US Market Commentary – week ending 22nd February 2008
The markets consolidate for another week, helping to form a mild support level. Wednesday was the hub of the week, with most economic activity occurring on this day, however, investors were left with mixed emotions. Although stocks are at bargain prices, they are still hesitant to buy up big at this stage.
Following an extended weekend due to the public holiday on Monday, investors returned to the markets somewhat subdued. Each trading day this week, the markets swung widely from buyers to sellers, resulting in extreme ranges between highs and lows. Typically, if buyers started the day, sellers ended it. And vice versa.
Major headlines for the week included:
Tuesday
- Markets flop due to inflation concerns
- LEH states it may face its “rockiest” quarter with a potential $1.3 billion in additional write-downs
- CS over-valued assets by $2.85 billion
- WMT earnings beat expectations by 2 cents, at $1.04 per share.
Wednesday
- CPI increased 0.4%, Core increased 0.3%. Both were ahead of expectations, with year-v-year increasing to 4.3%
- FOMC minutes from Jan 29-30 meeting released. Inflations expectations remain “anchored”. The Fed raises their core inflation forecast, but cut their GDP forecast.
- Crude oil exceeds $100 a barrel
- Housing starts rose 0.8%. This is a drop of 21% over the two previous quarters. Building permits slipped 3% to a 16 year low.
Thursday
- PMI (Philadelphia Manufacturing Index) fell 24 points. This suggests contraction in the manufacturing activity.
Friday
- Late day rally due to an announced bailout plan for bond insurer ABK
- Dec PPI (Primary Price Index) revised down to -0.3% from -0.1%
Technical consolidation ….
All the major averages showed sideways activity for the week, maintaining short-term support levels that have formed since early February. Basically, buyers have failed to show sufficient buying support to break upwards, while sellers have eased their pressure from January.
The S&P500 index has shown some mild buyer influence, compared to the Russell2000 index which has shown greater influence from sellers. Bottom line is, however, that there is no real direction sway either way.
The longer the major averages consolidate in a sideways pattern, the greater the potential the markets may find buyers. This is good for investors, but bad for the short-term traders who have a bearish outlook.
Activity such as this also affects volatility. The CBOE VIX index has also consolidated around 25 points. This is still a high value, but without direction does not offer a hint for what activity might transpire in the coming week.
Sentiment ….
Investors are yearning for some good news. We had seen the markets start positively on a couple of occasions this week, only to find them relinquish their gains as fear took over. This caused wild intra-day swings between highs and lows, and suggests continued weakness from buyers.
There was also a large number of very negative announcements, both economically and company specific. Yet, we failed to find significant selling pressure to drive the markets down in a panic.
This last point is actually a positive for long-term investors. Due to a 15% decline in the markets recently, investors may now be at a point where they are perceiving them to be oversold. This could lead to a significant amount of buyer accumulation with stocks at “discounted” prices, and potentially a recovery.
However, it is early days just yet. Although there was a lack of selling pressure on poor economic data, there was also weakness from buyers. And therefore, a stalemate has occurred.
Economics in the week ahead ….
This coming week will be another packed with action as numerous key economic reports are scheduled for release:
Monday: Existing Home Sales for January – after market open
Tuesday: PPI before market open, and Consumer Confidence after market open
Wednesday: Durable Orders before market open, and New Home Sales after market open
Thursday: GDP Preliminary, and Chain Deflator Preliminary. Both before market open.
Friday: Personal Income/Spending, Core PCE Inflation and Prices (all before market open). While Chicago PMI is released just after market open.
Market Outlook ….
Although the Financial sector has consolidated, we are still finding numerous reports in this sector which show that the negativity is not yet over. There is only so long that sellers can withhold reacting to such news, so any future announcements of surprising debt could only lead to a high potential for downward activity.
The economic reports scheduled for release this week are also “high probability” for a reaction by sellers. The Housing market has been hammered for the last 2 years, and there have been no signs that the weakness in this sector is going to ease any time soon.
We also have a number of key Inflation figures scheduled for release. As was shown last week, investors are very nervous over inflation at the moment. The Federal Reserve has been lowering rates at a hefty pace, in an attempt to instigate spending in the economy. However, inflation is trading well outside the Fed’s acceptable level.
Should this weeks figures show a continued increase in inflation, this could influence the Fed Reserve to keep rates on hold – disappointing a market that eagerly wants further rate cuts.
Basically, the Fed is caught between a rock and a hard place. Inflation is currently at a level that suggests increasing interest rates to slow the economy down. However, the economy needs a boost due to the turmoil suffered in the Finance industry for the last year.
Investors will be on the edge of their seats this week, which is likely to increase volatility significantly. Directional activity could go either way, and could flip from one day to the next. Such is the impact of this weeks economic reports. However, if you were to choose the more likely direction of the markets, there is greater weight that sellers are likely to dominant (at this stage).
Strategy Analysis ….
Continued consolidation in the markets offers fewer opportunities all round.
Traders: It is still too risky for short-term traders to enter into positions while there is a lack of direction. Should the major averages break up or down, use this as the trigger for entry into new trades. Until then, we need to patiently wait and monitor.
Option Writers: In normal market conditions, this would be an ideal time to be entering into new Covered Call/Naked Put positions. However, these conditions are far from normal. With greater weighting towards the Bears at the moment, Covered Puts are the preferred strategy to consider. However, while there is risk that these markets may be considered oversold and could continue to consolidate, investors may prefer to manage current positions and not look to enter new trades at this stage.
Investors: As per last weeks statement, this could be an opportunity to accumulate stocks at low prices. Be aware that there is still room for these markets to trade further down. Therefore, only consider entering into new trades if you have a protection plan (such as purchasing Index put options).
