US Market Report – week ending 31st August 2007
It was a relatively neutral week of trading as investors pondered over economic data and major downgrades in the Financial sector. The week had started with Bears negating the previous weeks activity, but it ended with the Bulls in control.
Investor sentiment has been volatile to say the least. The fallout from the Subprime Lending news over recent months has left many investors uncertain on what direction the markets might take in coming months. This is evident in lower average daily volumes over the last 2 weeks.
However, investor sentiment is much stronger. Panic selling is no longer taking place and as the Subprime activity is mostly contained to the Financial sector, investors have been entering into positions at discounted prices.
Currently, we are using the Russell2000 index as our benchmark for market performance due to the heavy weighting the Financial sector has on the S&P500 index. There are some very interesting technical points to consider right now, which could lead to a strong market movement in coming weeks.
Firstly, the Russell2000 index has a strong resistance level at 800 points. Amidst this recent market turmoil, the index has failed to break above this level.
At the same time, the 200-day moving average (considered the long-term benchmark for market trend), has retraced to this same resistance level. If were to find the markets stalling at this resistance level again, a clear sideways market would be established.
Candlestick activity on the Russell2000 has shown weakening buyer sentiment as it slowly approaches the resistance/200-day moving average. This is a very similar movement up to the 21st August, where the index subsequently stalled for the 2nd time at 800 points.
FMR Analysts also uses the Directional Movement indicator. It currently suggests a lack of market trend. This is the same type of activity identified in mid-July, just before the change in market conditions.
Although we cannot define which direction the markets might break, once the black line on the Directional Movement indicator rises, this will suggest we have a trending movement in play. The direction will be defined by the movement of the candlestick and whether the green directional movement line is above (denoting upward market) or the red directional movement line is above (denoting downward market).
For the Bulls, the strongest sign they have that this current market has potential to break upwards is that a higher low point formed in this last week. As the Bears were not able to hold onto the early advance, a higher low point has formed and might be the catapult the Bulls need to break the 800 point resistance.
It is imperative that we revise the weekly chart as well. For the Russell2000 index, the weekly chart shows a great deal of indecision. Short-term moving averages suggest a downwards trend, while the index is trading on the 200-day (weekly) moving average line. Due to the long-term upwards trend this market has experienced, it would suggest that this recent retracement should begin to find buyer activity returning.
However, our Directional Movement indicator is giving us a contradictory result. Although there is direction being shown (with the black line), the red directional line is above the green, suggesting a downwards trend in play.
When contradictory signals are being given, it is best to stay out of the markets. For this reason, we are remaining Neutral until we begin to find confirmation in our analysis.
Housing hurts ….
On the Friday of the previous week, New Home Sales data had helped lift the markets showing an increase in numbers for July. However, Existing Homes sales figures were released on Monday shortly after market open. Data showed that existing home sales fell 0.2% in July, and this set the mood for the day.
The end of the Housing Boom has been a thorn in the side of the Bull market over the last 18-months. Construction stocks such as DHI, KBH, CTX and LEN have done nothing but retrace significantly during that period.
Now with the Subprime Lending calamity affecting the industry, there are very few positives to consider.
Financials not getting a break ….
The beginning of the week was disastrous for the Financial sector. Research firm Lehman Brothers lowered their earnings expectations for CFC, one of the hardest hit by this subprime factor. Then fellow research firm Piper Jaffray downgraded their rating on CFC. The stock has lost 40% in value since mid-July.
Research firm Goldman Sachs lowered their earnings expectations on BSC, LEH and MS, causing the financial sector to suffer even more. But that wasn’t the end to it. On Tuesday, research firm Merril Lynch downgraded C, BSC and LEH to Neutral causing further negativity for the Financial sector and suggesting that there is likely to be far more negative news and adjustments in coming weeks.
Federal Reserve in the spotlight ….
The Federal Reserve Open Market Committee (FOMC) released the minutes from their recent meeting on Interest Rates at 2pm on Tuesday. Investors have been hoping that the Subprime fiasco would cause the FOMC to suggest a lowering of Interest Rates was being considered, however, the minutes did not suggest this was the case. This caused the markets to fall further on Tuesday, undermining the hopes of the broader market.
On Thursday, the Federal Reserve then added another $US10 billion of temporary cash reserves into the market in an effort to prop up an illiquid market. The cause – Subprime lending!
Federal Reserve Chairman Ben Bernanke was scheduled to speak at 10am, and as many analysts expected, he failed to offer any hope to investors that Interest Rates might be lowered in the coming months.
However, President Bush had already announced that the government would help subprime borrowers avoid foreclosure. Whether this action is too late to stem the hemorrhaging affect shown in the data over recent months is yet to be seen. But it did help inspire buying activity into the end of the week.
Long weekend to give investors a break ….
Monday is a public holiday for Labor Day, so investors will be given an extra break. The shortened week will not be a quiet one, however, so investors will need the time to prepare for continued volatility.
Economic reporting at its best ….
Tuesday will see the release of Construction Spending for July and Auto/Truck Sales figures for August.
Wednesday has the Federal Reserves Beige Book to be released at 2pm. This is likely to give investors continued frustration as to a lack of direction on Interest Rates.
Thursday is a quiet day for scheduled economic reports, however, Friday has the release of Unemployment data before the market open. This report is one of the key economic reports to evaluate strength of the economy.
Volatility remaining high ….
As the markets fell earlier in the week, the VIX index rallied strongly to suggest continued negativity is likely to find a continued downtrending market. Even though buyers returned through the tail end of the week, the VIX index only retraced slightly and has not yet suggested that investors fears are easing on the current market conditions.
FMR Analysts holds the opinion that we should not be looking for a Bull market until we have confirmation that the market trends are Bullish and that the VIX indicator retraces towards at least 18 points.
The VIX indicator is known as the “investor fear gauge”. When it is at high levels, investors are more “fearful” of falling markets, and the indicator coincides with falling markets.
FMR Analysts Outlook ….
The last week has failed to give us confidence in market direction. As an almost Neutral week of activity, we will still be looking for further directional confirmation heading into the shortened week.
Using the Russell2000 index as a benchmark, if the index is capable of breaking through 800 points and holding above this level, we would be considering the potential for a continued Bullish rally.
However, if a Bearish reversal pattern forms at the resistance level of 800 points, we would expect a retracement back towards 765 points, or even 750 points.
To confirm a trending movement, we will be evaluating the Directional Movement indicator on the Russell2000 index, looking for a signal that a trend is in play.
FMR Analysts Strategy Analysis ….
Due to the Neutral outlook for the coming week, FMR Analysts would not be suggesting entry into new investment positions at this point in time. With the VIX indicator still trading at high levels, and with recent market volatility showing investors swinging from one direction to another, the risk of investing into the current markets is quite high.
If an upwards trend were to form over the coming week or two, this would be an ideal time for stock investors to accumulate stocks. However, be wary of the Financial sector at this stage.
Technology has continued to prove strength, so investors who are persistent in buying stock could consider this sector of the market.
Option Writers should be very cautious. The risk that the markets might drop heavily is still quite strong. Therefore, do not look to enter the Naked Put strategy at this stage.
Covered Call writers might consider completing September positions at this stage, though as we stated last week, if there is a market rally in the coming week, this would benefit Call Writers, so continue to monitor on the short-term for this potential.
Short-term traders might like to consider lower risk, non-directional strategies such as Bull or Bear Spreads. Whether you consider Call or Put strategies will depend on your outlook for the stock you are considering.
There are opportunities presenting themselves at the moment, but FMR Analysts is still tentative on market trend direction. For this reason, we are remaining relatively conservative on our decision making for the time being.