TSG Stock Market Letter

Week Ending January 9, 2009

Topics Discussed This Week:

First Five Days positive!

Leaders still pointing higher

Q4 earnings – Off to a rough start

Jobs numbers get worse

Have policy makers lost it?

The Big Picture

Last two weeks

Quote of the week

“Many historical instances of monetary instability have been the result of central banks being prevailed upon to use their balance sheets for fiscal ends. Mixing monetary and fiscal policy is fraught with risks.” – Richmond Federal Reserve Bank President Jeffrey Lacker in speech to Maryland Bankers Association this week.

First Five Days positive!

Last week we discussed the First Five Day indicator that gives us our first glimpse of what the year may hold for stocks. The First Five Days (FFDs) introduced by Yale Hirsch founder of the Stock Traders Almanac says that as go the first five trading days, so goes the rest of the year, at least if the start is positive. As mentioned last week, the last 36 positive FFDs were followed by 31 up years for the S&P500 for a better than 86% accuracy rate. However, it has proven to be a poor down-year prognosticator with a forecasting rate of just random (50:50) for the rest of the year when the first five days are down.

When we crunched the numbers, fully expecting the results to be down in the first five days, we were pleasantly surprised. Granted, index performance this week looked pretty sad as the first table clearly shows. But even with a weak week and steady stream of bad economic news, the S&P500 managed a gain of 6.48 points (7.2%) in its first five trading days of the year (close of December 31 to close January 8) and that is good news. However, we’re not out of the woods just yet.

More reliable is the January Barometer also developed by Yale Hirsch, which says that as goes January so goes the rest of the year.  According to the 2009 Stock Trader’s Almanac, this indicator has “registered only five major errors since 1950 for a 91.4% accuracy ratio.”  Including ten flat years, the January Barometer registers an overall 74.1% indicator of both up and down years.

In other words, even though the First Five Days of January were positive, all bets for a good year will be off if the S&P500 is lower at the end of the month.

Technically Speaking

Leaders still pointing higher

Last week, Dan Zanger’s Sunday pix outperformed all major indexes except the emerging market ETF (EEM) and the Dow Transports (DJT).  As we see from the next chart, they are again outperforming the majors and managed a nearly 1% gain while the others faltered and that is mildly bullish.

This week Dan’s portfolio of stocks included Hess Corp (HES), First Solar (FSLR), Holders Oil Serv (OIH), Energy Conv (ENER) from last week as well as Apache Corp (APA), Noble Energy (NBL), Amazon (AMZN), Mastercard (MA), Apple (AAPL), Freeport Cu&G (FCX), Gramin Ltd (GRMN) 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 remain below average but all the major indexes experienced greater volume than last week. Since prices fell, this is mildly bearish. Rising volumes on falling prices shows more sellers entering the markets and that is not good news. Similarly, rising prices on falling volumes shows fewer buyers entering the market and that spells trouble in a rally. But so far at least, support levels are holding and that at least is good news. Rising prices need to be accompanied by rising volume if a rally (which is what we are now experiencing) is to be sustainable.

After peaking above 80 November 20, the Market Volatility Index (VIX) continued to slip, falling to 38.56 Tuesday before firming to 42.82 Friday compared to 39.19 last week. This shows that fear continues to ebb. However, the 52-week moving average is 33.45 so fear is still higher than the 12-month average.    

After surging over the last four weeks, the 19 commodity NYFE CRB Index continued to recover this week to close at 372.90 versus 370.68 last week and 351.81 three weeks ago. Since hitting a high of 611.51 three months ago and losing nearly 50%, the CRB Index has pared its loss to 39% from its peak. 

Gold took a break this week closing at $854.70/oz compared to $879.2 last week and $837.00 three weeks ago.  Although we are still in a deflationary period, investors continue to seek a haven in gold.

Surprisingly with the prospect of Obama taking office and initiating another trillion in stimulus and bailout packages and with the Fed funds rate to zero, the U.S. Dollar Index  continued to claw higher closing at 82.50 this week, up from 81.84 last week and 81.10 three weeks ago. Since bottoming in July, the U.S. Dollar Index has gained 14.6% but is down 5.9% from its November 21 peak.

And after a five month slide followed by a strong rebound last week, crude slipped again this week to close at $45.69/bbl off from $50.31 last week but still higher than three weeks ago when it closed at $42.91/bbl.  Interestingly, volume hit its highest levels since last May and that is bearish for the price of oil going forward in spite of the OPEC production cuts. Oil is down more than 68% from its halcyon mid-summer high of $147.20.

After falling 75 basis-points in early December, the U.S. bank prime rate and the Fed funds target rate held steady at 3.25% and 0.00% - 0.25% respectively with the effective Fed funds rate holding steady for the second week at 0.13% (from 0.15% three weeks ago). Meanwhile, credit markets continued to loosen as the 3-month London Interbank Offered Rate (LIBOR*) slipped again to 1.26% (from 1.4125% last week, 2.1856% five weeks ago). This compares to 4.81875% in October 2008.

Freddie Mac mortgage rates slipped again to 5.01% (from 5.10% last week and  5.97% five weeks ago) for the 30-year fixed mortgage while the one-year adjustable rate mortgage (ARM) rose to 4.95% (from 4.85% 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

Q4 Earnings – A rough start

In the first week of Q4-08 reporting season with a total of 378 companies having reported, average earnings are down 48% versus Q4-07.  This compares to -13% for the first week of Q3 earnings reporting season and as we know, the final tally for Q3-08 was a drop of 62% versus Q3-07. Given that earnings have so far experienced their biggest drops since first turning negative in Q3-07 and that results have deteriorated as reporting seasons have progressed, it is logical to expect results to continue to get worse this quarter. 

Economic Reports

Jobs numbers abysmal

All reports this week were negative, from November construction spending (-0.6%) to November factory orders (-4%) and while the December ISM non-manufacturing (service sector) reading improved to 40.6 (from 37.3), it was well below the contraction threshold of 50. Pending home sales also came in worse than expected but it has proven an ineffectual indicator and only confirms what we already know long after the fact in a deteriorating market.

However, these reports were all overshadowed by the much awaited jobs report Friday which was again worse than expected with a loss of 524,000 more jobs in December for the twelfth consecutive monthly drop. There have been 2.6 million jobs lost (so far pending further revisions) in 2008, for the largest loss since WWII.  Another interesting factoid is that the average number of hours worked per week has plunged to an all-time low, an indicator of further weakness ahead according to Bloomberg. Jobs numbers have suffered average downward revisions of 75,000 so we should expect the December jobs loss number to rise to at least 600,000 next month. November losses were revised to -584,000 from -533,000.

The December unemployment rate also rose to 7.2% from a revised 6.8% in November (originally reported as 6.5%).

Economic charts of the week

Synopsis

Have policy makers lost it?

Tough times call for drastic measures as we have experienced first hand of late but is there a limit to how much money policy makers can give away? And it is obvious the majority are strongly in favor of using the same policies to get us out of this mess that put us in this situation in the first place. It reminds me of that famous definition of insanity – doing the same thing and expecting a different result.

The federal budget deficit, estimated at around $450 billion for 2008, is projected to grow to $1.2 trillion in 2009 and that is without any more new spending or bailout initiatives. There is little doubt that with a Democratic President, Senate and Congress at the helm, Mr. Obama’s American Recovery and Reinvestment Plan estimated to cost $775 billion (so far) will most certainly grow in size. And it is equally likely that other programs will follow.  

Let’s do the math. At $1 trillion we are facing a budget deficit of 8% of GDP and that assumes GDP growth holds steady, which is not the case. But be that as it may, this size deficit would be a first in U.S. history. A shrinking economy and expanding bailout costs means the final ratio could be significantly higher. What does that mean?

First, Treasury will have to sell foreigners a lot more of its securities. At a deficit of $1.2 trillion, it would mean roughly three times more than last year. Are foreigners willing to pony up another $1.2 trillion in a deteriorating economy even if they are able?

When our Asian sugar daddies finally pull the plug, they will leave a debt-ridden cash junkie behind and we all know what happens when demand exceeds supply.  The cost of money goes up and the bigger the need, the faster the cost will rise as debt rapidly becomes a much more challenging habit to maintain.

So while spending like there is no tomorrow to stem the tide of bankruptcies and foreclosures may seem like a good idea on first blush, it is a plan that has the potential to produce some short-term gain in exchange for serious and very expensive long-term pain.

When that happens, expect to see the word ‘risk’ to gain a big pant-load more respect. 

Big picture - Not looking bullish

Stepping back to look at the big technical picture, the Vanguard Total Market ETF (VTI), a good overall market gauge, continues to meander higher but on declining volume in a situation known as bearish divergence. As we see from the next chart (weekly), although volume has moved marginally higher in the last two weeks, it is well below the levels it experienced a couple of months ago and price has been more or less contained in an upward sloping trend channel, also known as a bear flag.

- Chart by TradeGuider.com Data by RealTimeData .com

Unless we see a significant increase in volume and more consolidation, this does not bode well for this rally in the weeks or months ahead.

There is a similar pattern on the weekly DB Commodity Index ETF (DBC) managed by Deutsche Bank chart that tracks the performance of over 200 commodity futures related industry groups in 40 sectors although volume has increased to back to near more normal levels this week.

Stories of interest this week…

Fed’s Lacker Says Fed Loan Programs ‘Fraught With Risks’

http://www.bloomberg.com/apps/news?pid=20601068&sid=auDZw8eyPuIA&refer=economy

Banks’ ‘Catatonic Fear’ Means Consumers Don’t Get TARP Relief

http://www.bloomberg.com/apps/news?pid=20601109&sid=aqLT6v88t.Jo&refer=home

Hard-Hit Families Finally Start Saving, Aggravating Nation's Economic Woes

http://online.wsj.com/article_email/SB123120525879656021-lMyQjAxMDI5MzAxNjIwMDY1Wj.html

Paulson Bailout Didn’t Give Taxpayers Buffett’s Terms

http://www.bloomberg.com/apps/news?pid=20601110&sid=aY.uOADeVX4o

Paulson Backs ‘Robust’ Stimulus, More TARP Bank Aid

http://www.bloomberg.com/apps/news?pid=20601110&sid=autVfzFy7HHg

Lennar Declines After Minkow Alleges ‘Ponzi Scheme’

http://www.bloomberg.com/apps/news?pid=20601110&sid=am6Nqfg6QZbQ

Billion-Dollar U.S. Verdicts Vanish After Appeals, New Rulings

http://www.bloomberg.com/apps/news?pid=20601109&sid=a3pNSz7zXQTk&refer=exclusive

Sell Copper, Nickel Before Index Rebalancing Ends

http://www.bloomberg.com/apps/news?pid=20601109&sid=asfEs1P.OB3c&refer=exclusive

Industrial Output Falls Across Europe as Recession Deepens

http://www.bloomberg.com/apps/news?pid=20601068&sid=at5mCmlQtE7M&refer=economy

Videos

Peter Schiff on what to expect in 2009

http://www.youtube.com/watch?v=9h2x7R8pxUs  

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