US Market Report – week ending July 13th 2007
Earnings season has officially begun, and with continued Merger & Acquisition activity fueling bullish market sentiment, the Bulls found favor through the last week, driving the major averages into new long-term highs. In particular, focus was on the DOW Jones Industrial Average, which posted its first 200 point gain since July 2006 and closed the week at an all time high of 13,907 – just short of 14,000.
As we had reported last week in our technical revision, a sideways consolidation pattern on the DOW, S&P500 and Russell 2000 indexes indicated we should have a short-term bearish reversal at the resistance levels. At the start of the week, weak bullish activity helped support this outlook, but then profit taking on Tuesday confirmed it.
There was a short-term bearish reversal pattern on the DOW Jones Industrial Average, S&P500, NASDAQ, and Russell2000 indexes. At this point, investors and traders would have been forgiven to have expected continued bearish activity, at least on the short-term and until the major averages had retraced to their recently formed support levels.
However, this was not the way the markets wanted to trade.
Earnings season has begun …
With Earnings season officially kick started after market Monday with AA, there were high expectations of continued growth in earnings across the board. However, Tuesdays market retracement was due to the weaker than expected report from AA, and more so from rising fears that the Subprime lending market will have a major affect on the Financial sector.
Over the last 6-months, we have already seen this phenomenon of the Subprime lending market, where there has been an exorbitant amount of defaulting on high risk loans. Most of which derive from the lower end retail market. This has been of great concern to economists, especially as housing prices have continued to remain high (out of reach for a large percentage of the population), while New and Existing Home Sales have been slowing.
Earnings season is in full swing, and although analysts have broadly stated that we should find continued growth across the markets, numerous downgrades of earnings expectations should be of great concern.
Typically, earnings season is a relatively volatile period. Especially through 2007, where the economy has slowed down, and therefore, profitability is not meeting the “high expectations” that were being surpassed in 2006.
Investors should be watching the Financial sector very closely. Large institutions such as MER, JPM, BAC, COF, FITB, BK, C and WB are scheduled to report throughout the week. If a number of these companies miss their earnings expectations, then expect sellers to hit this sector, and therefore, the markets to fall.
There are many companies reporting this week. This will be the benchmark to the coming weeks as investors hope continued company growth will fuel a bullish market. In the following weeks, an increase in the number of reporting companies will only fuel volatility.
Focus coming back to economic reporting …
Where the last week had little influence from scheduled economic reports, the coming week is likely to be hinged on it.
There are 3 key economic announcements to be made through the coming week. Firstly, on Tuesday is the release of the PPI report at 8.30am (before market open). The PPI report is the Producer Price Index, and it measures the prices of goods at a wholesale level. If prices are rising, therefore the index, then it means there is less profitability for businesses if they maintain their sale price to consumers. Typically the only option for business is to raise the cost of goods to the consumer so they can continue to make a profit. This is measure by the CPI.
CPI, or Consumer Price Index, will be released on Wednesday at 8.30am (before market open). This economic indicator is one of the key measures used by the Federal Reserve to measure Inflation and set Interest Rate levels.
Because investors have been hoping the Federal Reserve would lower Interest Rates through most of 2007, the release of CPI and PPI data has been extremely important.
Finally, on Friday we will see the release of the FOMC (Federal Open Market Committee) minutes from their June 28th meeting. Analysts will be scouring this report for any signs that the Fed may be intending to raise or lower rates in upcoming meetings. Typically, however, these minutes confirm the speech given at the latest Monetary Policy statement.
On June 28th, the Fed left interest rates unchanged. Though, they did state concerns that Subprime lending issues and the Housing market are taking its toll on the economy. Investors were hoping the Fed would lower rates, but this is not likely to occur as Inflation still remains well above the Fed’s target level.
Financial stocks come to the aid of a faltering market …
Relief in the Financial sector was the cause of the strong rise in the markets on Thursday, however, negating the bearish activity earlier in the week. The buyer demand behind the rally was extremely strong, with volumes on both the NYSE and NASDAQ markets exceeding averages.
As the rally pushed major averages through resistance levels, many analysts have found renewed support for a continuing Bullish market. Buyer strength such as this has not been surpassed for a very long time, questioning whether or not the economy has slowed enough to reflect any need for the markets to falter.
There is no question that the economy has slowed. Data proves this over the last 12-months. But investors are yet to experience any need to sell heavily. Hence the depth of buyer support seen through the last week.
One cause of this buyer drive has been the large number of Merger & Acquisitions of late. Many companies are “cashed up” after a strong booming economic period that started in 2003. This has given them the ability to purchase smaller companies that have innovative products/patents, before they have been released to the public. The most recent example of this is the fight between Rio Tinto (RTP on the
The Materials sector, which is experiencing a massive global boom due to high demand in
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Volatility decreasing …
Outside of the economic concerns of the
In recent weeks, we have seen the VIX rising. It has almost returned to the levels of late February, when the Chinese market caused global markets to retrace in fear of an end to the Chinese Boom. In the last week, however, we have seen some volatile activity on the VIX. Tuesdays markets found a strong increase as investors also perceived a bearish reversal during a medium-term consolidation, a sign that we could expect further downward markets. However, the return of buyers on Thursday has alleviated those fears, and the VIX has spent the latter half of the week retracing.
This indicator is still well above “normal levels”, where we would suggest it is an ideal time for purchasing stocks or options. At these higher levels, selling stocks or writing options remains the preferred strategies.
FMR Analysts Outlook …
It is hard to deny that the bullish breakout through this last week is not likely to fuel further bullish activity. What we need to see is a confirmation from buyers. That is, continued bullish activity.
Because we are now at the start of a precarious earnings season, it would not surprise us to see investors panic selling stock if a few key companies miss their earnings expectations. That would send the major averages back into the trading ranges that have dominated since the end of May.
For now, investors should maintain a Bullish outlook. If you are more cautious, then this would not be the ideal time to be entering into the markets. Technically, we should find further upwards activity, with the next market pullback holding above the resistance levels that had recently formed. This would denote a “higher high” point, and therefore, an upwards trend.
FMR Analysts is expecting volatility, with a Bullish undertone as market sentiment appears to be favoring buyers over sellers. We must be wary of the market reaction to economic data scheduled for this week. In particular, the PPI report on Tuesday, the CPI report on Wednesday and the release of the FOMC’s minutes on Thursday.
Strategy Analysis …
Volatility analysis continues to suggest Options Writing as the ideal strategy to adopt in the current markets. For stock investors, while this also suggests selling of shares, because we have experienced a strong bull run in the last week, it is prudent to first identify exhaustion in the stock/market before committing to a sell of shares.
Investors who hold July option contracts will need to evaluate their position/s this week as July options will be expiring on the 20th July – this Friday. Option Writers need to ensure they check where their positions may be Exercised, and take appropriate action if necessary. Option Traders need to evaluate the need to close positions. There is virtually no time value left on the July contracts, so you will only be able to realize Intrinsic Value if the position is closed or Exercised.
August options writing would be suitable at this point in time. There are 5 weeks until expiration of these contracts. Ideally, if investors can enter into option writing positions for August towards the end of this week, the additional decrease in volatility and time over the weekend (as July contracts expire), will typically help decrease the value of the option.