| TSG Stock Market Letter August 3, 2007 |
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| Written by Matt Blackman | |||||||||||||||||||||||||||||||
| Sunday, 05 August 2007 | |||||||||||||||||||||||||||||||
TSG Stock Market LetterWeek Ending August 3, 2007TradeSystemGuru.com Topics Discussed This Week:
We decided to take a break from our housing harangue in our opening monologue. Nothing has changed in that department and we expect it to continue to deteriorate for the foreseeable future but will keep you informed regarding any significant news or event. Instead, this is a good time to do our mid-summer market report card. The market is down but is there anything on the charts that should cause us concern? Here we take an index top-down approach to gauge its temperature and vital signs. Market Report Card – How fare the major indexes?
Figure 1 – Weekly chart of 8,300 stocks of the on the three major U.S. exchanges tracked by the VectorVest Composite Index over the last five years showing the index price of $28.90 currently sitting on its 50-week moving average (blue line in upper graph). It is also above its long-term up trendline (dashed purple line). U.S. stocks currently exhibit an average PE of 29.49, earnings per share (EPS) of $0.98 and dividend (DIV) of $0.40 (see lower graph). It is interesting to note that PE for the index has fluctuated from a high of 60.51 in May 2003 to a low of 24.77 in October 2005. At the peak of the overall market in March 2000, the index PE hit 31.88 then dropped to a low of 21.58 a year later. The best time to buy the overall market would have been in March 2003 when earnings per share were near a multi-year low of $0.34. The overall take? PEs have provided little help in knowing when to buy and sell stocks. In fact composite fundamentals are of little help in choosing entry and exit points. Price is the best and only reliable leading indicator. Chart by VectorVest.com  Figure 2 – Weekly chart of the Dow Jones Industrial Average (INDU) showing 2-standard deviation trend channel with index still near the upper channel border together with 50 and 200-week moving averages. Other than spikes in down-volume over the last two down weeks, there is nothing on this chart to suggest a reversal although there is a chance that price will continue to revert to the mean (return towards the bold mid-channel line currently around 12,700. Chart by GenesisFT.com
Figure 3 – The Nasdaq Composite (COMPX) is also still well entrenched in its uptrend that started in 2003. It dropped in the last two weeks but only to its up-trend center channel line. Like the INDU, it is still well above its 50-week moving average. Other than two weeks of well-above average down volume, no technical sign of an imminent reversal here either. Chart by GenesisFT.com  Figure 4 – Weekly chart of the Russell 2000 showing that small caps have taken more of a hit than their larger-cap counterparts. As we see, the Russell breached its 2-standard deviation lower trend channel this week and its 50-week moving average last week both of which occurred on larger than average volume. Since small caps tend to lead in rallies and corrections, this is something to watch for in the weeks ahead and could be a warning of trouble for the overall market. Chart by GenesisFT.com
Figure 5 – Weekly chart of the MSCI Emerging Markets exchange traded fund (symbol EEM) showing the more than 300% increase since the rally began in 2003. Again, other than two huge down weeks on high volume, no signs of trouble here. Price is still above its mid-channel trendline and well above the 50-week moving average. Chart by GenesisFT.com Market overview – Is there anything to worry about?Silly question! There is always something to worry about. If you’re not worried, you aren’t taking the investment game seriously. However, now on top of the fact that we are in the fourth year of a bull market in which the Dow has yet to experience a drop of 10% or more, we have the sub-prime situation beginning to implode and no one knows how bad it will get. So far, other than a very few analysts who until recently were viewed as ‘doom and gloomers,’ most (including the Fed) assumed that falling housing prices and an imploding sub-prime situation would not severely impact the broader economy. They are now beginning to realize and admit (gasp) that they were wrong. But if there are any technical signs of an imminent reversal in markets, we have yet to spot them. There are two situations worth watching that we have alluded to in the charts above. First, the last two down weeks have occurred on above average volume. However, this could signify a shaking the weaker hands out of the markets by the drops and often indicates capitulation just before the rally resumes. The second sign is a little more troublesome and that is the weak strength of small caps relative to their large cap counterparts. Since small caps tend to lead, this is something to watch and if weakness in this group continues, it could warn of further weakness ahead. Now let’s check in on our weekly numbers and reports.
Another volatile week for stocksIt was a reasonably good week that is until Friday. But as we see from the numbers in the table above, it was a lot better than last week when the Dow lost 4%, Dow Transports 6% and the Russell 2000 more than 7%. As we see, Transports and the Russell were again among the worst performing sectors of the market. Technically SpeakingYes it was another negative week but the good news from the bull’s perspective is that it wasn’t worse. A look at the charts shows that the indexes are still firmly entrenched in uptrends with few technical signs of reversal. Not to say that a reversal can’t occur, just that there are no clues that we can find, other than the fact that volume was above normal during the last two weeks of drops and the Russell 2000 index of small caps have been taking the worst of it, which is bearish considering that small caps often lead in a rally and a correction. Market Leaders Point Modestly Higher
Figure 6 –This week’s Dan Zanger’s market leaders were Crocs and Garmin again along with Research in Motion, Apple, Baidu.com and Chipotle Mexican Grill. The leaders were up 23% for the month last week but just 12% this week while the SPY is down 5.6% compared to a drop of 3.5% last week. Stocks courtesy of The Zanger Report. It was another good week for commodities as the NYFE CRB Index up to 423.16 up from 417.34 last Friday. Gold closed the week at $678.10 up from $660.00 last week but all that really shows at this point is that the U.S. dollar has resumed its slide. It was another challenging week for the greenback as the U.S. Dollar Index closed the week at 80.06 down from 80.81 last week after the three-day rally ran out of gas after it hit a 15-year low. Forget the Fed’s inflation model, if the dollar keeps falling, it will continue to push inflation higher and the best way to fight a falling dollar is by raising rates (see Synopsis). The NYMEX crude oil (continuous) took a break this week as it dropped to close at $75.37 down from $77.02 last week although it didn’t seem to provide much help to the energy-hungry Dow Jones Transports Average. Emerging markets took a break this week as the MSCI Emerging Market Index ETF (EEM) closed at 127.75 down from 131.05 last week. However, its uptrend that began in March 2003 is still very much alive and well. Earnings show more improvementWe are now one month and roughly half way through Q2-07 reporting season and with 2109 companies having now reported (up from 1352 companies last week) Q2-07 earnings, net income improvement jumped up to 10% versus Q2-06 from 7% last week and compared to 8% for Q1-07 versus the year before. Economic ReportsHere’s what the charts had to say this week. Housing sector update
Chart 1 - Last week we mentioned the obvious inconsistency between home prices and the overall health of the real estate market. On Tuesday this week we got a more accurate glimpse into prices with the release of the Case-Shiller home price index. May data showed that home price drops are accelerating with the 10-city May paired-sales composite falling 3.4% and the 20-city composite falling 2.8% versus May 2006. This was in stark contrast to data released by the Commerce Department showing that median prices rose 0.9% from May 2006 and the National Association of Realtors that showed that the median price of a home dropped 2.1% in May from May 06. 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. How can each index report different results? Statisticians call it sampling error and the more erroneous the sampling technique, the more skewed the results.
Chart 2 – Annual rate of change in the composite of 10 cities showing that home price drops are accelerating. In May the 10-city composite rate of change fell to -3.4% over the previous year compared to -2.7% last month while the 20-city composite dropped to -2.8% from -2.1% in May. Over the last year home prices rose in Atlanta (1.7%), Charlotte (7%), Portland (5.7%), Dallas (1.8%) and Seattle (9%). Detroit registered the biggest drop at -11% followed by San Diego (-7%) then Phoenix (-5.6%).
Chart 3 – Then on Wednesday, the National Association of Realtors announced that their “forward-looking indicator” into the health of the housing market in the months ahead jumped 5% in June from May. However, May had been revised downward (from 97.7 to 95.5) which lowered the change from April to May from -13.3% to -13.5%. This did not stop new NAR head cheerleader Lawrence Yun to conclude (yet again) that the market is likely to stabilize in the months ahead. “Home prices should stay close to present levels in the months ahead given an accumulating pent-up demand,” he said. They never seem to learn, do they? As we see from the chart, this is only the second time this year that pending sales have been positive and the negative trendline is steepening. And the foreclosure train is gaining momentum. Certainly no indication of a “pent-up demand” in any data I have seen.
Chart 4 – July Chicago PMI on Tuesday came in at 53.4, a rather sizable drop from June’s 60.2 reading but consistent with the 31-month trend.
Chart 5 - On Wednesday we learned that the ISM number was 53.8 down from 56 in June. Again the trend since January 2005 is still clearly negative.
Chart 6 – On Friday, the Labor Department disappointed the street with an increase of just 92,000 new jobs in July versus the consensus estimate of 135,000. It also revised May and June numbers downward. While jobs numbers lag the market, these data are consistent with the charts above – the economy continues to cool.
Chart 7 – But while the rest of the data suggest cooling, layoffs are flat dropping another 23% in July according to the Challenger report on Wednesday. Next WeekA bit of a slow week coming up. Here are the economic reports we’ll be watching. - Tuesday, June consumer credit (previous $12.9 billion). - Friday, July import prices (previous 1.0%). SynopsisThe Fed’s Mission ImpossibleThe Fed is now firmly entrenched between the proverbial rock and a hard place. Do they do the right thing and support the dollar while fighting inflation? But we all know what that would do to millions of homeowners already struggling to make mortgage payments. See http://tinyurl.com/3c9u6a But helping this group will mean that the dollar continues to slide and inflation becomes a bigger problem for the general economy. Just how serious is it? In his weekly e-letter John Mauldin summed up “The Mortgage Pig in the Python” in the following table that shows the amount of adjustable rate mortgages that reset each month this year and next. As Mauldin commented in his newsletter, “[n]ote that these reset numbers are a driving factor in the increasing rise in foreclosures. Pay attention to the numbers I highlight in red for January through June of 2008. The largest portion of mortgage resets is not until next year.”  Billions$ in value of mortgages resetting. Here is how Mauldin explained the problem. “We have just seen $197 billion of mortgage resets so far this year. That is less than we will see in two months (February and March) of next year. The first six months of next year will see more than the total for 2007 or $521 billion. This suggests to me that the number of foreclosures is due to rise dramatically from the already high current levels, putting more homes into a weak housing environment. Bernanke is right. The pressure from housing will diminish over time. But it is not going to be over in a few months. It is going to take at least another year and maybe 18 months for a bottom in the housing market to develop.” But is Mauldin’s 1-year to 18-month housing bottom expectation overly optimistic? It is based on two very significant assumptions. 1) Interest rates will at worst stay the same or more likely come down to provide mortgage stress relief and; 2) that we don’t go into recession. If one of those assumptions is wrong, the bottom will be both further off and uglier. It is also important to point out that Bernanke and the Fed only set the overnight lending rate. Mortgage rates are set by bond yields and a run for the exits by foreign investors has the potential to drive yields (and mortgage rates in their wake) significantly higher in a hurry. What would cause such an exit? A continually weakening dollar is the most obvious catalyst. One final thought. Based on the trajectory of the Case-Shiller housing index, prices across the nation are projected to drop 7% by year end. That will put a large number of homeowners with unbearable mortgage payments underwater with only one option - foreclosure. I do not envy Mr. Bernanke and his team at the Fed. They have some very tough decisions to make which will seriously impact the viability of our economy going forward. ------------------------------------------------------------------------------------------------------ If you find this newsletter insightful, please feel free to forward this newsletter and share it with a friend (or simply have them opt-in free from our home page http://www.tradesystemguru.com to be added). DisclaimerTradeSystemGuru.com obtains information from sources deemed to be reliable; |
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