Inflection Period Near-Term in the Markets
by Stephen Tetreault, T-Waves | July 29, 2008
PrintLet’s also keep our focus on the price of crude as a continued drop in price could be a positive for equities in the near-term however it could be a negative signal for the energy patch, also we will need to watch the bond market as a retracement here could result in a rotation out-of or into equities in the short term. As always I’ll be watching the Transports, Small/Mid-caps along with the SOX for early directional indicators/ signals and clues along with the overnight Asian markets! PLEASE REVIEW my Value plays in the gold, uranium and silver sectors at the end of the report many are encroaching into the buy-zones, please always do your due diligence before playing any idea/suggestion presented.
Well where did the month of July go….we only have 4-trading days left to the first month of the third quarter and as such we could see month ending window dressing but the reports on Thursday (GDP, Initial claims and Chicago PMI) and Friday (Non-farm-payrolls, and the ISM-manufactures report, truck and auto-sales, construction spending) are going to be potential huge market drivers. I believe that these highly hyped and manipulated pro forma reports could help infuse (become a catalysts) for a bullish/upward bias because all the bad news may be priced in early in the week especially if we retest the recent relative lows of a 61.8% retracement of this rally. The FOMC meeting the following Tuesday has a bias for a quarter point rate hike priced into the announcement so any talk about not hype and speculation of a continued pause would be bullish….I don't expect much out of the bail-out specialist-helicopter-money-infuser inflation creator Bernanke….but with FOMC members Fisher, Plosser and Stern already calling for a rate-hike the bias statement may become mush more hawkish. The Fed should hike to combat inflation and to support the dollar but we will need to see if this move isn’t pushed out till after the elections. A rate hike in my opinion would be construed that the Fed believes the economy is no longer on life support and a positive, however, we did get testimony from Bernanke just over a week ago that the Fed thought economic weakness was a bigger problem than inflation so right now I’m leaning toward a continued pause by this lamebrain Fed. We still have this week for discussions and the data to heat up/ cool down before the markets have to start taking a positional bet on the FOMC action.
The big event for Monday could be the housing bail-out bill. The support for Fannie and Freddie could imply that existing shareholders are eventually going to succumb to heavy dilution and the sell-off on Friday ahead of the weekend vote suggested traders are also worried current equity holders are going to get slammed. This could continue to pressure the financial sector in general because we are hearing a consistent tune playing in the back-ground about the many more banks and lenders in trouble; as more equity being sold just to survive is consistently diluting existing holders (if /when we start to see dividends start to erode, look out below).
Despite being very-cautiously bullish near-term (looking to buy the dips) I have to proclaim that we have to expect the unexpected. We are approaching the two worst months of the year for the markets (Aug/Sep) and anything is possible; my best forecast from my wave analysis is that we sell off after the open on Monday and into Tuesday retesting at least a 50-60% retracement of this recent relief rally, then we catapult upward late Tuesday into Thursday due to better than expected GDP headline numbers than it will be a wait and see game for Friday’s employment numbers.
The mega relief rally was nice, but not entirely convincing, as the over extended rally in the major indexes ended Thursday with an accelerated-brisk sell-off into the close as investors were disheartened at a worse-than-expected drop in existing home sales and some negative earnings reports; and a modest rebound in oil prices exacerbated the turn in market sentiment.
The sell-off was led by banks and brokerages but widened to include energy stocks transports, semiconductors etc. as the secession wore on…On Thursday the Dow lost 291+ points; the Nasdog lost almost 46-points, the Russell-2000 lost almost 17-points while the SPX lost 29.65-points.
The indexes regained some of Thursday’s steep losses on Friday, technology and small/mid-caps were the biggest winners…the Dow gained 21.41 the Nasdog regained 30.42 points, the Russell-2000 gained back 7.95 points while the SPX gained back 5.22 points.
This was a befuddling whipsawing week for the markets as buy/sell signals were quickly initiated then dissolved; as I suggested on Tuesday we generated a buy signals late morning early afternoon and it was confirmed into the close as the late day surge pushed the indexes over overhead resistance points but the follow through on Wednesday was extremely lackluster at best, and we generated a sell-signal into the close then the sell off on Thursday brought back fears of another significant down-thrust leg on Friday's but shortly after the open, the volume dried up and the lack of selling rekindled hope for the giddy bulls; that Thursday’s sell-off was just a correction. You may remember I changed to cautiously bullish after Tuesday's tentative breakout and suggested we switch to buy the dip mode, well that play is still valid somewhat until we breech near-term-support (neutral-to a slight bullish bias).
The Dow failed at the Fibonacci retracement level at 11700; it was a near perfectly technically-scripted failure at strong resistance. The Dow closed positive on Friday but it was a huge battle between the bulls and bears. IBM, BAC and GM were the biggest losers. ( as a point of reference the (5) financial stocks in the Dow accounted for nearly 104 of the 283 points the Dow lost on Thursday, so you can see why the financials are our indicator to watch).
I am not changing my buy the dip view as long as the Nasdog and Russell-2000 remain the strongest indexes; currently the Dow is handicapped by the financial components, as is the SPX and the sell-off in the commodity players. However I must caution my bullish friends that the internals appeared to be breaking down distinctly as the trading week progressed; as Thursday was ugly with 5:1 declining over advancing volume; this was in my opinion much more than profit taking. It was fears the credit crunch was coming back to raise its ugly cobra like head and poison the markets again. News of record discount window borrowing and two more failed banks is only going to increase those fears.
This weekend Congress passed a housing rescue “Bail-out” bill Saturday aimed at sparing 400,000 struggling homeowners from foreclosure; President Bush is expected to sign the measure quickly. The measure, approved by a 72-13 vote during a rare weekend session in the Senate, lets homeowners who cannot afford their monthly payments refinance into more affordable government-backed loans rather than losing their homes. The bill also offers a temporary financial lifeline to the troubled mortgage companies Fannie Mae and Freddie Mac, (FNM, FRE) and tightens controls over them.
Bill Gross, managing director of bond house Pimco, weighed in on the housing bill currently before Congress, calling the legislation that is designed to lower the cost of mortgage credit "the best way to begin the long journey back to normalcy" in the housing market.
New York Fed President Timothy Geithner, speaking before the House Financial Services Committee, warned that strong financial supervision will be needed to reduce the growing moral hazard of recent Fed-head and government backstops such as the Bear Stearns bailout and expanded capabilities of the Treasury and Fed to support the government-sponsored agencies FNM/FRE.
The markets could easily run higher if market intervention and manipulation by our government continues as it appears that they are genuinely afraid of a potential freefall (in the financials) is trying to create a market-intervention mechanism to help engender confidence that stocks aren't headed into the cesspool or to zero. They are hoping that their 30-day moratorium on shorting the 19 financial service companies (their primary-dealers who they sleep with in this financial-prostitution bed) will allow stocks to stabilize, but if it doesn't, rumor has it that Cox may decide to extend this rule for another 30 days, or maybe even make it permanent, and worse yet for bearish/short-sellers he is if pressured by the vast array of bullish-funds expand the ability or should I say inability to short all stocks or even change the uptick rule whatever he thinks is needed to ensure more confidence in the market and sustain a continued relief rally built on direct manipulation (a bulls best friend).
We must keep focused on liquidity (money-supply) and credit issues as the Fed reported this past week that bank borrowings at the discount window rose to an average of $16.4 billion per day in the past week and this was the highest level ever-recorder. From my perspective this does not bode well for the health of the financial sector; hence why I was so bearish on Thursday and Friday; so many banks, lenders etc are now looking like proverbial wards of the government. Most if not all are unable to raise money in the equity market and banks and lenders are not lending to one-another for fear of more deadly and yet undisclosed skeletons in the closets. This suggests the economy is not going to have a growth spurt any time soon; as credit markets for the most part are still toxic. The subprime-slime mortgage implosion has taken a toll on these greedy overleveraged banks and other financial companies, which have reported to date $468 billion of writedowns since the start of 2007…by the end of this year I expect the number to grow to 750-800 billion or greater.
So far the Fed-heads have responded to the credit crisis by narrowing the gap between the discount rate and the benchmark rate and increasing the term of commercial-bank loans to 90 days from overnight; this is a huge manipulative jump-start and by now the cancer in the credit markets should have been in remission, but that is not the case. This usage now of the discount window reflects the growing need/reliance for not just an overnight backstop but as a permanent source of funding. The Fed-head report shows banks are taking advantage of the lengthened terms, as sort of a carry-type trade. It’s worth noting as well that commercial banks also have $170 billion in outstanding Fed loans from the central bank's (TAF) Term Auction Facility, which conducts sales of 28-day funds every two weeks.
This past week the Fed also reported that the M2 money supply rose by $300 million in the week ended 7/14. That left M2 growing at an annual rate of 6.8% for the past 52 weeks, above the target of 5.0% the Fed once set for maximum growth.
We also saw on Friday that the Fed seized two more banks after the close on Friday and immediately sold them to Mutual of Omaha Bank. The two failing banks were the First National Bank of Nevada with assets of $3.4 billion and $3 billion in deposits. The bank just completed a merger of its own with the First National Bank of Arizona on June 30th. The FDIC said the estimated cost of the transactions to its insurance reserve account would be $862 million. This is starting to raise red-flags….the 28 branch banks will reopen on Monday as Mutual of Omaha Bank.
The second quarter of 2008 has been a stellar quarter of vastly under-guiding, having analysts stealthy walk down estimates and than firms have through pro forma accounting trickery meet/beat expectations as for a quarter that was supposed to be negative in terms of earnings the overall outcome has been significantly better than expected as so far more than 2/3’s of the Dow have reported, and 70% of those reporting have managed to beat the consensus and with over 45% of the SPX having reported almost 75% have meet/beat consensus. The historical average is for a 60-62% beat; so on the surface this is very bullish right….of course it is if that is the only number to consider and you (like Kudlow) stop your analysis at this juncture. Unfortunately we historically have seen the best international blue-chip firms reporting earnings and historically the overall quality of-earnings declines as the cycle progresses toward the end of the reporting period. Secondly when you cut through the bubble-vision hype you can see that earnings dropped 17.8% for the quarter; furthermore if you exclude energy firms those earnings then dropped by 25.8% for the quarter; additionally the cancerous financial sector was expected to produce an earnings decline of 60% but instead it report a massive 90% drop. Worse yet when we look ahead overall guidance has also been worse than expected with an almost unanimous outlook across all sectors that 2008Q3 and 2008Q4 will be worse and these firms will produce lower profits. Hence from my perspective it is not surprising that the relief rally is shaky and faded as the week progressed.
From a technical chart perspective, I believe the rally stalled and reversed on Thursday because the SPX triggered a technical resistance level that held; I would 9as a bullish investor) like to see another test of the SPX relative low from a couple weeks ago 1,200 to be more certain about near-term market capitulation, but I believe the ultimate downside objective before we can sustain a decent reflective “V” bottom reversal rally is closer to 1,150-1,160.
I still believe it is too early to be adding to any bullish positions in the financial sector, which has seen a pattern of investors prematurely calling bottoms and jumping in only to get their limbs removed as their blindfolded chainsaw juggling act is meet with disaster. I believe the key to look for a bottom in the financials is a distinct and solid up turn in the housing market as this is where the cancer first was uncovered, although the problem in the financials has broadened from being purely mortgage-related to commercial and industrial loans related as the credit markets have practically seized up and now its moving into the credit card and durable-goods credit areas (those like Low’s Home Depot and Best-Buy that extended credit at the drop of a hat).
We saw that existing home sales fell 2.6% to an annualized rate of 4.86 million units in June, lower than the 4.95 million rate that was anticipated….home sales fell in the Northeast, Midwest and South, but rose 1.1% in the West; the NAR (National Association of Realtors) estimates that foreclosures now represent 34% to 40% of all existing home sales.
The median price of existing homes dropped 6.1% in June from year-ago levels and the number of total existing homes on the market rose 0.2%, pushing the supply of homes for sale to 11.1 months worth from 10.8 months in May.
On a positive note while existing home sales continued to decline, the four consecutive monthly increases in sales in the West suggest a possible change in trend in that region, a welcomed however, over the next few quarters foreclosure sales are likely to comprise an increasing proportion of home sales, which could put further significant downward pressure on home prices; as the supply increases.
A legislative bill aimed at curbing oil speculation is on the skids after Democratic and Republican leaders failed to reach an agreement on amendments to the bill regarding expansion of offshore drilling. Financial industry groups and investment banks are opposed to the legislation, whose outlook is grim unless lawmakers can quickly come to a compromise, the Wall Street Journal reported. But the bill could be revived after the recess in August. This past week we saw that the U.S. Commodity Futures Trading Commission charged an Amsterdam-based proprietary trading firm Optiver Holding with manipulation of the crude, gasoline and heating oil markets, saying the scheme brought roughly $1 million in profit to the defendants.
Among the horde of economic reports due to be released this week is one that could on a headline basis lead many investors to believe that the worst is over for our ailing economy; but in my humble opinion any knee jerk relief rally off of this report (GDP) should be sold into as street-smart investors would do well not to become overly embroiled in any giddy euphoria surrounding this report. One of this week’s big economic releases will be the pro forma GDP preliminary report from our fuzzy-math experts at the Commerce Department's which will be released on Thursday. The consensus estimate is that the economy grew 1.8-1.9% from April through June, well above the anemic 1.0% in the first quarter and could lead some traders and investors to believe the economy is on the rebound…from my vantage point it is not likely; I believe this GDP report will mark the very-top in growth in 2008 and early 2009. This release and better than expected numbers is not a story of a resilient consumer that has seen their wages increase to keep pace with inflation (most Americans during the past 7-8 years have not seen their real wages increase at all, just the number of hours worked has increased to keep pace with the cost of living and commodity/energy inflation) bottom or a miraculous turnaround in home prices their largest asset. This relief rally and increase in GDP is the fairy-tale of a well-timed policy response to the economic downturn; called the Father-Bush tax-rebate checks. I believe the expected uptick growth can be attributed directly to the rebate checks that have been sent out during the past quarter via what I call a lamebrain so called economic stimulus plan. Now that this money has all been spent (mostly on gasoline and other necessities, I fail to see additional support for future economic consumption for the rest of the 2008 heading into 2009.
The initial knee-jerk reaction to the seemingly robust GDP number could be a short term short-squeeze relief rally; but it could quickly be undermined when so called analysts had it pointed out to them that the details of the report are quite dismal or by new employment numbers due out the next day from our fuzzy math experts at the labor department. I expect employment figures to confirm a worsening economic situation with 135-145,000 more jobs lost adding to the year-to-date total of 500,000+/- (the consensus expects companies to have cut payrolls by 68,000 during July). The non-farm payrolls on Friday will be a critical test of the current bullishness of the markets and so called economic-reversal in tonality to one of a strengthen economy…current estimates are still for minimal job losses of 68,000 jobs compared to normal recession losses of 200,000 to 350,000 per month. If job losses remain light/mundane through labor department pro forma fuzzy-math deception it would be a good sign and the markets could rally as they will take their time to digests the numbers, (a lower than expected job loss would be very market friendly) However, this post we saw a sharp spike in unemployment claims and those losing jobs in the financial sector are increasing (this past week initial claims came in at 406,000 suggesting job weakness was increasing). The payroll report will be the most important report of the week.
Other economic data points coming out include consumer confidence figures for July from the Conference Board on Tuesday and after Friday’s better than expected up-tick in the Michigan Sentiment report this number could come in better than expected (a bullish market-mover if it does) {The Michigan Sentiment number for July spiked to 61.2 from June's 56.4 reading; the first move higher since January; I am crediting the tax rebate checks and a temporary firming of home prices in many areas. Now a reading of 61 is hardly something to become extremely bullish about but significantly better then the expectations for something in the low 50s. Current conditions rose 6 points to 73.1 and expectations rose 4 points to 53.5. Inflation expectations remained high at 5.1% but appear to have eased somewhat from the first July reading at 5.3%.} The Chicago Purchasing Managers index for July, will be released Thursday; the PMI measures activity in the manufacturing economy, the consensus is for a reading of under 50, a better than expected number greater than 50-would be very market friendly. The Chicago PMI will be seen as a preview of the ISM report due out on Friday. These are both indicators of current economic activity.
Last weeks (Friday’s) New Home Sales for June was better than expected as new sales totaled 530,000 units much better than the 501,000 expected and better than the previously reported 512,000 in May. However, the Census Bureau revised the May numbers up to 530,000 as well as the April numbers to 540,000 from 520,000. This surprising improvement in sales was good news to everyone in the homebuilding arena. We also saw that new home prices rose slightly to $237,871 from $231,087 in May for a 2.94% gain; and the overall inventory decreased slightly to 10.0 from 10.4-months. Sales in the second quarter declined only 17% over Q1 compared to drops of nearly 40% in the prior three quarters.
On a positive note: YRC Worldwide (YRCW) reported profits that dropped 35% and blamed the decline on the struggling economy CEO Bill Zollars had been up front about worsening conditions for many months, no wonder their stock has tanked, however on he stated on CNBC that they were seeing signs of life in the economy. He said sizes of shipments were increasing, as were numbers of shipments. He said it was too early to start calling a bottom but the signs were encouraging. Given his early warning on the economic malaise this is a positive sign that there are starting to show early stages a change.
The market action during this next week will be crucial to the formation of sentiment and tonality. The only way to do that is to closely monitor the actions institutions are taking. This can usually be done quite easily because institutions usually make moves in fairly systematic and predictable patterns; as such the first and easiest way average investors can spot this behavior is by recognizing large volume spikes along with an abnormal move in a stock or sector. That signals a possible change in the current trend of institutional buying or selling, and potential reallocation…..I will be monitoring these development closely.
As I always say if you’re a longer term investor remember when time are volatile and uncertainty seems to be cropping up almost on a daily basis CASH is always king.....I am of the opinion that in the days ahead the bulls and bears are going to wage a significant bloody battle for control of the markets directional sentiment and overall tonality as we head into the end of this month. We are teetering on the possibility that a continuation of this bullish trend for another 3-5% potential upside still exists, or we could be seeing the end-of this bullish run/cycle. If we see any renewed selling accompanied by volume it will surely send the bulls running for cover; and the various funds that have amass profits this past week will be quick to protect profits and hit the sell-buttons on any sign of trouble….the landscape is littered with a large number of skittish profit holders that will be quick to hit the sell-buttons
In the weeks ahead I am of the opinion that the bulls and bears will start to wage a significant battle for control of the market sentiment and control, and if the bulls can somehow find the fuel (money/liquidity) they could maintain the bullish tonality especially if they are able to push the Dow over 11,900 and the SPX over 1300 on multiple closes on decent volume then I might have to change my out-look to one of buying the dips until the trend and sentiment changes once again myself. I amazed to some extent that once again the hyping shills on the financial bubblevision media channels are stating that this recent relief rally is once again the start of a new bull-market that could push significantly higher into the earnings/confessional period that kicks off in the weeks ahead.
Copyright © 2008 Stephen Tetreault
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