US Market Report – week ending 14th December 2007
A disappointing FOMC Monetary Policy adjustment and worrying Inflation data caused investors to exit the markets this week. The Financial sector continues to provide bad news, fuelling the exodus. While the Retail sector is suffering from lower sales heading into the final week before Christmas.
Investors traded cautiously at the start of the week, ahead of the FOMC’s (Federal Open Market Committee’s) announcement on Monetary Policy on Tuesday afternoon. There was much expectation that the FOMC would lower Interest Rates by half a percent, alleviating the Financial sectors credit problems.
However, this was not to be the case.
The FOMC released a quarter percent reduction in the base rate to 4.25%, stating that higher energy and commodity prices could find inflationary concerns in 2008. They are concerned with a slowing economy, however, inflation is by no means completely under control.
By the end of trading on Tuesday, the DOW Jones Industrial Average closed down 294 points, or 2.1%. The S&P500 index had lost 39 points, or 2.5%, the NASDAQ index had lost 71 points, or 2.6%, while the Russell2000 index had lost 26 points, or 3.3%.
As FMR Analysts had discussed in the previous weekly report, the market reaction to this would set the trend for the remainder of the week. There was some uncertainty through Wednesday and Thursday, but sellers continued to influence the markets on Friday, heading into the end of the week.
With all major averages closing near their weekly lows, it was a strong domination from sellers. Weekly results for the major averages are as follows:
DOW Jones Industrial Average = -284 points, or -2.08%
NASDAQ = -75 points, or -2.76%
S&P500 = -38 points, or -2.52%
Russell2000 = -33 points, or -4.19%
Inflationary pressures likely to limit an Interest Rate lowering …
Later in the week, the release of the PPI (Producer Price Index) and CPI (Consumer Price Index) data suggested that although the
Most of these pressures are based on higher energy costs. Although trading below its all time record high of $98.70 a barrel, set in late November this year, Crude Oil prices are still high. As of Friday’s closing value, crude was trading at $92.25 a barrel.
As demand for heating oil, natural gas and gasoline are increasing heading into winter, investors are likely to feel the crunch in their “savings”. The FOMC had warned of this in their latest Monetary Policy statement, and this was confirmed on Thursday and Friday when the PPI and CPI data was released.
The PPI had increased a massive 3.2% due to rising energy prices, rocketing to record level. This was far greater than analysts had expected. PPI measures prices of goods at a wholesale level. Prices of goods at the beginning, and intermediate stages, of production can provide insight into inflationary pressures. Along with commodity prices, this can be a leading indication as to the prices of goods at a consumer level (CPI).
CPI was then released on Friday, and it too provided concerns for inflation. For the same energy reasons, the CPI increased 0.8% in November, with Core CPI (excluding Food and Energy), also increasing unexpectedly.
Usually we will see the PPI acting as a leading indicator to the CPI. This is due to the pressures of rising costs at a wholesale level taking a little time to flow through to the consumer. However, there is not a great deal of lag time in this effect, so many economists are concerned over next months results. The FOMC uses the CPI data as one of its main inflation indicators.
Retailers are struggling, and putting hope into a last minute spending spree …
The Christmas shopping season is the busiest, and most profitable period of the year for Retail companies. In years gone by, analysts and investors could count on a “pre-Christmas” market rally based on expectations of consumer spending during this period.
However, in more recent years, shoppers have delayed their spending habits, waiting for the post-Christmas sales and discounts to buy up big. The pre-Christmas rush has dwindled and kept Retailers on edge to whether it will be a profitable season or not. A poor Christmas shopping season usually spells disaster for annual profits.
This year is no exception. Poor weather across a large portion of the country and uncertainty over the direction of the economy have led to a poor week of spending.
Internet shopping has become more popular in recent years, but shoppers cannot purchase and receive goods the week before Christmas due to delivery constraints. Reports over the weekend are showing that online Retailers have not had the same growth as they have seen in recent years, sealing their fate for a lower than expected holiday season.
Volatility remains high …
The CBOE Volatility Index (VIX) remains high heading into the end of 2007. The VIX is considered the investors “fear gauge”. When it is high, investors have greater fear of a falling market, and when it is low, investors have little fear that the markets will fall.
Since the start of the recent Bull market in 2003, the VIX indicator has slowly been trending in a mild downwards trend. This was until early 2007. Since then, we have seen a major change in characteristics of the VIX, as has been reflected in the broader market averages.
While the VIX remains in this volatile state, trading at high levels, investors need to remain extremely cautious.
Index Analysis …
On the medium-term, the markets appear to be maintaining their medium-term trends. However, the retracement of the markets this week has formed Lower High points, and could be the pivot point for lower markets in the coming weeks.
Through 2007, the market corrections experienced in Feb/Mar, July/Aug, and Oct/Nov have all held at roughly the same levels. For the S&P500 index, this has been at approximately 1,425, while the Russell2000 index has held at roughly 750 points.
However, after only mild buyer influence has lifted the markets from these support levels recently, a Bearish reversal point has formed Lower High points, which could technically lead to downward trend.
Support levels will again be tested this coming week. If broken, the combination of Lower High points and a Lower Low point defines a downwards trend. In which case, Bearish strategies should dominate.
The week ahead …
In the week before Christmas, there are a number of market influences likely to affect direction. There are some key economic reports scheduled for release, Energy prices appear to be on the rise, while the Financial Fallout is not likely to be completely over yet.
Monday – Don’t be surprised to see some relief buying. Retail stocks might suffer through the week due to lower sales reports. No key economic reports.
Tuesday – Housing Starts and Building Permits data scheduled for release before market open. Market reaction is likely to dictate direction for the day. Not expecting a strong report to influence buying.
Wednesday – No key economic reports.
Thursday – GDP (final) figures for 3rd Quarter. Not a great influence as it is confirming previous data. However, the Chain Deflator data could influence opinions on Inflationary pressures. Again, not expecting bullish activity from this data.
Friday – Personal Income and Spending, and more importantly, Core PCE Inflation data. Both scheduled for release before market open, and will give precedence for the days’ activity. Expecting negative market reaction at this stage. Last trading day for December option contracts.
FMR Analysts Outlook …
The week ahead appears to show reasonable potential for further Bearish market activity. From a Technical perspective, buyers had failed to lift the major averages significantly from their long-term supports, and as concerns for Christmas Shopping and the outlook that the FOMC may not lower rates again, we could find that investors will look to exit positions ahead of the New Year.
The economic data scheduled for release on Tuesday and Friday could be the only key for the Bulls. Depending on the results and market reaction, the Bulls will be banking on this data to help the major averages hold support, and possibly find sufficient buying strength to rally into the New Year.
Uncertainty for Financial stocks also remains a major influence. It seems each week we are on edge waiting for another “surprise” announcement that will cause investors to send Financials lower.
Certainly these share prices are at attractive lows for the long-term investor, which is the only hope they have at this point in time. We have no doubt that despite potential Government bailouts, Central Bank intervention and investment capital from all over the world, the Financial industry is highly likely to continue divulging surprises over the coming months.
Energy is also going to continue to plague the markets. Crude prices do not seem to be relinquishing their all time high prices. They might struggle to get through $100 a barrel, however, do not expect them to be trading below $85 heading into 2008, let alone any lower.
FMR Strategy Analysis …
Traders: Bear strategies dominate analysis at the moment, particularly due to the lower
Investors: Protection strategies should already have been adopted, as discussed in early November. To adopt protection strategies now could be quite costly. With a good to high potential that the markets will continue to fall, some investors may look to exit positions. Due to the short-term market outlook, and the reasonable potential that 2008 will result in a Bear market, investing into new positions is not recommended at this stage, unless the investor also adopts protection strategies.
Option Writers: This is the last week for the December option contracts. Evaluate your positions for the potential to be Exercised, and take action if you do not want your position Assigned.
Should the Bears continue to dominate the markets and the major averages breach their support levels, Option Writers should switch to Covered Put positions. We recommend ITM Covered Put writing at this stage, in an effort to manage risk.
Naked Put positions are VERY HIGH RISK at this stage. Covered Calls are High Risk, and should only be entered by investors with experience.