TSG Weekly Stock Market Watch

Week Ending May 11, 2007

TradeSystemGuru.com

o    The great REIT run-off – How are they really doing?
o    Retailer weakness shows signs of spreading.
o    Earnings improvements also flagging.
o    US dollar strength belies stock rally motivated by rate-cut hopes.

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In our Synopsis last week, we took a look at Real Estate Investment Trusts to see if the housing meltdown was beginning to impact them. This week we take a closer look at both Equity and Mortgage REITs to determine what they are saying about the property market.


Figure 1 – Morgan Stanley REIT Index (RMS) showing strong upward trajectory.

While the news for homebuilders and existing home sales steadily gets worse, analysts have been weighing in on how this will impact other real estate sectors. So we decided to analyze the group to see if it was trying to tell us something. Take a look at any number of REIT indexes like the Morgan Stanley REIT ($RMS) and there are no signs of any weakness and in fact the slope of the rally up trend has only gotten steeper in the last year (Figure 1).

Figure 2 shows a performance graph of Equity and Mortgage REITs compared to the broad stock market since January 2000. Both REITs handily outperformed stocks until the stock market rally began in March 2003. Mortgage REITs peaked in early 2004, while the Equity counterparts have continued to do well as a group and are now up over 100% from 2000.


Figure 2 – Comparison of REITs to the broader market as represented by the VectorVest Composite Index (VVC) of more than 8,000 US stocks. Mortgage REITs suffered a trendline break in early 2005 and have been in a technical downtrend ever since. While earnings per share (EPS) for Equity REITs as a group (red) remain strong at $2.00, they have dropped from $1.45 in February to just $0.86 in May for Mortgage REITs (green). Meanwhile averages EPS for the VVC bottomed in May 2003 at $0.30 and are now $0.98 in a solid uptrend. Chart by www.VectorVest.com



Figure 3 – Top five performing large cap (min. $200 million) Equity REITS over the 52-weeks up to May 2006 one year later. Only one, Kilroy Realty (KRC), has broken its up trendline. Chart by www.VectorVest.com

We then charted the five top-performing Equity REITs as of May 11, 2006 and the charted their performance for the next year (Figure 3). The results are shown in Figure 3. Two SL Green Realty (SLG) and Kilroy Realty (KRC) are currently below their 2007 highs and only the latter has broken its up trendline.


Figure 4 – The five top 52-week Mortgage REITs performers to May 2006 one year later and we see that they are all below their 2007 highs. Chart by www.VectorVest.com

While it is too early to declare the rally in Equity REITs over (in fact their relative strength remains strong), Mortgage REITs are struggling both technically and fundamentally. Although home prices are down in 18 of 20 major cities across the US, the commercial sector remains vibrant and hot spots including New York City continue to be robust for both commercial and residential real estate.

Paraphrasing author Samuel Clements (AKA Mark Twain) after reading a newspaper report of his own demise, rumors of the death in Equity REITs are much exaggerated and shorting them not a good idea, at least not until there are signs of more weakness. But without the availability of abundant cheap money that became the norm in the mortgage sector, only time will tell how long Equity REITs can keep powering higher.

Now let’s check in on what happened in the stock market this week. 

Summary

After five weeks of across the board gains for the major indexes, they lost momentum this week with three of the five losing ground and the Dow suffered its biggest single day drop this week since March. This was in spite of the fact that oil lost ground, which should have been good for Transports. 

Technically Speaking

Although some of the air came out of the hot-air balloon that have carried stocks of late, stock momentum remains strong as the NYSE Index, Russell 2000 S&P500 and Nasdaq Composite are at or near highs.   

Commodities corrected this week as the NYFE CRB Index closed at 405.71 down slightly from 406.01 but this recent strength has more to do with a bounce in the US dollar than a fall in commodity demand.   

Meanwhile gold dropped again this week closing at $672.30 from $690.00 last week. Silver took a similar rest.

NYMEX crude oil (continuous) rose a little to $62.37 this week from the two-week low of $61.93 last week. But oil remains below both its 50 and 200-day moving averages which is interesting considering that we are well into high summer driving season demand.

Meanwhile the greenback finished its second week of rallying showing that unlike equity investors, their currency counterparts hold out little hope for a drop in the Fed funds rate anytime soon. The U.S. Dollar Index closed at 82.02 up from 81.63 last week and 81.35 two weeks ago.

Earnings

With a total of 3404 companies (up from 2455 last week) having reported earnings for Q1-2007 held steady with an improvement this week coming of 9% versus the same quarter last year. With earnings season more than three-quarters over, there is little chance that earnings improvements will match the 29% level hit for Q4-07.

Economic Reports

Here’s what the charts had to say this week.


Chart 1 – March consumer credit rose by $13.5 billion versus the consensus $5 billion showing that the consumers’ ability to spend (and borrow money) remains in tact.  Even with the mortgage meltdown, the trend remains up.


Chart 2 – Import prices were also stronger than expected jumping 1.7% in April versus the expected rise of 0.9%. March sales were revised to a gain of 1.5% from 1.7%.    


Chart 3 – The trade deficit jumped to $63.9 billion versus the consensus $60 billion up from $58.44 billion in February.


Chart 4 – April retail sales took an unexpected turn for the worse dropping 0.2% versus an expected rise of 0.4%. But it was the worse than expected earnings reports from retailers including Wal-Mart (which announced its worst monthly same store sales decline in 28 years) on Thursday that generated fears that the all-important consumer was again tiring, causing a sell off with a Dow drop of 147.74 points for the biggest one-day drop since March. But then strangely, even with the disappointing retail sales report Thursday, a weaker than expected April core PPI (unchanged) fuelled hopes for a Fed funds rate cut and the market rallied.  The market may have a great memory but it's extremely short!

Next Week  

A busy week again for economic reports next week. Here are the ones we’ll be watching.

-    Tuesday, April Consumer Price Index (previous 0.6%), April Consumer Price Index (ex-food & energy) previous 0.1%,      March Treasury International capital flows (previous $94.5 billion) and May NAHB housing market index (previous 33).
-    Wednesday, April housing starts (previous 0.8%).
-    Thursday, April Leading Economic Indicators (previous 0.1%) and May Philadelphia Fed Business Index. Previous: 0.2.   
-    Friday, April Producer Price Index and PPI (ex food & energy) previous 0.0%, April retail sales (previous 1.0%). April retail sales ex-autos (previous 0.8%) and March business inventories (previous 0.3%).

Synopsis

There were more signs of flagging consumer spending this week, especially in the lower income brackets with the revelation that Wal-Mart experienced its worst monthly decline in same store sales of 3.5% for April in more than 28 years, handily surpassing the previous worst decline of 0.6% in April 1996. In a survey of 51 retailers, the average gain for the month was an anemic 0.2% versus 6% in March according to the Wall Street Journal. This together with decelerating earnings are further signs of slowing, which is significant considering that rising earnings and consumer spending have been the major fuel propelling stock prices higher over the last four years. Could this be a sign of a trading range doldrums market at best ahead?

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