US Market Report – week ending 3rd August 2007
Market activity has turned in its most volatile trading period in years. The major averages were swinging 2% between highs and lows nearly each day, resulting in a week that has been turbulent and found investors left confused and uncertain.
After the markets had broken downwards into new medium-term low levels at the end of July, investors panic sold off stocks on the heals of weakening data in the Mortgage Lending sector. Increasing defaults in the “Subprime Lending market” have lead to speculation that the “Prime Lending market” will begin to show signs of defaulting loans very soon.
The Subprime market refers to those home borrowers who have poor credit risk. During the market boom over the last 5 years, mortgage lenders have begun lending money to purchase property to just about anyone. No Document structures, low deposit, and negation of previous bad credit have seen a large number of people being able to purchase their own home.
However, as Interest Rates have been rising in the last couple of years to stem increasing Inflation, a combination of the cost of living and higher mortgage repayments have seen this Subprime market defaulting on their loan payments. The affect of this has seen those companies who have a large portion of their market in this sector, not being able to cover the cost of the defaulting clients. For this reason, we have seen a few of the weaker companies cease trading and file for bankruptcy in recent months.
Now, some analysts are speculating that the higher cost of living and higher interest rates will see defaulting mortgages shift into the Prime market – which is the broad base of citizens who purchase property. If this were the case, it is a major negative fundamental that could lead to a much heavier correction in the markets.
FMR has been reporting the Subprime affect for months ….
Since late 2006, FMR Analysts has been reporting how this Subprime affect was likely to lead to a market correction. Statistical data was showing the signs of weakness as early as December last year, but the broader economy helped the markets continue their upwards trend.
It stems from the broader ending to the Property Boom that has taken affect on Construction stocks over the last year. Construction stocks have suffered strong downward trending movements for some time, as housing sales (New and Existing) have been declining due to the populace not being able to afford the higher prices.
Confirming our outlook for a potential market correction, the last month and a half has seen the FMR Analysts Strategy Outlook suggesting Protection for Bullish positions. In particular, we have focussed on stock investments, suggesting traders should purchase Put option contracts to protect against any potential downwards movement in their stocks and/or markets as a whole.
Any trader who has adopted these strategies will have found their portfolio mostly covered against this recent market correction. The degree to which it would be completely hedged will depend on the positions themselves.
Investor Sentiment has been drained from the markets …
Confidence in the markets is clearly not present amongst investors presently. Throughout the last week, any positive buyer activity was soon followed up by stronger selling pressures. Despite Wednesdays and Thursdays trading posting positive market gains, buyers were unable to maintain that pressure through to the end of the week.
From Subprime fears, to a weakening Housing market, to uncertainty in Inflation, there does not appear to be too much positive news for investors to use as a means for stock accumulation at present.
Earnings activity in the last week, although mostly positive, was not strong enough to negate the broader economic fears. GDP data was slightly better than economists had expected, but this has been mostly built into market expectations and had little affect on the broader activity of investors.
As news transpires over the coming week, do not be surprised to see further panic selling whenever there is a headline related to the Financial sector. Positive earnings reports might cause a temporary relief, but FMR Analysts are not expecting buyer demand to return just at this point in time.
S&P500 Earnings mostly released, but many more are still to come …
Majority of the S&P500 listed companies have released their earnings over the last few weeks. However, the broader market is still complete the season, and the next 2 weeks will have a large number of stocks reporting. Therefore, the markets could still find further volatility on a day-to-day basis.
With earnings results producing “flat growth” for the economy in the 2nd quarter of 2007, the coming few weeks are not likely to produce enough growth to pave the way for an expanding economy.
The following table is a list of stocks that believe could lead to some interesting market activity on the release of their earnings reports. They are relatively predominant companies, however, not clear market leaders.
| Monday – 6th Aug | JCOM | Time not Supplied |
| Tuesday – 7th Aug | CSCO | After Market Close |
| | DUK | Before Market Open |
| | EP | Time not Supplied |
| | KG | Before Market Open |
| | MMC | Before Market Open |
| | MVL | Before Market Open |
| Wednesday – 8th Aug | AIG | After Market Close |
| | S | Before Market Open |
| Thursday – 9th Aug | GG | Before Market Open |
| Friday – 10th Aug | Nil | |
Focusing back on Economics in the coming week …
Following a week where there were some key economic reports, the coming week is relatively quiet. However, it has one of the most market moving announcements scheduled for Tuesday.
The FOMC (Federal Open Market Committee) will be meeting to discuss Monetary Policy. Their announcement at 2.15pm EST is a release of changes to Interest Rates and is accompanied by a report on the economy as a whole.
It has been nearly a year since the FOMC last increased Interest Rates, and there are low expectations that we might find a rate increase this week. Because economic data has shown stability in recent months, many economists are expecting interest rates to again remain steady. Therefore, investor and analyst focus will be on the accompanying policy statement for any hint that rates might increase in the near future.
Through the week there are some additional minor economic reports, such as the Preliminary Productivity report before market open Tuesday, Consumer Credit later that day at 3pm, and the Treasury Budget at 2pm on Friday. But all eyes will be drawn to the FOMC statement Tuesday.
Higher probability of further downwards market activity ….
Despite our evaluation of investor sentiment, our expectations that there is a higher probability of further downwards market activity through the coming week is supported by a Technical Evaluation of the major indexes.
The S&P500 index has failed to hold a base around 1,455, which it had been forming at the beginning of the week. If this movement was merely a “blow-off” from investors who wanted to bank their profits, it is likely the activity experienced on Friday would not have occurred.
What Friday’s trading shows us is that buyers do not have the depth to control the markets at the moment, stalling and giving way to strong selling pressures.
Support levels on all of the major averages have been broken, denoting a change in market psychology. In particular, the broader Russell2000 index has declined more than 10% in the last 2 weeks.
As we have mentioned, there is not a great deal of incentive for buyers to want to enter this market just yet. But whether or not this market will turn into a Bear market is yet to be confirmed.
This current market correction is most likely to find some buyer support at some stage. The economy is still strong, though not expanding at the same strength it had been over more recent years. Investors are likely to find a number of strong companies trading at prices they will find attractive (discounted) very soon, and that could lead to a market rally.
The Subprime fears will not last indefinitely, and once the sentiment has dissipated, investors will have cause to buy stocks again. For this reason, readers should monitor this market correction for some stability, looking for signs of buyers returning
Volatility supporting selling of stocks …
With the VIX indicator trading at a 2 and a half year high, the indications that Sellers are dominating the markets is certainly clear. Until this indicator begins to ease, investors are best suited to managing current positions, rather than entering into new Bullish positions.
This high level of fear is likely to see sellers reacting more strongly than buyers over the coming week, and hence our expectations are not only for a volatile market, but one that has a higher probability of closing the week down.
FMR Market Outlook …
As we have mentioned, our expectations are that the markets are showing a higher probability of being dominated by sellers over the coming week. As we had reported last week, we would not be surprised to see some mild recovery, probably following the FOMC statement where we expect Interest Rates to remain steady. Because of this, Monday’s trading could be relatively steady or even a mild recovery.
Through the second half of the week, we do not expect there to be much incentive for investors to continue buying stock. This could lead to a fall in the markets. The severity of this will dictate whether or not the week closes in the negative.
Strategy Analysis …
For those investors who have suffered a loss to their portfolio in the last 2 weeks, it is probably too late to be considering Protection strategies on your stock positions now. Put option premiums are high, and therefore, the cost to protect some positions will far outweigh the profit potential.
The probability that there may be more downward pressures in the markets, however, means investors should be considering action on a Bullish portfolio. The simplest strategy to adopt here is to Sell stock positions. That is, close out of Bullish positions. It is certainly not the right time to be entering new bullish positions just yet, until a market bottom has been found.
As an alternative to entering protection strategies on current Bullish positions, the investor might like to consider protecting their portfolio with an index position.
If you have numerous positions that are being greatly affected by the current market activity, you could purchase an Index Put option, or Short Sell an Index CFD to Hedge your portfolio.
Downwards activity in the markets would see both an Index Put option and Short Sold Index CFD positions gain in value. This would offset any losses incurred in the bullish portfolio (though investors need to be aware it will not hedge 1 for 1)