US Market Report – week ending 24th Aug 2007
Investors were far more optimistic over the last week, posting a mild recovery against the massive sell-off that had occurred in the previous 2 weeks. However, is this market poised to resume the previous bull market, or is further volatility likely to persist?
Negative sentiment surrounding the whole Subprime lending activity appears to abated, yet many analysts are suggesting its not yet over. Clearly the market rally experienced in the last week was quite significant. From an intra-day low of 1,370 on the 16th Aug for the S&P500 index, to the closing value of 1,479 on Friday is a recovery of nearly 8%.
The major concern with this current rally is the low volume. As the week progressed, there were really only 2 trading days where buyers were predominantly in control: Wednesday and Friday. And the volume on these days was not sufficient to suggest a confident market willing to negate the recent market fall.
This suggests that investors are still quite nervous that there is likely to be more repercussions from the Subprime lending fallout.
Short positions being Covered ….
Although selling pressure in the Financial sector is a major drive behind the rally this week, FMR Analysts also believes that closure of Short positions will have been a major factor.
Short positions are where investors/traders sell a position before they own it. Their expectation is that the markets will fall. So, they “borrow” shares through their broker, sell them at the market price, but still owe shares back to the broker. When the stock price has fallen, they buy them back at the lower market price, give the shares back to the broker, and pocket the difference between the high sell price and the low buy price.
A rising market will cause a loss to a Short position as the investor/trader must buy the stock back at a higher price.
Because the markets were trending downwards over the last few weeks, a high number of Short positions were taken by speculators. With a rally in the last week, exit points have been triggered and many Short traders have closed their positions.
What is of great concern for the Bulls, those speculating that there will be continued upward market activity, again is the volume. If many Short positions were being closed and Bull investors were also buying up stock in anticipation of continued upward activity, there should have been more volume.
More volume equals more depth to the buyer influence. Weak buyer activity equals a degree of uncertainty behind the rally.
Financial stocks recover ….
It is clear that the Financial industry has suffered most during this recent tumultuous period. Results from the recent earnings season suggest the broader economy is still quite healthy, even though profits are not increasing at the same rate they were last year. Still, quite a large number of significant companies produced positive earnings reports. Most of which are Technology related.
With the broader economy still quite healthy, the recent market reaction could help boost investors desire for the Federal Reserve to lower Interest Rates, however, we need to see Inflation falling first.
In the coming week, the Core PCE Inflation report will be released. This is considered one of the key indicators for the Federal Reserve to decide on Monetary Policy. The Personal Consumption Expenditures indicator is used to measure future consumer demand. If consumers stop spending, because the economy is based on personal spending, there could be a real threat to a weakening economy.
Currently, investors are concerned that with Interest Rates at 5 year highs that this could put a strangle hold on consumer spending, creating a larger negative market reaction. However, the Federal Reserve still views Inflation to be outside their target range, and therefore, does not warrant a lowering of Interest Rates.
Focus back on Economic reports ….
Following a quiet week of economic reporting, the coming week will create a little more influence from scheduled economic reports. Aside from the release of the Core PCE report before market open on Friday, investors will need to sift through Existing Home Sales shortly after market open on Monday, Consumer Confidence data shortly after market open on Tuesday as well as the FOMC (Federal Open Market Committee) minutes from their recent Monetary Report later that day, Preliminary GDP figures before market open on Thursday and Personal Income and Spending figures before market open Friday.
Because the recent market downturn is not yet reflected in the economic data to be released through the week, FMR Analysts is not expecting major negative reactions to this weeks economic releases. However, if the market is considering this point as well, there might be some adverse selling pressure in anticipation of future economic reports showing weakness.
Again, the turbulent market activity experienced recently could continue on the slightest of negative reports. We could find it takes a couple of months before the reality of the Subprime effect is reflected in the economic reports.
Earnings season is officially over, though technology giant DELL is scheduled to release their earnings report after market close on Thursday August 30th.
New Downward trends to be tested this week ….
Technically the markets are in a counter-trend rally. Due to the establishment of lower high points and lower low points on the major averages, a downward trend had formed (on the medium-term) on the S&P500 index.
However, we need to consider the fact that the S&P500 index is heavily weighted in the Financial sector. For this reason, it might not reflect the broader market sentiment. For this reason, we have also reviewed the Russell2000 index this week.
Market activity over the last week on the Russell2000 index is not as confident with buyers. Clearly the recovery in Financials this week has helped boost the S&P500 more than the broader market.
The Russell2000 index has rallied to a short-term resistance level around 800 points. This resistance has formed from the previous
If we were to find the Russell2000 index stall and retrace on the short-term, confirming the resistance level, there is a strong probability we will find a Consolidation Pattern forming, if not the next leg of a downwards trend.
Although the last two low points help define a downwards trend, it appears there is a mild support level around 750 points on this index. This is a 5% retracement from the current levels and would be the expected profit target for short-term traders.
This coming week will either see an upwards break of the resistance to support Bullish investors, or it will result in a reversal of the markets and a clear statement that the Bears are not yet finished with.
Crude Oil consolidating back off its highs ….
Crude Oil eased in value over the last week. In late July, Crude Oil had rallied up to its all-time highest levels, just below $80 a barrel. With investors focused on greater Subprime concerns, this commodity has retraced in value and is now trading around $70 a barrel.
This is very similar activity to what we had seen in August of 2006, so depending on the affect of the recent hurricanes in the Gulf of Mexico (where a major supply of Crude Oil is produced for the US), and consumption data in the next couple of weeks, Crude might continue easing in price.
For now, FMR Analysts is monitoring Crude Oil for to hold value around $70 a barrel. We believe the future of the Oil industry is likely to push the commodity back into all time high prices as we have seen over the last 18-months.
Volatility eases, but is not over ….
A positive sign for Bullish investors is the significant decrease in the CBOE Volatility Index (also known as the VIX). This index is a gauge of Investor Fear. As it rises, it suggests there is greater fear that the markets might fall. When it is trading at lower levels, it suggests investors are not fearful of volatility, and a steady trending market is more likely to persist.
Over the last 2 weeks, the VIX has retraced from an intra-day high level of 37.50 points on the 16th August, to its closing value of 20.72 on Friday. To put things into perspective, the only other time the VIX has been as high as it was on the 16th was before the Technology crash of 2000. It then was trading above 40 points, and subsequently led to a 3-year Bear market for the
The VIX has eased, but still remains high. A combination of this indicator rising and the Russell2000 index breaking below 785 points is likely to see a short-term retracement in the markets (at least).
FMR Analysts Outlook ….
For the time being, FMR Analysts is remaining very cautious. Although market sentiment has eased in terms of the Subprime lending fears, we are not yet convinced that buyers are prepared to put their money back in the markets.
In fact, as we had mentioned last week, we do not believe a market rally would be the best thing for investors right now. The dust needs to settle on the Subprime fears, allowing investors to gain confidence in the markets again. If the markets were to rally now, this might lead to a much deeper retraction in future months, and investors will be on constant watch for negative reports affect confidence.
Ideally, if the markets were to retrace in the next week, this would keep everyone in check. The broader market would realize patience is required for signs that selling pressure has eased, and buyers would begin to build their confidence.
Whether the markets were to continue trending downwards will rely on whether or not there are major negative reports released. Do not be surprised if there was a report from a Financial Institution that caused the markets to sell. We might be lucky and have a week where Subprime news does not affect investor confidence, but due to the severe affect this has already had (and is likely to still have) on the Financial sector, we have no doubt that we have not yet seen the end of this.
FMR Strategy Analysis ….
Bullish investors would consider this to be a good time to buy strong companies at discounted prices. It would be if the markets were to continue rallying from this point on. However, FMR Analysts believes it might be just a little too premature to enter positions right now.
If the markets were to continue rallying from this point, we would suggest entering bullish strategies on the first short-term retracement. Once weak selling pressure has presented itself, and buyers return, this would be a solid confirmation for entering into the markets.
Therefore, we remain Neutral on the medium-term outlook at this stage. This leads to caution on the long-term until we can confirm a resumption of the long-term upwards trend, or that a change in trend has occurred.
Short-term traders will be looking for confirmation of upwards activity early in the week, or for the bearish reversal to form on the major averages. Don’t be fool hardy and rush into positions on Monday. Wait for clear market activity to confirm your expectations.
Option Writers could begin entering into positions for the September contracts. Put Option Writers are best to not enter new positions at this stage. Although the VIX is still relatively high, if the markets were to retrace on the short-term a better entry level might present itself if support levels on the major averages are held.
For those call option writers who currently hold stock, if the markets continue to rally on the short-term you could receive higher premiums later in the week. Again, both call and put option writers are waiting for confirmation this week on short-term activity before taking action.
The short-term market relief has eased prices on Put options. Investors who missed entering into Protection strategies a month ago (as recommended by FMR Analysts) could use this relief rally as a chance to enter into protection strategies. As mentioned before, wait for confirmation of short-term market activity. A rally would mean no need to purchase the Put protection yet. A retracement means purchasing protection for a 3 to 6-month outlook.