Archive for February, 2009
After a strong close yesterday and overnight strength in many foreign markets, it was shaping up in the pre-market this am to be a strong opening. That’s exactly what we got, but the trade of the day was to short anything on the opening because that was the high of the day. The rest of the day was steady selling nearly all day, with the exception of a relatively weak attempt at a bounce around 2:15 that was quickly snuffed out within 15 min. Nothing was spared today. The financials, which had kind of held their own early, finally succumbed to the late selling pressure although the BKX managed to close even. The brokers and exchanges all got hit hard today, but then so did most everything else. Oils, oil servicers and anything else energy related, including coals and solar, were all under extreme pressure today as fears continue to mount that we’re nowhere close to the end of global slowdown and according to some well followed economists, we’re only in the 4th inning. Even tech stocks, which have been relatively strong recently, were under the gun today with nearly all being down in the 5% range for the day. For GOOG that equated into a 16+ point loss. In other markets, the dollar staged a strong rally starting about midnight last night against nearly every major currency and gold eased off slightly today. The biggest bull market in the world right now is in gold coins which are in short supply worldwide as those with the capital seek safe ports.
The net result is that with a 27 point drop in the S&P 500 today we’re sitting right at the low of the past 12 years made back in October 2002. For long term investors they’re back where they started 12 years ago in 1997, as you can see in the chart above. I hate to even consider that return when you factor in the inflation factor for the past 12 years. As you can see on the chart the next support cluster comes in at the 685ish level on the S&P though there is a little support where we are now from late 97 and the intraday lows from November. We are still in a primary down trend. However we are starting to get some indicators into the oversold position and if you look at the market historically you rarely have the kind of drops, see chart, especially from the 1300 level to here, compared to the 2001-2003 period, when there were several periods of nice rebounds. We haven’t had one, so as I stated last night, I think we’re entering that territory where we could see a reversal, which could be somewhat violent. I try not to get caught standing in front freight trains and trying to pick bottoms, however if you’re short you may want to be alert.
After an extremely ugly day on Thursday and a big whoosh down Friday morning on worries what was going to happen to the financials the market staged a good rebound Friday afternoon to only close down about 1% for most the major indexes. The one exception was the NAZ which was just slightly down. The end result was a bullish candle formation on most the indexes.
In the 15min chart below, we see that we broke back above the upper line of a bullish falling wedge pattern. Of course you can see that we conviently bounced just above the prior low in Nov. I’m not looking for too much here as we now have a lot of resistance in the low 800 level and then further resistance at the 830ish level on the downside of the up trend line. So technically we could be set up for some further upside. But as always the case it seems lately, what comes out of Washington will probably have a pronounced effect one way or the other this week.
Stocks are falling because corporate profits are falling back to their normal percentage of GDP after swelling far beyond that. Since the market usually prices stocks as a multiple of their expected earnings, falling earnings usually mean falling stock prices. Important as the profit numbers are, the way we got there may be intensifying the market’s sour mood.
In 2007 corporate profits accounted for 14% of GDP, about double the usual level, a 55-year high. At the beginning of 2007, S&P expected earnings for the S&P500 (SPX) would come in at $92 per share for that year. Now, Merrill Lynch economist David Rosenberg expects to see $28 per share for 2009 and (optimistically in my view) a rebound to $55 for 2010, according to the February 14 edition of John Mauldin’s online newsletter. In other words the market price of the SPX was based on forward expectations of $92 in earnings just two years ago, and is now looking at $55 next year if we are lucky. And the market may be conveniently overlooking, if not wishing away, the goose egg we are laying this year. The downward trend from the 2007 peak is not good news either.
But just how real were the peak earnings in the first place? Clearly in financial services, not so much. For example, take the financial companies’ earnings reports for 2006. To make the 2006 earnings picture reflect economic reality, we would have to reduce earnings reported in 2006 that were derived from transactions made and loans extended that year, by the subsequent write-offs related to those transactions.
Non financial earnings may have been more “real” but they were less than sustainable in many cases. A key problem here lies with the off shoring of the US industrial base. It runs like this. Since the Reagan years, American companies have moved jobs overseas to take advantage of cheaper labor. The idea was to make things cheaply over there, sell them at retail over here, and fatten profit margins. The problem is that by shipping so many good jobs over there, American companies reduced the number of Americans who could afford their products. Managements thought they were serving their customers better by cutting prices but they ended up destroying many of their customers instead. Off shoring works if you are the only company doing it (your employees land good jobs elsewhere and continue to afford your product) but not if everybody does it (and the employees are forced to take lower wage jobs, assuming these can be found).
Henry Ford would never have done this. He paid his workers the then unheard of wage of $5 per day and he didn’t do it out of charity. He did it because he wanted to expand the market for automobiles. He wanted consumers who could afford the products they made.
I know that some people think that our companies had to off shore in order to stand up to foreign competitors. My answer to that is two-fold. First, many countries like, for example, China, have figured out how to game the WTO rules so that they can export goods to other countries and keep imports out, while staying within the letter of the agreement. Secondly, German and Japanese companies, for example, seem to make more efforts than our companies do, on balance, to keep jobs at home.
In the early part of this decade, consumers kept up their lifestyle despite stagnant or falling incomes by borrowing against their homes so they could buy more “stuff.” Eventually that strategy failed when home prices crashed. No one could expect any longer to get bailed out of their home equity loans with profits to be earned by selling their home to the next buyer at an ever more inflated price.
Consumers were supporting their spending not with wages but with asset price gains. Funding your purchases by taking money out of your home is very different than funding them out of ongoing wages. You can only take money out of your home, once. Similarly, corporations could only plump up their earnings by off shoring their labor, only once. If you increase profits by finding lower cost ways to manufacture by improving technology or expanding know-how, that is part of the ordinary course of business. In other words: the big increase in corporate profits reported in the last 15 years was an anomaly, similar to what security analysts would call a one time gain.
When security analysts dissect earnings reports we differentiate “operating” earnings which spring from a company’s usual course of business, from “one-time” gains that come from such items as the gain realized from the sale of a major asset such as land, a building, or a corporate division. I would contend that much of the increase in corporate earnings between, say, 1990 and 2006 were in fact, one time gains.
As the market drops, investors are waking up to a cold fact. Corporate earnings will not rebound to 2007 levels any time soon — assuming those earnings existed in the first place.
Stocks today traded in a narrow range today after some early selling the first 30 min. It then proceeded to make a slow climb back up to the 795 range before zigzagging back and forth downward to close at 788, down les than a point from the prior day. I think there may have been a collective sigh of relief that we at least stabilized or at least took a breather from the prior days selling. The net result was that most the major indicies closed right at their prior close give or take a fraction.
After hours HPQ disappointed investors with slightly worse than expected and was hit for a couple of points, but to be honest, I thought their sales and earnings were not too bad considering the economic situation. They’ve obviously made some good efforts on their cost cutting program.
The dollar continued strong and is close to making a breakout here to the topside sitting right at resistance and gold after being weak early manage to add on to its gains later in the day and seems to be determined to break the $1000 barrier again. Seems to me that that the trade is getting awfully crowdwd these days with the move up getting a lot of media attention. Where were all these buyers 60 days ago when the price was 30% lower? Did they really expect the new administration to be doing anything other than what they’re doing. So at the moment we’re sitting right at the next resistance level from the high in July as seen on the chart below. Admittedly and belatedly, as often the case, the media has been all over the story that Europe due to massive loans to Eastern European countries may have even bigger problems than us, and act like its a big surprise when anyone that reads anything other than the funny pages has seen this coming for many months. Overnite the dollar has started to pull back some.
Well, if you thought Friday was boring like I did, then Monday was anything but. With a large gap down, I kept waiting for at least some semblance of a rebound to put on some shorts but it turns out, other than a relatively slight bounce into the 11:00 hour, that was about it. The rest of the day the market chopped around below the 800 level though it did try a little rally into 3:30 which would have been rewarded on the short side if you weren’t particularly ambitious. I spent most the day watching and being glad to at least have some silver and gold plays, obviously not enough, which were the only commodity stocks positive. The net result was a really ugly day with most the major indexes down about 4% on average. The BKX was especially hit hard with the brokers taking a big hit led by GS. I remarked to someone that the BKX would need to nearly double just to get back up to its horizontal resistance line around 47.
Obviously we have definitely broken our recent up trend line and generally strong support into the low 800 area for the S&P. Though somewhat oversold after today, we’re not at extremes yet though the DOW did close right on a prior low and has at least a little support here, but in this market, who can say how much.
I think our best bet would be if we could get some more selling early this am and then see if we could set up for some short term bounce from there. According to Jason Goepfert at the well respected Sentiment Trader “If SPY gapped upthe next morning, buying that open and holding for two days resulted in 3 winning trades out of the 8 attempts, with an average return of -1.1%. The average drawdown was equal to the average maximum gain at 4.4%. The average drawdown THAT DAY was -3.3% with all but one suffering at least a -2% drop at some point during the day.
Now for the other side…if SPY gapped down the next morning, buying that open and holding for two days resulted in all 6 winners, with an average return of +5.4%. The average drawdown during the trade was -2.6% versus an average maximum gain of +8.1%.” So that’s what I’m hoping for since for now the former support we had in the low 800 level will probably act as resistance, plus we’ll now have gap resistance at the 820 level. I think the primary thing for everyone to remember is patience.
Friday was a boring day, perhaps due to fact that we had a three day weekend coming up. If you missed the early move and resulting short opportunity about 11:00 the balance of the day was primarily chopping around. We barely managed to hang on to our up trend line on the daily and as you can see below, our horizontal line on the 15min chart.
The net result was the DOW was down 82 points while the S&P500 dropped about 8 points. Obviously we’re still seeing a lack any substantial interest in buying, even at these levels, which can certainly be understandable considering the uncertain economic picture.
The recent backup in rates may be telling us that the market is afraid that the US will have to start paying even higher rates of interest in the future on its bonds if we are to fund our stimulus plans. Higher rates would of course mean, lower bond prices.
The comparison between our conditions and those Japan faced in the ‘90s provides clues on bond price moves. For me the message is, avoid long dated Treasurys. We might also be grateful if the worst we experience is a “lost decade” like Japan’s.
Just because Japan kept rates low and bond prices high longer than many people expected, doesn’t mean we’ll be able to do the same thing. Even though Japan’s economy was in some ways less robust in the ‘90s than in the ‘80s, its high savings rates and large trade surpluses meant that there was plenty of demand for Japanese Government Bonds (JGBs) at low rates. In other words, they had the economic conditions to support low rates over the long term. I’m not sure we can say the same.
Certainly Japan’s economy stagnated in the 1990s. Its stock and property markets have yet to regain their 1989 peaks. And despite their policies of public works spending and low interest rates, Japan prolonged its recession by propping up weak banks. Japan papered over the losses at these institutions, hoping that with low interest rates, even weak banks would enjoy fat net interest margins on new loans. That would enable them to make enough money to cover previous losses, the argument ran. It didn’t work, and eventually Japan had to get tough with its “zombie” banks.
Still, Japan has done much better than advertised. For example, during the last two decades Japan’s leading firms battled each other for world domination in autos and consumer electronics while US firms were out of the running. Think Toyota vs. Nissan and Honda, or Sony vs. Hitachi and Sharp. Not bad for a “failing” country. Japan has underplayed its economic performance in the press and this helped Japan defend and build its trade surpluses. Sometimes “misunderestimation” can really work for you.
The Japanese export machine – coupled with high domestic savings rates – gave Japan running room in the ‘90s that we don’t have now. They could afford economic stimulus and to keep dead banks walking. First, Japan’s high savings rate meant that Japan did not have to rely on foreign buyers for JGBs. Second, its trade surplus ensured demand for yen. Therefore, even though Japan was keeping rates low in order to prop up weak banks, the Japanese never had to worry about a crash in the yen. Indeed, with low rates, Japan got to reap the benefits of a weak currency in terms of keeping exports cheap, but with the trade surplus they never had to worry about the kind of devaluation that would be disruptive.
Unlike Japan’s our Government is looking at a tough funding problem. With our low savings rates and declining economy, we need foreigners to buy Treasurys in order to fund our budget. And that’s not all. Not only will we run fiscal deficits in the trillions over the next two years, we continue to run large trade deficits too. If you import fewer goods than you export, the only way to balance your books is to sell securities – and so we also need foreigners to buy our bonds in order to fund our import habit.
For the moment demand for our bonds and for dollars has held up mostly because other countries seem to be doing as badly as we are economically. The Eurozone’s banks are weaker than ours by some measures, and the Europeans are not sure how to coordinate their response. Asian countries dependant on US consumers are suffering export crashes too. Nonetheless the Asian economies and the Eurozone have higher savings rates and better trade balances than we do.
As Nixon’s economist Herbert Stein said, “If something cannot continue, it will stop.” So it may be with Treasurys. Sooner or later we may have to pay up in order to keep the Government funded. Today the 10 year note yields 2.90% and the 30 year bond yields 3.69%. The risk/reward on long Treasurys looks ugly.
AAPL has been a great trader the past 10 days giving very good conservative signals as seen below on a 10min chart, though in actuality I was using a 5min chart, they’re very similar and the 10min shows up better here because of size restrictions. As you can see it broke above its 200ma (moving average) on Feb3. at approximately 92.50ish and then made a quick move up to the 96 range. That was more than I could resist for a short trade so as it pulled back and broke the 20ma it was time to book some profits.
Now notice that on the pullback during the early AM selling on the 5th that it bounces right from its high on the morning of the 3rd, so the horizontal trend line held. Later that day it comes up and takes out the high from the previous day. That told us that there was more potential in the stock if the market cooperated. As you can see in the chart, it did, rocketing up another almost 7 points in the next two days. Of course, it always helps to have Mr. Market on your side. You can also see the advantage of using trend lines in your trading as it helps to really give you good confirmation visually when an up trend may be coming to an end for the particular time frame you’re trading in. Besides breaking the trend line, it also broke back below the 20 and 50ma, so it eas time to say goodbye once again, primarily because both of the shorter moving averages were so far above, what I like to call extended, from the 200ma. As you can see however, AAPL did hold the higher horizontal line and had a good day yesterday, so I’m still keeping a close eye on it.
The market managed to stage a late afternoon rally on increasing volume as it once again managed to hang on to the critical low 800 level. After early morning selling, then a slow climb back up close to its prior close, it looked like the bears were moving in for another mauling as the SPX made its low for the day with good selling pressure once the index broke back below the 820 level. But the pressure, though fast was not on heavy volume and soon the bulls took over with a dramatic increase in volume the last hour with the net result the S&P 500, NAZ and the Russell all ending just a fraction higher on the day. The DOW was basically even. The question is where does all this take us. Looking at the SPX daily chart below you can see that we managed to tenuously hang onto out lower TL.
The market needs to make its stand here. A close below the lower trend line would not be favorable and especially a break of the prior low at 804 will set off red flags from a technical viewpoint. So the result is for the moment we remain trapped into this rapidly diminishing trading range. We need a move back above the 875 range and then above the upper trendline soon or we find ourselves going back to test our prior lows. Sentiment indicators are about neutral with some favorable and others not so with no real clear indication, ie probably why we remain locked into this pennant.
On other fronts, gold has managed to break out the past day or so and gold stocks which had stopped to take a breath at the end of last week resumed their upward trend. Next resistance area on gold will be the 990ish range as you can see in the chart.
Bond prices have started moving back up past few days since our leaders newest game plan in case no one has noticed. Personally, I think this is a relatively short term bounce but with so many economic unknowns not willing to bet against it at the moment, therefore I closed out my TBT trade at the end of last week, fortunately in hindsight as its come off about 3 points. See trade of the day. The only position I’m holding currently from a trading standpoint is a small Q call one that I will definitely stop out of if we break the 804 level.
Normally we hate analysts who recommend stocks at 100 and finally downgrade them at 15. So why should you listen to me when I tell you to avoid bank shares now? Even when the KBW Bank Index (BKX) has fallen from its February 2007 peak of 121.16 to 28.52 yesterday?
If you were investing during the early 1990s you did well if you bought the shares of strong banks in December 1990 near that market’s low and the shares of weak ones about two years later. The trouble this time is that… most banks are weak.
The big banks can look forward to more problems on many fronts. First, housing troubles are by no means done. There are plenty of adjustable rate mortgages out there whose borrowers are paying low, “teaser” rates and there will continue to be until 2011. Until that time we won’t know if these borrowers can handle a reset to market rates. That would be bad enough under current economic conditions, but for the moment the recession may be deepening. Many economists expect the “official” unemployment rate to peak at 9-10% in this cycle. That would translate to 15% or so of people willing to work full-time who can’t, once you factor in the “discouraged workers” who have quit looking, plus those who have involuntarily settled for part time work. So we can expect higher charge-offs on bank credit card portfolios and even on fixed rate mortgages formerly known as “prime.” Moreover, whatever is bad for first mortgages is worse for second mortgages such as home equity loans. Since the first mortgage holder normally gets first call on all proceeds from the sale of a home, if the first mortgage holder is not paid in full, the second mortgage holder gets… zero. And as for the once-lucrative business line of investment banking, well, don’t get me started.
So you want to look at regionals instead? Ha. Since many of them cannot compete with the majors on mortgages or credit cards, they are heavily exposed to… commercial real estate. Not good. According to research firm Reis, Inc., “rents fell in 43% of buildings of all types in the fourth quarter, up from an average of 25% in the first nine months of 2008,” Bloomberg reported today. That’s consistent with retailers’ woes: bankruptcies at Linens and Things and Mervyn’s, 500 stores to be closed at Starbucks (SBUX). As for mortgages secured by office buildings, Reis projects an 8.8% default rate. That’s ugly. After all, the great majority of banks have less than a dime of equity for every dollar of assets. If a business line such as commercial mortgages has a default rate that large, the capital devoted to that business line is dead money at best.
All of which brings me to my last point. Ongoing bad news implies more FDIC takeovers for small and midsize banks, more federal aid for banks that are too big to fail. If the FDIC takes over a bank, the shareholders lose everything. So far that has not happened to shareholders of big banks that have gotten TARP funds, but that situation could be too good to last. Sooner or later taxpayers may want something back from the banks in exchange for their TARP money, enough ownership to dilute if not wipe out the existing common. Either way, if you own bank shares there is a target painted on your back unless your institution has a well protected niche and excellent asset quality.