US Market Commentary – week ending 20th March 2008
Volatile market activity had investors on the edge of their seats in a shortened trading week. A surprise lowering of the Discount Rate used by Financial institutions preceded a drop in Interest Rates by the FOMC, while Financial stocks may finally be finding a bottom.
Last weekend, investors were surprised by a couple of announcements. Firstly, one of the larger Financial firms – Bear Stearns (BSC) announced that they were being sold to JPM for a measly $2 per share. Secondly, the Federal Reserve announced a lowering of the Discount Rate ahead of their Interest Rate meeting scheduled for Tuesday the 18th March.
The BSC announcement rocked the Financial sector. We had been reporting for months that there was a high probability that there would be greater fallout in the finance sector, and that investors should remain very cautious for this sector. Of course, none of knew who or in what form we would hear a major announcement such as this, but it was expected.
BSC had been trading as high as $159.36 only 10-months ago. It closed at $5.96 on Thursday. There would be many investors who have been hurt badly by this activity, and this should act as a warning to investors who hold other Financial stocks in their portfolios.
Twice this year we have been surprised by the Fed Reserve lowering the Discount and Interest Rates at unscheduled times. This action is a clear signal on how worried the Fed Reserve is for the state of the economy.
To date, they have made available up to $400 billion for borrowing, which includes the $200 billion announced last weekend. This is of great concern because the Fed Reserve is worth $800 billion! There is only so much they can offer to lend before the finance sector can no longer be propped up.
But it is not all doom and gloom for this sector. On Tuesday, two leading finance companies reported good profits, helping to lift the sector against the negativity that BSC has produced. Both GS and LEH produced better than expected earnings reports, easing the fears that have been escalating over numerous months.
A wild ride for even the most confident of investors ….
Announcements made last weekend were only the start to the rollercoaster ride. A heavy fall on Monday was followed by a strong rally on Tuesday. Later in the day Tuesday, the FOMC (Federal Open Market Committee) announced a lowering of Interest Rates by ¾% to 2.25%. They stated there was “uncertainty about inflation”, but that it should “moderate in coming quarters”.
This did little to ease investors, and subsequently the markets dropped on the announcement. But there was sufficient buyer demand to lift the markets through the latter afternoon, resulting in a strong day of trading.
Many investors had been hoping there would be further buying activity on Wednesday, but this was not to be the case. Strong selling pressure dragged the markets down as Gold plunged $69 to close at $939 an ounce, while Crude Oil prices all sank 4.5% to close at $104.48 a barrel.
With the US dollar falling, commodities retracing off long-term highs, and a continued high level of uncertainty for investors, the markets sank heavily on Wednesday.
However, another switch in sentiment saw the markets rallying into the end of the week. With Friday’s markets closed due to Easter Friday, Thursday was always going to be an exciting day when considering the announcements made earlier in the week. Buyers subsequently returned to help post a positive result for the week, and to offer some hope that a market bottom may finally have been found.
Caution heading into the next earnings season ….
Many investors are now viewing the markets to have receded enough to warrant accumulation. There is certainly cause for the long-term investor to begin evaluating Blue Chip stocks which do not have exposure to credit risk, but which have fallen due to the negative sentiment that has controlled the markets for the last few months.
Should the markets stabilize over the coming weeks, this will provide a stronger cause for investors to accumulate as it represents the potential of a market bottom. As long as there are no surprise market announcements, this very well could be the best opportunity for consolidation/accumulation we have seen in this downward trend.
But investors should take heed that the first quarter earnings reporting season is not too far away. The end of March is almost nigh, and within a month we will begin experiencing the next round of earnings reports.
Because many companies have been shaken by the retracement in the Finance sector, analysts and economists will be watching these results for signals on how well business has faired through the last quarter.
What this means for the average investor/trader is that they should be cautious at this point in time, and not merely jump into stocks/trades immediately. Patience and clear evaluation of how the markets transpire over the coming few weeks will either confirm that there is potential for a market reversal in trend, or it will confirm that there are greater troubles with this economy than we first had expected.
Economic announcements in the coming week ….
There may not be too much for investors to cheer about in the coming week, as the scheduled economic announcements could all favour the Bears.
On Monday, Existing Home Sales will be released shortly after market open at 10am. As many would be aware, the
Consumer Confidence data will be released on Tuesday, also at 10am. As one would expect, results in recent months have reflected the uncertainty that has arisen from the Finance sector. And we are expecting this figure to miss expectations based on market activity over the last month.
Wednesday will find further housing data with New Home Sales at 10am.
Key economic indicators will be released on Thursday, with GDP (final) and Chain Deflator data both at 8.30am before market open. These two indicators will help confirm the state of the economy, and has a high probability of disappointing investors.
Finally, on Friday, Personal Income and Spending and Core PCE Inflation data will be released before market open at 8.30am. Again, this data could weigh heavily on investors with a high probability of not meeting expected targets.
All in all, investors will either be given cause to continue buying stock, or will find cause to take some quick profits.
Market Outlook ….
We are beginning to see signs that maybe investor sentiment believes the markets have retraced enough. The markets are typically weighted with investors buying stocks and wanting share prices to rise. When markets retrace, this is an opportunity to buy at lower prices, and so subsequently the markets will rise over the long-term.
There are times when the markets become over-inflated and they rise too quickly. This will usually be followed by a strong market retracement. And this is what we have experienced over the last 12-months.
So the million dollar question is whether the markets have retraced enough for investors to perceive them to be at “fair value”, or if sentiment remains negative and is waiting for the next big negative announcement to trigger the next downward leg?
Economic activity over the last week suggests the worst may be over for the Finance sector. Much of the credit risk exposure should already have been exposed, and with greater ability to cover their risk (due to the Fed Reserve and international investors), this is the best opportunity for stabilization over the last 6-months.
What concerns us is that this may just be the “eye of the storm”. The markets had begun consolidating ahead of the recent announcements that caused the last retracement. Could we find another major announcement such as the BSC/JPM buyout in the coming weeks?
The answer here is Yes! There is still a potential that the finance sector could produce another unexpected announcement disclosing risk that none of us had been expecting. For this reason, any action by investors or traders should be well thought out.
One would be crazy to think that the Finance sector is a “great buy” right now. It is just too volatile. Commodities are also coming off all time highs after having rallied phenomenally over the last 6-months. Here too the investor would be at high risk if they were to buy stock in related companies.
There are some bargains out there at the moment, and therefore, the wise investor would be able to benefit with medium to long-term investment strategies. However, thoroughly scrutinize the company you are evaluating, considering what impact there has been on its’ business from the recent market retracement.
Strategy Analysis ….
Traders: A consolidation period is one of the hardest trends to trade as direction becomes difficult to choose (unless you are an options trader adopting neutral strategies such as the Straddle). Monitor these markets for the short-term. If you must trade, use less capital and fewer trades.
Option Writers: There is no cause to exit out of Covered Put positions just yet. There is potential that the markets may find further buyer activity in the next couple of weeks, but it only takes 1 announcement to trigger selling fear. Evaluate your position/s and monitor over the coming weeks. It is still too early to be considering Covered Call/Naked Put positions.
Investors: One may consider accumulating stock in companies that have limited exposure to the commodities and the credit risk of the Finance sector. Should the markets continue to retrace, look for the next bottom/consolidation as an “averaging down” opportunity. Maintain limited exposure, however, as we are yet to have confirmation that the medium-term downwards trend has ended.
