US Market Report – week ending 10th August 2007
The Fed Reserve speaks out on Interest Rates, disappointing the markets as a whole, but failing to incite Sellers. The Subprime lending industry isn’t done yet, with global repercussions hitting Europe and
Over the last few weeks, the markets have copped a hammering. Since the beginning of this bull market in early 2003, there have been several market “corrections” but none as severe as this most recent.
It is healthy to see the markets retrace. It allows new buying sentiment to enter, driving the markets to higher levels. This is how a “trend” works, with stronger directional activity, and mild counter-trend movements.
However, the recent market pullback has been accompanied by strong selling sentiment. Using the S&P500 index as a benchmark, there has been over an 8% retracement in market value in the last 3 weeks. The broader Russell2000 index has lost more than 13% in value!
But has anything really changed over the last 6-months?
The cause of this correction is that the “fear” of the subprime lending market collapsing is the beginning of a Bear market. However, fundamentally, the economy is quite the same as it was 12-months ago when we were already exhibiting signs that the subprime market was failing.
Company profits are still quite strong, with Merger and Acquisition (M&A) activity stronger than ever. A very healthy sign that business is prospering.
Unemployment is quite low, and while Interest Rates weren’t lowered by the FOMC (Federal Open Market Committee) on Tuesday, rates are still at reasonable levels and not high enough to negate Consumer Spending.
No, this current market correction appears to be more sentimentally driven and not so much Fundamentally. This understanding will have a major impact on those investors who are concerned for their portfolios.
Interest Rates remain steady ….
The FOMC kept Interest Rates unchanged at 5.25% basis points this week. Many analysts, like the flamboyant Jim Cramer, were extremely vocal about the lack of attention the Fed Reserve is paying to the Consumer. There is a general consensus that Interest Rates should be lowered to ease the pressure on the consumer, especially in light of the turn in the Housing market (fuelled by the Subprime lending situation).
However, as FMR Analysts have stated over the last 6-months, we do not see a reason for Interest Rates to be lowered. At the end of the day, Inflation still remains above the Feds expected target range of 2 to 3%.
Crude Oil prices rising under the radar ….
While investors have been panic selling stocks, and wild fluctuations on the markets are a reflection of the devastation Hurricane Katrina had on
At the beginning of the year, Crude had been trading at $50 a barrel. It recently peaked just under $80 a barrel – the highest level it has ever traded at.
The last peak in Crude oil was in July/August 2006, which caused the markets to fall heavily. Although Crude has pulled back in price in the last two weeks, we expect investors will begin to realize the implications of this quiet advancement and start taking note.
If consumers are already concerned over money matters and are beginning to tighten their spending, higher fuel costs will only exacerbate this.
Volatility at an all time high ….
From FMR’s point of view, we have never experienced Volatility to be so high. Up until last week, the CBOE VIX index (considered the major measurement of Volatility in the markets), had been trading at long-term highs. Heading into the beginning of this last week, there was a sense that the recent selling was beginning to abate, and that this might lead to a rally.
However, with the wild fluctuations and strong daily movements on the major averages this week, the VIX index has broken into a new record high level. This means investors are Fearful that the markets could fall.
FMR Analysts has always used this index as a strong decision marking indicator. With it trading at such high levels, it just cannot be ignored at this point in time and will have a major influence over what action investors will take on the short-term.
To put this into perspective, during the Tech Wreck of 2000, the VIX was trading around 30. It had peaked in 1998 just above 40. During the bear market that followed, it again reached 40, but subsided in 2003 as the Bull market began.
Currently, the VIX is trading above 28 having gained 10 points in the last 3 trading days.
Slowing momentum in the charts ….
From a technical perspective, there is no doubt that we are experiencing a “counter-trend” movement. The markets have pulled back in a Correction that still could fall a little further. However, activity in the last week is showing signs that selling pressure might be starting to slow.
An evaluation of the weekly chart of the S&P500 index shows us that this type of activity does not necessarily means the end of the bull market. In fact, it could be a great opportunity for investors to enter stocks at discounted prices.
Midway through 2006, the markets had conducted a 3-month correction. The next similar movement last just over a month earlier this year in February/March. Although selling pressure has not clearly abated just yet, it is not all doom and gloom for the Bulls.
Until we have a clear change in trend on the weekly chart, FMR Analysts will not begin calling a Bear market just yet. We need to see a failing of Buyers on the next upward run of the markets, which would cause a lower
Patience for now ….
The markets might not rally just yet, but because of trend definition, we will be monitoring for some stabilization. If a support base forms, this will offer a reasonable entry point for Bullish strategies. This requires patience in monitoring markets as it could take a couple of weeks to confirm that a support base has formed.
In the meantime, the wild volatility we have experienced over the recent weeks is not likely to subside. There have been movements intra-day that have exceeded 2% on the major averages, whipping from bullish to bearish (and vice versa) activity nearly every day in the last week.
Economic data ….
After the FOMC released their Monetary Policy statement on Tuesday, causing wild fluctuations intra-day between buyers and sellers, investors will now begin focussing on the economic data releases for the week.
On Monday, Retail Sales figures for July will be released before market open at 8.30am. Tuesday is an extremely busy day with CPI and PPI data at the same time before market open. These two reports are considered the benchmark for Inflationary figures, and therefore, could have a major influence on whether or not the markets hold or continue to fall.
Focus will return to the Housing market on Thursday as Housing Starts and Building Permits figures are released before market open. Considering the affect the Housing industry has had on market activity over the last year, these figures are likely to influence investor confidence as well.
FMR Market outlook ….
We are expecting some stabilization this week. The Financial sector has been hit pretty hard, which reflects on the broader economy, but is not likely to be a catalyst to a Bear market just yet.
The Subprime lending market is still likely to be a major concern for Analysts and Investors alike, but much of this activity should now be factored into the current market levels.
Earnings season is basically over, and the FOMC has released their policy statement. Investors will now focus back on economic data for signs of economic strengthening or weakening, and the coming week is a busy week for economic reports.
It is not likely there has been any major fundamental changes to the economy over the last month. Therefore, we are not expecting any major changes to CPI and PPI data. It is more likely that these figures will meet or slightly miss economists expectations, with a very low probability that they will exceed.
Strategy Analysis ….
Bulls should be holding steady right now, while Bears are on watch for signs that buyer weakness would be confirmed.
From FMR Analysts’ perspective, this means we are somewhat Neutral at the moment. Investor fear has not yet shown signs of ending, especially with the VIX trading at record highs, while it is too early to expect a support level to form and end the recent selling pressure.
August option contracts Expire this coming weekend. Investors who have written options for August will need to evaluate their positions. If you do not want to be Assigned on the position, you will need to close before the end of the week.
Due to the high volatility at the moment, option premiums are at an extreme high. This is one of the best times to be writing options, but only if the investor is confident that the markets are not likely to fall heavily over the coming month.
Because the markets have fallen quite substantially in recent weeks, and because of investor fear, put option premiums are at a high. The Time factor for writing Put options is not quite ideal with 6 weeks until the expiration of the September contracts, but as of next week it will be perfect.
Therefore, option writers might like to consider monitoring Put option writing opportunities for entry into the end of this week.
Directional traders will need to be patient. There is no clear trend right now after sellers have eased momentum in the last week. FMR expects that we will experience some consolidation, which if followed up with an upwards break, would be the time for short-term traders to enter into Bullish trading positions