US Market Report – week ending 20th July 2007
With a plethora of influential Earnings reports released through the week, and following a major upwards break the previous week, US stocks failed to find clear direction until the end of the week. And then, it was profit taking as fears over Subprime Lending facilities continued to plague investor confidence.
Investors had found enough Bullish sentiment to drive the markets into new territory on the 12th July. But they failed to follow up with sufficient buyer demand to warrant confidence for a continued bull run.
Through most of the last week, investors held the markets relatively steady. There were numerous economic reports released, potentially offering investors cause for further buying activity. However, this did not transpire, and subsequently a consolidation pattern formed.
On Fridays trading activity, however, profit taking came to the forefront of investors minds. Strong selling pressure negated nearly half of the July 12th gains, and has the major averages trading near the resistance levels that had persisted through May and June.
Earnings galore …
Starting the week was Blue Chip stock GE (General Electric). On Monday, GE had reported a positive earnings result. It was not exceptionally great, but sufficient to cause investors to lift the stock. Other Blue Chip companies reported, with CAT, UTX and HON posting gains. As members of the DOW Jones Industrial Average, the index was given a healthy boost to post another new long-term high.
Further economic reports from Blue Chip stocks on Tuesday, namely JNJ, KO and AXP. They helped boost the DOW again, but with concerns from economic data released before market open, the day ended mixed across the board.
In after market activity on Tuesday, INTC released their earnings report and missed analyst expectations. This lead to a lower open on Wednesday and was fuelled by a poor report from Technology leader YHOO, who lowered their full-year guidance.
The Financial sector took most of the brunt of selling, not only due to Subprime concerns, but also with JPM releasing their Q2 earnings missing expectations. There was also a massive shake-up with leading Fund Management firms as analysts downgraded BSC,
It was Technology that then lifted the markets on Thursday. IBM beat analyst expectations, negating the influence of YHOO the day before. Friday then produced the greatest weakness experienced all week as GOOG and MSFT missed analyst expectations, resulting in a massive retracement on the major averages.
Over the coming week, there is a substantial increase in the number of companies reporting their earnings. Some of the more important companies to consider include:
| Monday | AXP | Time not Supplied |
| | HAL | Before Market Open |
| | TXN | After Market Close |
| Tuesday | AMX | After Market Close |
| | AMZN | Time Not Supplied |
| | T | Time Not Supplied |
| | BP | 02:00 AM |
| | CTX | After Market Close |
| | CERN | After Market Close |
| | CHKP | Before Market Open |
| | DD | Before Market Open |
| | LLY | Time Not Supplied |
| | LXK | Before Market Open |
| | LMT | Time Not Supplied |
| | NBR | Time Not Supplied |
| | NSANY | Time Not Supplied |
| | NOC | Before Market Open |
| | OXY | Before Market Open |
| | PEP | Before Market Open |
| | X | Time Not Supplied |
| Wednesday | BUD | Time Not Supplied |
| | AAPL | After Market Close |
| | BIDU | After Market Close |
| | CL | Before Market Open |
| | COP | Before Market Open |
| | GLW | Before Market Open |
| | | After Market Close |
| | GD | Time Not Supplied |
| | GENZ | Time Not Supplied |
| | HMC | 02:00am |
| | QCOM | Time Not Supplied |
| | BA | Time Not Supplied |
| | WLP | 06:00 am |
| | XRX | Before Market Open |
| Thursday | MMM | Time Not Supplied |
| | APA | Before Market Open |
| | BMY | Time Not Supplied |
| | CELG | Before Market Open |
| | DHI | Before Market Open |
| | XOM | Time Not Supplied |
| | F | Before Market Open |
| | K | Before Market Open |
| | LLL | Before Market Open |
| | QLGC | After Market Close |
| | DOW | Before Market Open |
| | WDC | After Market Close |
| Friday | Nil | |
Subprime worries continue to be the thorn in the markets side …
The broader market failed to follow the Blue Chip lead early in the week, which resulted as the cause of the S&P500 and Russell2000 indexes underperforming against the DOW index.
Despite the strong market rally, and mild support from Blue Chip earnings results, investor sentiment was not sufficient to drive the indexes higher. This was due to continued concerns with Subprime lending facilities.
Over the last 6 months, mortgage lending to high risk individuals has experienced an increasing number of defaults as the weakening housing market and higher interest rates have hit the economy.
Although investors were focussed on earnings reports, the plain fact that the economy has slowed and that Subprime lending will continue to be of concern in the coming 6-months has resulted in a failure of the markets following through with sufficient buyer demand.
Volatility has increased …
Over the last month, the VIX index (which is a measure of investor fear) has been trading well above average levels. This suggests that there is a large number of investors who are in fear of the markets retracing.
The VIX index is an evaluation of volatility. When it is high, it means investors are fearful of the markets falling. Low volatility means a good time to be buying.
As we can see from the VIX chart, there has been an increase over the last week, suggesting now is a better time to be selling. Most of the rise is due to Friday’s market retracement, however, when coupled with the technical evaluation of the current markets, it is a good confirmation for those considering closure of stock positions, or for those entering into option writing positions.
Reporting the Economics …
Last weeks release of the PPI (Producer Price Index) and CPI (Consumer Price Index), did little to sway market sentiment. Both indicators are key economic measures for how the Federal Reserve will maintain Monetary Policy. That is, if Inflation appears to be increasing due to a rise in these indicators, then the Fed Reserve will raise Interest Rates.
PPI was slightly higher than what economists had been expecting. These results do not suggest it is time to panic. A mild rise of 0.3% has the economy, on a Producers level, continuing to shift relatively sideways.
On a Consumer level, it was much the same story. CPI was only slightly above the expectations of economists, coming in at 0.2%, while the Core rate met expectations.
Due to this, many are not expecting any major economic influence in the coming month, especially from the Fed Reserve. Interest Rates have been steady for some time now, and although investors would like to see rates lowered, there is no need to be changing the balance right now.
Interest Rates are increased to slow consumer spending. When prices of goods and services are increasing at a greater rate then what consumers are earning or can save, then the country is in trouble.
With inflation still hovering above the Fed’s expected target rate of 2-3%, it is not likely we will find a lowering of rates at this point in time. Consumers are still spending relatively freely, while the cost of goods is not rising exorbitantly.
The Housing market is a major concern, however. Over the last week we had the release of Housing Starts and Building Permits numbers. The first beat economist expectations, just. The latter fell below analyst expectations. This is not a good sign for this sector, which has suffered over the last 12 months and is likely to be the major influence on any future market pullback.
For the coming week, it is an extremely quiet week for economic announcements. Monday and Tuesday have no major releases, while Existing Home Sales numbers will be released shortly after market open Wednesday.
The Federal Reserve will release the Beige Book at 2pm Wednesday as well. This report outlines the data collected by the various Federal Reserves around the country, and presented to the FOMC (Federal Open Market Committee), who governs the decisions on raising/lowering interest rates.
This could have influence on the markets, however, as we have recently had an FOMC meeting with an accompanying statement, it is not likely that these notes will present any new material that could strongly influence market direction.
On Thursday, look for New Home Sales figures to have some influence on the markets. Again, this will be shortly after market open. And finishing the week off will be some potential for influence from the Advanced GDP figures for the 2nd quarter. These will be released before market open on Friday.
FMR Analysts outlook …
With so many reports scheduled for release over the coming 2 weeks, it is extremely difficult for any analyst to formulate an expectation for market direction through that period.
The markets have shown a lack of buyer support following the upwards breakout of resistance just 2 weeks prior. Friday’s market activity clearly shows a quick willingness for sellers to enter the markets. And with numerous “top end” companies failing to meet earnings expectations, there is a real threat that this quarters results will fail to meet market expectations.
For this reason, it might be more prudent to air on the cautious side of our analysis. That being, to expect high volatility but for a greater expectation for investors to react more bearishly than bullish.
Should a strong earnings report be released by an influential company, this is not likely to invigorate buying as much as a few “weaker” reports that slightly miss expectations. Therefore, we believe there is a higher probability for bearish activity.
Couple this with the fact that there are 2 key housing data reports scheduled for release, and the weight is more in favour to the bears.
Strategy Analysis …
Due to the high levels on the VIX indicator, and due to the time period until the expiration of the August option contracts, now is an ideal time to be writing Call options.
It is more probable that good prices will be attained for written calls. For those holding stocks that they intend to write against, should the markets fall, the value of the written calls is retained. Should the stock prices rise and close above the strike price of the written call options, then you could sell your shares at that strike.
FMR Analysts believe it would be dangerous to be writing Put options in these conditions. There is a high probability that the markets might retrace from long-term highs, and this means a higher probability that the positions might be exercised or require closure.
If you are happy to purchase stock in the underlying of the written puts, or if you are extremely confident in writing puts and not requiring closure of the position before expiration, then the higher premiums that could be generated right now (due to high volatility), would be a benefit to this strategy.
Stocks are typically not in the best scenario for purchasing right now. Many are trading at or near long-term highs. Again, the probability of a falling market would suggest that now is an ideal time to sell stock if you are considering this action. Take some profits while the markets are high, and monitor until a pullback has made the same stocks a little cheaper.
For those investors with stock positions they do not want (or cannot) sell, you may consider purchasing put protection. It would be quite costly at the moment to do so, due to the high volatility on the VIX indicator, but it could be good peace of mind should the markets retrace heavily in the coming months.
Be wary of over paying for put options, and ensure you run a pricing model such as Black Scholes (a service soon to come to the Strategy Analyzer systems), to check if the option is trading at fair value.