US Market Commentary – Week ending 29th February 2008
A steady week turned into panic selling, focusing on the Financial sector. Economic data confirms a slowing market, giving very little hope for investors. Commodity prices continue to rise, while Federal Reserve Chairman Ben Bernanke fails to provide any support in his speech to the Financial Services Committee.
The major averages stalled at resistance levels, confirming a short-term consolidation pattern following the market retracement that began in October last year. Mild buying activity early in the week was not sufficient to provide a potential upwards break, resulting in a stall in the markets that has resulted in a confirmation of short-term resistance.
For the S&P500 index, a stall below 1,400 points is equal to the previous bearish reversal point that had formed in late January. This clearly suggests that there is unwillingness from buyers as the markets trade up.
Selling pressure was not just designated to Blue Chip stocks (represented by the DOW Jones Industrial Average), or the Financial sector. The broader market, represented by the Russell2000 index, also formed a bearish reversal point on resistance and ended the week pushing for a new short-term low.
With the markets retracing heavily on Friday, we now have a situation where a test of support will occur. If selling pressure persists this week, the markets will push for new lower low points and break down and out of the consolidation patterns. This will leave market participants in a very precarious position, and would find further selling pressure driving the major averages down.
Major news activity for the week includes:
Monday
- Standard & Poor’s takes MBI off “credit watch”. ABK affirmed with AAA rating.
- ERTS offers $2b for TTWO, and $2.4b private equity buyout of GYI
- LOW reports 33% decline in 4th quarter earnings
- Existing home sales dipped 0.4%, and now at a 9-year low. Economists were expecting a 1.8% decline.
Tuesday
- IBM directors authorize a $15b stock repurchase program
- PPI (Primary Producers Index) higher than expected at 1%. Year over year reading at 7.4%. This is the highest rate since October 1981
- Commodity prices increasing with CRB index gaining 1.1%
- Consumer Confidence at a 5 year low
Wednesday
- Lending caps on FNM and FRE are lifted as at 1st March.
- Federal Reserve Chairman Ben Bernanke gives semiannual testimonial speech to the Financial Services Committee, stating: “the economy continues to face challenging headwinds, and the Fed will likely move to continue fighting those challenges with further rate cuts”.
- TOL (a homebuilder) recorded an earnings loss of 61 cents per share. Analysts were expecting a 50 cent loss.
- FNM reports a $2.63 per share loss in earnings
- MSFT was fined $135b by the EU for violating antitrust laws.
Thursday
- Bernanke states “smaller banks may fail”, causing a sell-off in Financials.
- Moody’s takes negative ratings action on regional banks
- Preliminary GDP remained unchanged.
Friday
- Markets plunge!
- PCE is better than expected. Personal Spending increased 0.4%, and income increased 0.3%. Core PCE gained 0.3%, indicating rising inflation
- Chicago PMI reported at 44.5 in Feb. Below 50 indicates a contraction in manufacturing.
- AIG announces a loss of $5.3b.
Economic outlook …
In the last week, investors were focussed on the economy of the country. Their concerns are that with it slowing down, and with the credit industry now being squeezed even tighter, that this could lead the markets to further bearish activity.
And rightly so!
Some of the big investment houses are reporting that there is more exposure to credit risk than was first expected. The outlook for the Housing industry is poor (at best), and not likely to recover any time soon. The FOMC (Federal Open Market Committee) has lowered interest rates heavily, in an effort to stimulate the economy. The Government has released a $160 billion stimulus package, while at the same time major financial companies are “selling debt” to overseas interests.
At the very least, the Financial sector looks grim! Earnings certainly missed their expectations, and now that there is greater debt being carried as creditors tighten their lending facilities, we are likely to find more and more weakness in this sector.
Despite the economy showing further signs that it is slowing, and with the Fed Reserve lowering rates to help stimulate spending, economic data has shown that Inflation remains at a tentative level above the Fed’s target range.
This is a very interesting fact, which will likely play itself out in the coming months. However, this situation is called Stagflation: where there is a period of Inflation combined with slow economic growth. This situation has only previously been experienced in the 1970’s, but could also rear its ugly head again in the naughty’s (00’s).
Last weeks economic data confirmed weakness. In the coming week, there are further key reports that are likely to produce volatility for investors:
Monday
- Construction Spending (10.00am)
- ISM Index (10.00am)
Tuesday
- Auto and Truck Sales
Wednesday
- Productivity – Revised (8.30am)
- Factory Orders (10.00am)
- ISM Services (10.00am)
- Fed Reserve Beige book (2.00pm)
Thursday
- Pending Home Sales (10.00am)
Friday
- Unemployment data (8.30am)
Investors will be particularly interested in the Fed Beige Book, which provides the notes that the FOMC used to decide on Interest Rates at their last meeting. Also of interest will be the Unemployment report, which is one of the 5 key economic indicators used to evaluate the state of the economy.
Market Outlook ….
Hold on for a wild ride!
We are currently at a pivot point where the markets will either hold support, or create a new leg in the medium-term downwards trend that has been persisting since October last year.
For now, there appears to be a greater probability that sellers will continue to persist. We have seen some consolidation on the short-term, however, the lack of buyers suggests there is little incentive for investors to accumulate stock.
Next weeks economic data may be the catalyst for further selling. Investors will be nervous over Fridays Unemployment data and may hesitate through the beginning of the week. However, it is highly likely Pending Home Sales will show poor figures to influence selling activity.
The Fed Beige book would typically give the markets something to react to, however, we feel that this may already be factored into the markets. Especially following Bernanke’s speech mid last week. There’s not much news to look forward to from the Fed Reserve as it is clear to the markets that the economy is slowing, and they are lowering rates to help inspire buying activity.
Should this week show sufficient buying activity to hold the major averages on support levels, we might just find a rally back to the recent resistance levels. However, this outlook seems to be nothing but “hope” at this point in time.
Strategy Analysis ….
Sellers are attempting a break of support, which could lead to a new downward leg in the medium trend.
Traders: Should we find further selling at the beginning of the next week, this could lead to some great short-term Bearish trading opportunities. If you are not on short trades already, look for opportunities in weak sectors such as Financials, Construction and Real Estate.
Option Writers: Covered Put positions remain the strategy of choice, and new positions could be considered at the moment. There is still 3 weeks left until expiration of the March contracts, which could produce reasonable returns. We suggest ITM (In The Money) Covered Puts to manage the risk against any potential upward surges in the markets.
Investors: Should this consolidation pattern (of the major averages) fail and a new downward leg forms, this would not be the time to accumulate stock. If the support does hold, accumulation would be a good strategy. For now, investors should continue to consider defensive action, entering into Put Protection for portfolios. Hold stocks for the time being, unless exposure to Financial, Construction or Property companies is held. These type of stocks should be considered for exiting. Lowering exposure to the markets is also a reasonable strategy should we find further retracement in the coming week.