TSG Stock Market Letter

Week Ending May 22, 2009

Topics Discussed This Week:

Rally on hold…

Leaders move up

Earnings still weakening

Builders get more optimistic but no support from data

Elliott Wave SPX Perspective

Last Week

Quote of the week

“I used to take $300 for the week -- that was walking- around money. Now I take $100 for the week. Forget about ordering sushi for lunch.” Former Bear Stearns trader Guy Irace.

Rally on hold…

Now ten-weeks old, the rally spent a second consecutive week consolidating, with the standout exception of the emerging market ETF which moved more than 5% higher. Up more than 30% from its March 6 low, the S&P500 index is still 4% above its 50-day moving average. 

Technically Speaking

Leaders move up…

Last week only two of Dan Zanger’s market leaders were breaking out, causing us to expect weakness this week. However, on Sunday May 17, four stocks, Potash (POT), Agrium (AGU), Chicago Mercantile (CME) and ProShares Ultra Short Real Estate (SRS), were moving higher second only to the EEM and as we see from the next chart, these stocks led the market this week which is bullish.

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 were below average this week that combined with higher prices is bearish.  A rally needs a steady supply of new bulls buying stocks to give it strength so below average volume on rising prices is bearish. Whether this is a much needed consolidation or an indication of a slow but steady return of the bears still remains to be seen.  

Meanwhile, the Market Volatility Index (VIX) ticked higher as the VIX closed the week at 32.63 down slightly from 33.12 last week but near where it was two weeks ago at 32.05.  Fear levels while historically high have stabilized but this indicator bears watching.    

Since rebounding off its December 5 bottom, the 19 commodity NYFE CRB Index has almost steadily gained ground with the index gaining ground to close at 404.26 up from 393.43 last week and up from 402.37 two weeks ago. The seemingly endless supply of cash from governments should continue to have a positive effect on commodities but when it doesn’t any longer, look out below.  This index is now up more than 23% from its December 5.   

But gold showed some strength this week. After the surge in gold to $1001.10/oz February 20 then dropping, the precious metal moved higher again this week to close at $958.80/oz up from $931.80 last week and $917.20 two weeks ago amid more US dollar weakness. But volume and open interest remain low which is bearish. It is important to point out that gold has a seasonal low in July and then rallies into year-end. 

Meanwhile, the US Dollar Index took a big hit this week falling to 79.96 from 83.02 last week and 82.53 two weeks ago taking out the December 2008 weekly low in the process.

Crude oil futures joined commodities in slipping this week as a barrel of crude closed at $61.67 up from $57.10 last week and $59.66 two weeks ago. Oil is still down 58% from its mid-summer high of $147.20.  

The Baltic Dry Index, an indicator that tracks the cost of shipping dry goods by sea, moved higher again this week albeit at a slower pace, gaining 7% to 2786 from 2544 (for 23% gain last week), to another new 2009 high as shipping demand continued to increase. This is bullish for both the economy and the price of oil but it is important to note that shipping has been quite volatile.

The U.S. bank prime rate and the Fed funds target rate held steady at 3.25% and 0.00% - 0.25% respectively while the effective Fed funds rate firmed to 0.18% (from 0.17% last week).  Meanwhile, the 3-month London Interbank Offered Rate (LIBOR*) slipped again to a new 52-week low of 0.66% (from 0.82563% last week and 1.00688% three weeks ago). This compares to LIBOR 52-week high of 4.81875% last October. 

On the mortgage front, Freddie Mac mortgage rates firmed again this week to 4.82% (from 4.86% last week) for the 30-year fixed mortgage while the one-year adjustable rate mortgage (ARM) firmed to 4.82% (from 4.71% 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 – The earnings-deficient recovery

Last week the average Price/Earnings ratio for the 8,011 US stocks of the VectorVest index hit a new all-time high of 143.5 compared to 130.45 two weeks ago.  This week that ratio continued climbing to another new high of 145.92 as earnings continued to fall. So far at least, this rally has not been accompanied by earnings growth with the average stock experiencing an anemic earnings growth rate of just 2%.

Figure 2 – The VectorVest Composite (VVC) is an index consisting currently of more than 8000 stocks so provides a more realistic picture of what is going on with the “average” stock as opposed to cherry-picked indexes like the Dow Jones Industrial Average or S&P500. Chart courtesy of VectorVest.com

At the beginning of the last recovery, April 11, 2003 marked the “golden cross” of the price of the VVC moving above its 40-week moving average and the beginning of a 56-month bull market. As the rally was getting underway in March and April 2003, earning growth (GRT in red) was a much healthier 8% and earnings growth had begun improving nearly a year before after hitting a low of 3%.

This time around as we see from the chart, another golden cross occurred two weeks ago but so far prices have failed to penetrate above the 40-week MA (purple line). As we said last week, if this rally is to survive two things need to occur. First, the 40-week MA will need to be decisively penetrated. Second, in spite of trillions in stimulus being pumped into markets around the globe, a recovery won’t last until earnings begin to recover.

One last note – the big spike in PEs is not limited to the average stock. As we see from this next link, PEs for the S&P500 have also spiked to record highs as earnings have cratered. See http://www.chartoftheday.com/20090522.htm?A

Economic Reports

Builder optimism not reflected in data

We got some good news on Monday on the housing front when it was announced that the May National Association of Home Builders housing price index jumped from 14 in April to 16 as builders continued to get more optimistic about their industry.

Unfortunately, building demand has so far failed to support this assumption. After brief recoveries (post revisions) last month, both housing permits and starts fell sharply again in April dropping 7 and 8.5% respectively month-over-month and are down 51.2 and 46.9% year-over-year. From their peaks in January 2006 both are down 77%. John Williams of ShadowStats.com defines a peak to trough drop greater than 25% as a Great Depression magnitude drop – certainly not the “green shoots” recovery that has been hyped by the plethora of bullish analysts out there of late.

Next week we will see if prices are responding with the release of the latest Case-Shiller existing home price data as well as both and new home sales figures.

Synopsis

We continue to climb the proverbial Wall of Worry this week, albeit more slowly. The government and Fed continue to take increasingly more active roles in our economy and markets and this ‘no end to the depth of their pockets’ approach continues to buoy stocks and commodity prices. The biggest risk currently to this rally is some event that indicates that these pockets have a bottom as we saw with the market response to a threatened downgrade of the UK’s credit rating this week.

Elliott Wave SPX Perspective

Last week, the highest probability Elliott Wave pattern on the one-hour S&P500 was a Zigzag from the March 10 low with the second 5-wave pattern (Wave C) in the process of unfolding.  This week that changed to an Impulse pattern from the March 6 low as the top probability count with the Wave 5 unfolding. But for this count to remain valid, the May 15 low of 880.07 cannot be taken out. This count suggests we will see higher prices from here until we either get a new high above 929 or a failed Wave 5 which would be very bearish.

Chart courtesy of the Refined Elliott Trader by Elliottician.com

On the lighter side…

Everyone has his day and some days last longer than others.

Winston Churchill

Stories of interest this week…

Obama’s Tax Proposal Won’t Create U.S. Jobs, GE, Microsoft Say

http://www.bloomberg.com/apps/news?pid=20601110&sid=aDppCCywYF3s

Welch Criticizes Obama on Handling Chrysler Bankruptcy

http://www.bloomberg.com/apps/news?pid=20601109&sid=aETI5aIj4WhM&refer=exclusive

Greenspan Says Banks Still Have a ‘Large’ Capital Requirement

http://www.bloomberg.com/apps/news?pid=20601110&sid=aiOYLnM2WxuA

Bear Stearns to Algebra I Means Lost Dollars in Wall Street Trickle-Down

http://www.bloomberg.com/apps/news?pid=20601109&sid=aQJzd0DkdWuQ&refer=home

TARP Warrants Show Banks May Reap ‘Ruthless Bargain’

http://www.bloomberg.com/apps/news?pid=20601109&sid=ae2fQFMrDer4&refer=home

Brown Goes Full Circle as Debt Raises Rating Doubt

http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aFVACM4c4WXo

Canada Dollar Touches 7-Month High as Commodity Currencies Gain

http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aNDgSEEBWEtc

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