| TSG Stock Market Letter September7, 2007 |
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| Written by Matt Blackman | |||||||||||||||||||||||||||||||
| Sunday, 09 September 2007 | |||||||||||||||||||||||||||||||
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TSG Stock Market LetterWeek Ending September 7, 2007TradeSystemGuru.com Topics Discussed This Week:
Here is what happened in markets this week.
Stock recovery encounters more turbulenceMarket players were skittish again this week as more evidence emerged that turmoil in the credit markets was insidiously spreading to the broader economy. After two good days to begin the week, stocks ended giving back those gains as the week wound to a close thanks to downright lousy housing, layoff and jobs reports. By the reaction, it was clear that few expected the news to be so bad. But the silver cloud is that volumes remained low as the pros just back from summer vacation opted to stay on the sidelines so it’s too early to tell if the injuries inflicted this week were more than mere flesh wounds. Technically SpeakingAgain, the global plunge protection team pushed liquidity into markets in one form or another this week but as markets have now become cash-pump dependent, they now react less positively to it. Here is what the technicals are saying. Market leaders up but…By Thursday’s close, Dan Zanger’s composite of stocks in his Wednesday newsletter had gained a respectable 3.2% since last Friday compared to just 0.4% for the S&P Depository Receipts SPYDR (SPY), 0.04% for the Dow Jones Industrial Average (DJX) and 0.7% for the Nadaq Composite (IXIC). But by this Friday’s close, only Zanger’s portfolio remained in the green with a weekly gain of 1.1% (see Figure 2). As we see from Figure 1, Dan’s weekly portfolio as of September 5th outperformed the market over the last month, and for the third week his bias remained long. While this is bullish, we may be in for some more downside as the leaders rolled over pretty hard on Friday and that has bearish implications. His leaders this week again consisted of 10 stocks including past bullish favorites Garmin (GRMN), Baidu.com (BIDU), Apple (AAPL), Dryships (DRYS), Oil Holders (OIH) and Research in Motion (RIMM) as well as past picks Amazon (AMZN), National Oilwell (NOV) and Excel Marine (EXM). Perennial performer Google (GOOG) was conspicuously absent.
Figure 1 – Monthly performance of Zanger’s market leaders compared to the SPY (proxy for the S&P500), the Dow Jones Industrial Average (DJX) and Nasdaq Composite (IXIC). Data courtesy of The Zanger Report, performance chart courtesy of VectorVest.com. Trading volumes during the first week back from the summer hiatus were even lower than last week which means if the pros have returned to work, their resources haven’t just yet. That stocks dropped on low volumes is good news especially for indexes such as the Dow Industrials, S&P500 and NYSE that are still trading at or above their linear regression (2-standard deviation) trend channel mid-lines and 50-day moving averages. It also means that many of the catapult or ‘W’ patterns mentioned last week are still alive. However, technicals are less reliable when markets are highly news or event dependent like they have been over the last two months.
Figure 2 – Performance over the last week of Zanger’s market leaders compared to the SPY, DJX and IXIC. Data courtesy of The Zanger Report, performance chart courtesy of VectorVest.com. On a weekly basis, after surging to a multi-year high August 17 the Market Volatility Index (VIX) settled down but has since surged again suggesting that fear is again coming into the market. Commodities also surged this week to close a hair above the 2-standard deviation trend channel midline and 50-day moving average as the NYFE CRB Index closed at 418.53 up from 413.49 last week and 408.65 two weeks ago. Gold had another good week as the yellow metal closed above psychological price resistance at $703.00 up from $675.80 last week and $671.40 two weeks ago. Up trends in both gold and the CRB Index are indications of rising inflationary pressure due in part to hopes that the Fed will cut the funds rate at least 25 basis-points at the September 18th Federal Open Market Committee pow-wow. But as the market awaits the Fed’s decision, the dollar took another beating. For the first time in 15 years, the U.S. Dollar Index fell below significant support at 80 as the index closed at 79.72 on Friday down from 80.79 last week. Still strongly mired in a downtrend that began in 2002, a weak resolve on the part of the Fed will be decidedly bad for the greenback. Pushed higher by a weakening dollar, NYMEX crude oil (continuous) again surged higher this week closing at $75.62/bbl up from $74.04/bbl and from $71.09 two weeks ago. Now that summer driving season is over, pressure on gasoline (and oil) will fall but don’t expect much in the way of relief here in the U.S of A. if the Fed lowers rates. Emerging markets outperformed U.S. stocks again for the third consecutive week as the MSCI Emerging Market Index ETF (EEM) ended the week at 132.15 down slightly from 133.95 last week but still well above its close of 127.95 two weeks ago. A resistance band still exists between 133.75 and 135 which will have to be decisively broken if the index is to move higher. EarningsWith the season slowly but surely winding down, 4041 companies have now reported Q2 earnings (up from 3990 last week) and earnings improvement moved up slightly to 13% from 12% last week. This compares to an 8% improvement for Q1-07 versus the same quarter the year before. Economic ReportsHere’s what the charts had to say this week. Construction spending and ISM register unexpected drops Chart 1 – While economists were expecting a flat month of construction spending on Tuesday, it dropped 0.4% in July for the largest decline since January. Originally, the June was -0.3% but that was revised up to a gain of 0.1% so the news wasn’t all bad. However, drops in residential construction are taking their toll, falling 1.4% in July compared to a 0.4% drop in June. Non-residential, government and private sector construction spending increased 0.6%, 0.7% and 0.7% respectively. Overall, the trend for construction spending has declined rapidly from positive in April to negative currently.
Chart 2 – Also released on Tuesday, the Institute of Supply Management’s manufacturing business index for August was also lower than expected with a reading of 52.9. It is the third consecutive monthly decline. While those directing the survey say the economy continues to grow at a “significant rate,” the overall trend over the last two years is strongly negative. Pending home sales paint troubling picture
Chart 3 – And on Wednesday, pending home sales came in at a depressing -12.2% versus June, disappointing everyone except the smart property market bears since it was more than twice the expected drop. Far more important than the month-to-month changes however, is a comparison to the same month the year before. Pending home sales plunged 16.1% from July 2006 according to data from the National Association of Realtors. A relatively new indicator launched in 2005, pending home sales tracks expected existing home sales based on the number of contracts signed. It is a leading indicator since it looks at closings in the next 30 or more days ahead. Head NAR cheerleader Lawrence Yun tried his best to explain the weakness. “It's difficult to fully account for mortgage disruptions in the index, and our members are telling us some sales contracts aren't closing because mortgage commitments have been falling through at the last moment,” he was quoted in the Wall Street Journal. But the depressing news did little to deter him from his course of pumping up the market. “These temporary problems are primarily with jumbo loans, and there are continuing issues for subprime borrowers, but there are no serious problems for the majority of buyers who qualify for conventional financing or FHA-insured loans. Some consumer concerns remain, but since mid-August the market has been stabilizing somewhat.” But unless I am missing something, pending sales does not include cancelled or collapsed sales where buyers back away from the sale on or shortly before completion date. However, the trend (purple line) tells all – it has been tilting more negative over the last few months.
Chart 4 –Taking our own advice, we calculated pending home sales using changes from the same month the year before (year-over-year) which provides a more accurate picture of what is really going on. Those who have looked at the data in this way began to get warning that things were seriously amiss in March 2006. Since then, pending home sales have dropped an average 11% every month from the year before. And as we see from the purple trend line, the negative trend is getting steeper. It’s no surprise that the National Association of Realtors and industry proponents don’t include this chart in their media releases. Data from the NAR. Layoffs jump and payrolls decline for first time in four years
Chart 5 – Then, the second shoe dropped on Wednesday with a pessimistic report from Challenger, Gray & Christmas Inc. showing that jobs layoffs surged more than 85% in August from July. It was the biggest monthly jump in layoffs since the firm began tracking the data in 1993. On a year-over-year basis, job cuts jumped 22% from last August. In a separate national employment report by ADP, total private employment grew at just 38,000 new jobs versus 41,000 in July. The August ADP number was the lowest since June 2003. This compared to an economists’ estimate for non-farm payroll of both government and private jobs for August of 120,000 so a very wide discrepancy between what economists were expecting and what they got. This metric together with pending home sales were two big reasons why the Dow dropped more than 140 points by close on Wednesday.
Chart 6 – And then on Friday the third and biggest shoe dropped with the figures even lower than suggested by the ADP survey and confirming the big jump in layoffs. Instead of rising 120,000 as economist expected, non-farm payrolls government and private jobs dropped 4,000 for the first fall since September 2003. Flying in the face of the many market cheerleaders including Bernanke who have been downplaying the mortgage meltdown, it was irrefutable proof that effects of the mortgage and credit crunch has spread through the wider economy. If the rate of growth in new foreclosures, which hit another new all-time high in Q2 (0.65% of all mortgages were in foreclosure, up 12% from Q1) and those late on mortgage payment (sub-prime borrowers late on payments rose to 15%) are any indication, it will get far worse next year. Much of what we are feeling now stems from the impact of $155 billion in adjustable rate mortgages (ARMs) that reset in the first six months of 2007 at substantially higher rates. According to Bloomberg news, nearly half of the foreclosures commenced in Q2 were on sub-prime adjustable rate loans but these loans represent less than 8% of all outstanding mortgages. But this is only the beginning. Another $318 billion in ARMs (including sub-prime) reset in the second half of 2007 and $521 billion will reset in the first six months of 2008, (see our August 2 discussion at http://tradesystemguru.com/content/view/76/58/#Fed ) This means that ARM mortgage resets will double from the first to second half of 2007 and then nearly double again in the first half of 2008! More about this in our synopsis… What was surprising however is that the unemployment rate was unchanged at 4.6% but since it is a lagging indicator, we expect that to change in the coming months. LIBOR diverges from the Fed funds rate – are higher rates ahead? Chart 7 – Talk in bond and credit markets this week focused on the big jump in the USD LIBOR (London Interbank Offered Rate) which as we see from this chart normally tracks the effective Fed funds overnight rate (FFR). LIBOR is the rate that international banks charge each other for the short-term loans and so far more market driven than the FFR. In July the two were just 13 basis points apart. But after climbing for more than 10 trading days in a row, the difference reached 50 b.p. as the LIBOR hit a six year high of 5.72% this week. What does it mean? Despite the billions in liquidity that central banks have been pumping into the global financial system, money is playing harder to get thanks to the mortgage maelstrom now spreading around the globe. As we see from the chart, it is only the third time in the last decade that the two rates have significantly diverged – the first occurring in the second quarter of 1999 as rates began to climb less than a year before the start of the last bear market. International banks are becoming more circumspect about loaning money and this is curbing a broad range of markets from multi-billion dollar merger and acquisitions to consumer loans. And since mortgage rates are often tied to LIBOR, they are worth watching. A continued rise will put added pressure especially on those with adjustable rate and new mortgages or refinancings in the coming months. As we see from the previous times when LIBOR has risen ahead of the FFR (1999 and 2004), it has led hikes in the funds rate by two or more months. Unless this time is different, market forces will push the Fed to raise rates otherwise the dollar will suffer and inflation pressures will accelerate. But this is certainly not what the market is expecting. No matter which way it goes, the Fed will be under increasing pressure and Chairman Bernanke, will face his greatest challenge yet. Data – St Louis Fed and British Banker’s Association.
Chart 8 – An update from July 20 (see link below) of our composite of 15 off-the-run sub-prime mortgage credit derivative swap (CDS) indexes tracked by Markit.com showing the nearly 40% price drop in CDSs (since January) and recent modest recovery. Only time will tell if this is just a dead-cat bounce or something more positive. (See http://tradesystemguru.com/content/view/72/58/#ABX ) Data – Markit.com
Chart 9 – But as we see, the lowest rated sub-prime category of CDSs (BBB minus) have levelled of late but are still in pretty bad shape after losing nearly 60% of their value since January. Chart – Markit.com Next WeekHere are the economic reports we’ll be watching next week.
SynopsisGrowing gremlins…We talked last week of the growing risk of recession and indicators that are pointing in that direction. As we have said before, the fundamentals will always lag a market downturn so we are constantly on the search for reliable but esoteric (perhaps less widely-followed is a better term) leading indicators. If the majority see a recession coming, history tells us that it won’t happen because the majority is always wrong at key turning points. Given the news this week in a growing number of sectors and the tough spot the Fed now finds itself, we believe that chance for a recession in the next 12 – 24 months has increased to 75%. But more importantly, the chances for a significant bear market have gone up as well and this is important for two reasons. First, it will come before the recession and second, this is when the majority of damage is done to your portfolio. Given these challenges, weak resolve on the part of the Fed resulting in a drop in the FFR will compound inflationary pressure in the U.S. and further reduce the appeal of U.S. Treasuries and other dollar-denominated assets for foreigners. Although inflation is initially good for stocks, the future cost may be more than we can afford given our current dependency on foreigners to finance our debt as it will mean substantially higher rates and more pressure on an already beleaguered consumer. All these factors further compound the risks of recession. There will be times in this type of scenario when stocks will rally but as we have witnessed, volatility is now high and should remain so in the coming months. For this reason, we believe it will increasingly become a trader’s not an investor’s market. But as we have seen from our market leaders, the best technical indicators have become less reliable so that traders could also have a tough time in these highly volatile, strongly event driven markets. In short, it will not be a friendly place for the non-professional… ------------------------------------------------------------------------------------------------------ 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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