Market Commentary - 6.29.2008
June 29, 2008
Its official – the talking heads are finally willing to admit we are in a bear market, as the Dow hit a new low this week and the S&P 500 approaches the lows reached in January and March of this year. With one day left in June, this has been so far the worst June for the Dow since 1930! It’s nice to hear all the “experts” finally wake up to reality, but it was quite comical to see the headline on CNBC “Shorting Stocks Could Be Way to Play This Market.” Of course, if you had been listening to them up until now, you would have been under the impression that a long-term buy and hold strategy is what you should stick to, finding great companies that pay dividends and dollar cost averaging and buying the dips. Your portfolio would be down 20% and some of those stocks they have been recommending for the last 6 months have dropped 50-80% off their highs, and now they are telling you to short those very stocks?
The bottom line is that watching Jim Cramer and the other heads on CNBC, and reading predictions by the market “experts” can be entertaining, but it will not make you money. Since the end of last year, we have constantly hammered home the fact that we are operating in a bear market, even though the “official” 20% decline from peak to trough had not occurred, and have kept our ultimate target level the same – roughly 1070 for the S&P 500 is the level we are watching for as “the” bottom.
It’s often said that “50% of a stock’s price movement can be attributed to the overall movement in the market, 30% to the movement in its sector and only 20% on its own.” Therefore, it’s extremely important to have an idea of where the trend is going in the broader market and different sectors. However, even if we knew where the market indices were going to be 6 or 12 months from now, it would not help us much as traders. Therefore, let’s take a look at where we are in the near term to try and get a sense of what to expect over the coming weeks.
Instead of trying to predict where the market is headed in the near term, as that is nothing but a fool’s errand (even a broken clock is right twice a day), let’s look at both sides of the coin to try and see what the probabilities are that we will bounce here vs. continue the decline:
First, for the bullish case – that is, there is a definite possibility that we are nearing a short-term bottom and are due for a technical bounce here. As we said above, the S&P 500 is sitting right on strong support – that being the lows hit in both January and March of this year:
Each time that level has been reached, there has been a sharp rally up to at least the next Fibonacci level of 1385. In addition, the S&P is extremely oversold (more so than in March) and technical indicators are showing some positive divergence. Most of the sentiment/breadth indicators, such as bull/bear ratios, stocks trading above/below 52-week highs, etc. are at extreme readings. Finally, as we said above all the talking heads are talking endlessly about a bear market and how it’s now time to short stocks. All of this combines together to form a strong contrarian signal that leads us to believe that the broader markets can very well be primed for a short-term bounce.
On the other hand, if we look at the Dow, we can see that we just breached the 2008 lows as well as the support level that has held since the summer of ’06:
The next support level is around the 11000 area, with the next Fibonacci level at 10698. This would suggest there is indeed more downside in the near term. In addition, the VIX Index which is a measure of implied volatilities of S&P 500 Index Options, or more importantly one of the most widely followed “fear” indicators, is sitting well below the spikes seen in August, November, January and March. When this index spikes, it has often corresponded to a market bottom and a sharp rally has followed. With the VIX sitting roughly 33% below the levels we have witnessed in January and March of this year lead us to believe we have yet to see the capitulation or panic selling that often corresponds to a major market bottom.
The above is by no means an all-encompassing analysis, but rather just a peak into some of the factors we are looking at in determining how to best position ourselves in the near term. The Dow and S&P 500 are two important broad market indices, but of course there are many more which show mixed signals as well. Based on everything we are seeing, we are more inclined to believe that a short-term bounce is in order, and once again it sounds like CNBC is on the wrong side of the trade.
Earnings
Not much excitement for the upcoming holiday-shortened week – H&R Block moved up their announcement to before the open on Monday and there is speculation they will have to take a larger than expected write-down from their mortgage unit; put option activity has spiked in the last week or so. We will also be closely watching Schnitzer as steel stocks appear have been one of the strongest sectors and are consolidating near their all-time highs.
- Monday – H&R Block (HRB)
- Tuesday – Apollo Group (APOL), Constellation Brands (STZ), Schnitzer Steel (SCHN)
- Wednesday – Acuity Brands (AYI), Family Dollar (FDO)
Economic Data
A fair amount of data coming out considering it’s only a 4-day trading week, with the focus on manufacturing and employment data:
- Monday – Chicago PMI (Manufacturing), Michigan Consumer Sentiment
- Tuesday – Auto/Truck Sales, Construction Spending, ISM Manufacturing
- Wednesday – ADP Monthly Employment, Factory Orders, Crude Inventories
- Thursday – Average Workweek, Weekly Unemployment, Hourly Earnings, Monthly Non-Farm Payrolls, Unemployment Rate, ISM Services
Strategy/Outlook
As we said above, it looks like there is a good chance of a near-term bounce in the broader market. With the volatility last week due to the Fed meeting, another record high in oil prices, and quarter-end positioning on Friday, we hope this week provides a clearer picture of where the trend is going. However as this is a holiday-shortened week, with Thursday being an early close and Friday a market holiday, it wouldn’t be surprising to see very light volume with little direction until next week.
Therefore we are entering this week without any directional bias, combining Call and Put positions to stay relatively market neutral. We will be at least partially closing out some open positions that have shown us really nice gains over the past few weeks in order to lock in some profits. It’s always very tough to trade in a bear market, but even more so with the extreme sector rotation witnessed over the past 6 months or so, with some sectors like banks down 50+% and some like coal miners up 50-100%. Some of the really weak names look like they can bounce here and some of the stronger names look like they might be topping. However, with the Fed keeping rates steady while other countries are raising rates to follow inflation, the tough talk on a “strong dollar” is just that – talk, and until trends are broken.
Until the market tells us otherwise, we will continue to seek out names in a strong up-trend sitting near support to buy calls on, and weak names which continue to trend down and are trading near resistance to buy puts on. Price patterns have been very profitable for us of late, and we will continue to trade these as they provide great reward/risk and clean, tight stops.
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Market Commentary - 6.22.2008
June 22, 2008
“The worst is behind us?” For the past several months, we have heard this same line from the talking heads, market “experts”, and even banking executives at the very companies which are a large part of the current market weakness. The story went that the Fed’s monetary policy using low interest rates combined with “creative” lending practices, along with the economic stimulus package billed to future generations of taxpayers, would lead to an recovery in the 2nd half of the year. Since the stock market usually is a leading indicator and since all the “fear” was already priced into the market lows back in March, they proclaimed that it was the greatest time to buy stocks in 20 years.
All of it sounded eerily similar to what those same people kept saying back in 2001 whenever there was a bottom – of course none of them ever ended up being “the” bottom as we witnessed one of the great bear markets in history.
Forgetting about the reasons they are telling their story – equity analysts want to get investment banking business from the companies they cover, banking executives want to pad their bonus numbers and convince foreign companies to invest capital, government officials are supposed to say publicly that everything is fine so as to prevent panic, etc. – their arguments just aren’t/weren’t based on facts, but rather just hope. From both a fundamental and technical perspective, the market has continued to deteriorate since the October decline, and although it’s not “officially” confirmed for either, we are in the beginnings of a recession and a bear market that will continue to make new lows.
Last week put the broader indexes on the path to re-testing the March lows, as the Dow broke 12,000 for the first time since March and the S&P 500 broke right through support at 1330. These past few weeks have been a reminder that all is not well in the US Financial industry, and crude oil is stubbornly refusing to take a breather from near record high prices. Earnings were weak across the board, automakers and banks are grudgingly starting to admit to themselves that things are going to get worse before they get better, and fear seems to be creeping back into the market as the VIX has climbed from 16 to 23 in just a few weeks.
Earnings
A healthy offering of reports out this week, which should for a minute take the spotlight off the miserable condition of the US banking industry. Wednesday will be the highlight, with tech, consumer, and agriculture well represented:
- Monday – Walgreen (WAG)
- Tuesday – Darden Restaurants (DRI), Jabil Circuit (JBL), Kroger (KR)
- Wednesday – Bed, Bath and Beyond (BBBY), General Mills (GIS), Monsanto (MON), Nike (NKE), Oracle (ORCL), Red Hat (RHT), Research in Motion (RIMM)
- Thursday – Accenture (CAN), ConAgra (CAG), Discover Financial Services (DFS), Lennar (LEN), Paychex (PAYX), Rite Aid (RAD), Tibco Software (TIBX)
- Friday – KB Home (KBH), Shaw Communications (SJR)
Economic Data
Nothing too exciting as far as reports coming out, but of course all eyes will be on the Fed as they decide the “fate of the rate” – that is either keep interest rates low to try and stimulate growth or raise them to temper inflation which is clearly creeping up faster they are comfortable with.
- Monday – NY Empire State Manufacturing Index
- Tuesday – Consumer Confidence, Durable Orders, New Home Sales, S&P Case/Shiller Home Price Index
- Wednesday – Crude Oil Inventories, Fed Policy Statement
- Thursday – Final Q1 GDP, Unemployment Claims, Existing Home Sales
- Friday – Consumer Income/Spending, PCE Core Inflation
Strategy/Outlook
While there is a chance of a dead cat bounce in the next few days, we expect the major indexes will continue this current descent to somewhere between the March lows and the 1300 level on the S&P. The indexes are becoming extremely oversold and there will most likely be a bounce off of one of those support levels in the next few weeks, so don’t be surprised to see one of those support levels act as an intermediate term bottom. The overall market seems to be reacting minute by minute to the changes in oil prices, and with daily swings of $3-$4 in crude oil it looks like the days of 200 point movements in the Dow are back. All of the oil and gas stocks which have exploded higher all year have pulled back sharply in the past few days, and many are sitting right at support, while others have failed to break out and have broken their trend lines.
While the near-term direction of commodity stocks is uncertain, as some would say we are only halfway through the bull market and others would say the “bubble” is about to burst, a lot of names look geared for a large movement one way or the other. With today’s announcement that Saudi Arabia will increase their crude output much more than expected, Monday should be an interesting trading day – the logical reaction would be for oil prices to take a dive and energy stocks to follow suit – however as we have seen over the past year the market’s reaction to news can be vastly different than expected.
For that reason, we are going to take a wait and see approach to energy producers for now, as we don’t want to step in front of the increased volatility that’s bound to occur over the next few days. As far as indexes go, the IWM (Russell 2000 ETF) has held up stronger than most of the broader indexes and appears to be forming a head and shoulders pattern, so we are watching closely for a short opportunity in the next few days.
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Market Commentary - 6.15.2008
June 15, 2008
The major indexes finished the week pretty much where they started, as investors digested another record high in crude oil, and wonder whether relief from the mild core inflation numbers that continue to be reported will be overcome by continued upward momentum in energy and food prices. It’s important to remember that in the last recession inflation numbers were found to be drastically understated, and one has to wonder if US monetary policy is based on questionable inflation data.
Consumer sentiment continues to decline and has reached lows not seen in 30 years. The consumer is fighting a constant battle - with deflation in the value of their assets - home, savings account, and retirement/investment account - against inflation in their fixed costs of energy, food, and health care. On top of that incomes are not keeping up, and the unemployment picture looks fairly bleak in the near future.
In the past few weeks we have talked about how we believed there was a near term top in the major indexes – the S&P 500 appeared to have peaked at 1440, and 1384 was the important support level that needed to be breached for the next leg down to occur. After consolidating in the 1380-1400 range for several weeks, the markets finally broke down to levels not seen since April on the back of huge moves in commodity prices.
The index is very oversold near term and found some support at the 1330 level – we expect to see a retracement to around 1384 over the next few days, which is an important Fibonacci level and also corresponds to the 50 day moving average.
Earnings
This week will be all about quality over quantity – just a handful of reports to look for, but they will all be closely watched as some of the bellwethers begin to report 2nd quarter earnings - investment banks will be the most closely watched, as investors still question whether the worst is indeed behind us:
- Monday – Adobe (ADBE), Lehman Brothers (LEH)
- Tuesday – Best Buy (BBY), FactSet Research Systems (FDS), Goldman Sachs (GS)
- Wednesday – CarMax (KMX), Commercial Metals Company (CMC), FedEx (FDX), IHS, Lindsay Corp (LNN), Morgan Stanley (MS)
- Thursday – Carnival (CCL), Circuit City (CC), JM Smucker (SJM)
Economic Data
The story remains to be the same – the housing/mortgage markets continue to deteriorate and the financial markets have yet to see any real improvement. With oil hovering around $140 and gas at the pump $4, consumer sentiment near record low levels, unemployment picking up as salaries stagnate, it’s hard to believe there will be much of an economic recovery any time this year:
- Monday – NY Empire State Manufacturing Index
- Tuesday – Net Foreign Purchases
- Wednesday – Building Permits, Producer Price Inflation (PPI), Housing Starts, Building Permits, Capacity Utilization, Industrial Production, Crude Inventories, Weekly Unemployment Claims, Leading Indicators, Philadelphia Fed Index
Strategy/Outlook
Tall eyes will be focused on investment bank earnings and inflation data this week, especially with the Fed decision on interest rates coming up next week. As we stated above, we are expecting a near term bounce in the broader market over the next few days before resuming this downtrend. Banks are trading near their March lows and it will be very telling to see if they can hold support and rally off the current oversold levels. If huge interest rate cuts and unprecedented funding facilities couldn’t bring these stocks to make a bottom, what’s going to happen when the Fed starts raising rates to battle inflation?
Of course, it sounds like a broken record, but energy prices will once again have a large impact on market action. Some energy related stocks have started to turn over and many are sitting right at important support levels – the pullback the market has been expecting in both commodity and commodity related stocks has yet to materialize, but at some point it will happen, and most likely in a quick and extreme manner.
We have a bearish near-term outlook, and would look to sell into strength at the resistance levels mentioned above. We have a lot of price patterns on our radar that we’re closely monitoring, and this should provide for some attractive setups sometime this week.
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Market Commentary - 6.08.2008
June 8, 2008
Just when you thought it was safe to get back in the market, Friday came along and dashed all hopes of a market turn around. At the beginning of last week, the S&P 500 was starting to rally back over 1400 bouncing off the 1370 short-term resistance. It looked like the Dow had built a temporary bottom at 12,350 and surged all the way to 12,600 on Thursday. Then the clouds started to roll in and the perfect storm was brewing before Friday’s open. First it was Mortgage Foreclosures, as reported mortgage delinquencies hit record highs in the first quarter as the sharp housing downturn put even more American households under financial strain. Then before the market opened on Friday the Unemployment and Non-Farm numbers came out. Unemployment was reported at 5.5%, its highest level in more than 3-1/2 years as American employers cut jobs for a fifth straight month in May.
After these two reports were out and the opening bell chimed, oil shot straight up on the dollar and market weakness. Oil hit over $139 dollars a barrel gaining more than $10 dollars a barrel on Friday. These were record breaking highs both on the overall price of oil as well as it was the largest price jump in one single day in Oil’s history.
The market spiraled completely out of control after this, the Dow dropped 394 points, its largest downward move in 22 years, settling at 12,209. The S&P dipped over 3% crashing through the 1,370 support level, support that has held since April. None of this spells anything good for the US Market Outlook, economists are already calling for Stagflation, which the country has not seen since the 70’s. But at this point nothing on the horizon is pointing to anything good. Gas just hit $4 a gallon for the first time in US history, Oil is at $140 a barrel for the first time in US history, unemployment is up, foreclosures are up, and there isn’t much of an end in sight to the credit crisis. HP is sitting with a bearish grin on our face right now. We have been calling for this for months but the market and the hopes and dreams of it’s investors didn’t want to see the writing on the wall.
Earnings
To say this is a boring week for earnings is an understatement, as no company with a market cap bigger than $5 Billion is reporting - really no names worth mentioning.
Economic Data
Everyone will be focused on inflation data and retail sales this week:
- Monday – Pending Home Sales
- Tuesday – Trade Balance
- Wednesday – Crude Inventories, Fed Beige Book, Treasury Budget
- Thursday – Weekly Unemployment Claims, Import/Export Prices, Retail Sales, Business Inventories
- Friday – CPI, Michigan Consumer Sentiment
Strategy/Outlook
The near term tops that were called for last week ended a little bit sooner and more abrupt than expected. Now the rocky road leading to the slippery slope is just beginning and coming up this week, we have our eyes focused on Thursday and Friday. Thursday the retail sales numbers are coming out, Friday inflation gets reported. With everything that has happened this past week, the US Market is in dire need of something positive if not neutral at the very least. As we said earlier the S&P has broken short term support at 1,370 and is eyeing 1,320 while the Dow creeps back once again to 12,000. We are bears all the way this week, the only thing that can help are some short term technical pull backs. However there doesn’t seem to be much out there stopping this market from trying to find a bottom. Oil and Gas are continuing to surge, leaving Americans lighter in the wallets which will have a ripple effect on spending and travel during this upcoming Summer Vacation Season.
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Market Commentary - 6.01.2008
June 1, 2008
Another positive week for the broader indexes as oil finally started to pull back as the market had hoped. The S&P 500 is now trading in a fairly tight trading range between its 50 and 200 day moving averages. We expect to see a retest of 1420-1425 in the next week or so, with resistance coming from the 200 day moving average, the broken trend line since mid-March, and the 50% Fibonacci retracement level from the October high to the March low, as all these levels are converging around that area.
It seems the top headline every day is what the price of crude oil is doing, and everything else seems to feed off of that. While most of the commodity related stocks we follow are still in a nice long-term uptrend, several have broken trend lines in the last week or so, and it will be interesting to see whether oil and energy related stocks have made a near term top, or whether this pullback represents a buying opportunity for the next all-time high, as has been the case all year long – remember when everyone was wondering whether we would see $100 oil last year?
Earnings
Another light week, with only a handful of meaningful reports:
- Tuesday - Guess (GES), SAIC Inc (SAI), Toll Brothers (TOL)
- Wednesday – Greif Brothers (GEF), Hovnanian Enterprises (HOV), Vimpel Communications (VIP), Williams-Sonoma (WSM)
- Thursday – Ciena Corp (CIEN), National Semiconductor (NSM), Smithfield Foods (SFD), Take-Two Interactive (TTWO)
- Friday – Signet Group (SIG)
Economic Data
Another busy week with employment data as the highlight:
- Monday – Construction Spending, ISM Manufacturing Index
- Tuesday – Auto/Truck Sales, Factory Orders
- Wednesday – ADP Employment, Productivity, ISM Services Index, Crude Inventories
- Thursday – Weekly Unemployment Claims
- Friday – Average Workweek, Hourly Earnings, Nonfarm Payrolls, Unemployment Rate, Wholesale Inventories, Consumer Credit
Strategy/Outlook
As we said above, we see a near term top in the broader indexes over the next few weeks. We would consider selling into strength, but the Russell 2000 has been a bit stronger than the S&P 500 so we would stay away from IWM options for now. The whole market is focused on energy and commodity related stocks, which have been in a strong uptrend since the start of the year – at some point the trend will end, but until that happens we will continue to look for attractive opportunities on the long side. As soon as the end of the trend is confirmed, there will be plenty of points to the downside.
Of late, we have nibbled on some short energy names which looked like were topping, only to get stopped out several days later as these stocks continue to make all-time highs. These ideas were a bit more speculative in nature – good risk/reward so they were small losses – but for now we will be a little more conservative when selling into strength in these sectors.
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