TSG Weekly Stock Market Watch

Week Ending July 27, 2007

TradeSystemGuru.com

Topics Discussed This Week:

• Markets encounter headwinds again.
• But market leaders are looking strong.
• More bad news in the housing sector.
• GDP registers improvement over last quarter.
  

Summary - Markets encounter headwinds again

No matter which side of the market you were on, it was one heck of a week. According to one money manager, the Dow has not suffered a 10% correction or better in more than 1,100 trading days or basically since the rally began more than four years ago. It was a week reminiscent of the melts of May 2006 and February 2007 but only time will tell if this will also provide a good buying opportunity. A Dow drop of 311 points Thursday was accompanied by a 13-month high in the Market Volatility Index (VIX) showed that a large number of investors suddenly decided that they were discounting risk too much and acted by selling stock. It is interesting to note that that the week of the last big melt ending March 2, 2007, the INDU (Dow Industrials), DJT Dow Transports), SPX (S&P500), COMPX (Nasdaq Composite) and RUT (Russell 2000) were down 4.22%, 7.3%, 4.41%, 5.85% and 6.19% respectively. Kind of similar to this week’s performance isn’t it?

Technically Speaking

Last week, the normally boring summer market came alive again except that this time it was an unexpected drop. Other than the size of the drops in stocks, there were other striking resemblances to the week ending March 2. Volumes on U.S. markets hit their highest levels since that week and volatility (as measured by the Market Volatility Index or VIX) registered its highest weekly jump since then as well. 

However, even with the melt this week, the major indexes are within their uptrend trading channels. After being glued near the top of their 2 standard deviation trend channels leading into this week, the five major indexes in the table above either touched or came close to the bottom of these channels this week. This means that the rally is still in play technically speaking. Time will tell if they break below these channels but no doubt many investors who see this as a necessary correction will look at this as a buying opportunity. 

Market Leaders Still Look Strong

But while the overall market fell out of bed on Thursday and Friday, Zanger’s market leaders shot higher jumping more than 8% between Tuesday and Friday. This week Google, Terra Nitrogen, Sunpower Corp and CF Industries were dropped and Croc, Garmin and National Oilwell were added. Last week they warned us of possible trouble ahead but as of Friday’s close this week, they’re looking bullish, which is a positive sign for the overall market. This basket of seven stocks is up 23% in the last month versus -3.5% for the SPY, an ETF proxy for the S&P500 Index (see Figure 1).
 

Figure 1 – Stocks courtesy of The Zanger Report. 

The stock melt was also felt in the commodities markets as the NYFE CRB Index dropped to 417.34 this week from 423.48 last week and 423.39 two weeks ago. 

Gold also got knocked back a few notches this week closing Friday at $660 down from $684.60 last week and $667.30 two weeks ago. But it is still higher than it was three weeks ago when it close at $654.70. 

Weakness in gold was partly due to strengthening of the dollar as the U.S. Dollar Index managed to claw its way back up to 80.81 from 80.15 last week when it hit a 12-year low. However it is still down from its 81.69 close four weeks ago. 

It was the sixth strong week for oil as the NYMEX crude oil (continuous) continued to climb closing at $77.02 up from $75.79. 

Emerging markets also took a hit this week as the MSCI Emerging Market Index ETF (EEM) closed at 131.05 down from 139.98 last week. 

Earnings

With 1352 companies having reported Q2-07 earnings (up from 742  last week), net income improvement notched up to 7% versus Q2-06, compared to 6% last week versus 8% for Q1-07 (versus the year before).

Economic Reports

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

More bad news in the housing sector

Chart 1 – On Wednesday we learned that existing home sales dropped another 3.8% to an annual rate of 5.75 million in June from 5.98 million in May after falling 0.3%.  It was the lowest sales rate since November 2002. As far as inventories are concerned, it was another good-news, bad-news story – the supply of unsold homes dropped 4.2% to 4.2 million but so did sales so the time to sell a home held pretty much steady at 8.8 months. The obvious non-sequitur given the challenges is that the median price of a home actually rose, if only marginally to 0.03% to $230,100 from $229,300 last June, according to the National Association of Realtors. May median existing home prices tracked by the Commerce Department rose 0.9% from May 2006 compared to 0.3% for the NAR over the same period. It will be interesting to see what the more reliable Case-Shiller home price index due to be released in a few days has to say. NAR median existing home prices dropped 1.26% in April 2007 from April 2006 while the S&P Case-Shiller index released last month showed a drop of 2.13% over the same period. 

Chart 2 – Then on Thursday, new home sales dropped a whopping 6.6% in June to an annual sales rate of 834,000 homes compared to a consensus estimate drop of 1.6%. May new homes sales were also revised from -1.6% to -2.2%. The big drop contributed to the Dow 311.5 point drop that day.  We then downloaded Commerce Department data and discovered that every report going back to July 2006 had been revised and the vast majority downward. As an example, remember when the market reacted so positively to the 16.2% jump in April? That number is now 10% and the 2.6% jump originally reported in March is now -1.2%. New home inventories held steady in June from May at 537,000 but the time to sell a home is now 7.8 months versus 7.4 last month.   

Chart 3 – The durable goods report came out the same day as new home sales and was pretty much overlooked by the market. After the 2.4% (revised) drop in May, June registered a rise of 1.4%. It shows that while financial markets are reeling in the wake of the sub-prime fiasco and flight to quality in the bond market, consumers haven’t changed their spending habits.  

GDP registers improvement over last quarter.

Chart 4 – The first estimate of Q2-07 GDP came in at 3.4%, a big jump after the 0.7% result last quarter. There is little doubt that real inflation is becoming more of a challenge and even the government’s index for personal consumption, a questionable measure at worst and extremely conservative measure at best of true inflation pressure, surged 4.3% in Q2. In the last two quarters, preliminary GDP estimates have been significantly higher than the final result. The first estimate of Q1-07 was nearly double the final number.   

Next Week 

It’s an action packed week coming up. Here are the economic reports we’ll be watching. 

-         Tuesday, June personal income (previous 0.4%), June personal spending (previous 0.5%), July Chicago PMI (previous 60.2), June construction spending (previous 0.9%). 

-         Wednesday, July Challenger layoffs (previous -21.6%), June Pending Home Sales (previous -3.5%), July ISM manufacturing business index (previous 56.0).

-         Thursday, June factory orders (previous -0/5%).

-         Friday, July nonfarm payrolls (previous 132,000), July unemployment rate (previous 4.5%), July ISM non-manufacturing business index (previous 60.7).

Synopsis

It was a tree shaking week much like that of March 2 but there are some positive signs. First both volume and volatility registered sizable jumps. If we see both settle down next week and even if prices drop a little further, this week has the potential to have been the necessary correction that investors were waiting for. This theory is further supported by the strength by the market leading stocks. Strength in the dollar shows that investors around the world still view U.S. dollar denominated assets as a place to run in times of trouble and that is bullish for the American economy. 

But if we see loses continue and volume build further, it will mean that this was the first leg in a shakeout that has more room to run and all bullish bets are off, at least for the time being.

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