US Market Report – week ending 27th July 2007
The DOW Jones Industrial average made its largest weekly loss for the year, with he broader market following suite. On average, the indexes fell more than 1.5% and have broken into new medium-term low levels along the way.
With earnings season well underway, investor focus was expected to concentrate on company profitability. As usual Merger & Acquisition (M&A) activity inspired some buying early in the week, however, analysts have shown some concern towards the growth of the markets as a large number of the companies that have reported earnings failed to meet expectations.
Earnings season was expected to show continued growth in the economy. Over the last 2 years, company profits have been growing steadily, however, the last couple of quarters have declined in their growth rate.
The greatest fear at the moment, in terms of company earnings, is that we have already passed the peak growth period, and coupled with other “slowing” economic factors, that the markets could experience an extended period of decline.
Many analysts have been surprised by the strong market growth that has been experienced thus far in 2007. Not many were expecting the major averages to push into new all time highs (all except the NASDAQ index that is). In fact, with the markets trading in a sideways channel in June, FMR Analysts was expecting a change in trend condition towards a downwards market.
However, buyer demand was sufficient to push the markets higher in early July. But now there is a real fear that further retracement might occur, and investors are selling profitable positions quickly.
False breakout …
Only 2 weeks ago the markets had broken into new long-term highs. Positive market sentiment lifted the markets, suggesting a continuation of the previous Bull trend should persist.
Buyer demand was not sufficient to cause a steady upwards trend to form, and subsequently we have seen the markets retrace heavily. Not only have the major averages pulled back into the previous trading range, but they are now trading below the support levels of those consolidation patterns.
This suggests the upwards break had been a “false breakout”, and might be considered the last “hoorah” of the bulls. Clearly sellers have pulled the markets down with some ease, and as long as there continues to be negative sentiment driving the markets, we should expect further bearish activity.
Investor fears at 3-year highs …
Nothing depicts how bearish this movement has been as the CBOE Volatility Index (VIX). The VIX has pushed up above the March highs. In fact, it has risen above the June 2006 highs and is trading at a level not seen since late 2003.
The VIX “fear indicator” is a used to measure investor fears of a falling market. When it is high, there is a higher probability that the markets will fall as investors are fearful of selling pressure.
The activity we are experiencing now is the strongest indication we have seen in this 3 year Bull market. It cannot be taken lightly, with investors taking head of its importance.
By all accounts, this indicator is suggesting stock positions should be closed, along with bought Call option positions. While bought Put options should be considered for profitability. This is also a strong signal for Selling Call options, especially for stock positions that investors need to maintain.
Chart activity is the first sign …
Independent of the V IX indicator and what it is suggesting is the plain fact that the major averages have broken their support levels in a quick, sharp price movement.
Just like the activity we had experienced in March earlier this year, the major averages have ended the previous trend and may attempt a new direction. The severity and depth of the market retracement that currently persists is very similar to the market movements of March.
Despite the fact that the March activity failed to produce a new downwards trend, there is no reason to suggest that this current movement may not fulfil the expectations from earlier in the year.
The ease at which investors drove the markets down, and the large volume activity that followed is a real threat for Bullish investors. FMR Analysts is on high alert for a potential change in trend, monitoring for a downwards trend to confirm with a lower high point and a break into a new lower low.
A market rebound is quite probable …
Do not be surprised to see a market rebound early in the week, however. Despite all of the analysis suggesting continued bearish activity, Monday trading can quite often find some relief against such a negative week such as the one we have just experienced.
This means investors should continue to take great care in evaluating pre-market activity before making a decision on what action to take during the day. If there are key earnings reports scheduled for release and investors are reacting pre-market, this could lead to trading in that direction for the day.
Earnings …
The last week of trading had an extremely large number of companies reporting their earnings for the 2nd quarter of 2007. That number has not decreased for the coming week, however, there are fewer leading companies scheduled to report.
Last Monday, the markets were influenced by positive results from T and MRK. Both beat expectations, helping a relief rally for the day.
Tuesdays trading was followed by strong selling, as reflected by poor earnings reports from TXN, AXP and CFC. The latter fuelling the woes of the Subprime lending industry, one of the major catalysts for the markets breaking downwards in the last week and a half.
When AMZN announced their earnings Wednesday, the stock price sky-rocketed. It did help the markets garner a mild rally, but was more a reactionary movement than having any depth to change trend. Blue Chips BA and GD helped the markets gain as well, for a generally positive day on the earnings front.
But sellers were back in the markets on Thursday. XOM released earnings Thursday, missing expectations, and fueling an Energy led market decline. Housing data was the key focus of the day, however, as numerous announcements from companies in this sector fuel the market decline.
Friday is typically a quiet day for earnings, and the last week was no exception.
In the week ahead, there are some key companies reporting earnings. FMR Analysts has listed this in the following table:
| Monday | ABN | Before Market Open |
| | APC | After Market Close |
| | SUNW | Time not Supplied |
| | VZ | Time not Supplied |
| Tuesday | GM | Before Market Open |
| | VLO | Before Market Open |
| Wednesday | CTSH | Before market Open |
| | MCO | Before Market open |
| | SBUX | After Market Close |
| | TWX | Before Market Open |
| | RIG | Time not Supplied |
| | DIS | After Market Close |
| Thursday | CS | Before Market Open |
| | NEM | Time not Supplied |
| | NOK | 06:00am ET |
| Friday | TM | 02:00am ET |
Investors are negative on economic data …
Last weeks decline was all about the Housing industry. Financial institutions suffered heavily on data that suggested New and Existing home sales are continuing to decline, and that companies such as C, FNM and CFC are likely to suffer horribly due to the Subprime debt they currently carry.
The economy had continued to grow, according to the Fed’s Beige Book and GDP data that had been released through the last week. The hope that investors would experience a lowering in Interest Rates is well and truly out of reach on the back of this data as there has been no easing on pressures in inflation.
In the coming week, one of the key economic indicators for Inflation will be released the PCE Inflation indicator will be released before market open on Tuesday. Any surprises in this release is likely to lead to very volatile markets.
We also have Personal Income and Spending data on Tuesday morning, Consumer Confidence at 10am Tuesday (shortly after market open), Auto Sales Wednesday afternoon, and Unemployment data on Friday morning.
All-in-all, it is another busy week of economic reporting that is mixed in with a large number of earnings reports.
FMR outlook …
As we have mentioned, we would not be surprised to see a market rebound on Monday, but our expectations for the week are for continued volatility. This is more likely to lead to Bearish activity then Bullish in our opinion.
If we do have another strong bearish week, look for panic selling. Investors are sitting on the edge of their seats right now, evaluating whether or not this could lead to a downwards market. The failure to hold new long-term highs on the DOW and S&P500 indexes would be of great concern to the Bulls.
Should the markets hold relatively steady into the end of the week, and economic data fails to give any surprises that would suggest a weakening economy, then this might give “bottom fishers” an opportunity to accumulate stock. Whether or not they will have the depth to lift the markets back to the long-term highs will have to be seen.
Strategy Analysis …
With Volatility up so high at the moment, now is not the time to be purchasing stock, or buying call options.
Now is the time to be offloading stock or writing options. For the August option contracts, there are still 3 weeks left until expiration. This will give plenty of time value on the option, and with volatility up high, a good potential return.
Investors with stock holdings that have not already purchased put options for protection may find that put option contracts are quite expensive right now. FMR Analysts have been recommending the purchase of put options for the last few weeks. The heavy fall in the markets has increased put option values, which may be too expensive for smaller portfolios.
Short-term traders could consider Bearish strategies. However, a downwards trend has not yet been established and therefore risk for short-term bearish strategies is still quite high right now.
Astute investors might like to consider an options writing position on the VIX.
Currently, the VIX is trading at a long-term high. There is still reasonable premium on the August options, and with a long-term support around $15, this is a high potential for profitability. The risk that the markets might rally and cause the VIX to decline sharply is reasonable, therefore, investors should consider as low a premium as possible.