TSG Stock Market Letter

Week Ending May 30, 2008

Topics Discussed This Week:

Stocks close higher on better economic news…

As leaders go nowhere

Earnings weakness proves stubborn

New home sales surge, home prices have now fallen more than in Depression...

Oil prices drive stocks

* No newsletter next week (June 8) 

Last Week

This week, oil was again the big story for stocks which got a boost from the falling price of crude. But they were also helped by better than expected GDP growth and a rise in new home sales.

Technically Speaking

Leaders flat

This week Dan Zanger included 14 stocks in his Sunday picks focused increasingly on stocks that had potential to drop and included Sohu.com (SOHU), Apple (AAPL), Potash (POT), LDK Solar (LDK), Sundtech Pwr (STP), Excel Marine (EXM), Hess Corp (HES), Energy ConvDev (ENER), US Steel (X), Canadian Solar (CSIQ), Dryships Inc. (DRYS) and ProSharesUltraShort Financial (SKF).

Here is how Dan’s pix compared to the major indexes over the last five days (see below). Not much changed on Friday. Last week his stocks led the indexes with a drop of more than 7% reflecting the fact that Dan is focusing more on short candidates.   

Figure 1 –Five-day performance of Zanger’s market leaders compared to the S&P500 (SPX), the Dow Jones Industrial Average (DJX), Dow Transports (DTX) and Nasdaq Composite (IXIC). Data courtesy of The Zanger Report, performance chart courtesy of VectorVest.com. 

It was another week of below average volumes on the NYSE, Dow Transports and Nasdaq as the major indexes clawed higher. Rallies occurring without strong volume are suspect because it means that there is a lack of commitment from buyers but a lack of volume on down weeks is mildly bullish. Given the range bound markets of late, we will need to see volume pick up before putting much stock in any rallies we may get.

Volatility reversed its trend as the Market Volatility Index (VIX) dropped this week to just above 18 from 19.55 last week and 16.47 two weeks ago.   

The 17 commodities that make up the NYFE CRB Index fell this week to close near 530 down from 550.91 last week and 548.06 two weeks ago. 

Gold also slipped this week to $891.71/oz from $925.80 last week and $900 two weeks ago, for the first major drop since putting in a bottom at $858.10 four weeks ago.  Gold generally demonstrates strong seasonal performance period between the end of January and end of June so this weakness is a concern for goldbugs. 

It was the third weekly fall as the U.S. Dollar Index rose to 72.86 from 72.06 last week and 72.94 two weeks ago.  This compares to a multi-year weekly low weekly of 71.76 and a drop below this level would be bearish indeed for a number of reasons – the biggest of which currently being higher oil prices.   

After surging above $135 last week, crude slipped again as the NYMEX crude oil contract ended the week at $127.66/bbl which is good news but won’t be enough to provide much relief at the pumps during the busy summer driving season.  This compares to $131.70 last week and $126.45 two weeks ago.  It was the thirteenth consecutive week that it remained above $100.

The U.S. prime rate held again this week at 5% and the Fed funds target rate remained at 2%.  The 3-month London Interbank Offered Rate (LIBOR) rose to 2.68% from 2.65% last week and 2.695% two weeks ago. LIBOR is the benchmark for $900 billion in subprime mortgage loans which typically adjust to it every six months. According to data company Dealogic, 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.  Freddie Mac mortgage rates strengthened to 6.15% from 5.98% last week and 6.01% two weeks ago for the 30-year fixed mortgage while the one-year adjustable rate mortgage (ARM) rate firmed up to 5.24% from 5.18% last week and 5.29% two weeks ago which it held for three weeks. With the number of mortgages resetting over the next year, stubbornly high mortgage rates will continue to exert a downward pressure on property sales (and prices). 

Earnings

Earnings weakness proves stubborn

Q1-08 earnings season ended its eighth week and with 4002 companies now having reported (3897 companies last week), earnings held at -29% (from -28% two weeks and -26% three weeks ago) compared to the same quarter last year. Earnings have shown a consistent negative trend over the last two quarters to fall as more companies have reported and this is bearish.  Looking at past seasons, there was a drop of 57% for final Q4-07 (3900 companies), a 21% drop (4205 companies) for Q3-07 and a 13% jump for Q2-07. 

Economic Reports

This week, there was more confirmation of a slowing economy but there was also some good news. April durable goods orders fell 0.5%, but we learned that the Q1-08 preliminary estimate for GDP growth was 0.9% up from the previous estimate of 0.6% and new home sales surged (see chart). As we see below, the rise in new home sales was probably just a short-term bounce and it is far too early to celebrate the GDP rise since this figure is preliminary and even final figures can be revised a year or more later.

Chart 1 – Last week we learned that month-to-month existing home sales dropped 1% in April. This week we learned that new home sales surged 3.3% in April but as we see from the chart, the trend remains strongly negative and the jump follows five consecutive months of drops.  But we also learned this week that quarterly existing home prices in the 10 cities covered by the S&P Case Shiller Home Price Index fell 14.1% from Q1-07 and price declines continue to accelerate year-over-year. This compares to an 8.9% y-o-y drop in Q4-07. 

Here is what Economist had to say about it (see link below). “[The latest Case-Shiller figures] reveal that house prices have already fallen by more over the past 12 months than in any year during the Great Depression. Robert Shiller, an economist at Yale University and co-inventor of the index, has compiled [an index] that stretches back more than a century. This shows that the latest fall in nominal prices is already much bigger than the 10.5% drop in 1932, at the worst point of the Depression. And things are even worse than they look. In the deflationary 1930s, America's general price level was falling, so in real terms home prices declined much less than they did nominally. Today inflation is running at a brisk pace, so property prices have fallen by a staggering 18% in real terms over the past year. In nominal terms, the average home is now worth 16% less than at the peak in 2006, and the large overhang of unsold houses suggests that prices have further to fall. If so, this housing bust could well see a bigger cumulative fall in prices than the 26% real drop over the five years to 1933. Most people would call that a pretty destabilising contraction.” 

However, despite the drop home prices are still roughly 60% above where they were in 2000. 

Next Week 

Here are the reports we’ll be watching next week.  

- Monday, April Construction Spending (previous -1.1%), May ISM Manufacturing Business Index (previous 48.6).

- Wednesday, May ISM Non-Manufacturing Index (previous 52.0).

- Friday, May Nonfarm Payrolls (previous -20,000), May Unemployment Rate (previous 5.0%), April Wholesale Trade  (previous -0.1%), April Consumer Credit (previous $15.3 billion). 

Synopsis

Energy prices drive markets

In the summer doldrums ruled by light volumes and generally tight trading ranges, stocks are being pushed around by oil prices and this could well continued into Labor Day. But the election is also drawing nearer and while it had become a popular past time taking pot-shots at the Republicans and polls put their popularity around 25%, it is still too early to tell which way it will go. However, one thing is certain. The political machine will continue to do its level best to put voters in the best possible mood come November and pumping up inflation is one of the easiest ways to achieve this end. But it’s a tactic that could backfire this time around given that it is increasingly putting folks in a bad mood at the gas pumps and grocery stores. 

Stories of interest this week…

U.S. Economy: Consumer Spending Gains Slowed in April
http://www.bloomberg.com/apps/news?pid=20601068&sid=a7ie.CYzdpFg&refer=economy

U.S. Economy Expands Faster Than Previously Estimated
http://www.bloomberg.com/apps/news?pid=20601103&sid=a9M82AJY9ptw&refer=news

Libor Proxies Gain as Traders Seek Truth With Swaps (Update4)
http://www.bloomberg.com/apps/news?pid=20601109&sid=a6Ik316RKJBc&refer=exclusive

The housing market - Dropping a brick (Subscription may be required)
http://www.economist.com/world/na/displaystory.cfm?story_id=11453745

Consumer Spending in U.S. Probably Slowed, Confidence Dropped
http://www.bloomberg.com/apps/news?pid=20601068&sid=aiDRrB9qylVI&refer=economy

Britons' Confidence Reaches Lowest Level Since Thatcher Quit
http://www.bloomberg.com/apps/news?pid=20601068&sid=ay8rcTIQllJA&refer=economy

India's GDP Growth Holds at Slowest Pace Since 2005 http://www.bloomberg.com/apps/news?pid=20601068&sid=aSSchhduwDCI&refer=economy

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