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Market Commentary - 7.27.2008

July 27, 2008

Is it Déjà Vu all over again? Every time there has been an extreme level of fear and capitulation in the stock market, the Fed has stepped to try and create a bottom. We saw this at the end of January and once again in mid-March. It’s about that time again, in July as the broader indices were making new lows and investor fear was starting to spike, they stepped in with a bailout package for Fannie Mae and Freddie Mac. The bailout is a new $300 Billion dollar housing relief package, and a ban on short-selling of 19 financial institutions. Near each one of these intermediate-term bottoms, we have also seen investors start to “hope” the worst is behind us and start buying on earnings reports that were “not as bad as they could have been.” All the while the talking heads and “experts” have pointed to each of those levels as “the” bottom when in fact there was still more room to fall.

That’s exactly how this week started off, with the rally that began last week continuing through Wednesday on the “hope” that the housing market is showing signs of a bottom and the worst of the credit crisis is behind us. Wachovia Bank rallied more than 150% in 7 trading days even after they reported an $8.9 Billion loss, slashed the dividend, and announced 10+ thousand layoffs. Apparently investors still trust the CEO’s of these institutions even after they have been dead wrong in their predictions that the worst was behind us and their turnaround plans would start to pay off. Every quarter we hear these executives promise they won’t have to raise more capital or cut dividends, and every quarter that’s exactly what has happened.

The rally didn’t last long though, as Thursday brought about a huge selloff across all sectors which wiped out all the gains from earlier in the week. Overall, the Dow and S&P 500 posted small declines for the week while the Russell 2000 and Nasdaq were up slightly. We have been talking for quite awhile about the relative outperformance of the latter two indexes, and have seen nothing to suggest this trend won’t continue.

We still expect a relatively short-lived rally into mid-August which should retrace half of the decline since mid-May – looking at the S&P 500 we expect this would take us to roughly the 1320-1330 level over the next few weeks. We do not expect any significant longer term rally, or turnaround in the broader markets until there are clear signs of improvement in both the financial and housing markets; considering there is still significant risk and deterioration on both of those fronts, we still believe selling into strength provides the best opportunities right now.

S&P 500 we expect this would take us to roughly the 1320-1330 level over the next few weeks

options-analysis-07272008

The week ahead

Earnings

Another busy week on the earnings front, and we will see if the market continues to cheer results that are “not as bad as they could have been.” Companies with a lot of international exposure have been so far been able to better weather the storm than those with mostly domestic operations, but as the global economy continues to slow and the dollar starts to strengthen, that trend could soon come to an end. Here are just a few of the companies reporting this week:

  • Monday – Amgen (AMGN), Hartford Financial Services (HIG), Kraft Foods (KFT), Loews Corp (L), Lorillard (LO), Questar (STR), Simon Property Group (SPG), The Mosaic Company (MOS), Verizon (VZ), WM Wrigley (WWY)
  • Tuesday – Alcatel-Lucent (ALU), BP, Coach (COH), Colgate-Palmolive (CL), Electronic Arts (ERTS), Entergy (ETR), EOG Resources (EOG), Lincoln National (LNC), MetLife (MET), Northrop Grumman (NOC), Rogers Communications (RCI), SAP, Sony Corp (SNE), Teva Pharmaceutical (TEVA), McGraw-Hill (MHP), United States Steel (X), Valero Energy (VLO), Waste Management (WMI),
  • Wednesday – Allergan (AGN), ArcelorMittal (MT), Avon Products (AVP), Comcast Corp (CMCSA), Corning (GLW), Cummins (CMI), Express Scripts (ESRX), First Solar (FSLR), Garmin (GRMN), Hess (HES), Noble Energy (NBL), Prudential (PRU), Reynolds American (RAI), Siemens AG (SI), Southern Co (SO), Starbucks (SBUX), Symantec (SYMC), Tyco Electronics (TEL), Visa (V), Walt Disney (DIS)
  • Thursday – Aetna (AET), Altria Group (MO), American Electric Power (AEP), Apache Corp (APA), AstraZeneca (AZN), Automatic Data Processing (ADP), CBS Corp (CBS), Chesapeake Energy (CHK), Constellation Energy (CEG), CVS Caremark (CVS), Deutsche Bank (DB), Dominion Resources (D), ExxonMobil (XOM), FPL Group (FPL), Goldcorp (GG), Hitachi (HIT), Imperial Oil (IMO), International Paper (IT), Kellogg (K), Marathon Oil (MRO), MasterCard (MA), Motorola (MOT), Parker Hannifin (PH), Sanofi-Aventis (SNY), Taiwan Semiconductor (TSM), Tyco Int’l (TYC), Unilever (UL),
  • Friday – Chevron (CVX), Cigna (CI), Clorox (CLX), FirstEnergy (FE), Ingersoll-Rand (IR), NYSE Euronext (NYX), PPL Corp (PPL), PSEG (PEG), Sun Microsystems (JAVA), Washington Post Co (WP), Total SA (TOT)

Economic Data

A big week for job reports as the market will be watching closely to see how quickly the employment situation is deteriorating – this past week’s sharp rise in the unemployment rolls could just be an outlier, or a sign of things to come. Also, watch closely for the reaction to the home price index, as the housing market has once again taken center stage:

  • Tuesday – Consumer Confidence, S&P/Case-Shiller Home Price Index
  • Wednesday – ADP Employment, Crude Inventories
  • Thursday – Revised Q2 GDP, Weekly Unemployment Claims, Chicago PMI
  • Friday – Auto/Truck Sales, Average Workweek, Hourly Earnings, Nonfarm Payrolls, Unemployment Rate, Construction Spending, ISM Index

Strategy/Outlook

First, we just want to say this is the toughest market we have ever traded in – the level of volatility and intra-day price swings over the last few months has been extraordinary. That’s why we have been tightening stops and quick to take profits, and we will continue to do so until the markets show a clear direction. The trade that had been working all year up until July, namely the long energy/short financials trade has obviously unwound in a hurry. Considering how quickly and violently commodity prices and commodity-related stocks have corrected, we expect some sort of rebound in the coming weeks. We also expect the financials to resume their rally and take us up to the resistance levels from May. This should provide great setups for short trades in these sectors.

The only sector that has been extremely strong and is not subject to wild price swing based on what the price of oil is doing is Drugs/Biotechnology, so we will continue to seek out attractive opportunities on the long side in this sector. These companies have held up well in a weak market, with strong earnings and positive outlooks, and it seems every week there is a major buyout announcement.

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Posted by admin | Filed Under Free Market Commentary 

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