of overall money supply is provided by M3 which was discontinued by the Fed in 2006. However, it is calculated by third parties such as John Williams of StadowStats.com. According to their latest report December 20, M3 has surged at an annual rate of 63.4% as of last week. Here William’s explanation of what has fueled this growth. “The growth here reflects a surge in demand deposits (checking accounts), savings accounts, institutional money funds and resumed growth in large time deposits. While these measures may reflect some impact from movement of personal funds out of Treasury bills back into the money supply accounts, greater impact is likely from some flow-through of the extreme systemic liquefaction launched by the Federal Reserve, and of increased bank lending, into the normal stream of commerce. Loans and leases in commercial bank credit have grown at an annualized 14.6% in the last three weeks, 9.3% in the last two weeks, and by 28.0% in the most recent week. The good news is that the system may be starting to return to more-normal functioning. The bad news is that the cost of systemic salvation remains higher inflation, irrespective of the sharp, short-term impact of collapsing oil prices on consumer prices.” We take a look at a longer-term monetary base chart back to 1920 and compare the current period with past periods of financial distress including the Great Depression in our latest Special Report entitled The Value Crisis – Will the dollar again by the government scapegoat? SynopsisAmid signs that markets were thawing, we have an interesting situation. While stocks are trying to put in a bottom, bonds have been flying high. As we see from the weekly chart of the Vanguard Broad Market ETF (VTI), it was the fifth week of a rather slow rally and the fourth week of stable or falling volume. That means one of two things. Either markets are consolidating or the rally is running out of gas. Any correction from here will need to hold at major support at 39.00 or the rally risks failing. In the face of a deteriorating economy and falling interest rates, bonds have risen to new highs. Since putting in a short-term bottom in June 2007, 30-year bonds have been surging, rising like a rocket in the last two months closing at the lofty price of 140^25. But all good things must come to an end and the question now is how long bonds can stay more than three standard deviations above their long-term trend midline. As a point of comparison, this is the first time in more than 30 years that they even got above the three standard deviation top line on the monthly chart.  Figure 3 – Weekly chart of the Broad Market ETF (VTI) showing the slow recovery on falling volume. While the last three signals have been bullish, it is still too early to say the this rally has legs. Chart by TradeGuider.com and data by RealTimeData.com
Figure 4 – Monthly chart of the U.S. 30-year Treasury bonds showing the two standard-deviation trend channel. Stories of interest this week…Fed Loans Guided by Raters Grading Subprime Debt AAA http://www.bloomberg.com/apps/news?pid=20601109&sid=ahpPBA8vqN2o&refer=exclusive Obama Inherits GM’s Game of Chicken in Rescue Plan http://www.bloomberg.com/apps/news?pid=20601110&sid=asC0l2x7DK_4 Paulson Urges Release of Next $350 Billion From TARP http://www.bloomberg.com/apps/news?pid=20601068&sid=ayWWVhIZiRAw&refer=economy Congress Ready to Tap $350 Billion in Aid, Frank Says http://www.bloomberg.com/apps/news?pid=20601110&sid=agVP8IC4hZGA TARP Board Member Sununu Wants More Strings on Carmaker Loans http://www.bloomberg.com/apps/news?pid=20601110&sid=aaYi5.kt9glk AIG Writedowns May Rise $30 Billion on European Swaps (Update1) http://www.bloomberg.com/apps/news?pid=20601109&sid=aQr2vnbm4Jww&refer=exclusive Crude Oil Tumbles Below $36 as Demand Drop Swells Inventories http://www.bloomberg.com/apps/news?pid=20601087&sid=a956vt6xK5Rk&refer=home Citigroup’s Debt Lowered Two Grades to A2 by Moody’s (Update2) http://www.bloomberg.com/apps/news?pid=20601087&sid=aQaq1bRSl5QA&refer=home VIDEOS The Mortgage Meltdown - It's Just Getting Started - 60 Minutes http://www.cbsnews.com/video/watch/?id=4668112n --------------------------------------------------------------------------------------------------------------------- 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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