Weekly US Market Report – week ending 2nd November 2007


By Matthew Brown

This week had it all: Interest Rate cuts, Crude Oil at record highs, panic selling on continued fears in the subprime fallout, key economic data and a plethora of earnings announcements. In the end, the Bears won the battle. But not convincingly!

The greatest fear for investors at the moment is that the markets have “topped out”, and that continued market growth has stagnated. There are numerous factors to support this statement. All of which culminated over the last week.

Firstly, a technical evaluation of the major averages. Using the Russell2000 index as a benchmark, we have a Lower High Point that formed on the 31st of October. The previous high held resistance that had formed in May/June/July earlier in the year, suggesting the Bulls do not have the strength to continue driving the markets at the same growth we have seen over the last two years. This suggests there is potential for a technical downwards trend to form, so many analysts and traders will be carefully watching these markets for a downwards break.

Crude Oil is another major influence at the moment. It is trading at an all time record high just below $96 a barrel. Consumers have already been feeling the pinch at the pump, but this rise over the last two months is highly likely to have a negative affect on the consumer.

Currency has also played a major part. The US dollar has been spiralling downwards for nearly 2 years. For American importers, this is a negative fundamental with the cost of imports rising. Because the US economy is in a Trade Deficit, goods in general are likely to rise. Foreign debt, and the interest owed, also increases.

Finally, the fallout from the subprime credit crunch is continuing to be felt through the Financial sector (one of the most influential sectors fro the economy). Leading international financial institutions such as C, MER, and LEH as well as domestic Banking giants like BAC and WB have all suffered from serious selling pressures in recent months. There have been no signs of reprieve at this stage, with continued uncertainty towards the impact on company profitability.


But not all is doom and gloom ….

The Federal Open Market Committee (FOMC), who establish Monetary Policy for the US economy, decided to again lower Interest Rates. On Wednesday the announcement was made that both the Federal Funds and Discount rates would be lowered by a quarter percent each. This sets the former at 4.5% and the latter at 5%.

A lowering of interest rates means both the consumer and business have less to pay in interest. Such a move is made to help instigate spending within the economy. Because of the negative impact of the subprime credit crunch and the slowing Housing market, a lowering of rates has been a relief that is hoped to save the US economy from falling into a recession.

Investors bought up stock on Wednesday following the announcement, but not sufficiently to forget all their fears. Selling pressure had returned by Thursday trading.

Supporting bullish investors this week was economic data for GDP and Inflation. The Advanced GDP figures were released to show a relatively strong economy with an unexpected 3.9% rise. While inflationary data on GDP is holding a 0.8% annual rate. A higher read on the GDP deflator (inflation) would suggest the FOMC would need to raise rates to slow consumer spending.

Unemployment also remains at a long-term low of 4.7%. There was a strong increase in unemployment in October, which could be part of the fallout from the Financial sector, but this did not change the annual rate. The average work week remained steady, while the hourly rate only increased slightly. Not significantly to warrant influence on the broader economy.

In the coming week, there are very few scheduled economic reports that are likely to have a major impact on investor activity. Import/Export prices and the Trade Balance are scheduled for release before market open on Friday, however, it will be a relatively quiet week for economists.


Technology is the shining light …

Tech stocks have been the only beacon of light over the last 3 to 4 months. Despite the negative impact that Financial stocks, a slumping Housing market and booming Crude Oil prices have had, leading Tech stocks continue to drive into new record highs.

In particular, AAPL, BIDU, GOOG, and MSFT. These leading tech companies have released positive earnings reports and have been trending at quite sharp inclinations. The only concern here is that a collapse of the broader markets would see these stocks come tumbling down.

It would appear that investors have been flocking to these stocks in a “flight to quality”. Whereas in the past we would have seen investors buying up market stalwarts such as PG and XOM, they have been flocking to leading Tech stocks as if they were Blue Chips.

But maybe they just are!

The likes of AAPL and GOOG could very well be the Blue Chips of today. Following the 2000 Tech Wreck that triggered a market recession, AAPL, MSFT and GOOG have survived to be bigger, stronger, and much wiser.


Volatility increases ….

The falling markets on Thursday, and a couple of weeks ago on the 20th anniversary of Black Friday, have caused the CBOE Volatility Index (VIX) to increase recently.

This key indicator suggests there is greater “fear” in the markets at the moment. The “investor fear gauge” is trading back up at medium term highs around 23 points after forming a support level around 17 points.

A rise above 25 points is likely to see the broader market forming lower low points, and subsequently a new downwards trend.


Earnings continues …

Although majority of the most influential companies have already released their 3rd quarter earnings announcements, there are still a large number of companies scheduled for release over the coming week.

Some of the more influential include:

Monday 5th November

APC

After Market Close

CAH

Before Market Open

MVL

Before Market Open

Tuesday

VLO

Time not supplied

Wednesday

AL

Time not supplied

AIG

After Market Close

CSCO

After Market Close

GM

07:00 am ET

JCOM

Time not supplied

NWS

Time not supplied

TWX

Before Market Open

TM

01:00 am ET

Thursday

F

Before Market Open

QCOM

After Market Close

DIS

After Market Close


FMR Analysts Outlook …

Last week we had discussed our expectations that the markets would fall. With Thursday market drop, our expectations have been confirmed. The fact that sellers entered the markets the day after Interest Rates were lowered is of great concern for investors, showing that there appears to be greater selling strength underlying the general market sentiment.

FMR Analysts will maintain the “bearish expectation” we had discussed last week. There is still a high level of “uncertainty” for medium-term market direction. Especially with Friday’s activity failing to follow through with much direction and holding a previous low point (as potential support).

If we were to find the Russell2000 index breaking below 785 points, a confirmation of a downwards trend and a change in trend conditions will have formed. Our expectations would be for a retracement back towards 750 points, which coincide with the lows of August.

With a large number of economists beginning to talk about 2008 as being a year of a “market recession”, investors are likely to become more nervous over the next month or two. Negative economic announcements are likely to have more of an impact then we would normally expect.

If the Russell2000 index holds its support level at 785 over the coming week, then watch out for the start of a medium-term trading range. There is strong resistance at 850, which has formed over the last 6-months.

What we might find occurs into the end of the year is a consolidation market as investors decide whether or not they should remain committed to stocks heading into 2008.


FMR Strategy Analysis …

Bulls continue to beware. The major averages have formed a lower high point, and if they break into a new medium-term low, will have a defined downwards trend. This is a turbulent period to be considering new positions, and should only be approached by confident traders/investors.


Bulls: A short-term rally would define a support level and potentially send the markets into a sideways consolidation pattern.

Bears: A lower high point has formed on the major averages, and if further selling pressure persists, we are likely to find a new lower low point. This would denote a downwards trend, ideal for the Bears.


Investors: For long-term investment positions you are not willing to exit right now, investors should enter into protection positions. Put options will have increased in value over the last week, making it more expensive to hold the protection. But if sellers persist this week, protection (or ideally exiting) will be a necessity. If you have a portfolio that reflects a particular index, such as the S&P500, purchase an index Put option to protect your portfolio. We suggest slightly Out of The Money because this will be slightly cheaper (and therefore less cost of risk), and if the markets do continue to retrace, will produce a reasonable return to offset loss on stock positions (though will not be a 100% hedge – merely offset losses). Time frame for protection should be at least December or January expiration, though January is more optimal. FMR Analysts do not suggest entering into new long-term stock positions at this point.

Traders: Consider Bearish reversal alerts for either CFD or Option traders. Look to enter positions if the markets continue to show bearish activity.

Option Writers: Volatility has increased, which is preferable for option writing. However, with a reasonable potential that the markets may continue to fall in value, Naked Put Writing is a very dangerous strategy to enter right now. You could enter into Covered Call positions to help lower breakeven levels for existing stock