TSG Stock Market Letter

Week Ending May 29, 2009

Topics Discussed This Week:

Rally off and running again…

Leaders on hold

Earnings still in the tank

Home prices still falling but sales off the lows

Elliott Wave SPX Perspective

Next weekly newsletter June 21…

Last Week

Quote of the week

“There’s consternation in the stock market. If we see a pick-up in long-term yields, an economic recovery will be much more difficult. That concern could be enough to halt the recent stock rally.”                                                                                                                                                                                                  Russ Koesterich Barclays Global Investors, San Francisco

Rally off and running again…

Stocks rallied strongly on Tuesday following the Memorial Day holiday based on a strong showing in the Conference Board’s consumer confidence indicator which is interesting – we have found this metric to be of little trading value. However, investors chose to ignore the most recent Case-Shiller home price index that showed home prices continue falling at an accelerating rate.

But then on Wednesday, markets experienced a big reversal day as the Dow gained nearly 2.4% in the morning only to give it all back and be down 2% by the end of the day. According to Bespoke Investment Group, similar reversals since 1900 have been accompanied by drops of more than 1% over the next week and the Dow was down an average 1.7% a month later.

But then on Thursday and Friday stocks resumed their upward move with all the major indexes closing higher on the week which is bullish. It has now been eleven weeks since the rally began.

Note, we changed our email address due to being hit by reams of junk mail. To email us, please send them to tradesysmailbag @ gmail.com (we have deliberately put spaces before and after the "@" sign to prevent automated email spiders from targeting us, sorry for the inconvenience). 

Technically Speaking

Leaders on hold…

Last week four stocks on Dan Zanger’s watch list were moving higher and they gained more than 5% which was bullish. This week, none of his market leaders on Monday were making new highs and that is somewhat bearish.

Weekly volumes for the major indexes were below average again this week but that may have been due to the holiday-shortened week.  The fact that volume was highest on Friday is also bullish. A rally needs a steady supply of new bulls buying stocks to give it strength so below average volume on rising prices is bearish. But it is important to point out that momentum has been falling and that increases the probability for a correction in the next few days.

Meanwhile, the Market Volatility Index (VIX) moved lower this week to 28.92 versus 32.63 last week and 33.12 the week before.  Fear continues to fall and while still higher than average, remains elevated but the fact that the VIX has been falling is bullish.      

Since rebounding off its December 5 bottom, the 19 commodity NYFE CRB Index has almost steadily gained ground and that continued this week as it rose to 417.04 up from 404.26 last week and 393.43 two weeks ago. As we said last week, 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 nearly 30% from its December 5 low.    

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 $959.30/oz up from $958.80 last week and $931.80 two weeks ago amid more US dollar weakness. Volume and open interest took a noticeable jump this week and that is bullish for the metal. Gold normally has a seasonal low in July and then rallies into year-end but there are factors at work, namely government generated inflation, that are more powerful this time around.

Meanwhile, the US Dollar Index slipped again this week to close at 79.34 down from 79.96 last week and 83.02 two weeks ago. A steadily weakening dollar is bullish for commodities, interest rates and U.S. multinational corporations with a larger share of their revenues derived from overseas sales.  

And not surprisingly crude oil futures joined the inflation-fueled party this week as a barrel of crude closed at $66.31/bbl up from $61.67 last week and $57.10 two weeks ago. Oil is still down 55% from its mid-summer high of $147.20 and the rapid drop has had a negative impact on supply which is bullish for prices.

The Baltic Dry Index, an indicator that tracks the cost of shipping dry goods by sea, continued to surge this week jumping 25.4% from 2786 last week to 3494 to another new 2009 high as shipping demand continued to increase. This is bullish for both the economy and the price of oil. This is further confirmation of growing inflationary pressure.

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 0.19% (from 0.18% last week).  Meanwhile, the 3-month London Interbank Offered Rate (LIBOR*) slipped again to another new 52-week low of 0.65625% (from 0.66% last week and 0.82563% two 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 4.91% (from 4.82% last week) for the 30-year fixed mortgage while the one-year adjustable rate mortgage (ARM) slipped to 4.69% (from 4.82% 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 – Still waiting for the recovery

Last week the average Price/Earnings ratio for the 8,011 US stocks of the VectorVest index hit a another new all-time high of 151.45 (145.92 last week and 143.5 two weeks ago) thanks to rising prices but no increase in average earnings.  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%.

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 prices failed to penetrate above the 40-week MA (purple line). That happened this week which is bullish from a momentum perspective.  As we said last week, if this rally is to survive we need to see prices stay above the 40-week MA and a genuine recovery in earnings.

Economic Reports

Home prices still falling but sales levels off lows

Last week we learned that while builder optimism increased, both housing permits and starts got worse showing that the stats had yet to support any improvement in housing demand. This week we got more of the same in the form of continuing deterioration in the Case-Shiller home price index for March. On a monthly basis, the 20 city composite index fell 2.17% from February and home prices nationally were down 18.7% on a year-over-year basis. With the lone exception of February, when the rate decline moderated, housing price declines have continued accelerate year-over-year. Price declines have averaged 1.84% a month since January 2008. According the C-S paired home sales in the 20-cities the index covers, home prices have fallen 32.2% from their peak.

As we see from the above chart, year-over-year price declines have continuously accelerated with a brief break in February. Since peaking in July 2006, home prices have fallen 32.2% nationally.

On Wednesday, we learned from the latest National Association of Realtor data that existing home sales increased from last month to 4.68 million in April, a gain of 2.9% from last month but down 4.3% from a year ago. From their peak, home sales are down 30% while median home prices are $170,700, up slightly from last month and down 26.1% from their peak. The inventory of unsold homes was 10.2 month in April.

Meanwhile, new home sales improved slightly in April to 352,000 (from 351,000 in March) and inventories dropped to a 10.1 month supply (from 10.6 months in March) which is good news for the industry. However, with permits and starts still running at 498,000 and 458,000 respectively, there is still too much product being added to bloated inventory levels as the next chart shows.

The median price of a new home rose 3.7% in April to $209,700, but prices are down 14.9% year-over-year.

Given the upticks in both new and existing home sales together with improvements in homebuilder sentiment (in the NAHB home price index), there is a definite trend to improvement in the industry and that is positive. But large inventories and rising foreclosure rates will continue to depress prices for the next few months at least.

Synopsis

We continue to climb the Wall of Worry this week but momentum continued to abate. This is offset on the positive side for markets by the government and Fed taking an increasingly more active role in our economy and markets which will be bullish shorter-term for stocks and commodity prices but increase the size of the ultimate bill. As we saw this week, this will also put upward pressure on interest rates and that is bearish for markets and the economy.

I will be taking a break for the next two weeks. Our next weekly will be published June 21. (correction)

Last week we were on the  beautiful Spanish island of Mallorca and this week moved north to the Tax Misery Index of the World - France. And boy is there a difference! Everything from wine, meals and accommodation to durable goods are more expensive thanks to higher taxes (plus a 20% VAT).

There is also much more evidence of an inefficient and regulation-heavy government at work and that becomes all too evident to the visitor. For example, I purchased a SIM card for my unlocked phone in Spain that cost 25 euros which included 30 euros worth of credit toward minutes. In France, the SIM card itself costs 50 euros and then minutes must be purchased on top of that - not really a good purchase for the visitor for a week or two.

Have yet to experience the underground econony here but gite (villa) accommodation in France must be paid for in cash or bank wire in advance and the vendors charge visitors for the exorbitant fees charged by French banks on top of the fees charged by their bank at home. And as we learned the hard way, you only find out what French banks charge after the fact.

Don't think I'll be coming back to France anytime soon, especially when Spain and Portugal are so much more pleasant, including the weather... I will be writing about my experiences in much more detail in an upcoming Stocks & Commodities magazine article entitled The Traveling Trader.

Elliott Wave SPX Perspective

Last week, the count changed to an Impulse pattern from the March 6 low as the top probability count with the Wave 5 unfolding and said for it to remain valid, the May 15 low of 880.07 could not be taken out and that it suggested higher prices. That turned out to be the case and this week and the count rating increased (probability increased).   

As we see from the next chart, the end of the latest Wave 4 shifted to the right. The next test for this count will be to see if Wave 5 fails (does not move above the top of Wave 3) which as we said last week would be would be quite bearish.

Chart courtesy of the Refined Elliott Trader by www.elliottician.com

On the lighter side…

However beautiful the strategy, you should occasionally look at the results.

Winston Churchill

Stories of interest this week…

GM Said to Plan June 1 Bankruptcy as Debt Plan Gains

http://www.bloomberg.com/apps/news?pid=20601087&refer=top_news&sid=axMQSpTxgYL0

Biggest Losers in GM May Be Taxpayers, Altman Says

http://www.bloomberg.com/apps/news?pid=20601110&sid=abijI88Xnmxw

Unemployment at 8 Percent Is the New Normal as Growth Slows

http://www.bloomberg.com/apps/news?pid=20601109&sid=a3i27FMViXmY&refer=home

Wall Street Derivatives Proposals Adopted in Treasury Overhaul

http://www.bloomberg.com/apps/news?pid=20601109&sid=aMMeY6OodQW4&refer=exclusive

Housing Hitting Bottom Means Fewest Starts Since 1945

http://www.bloomberg.com/apps/news?pid=20601068&sid=aDSgjBGniq0E&refer=economy

Home Prices in 20 U.S. Cities Fall More Than Forecast

http://www.bloomberg.com/apps/news?pid=20601068&sid=aJjnVOs7SUW8&refer=economy

S&P 500 Rally Is in Last Stages, Aurel Says: Technical Analysis

http://www.bloomberg.com/apps/news?pid=20601084&sid=a68ndLIv7BeM&refer=stocks

Short Sellers Pare Bearish Bets After S&P 500 Surges

http://www.bloomberg.com/apps/news?pid=20601084&sid=aXn9t_donoJc&refer=stocks

Latvian Hookers Signal No Recovery for Economy: Matthew Lynn

http://www.bloomberg.com/apps/news?pid=20601039&sid=aSRh7Cf2DTrU&refer=home

VIDEOS

Faber Sees U.S. Inflation Approaching Zimbabwe Levels

http://www.bloomberg.com/avp/avp.asxx?clip=mms://media2.bloomberg.com/cache/vNbfJ.kepSzo.asf&vCat=/av&RND=433773945&A= 

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