11/30/2008 4:09:50 PM
This week, we have an abbreviated weekly which shares our coverage of the markets over the last week and our outlook. We may publish an interim subject mid-week before next weekend's regular letter.
The week in Review - Events & Fundamentals:
Monday, November 24th:
There was a single economic report of interest released:
- Existing Home Sales (Oct) came in at 4.98M versus an expected 5.05M
While the existing home sales missed expectations, the remaining inventory of homes represents a sizeable 10.2 months of supply at the current sales rate. The bottom will be signaled when this number shrinks on a consistent basis. The median home price decline (11.3%) to $183K was the largest on record.
Citigroup moved to center stage, this time as a positive rather than worry about it failing. The government decided to intervene as Citigroup is just too large a bank to be allowed to fail. The government made a direct investment of $20B in cash with guarantees of another $306B in assets. They will also supervise/limit executive compensation and quarterly dividend payments of more then $0.01 must be approved by the government. The message was clear to short sellers that the government will not allow the big banks to go under so the profit potential of these trades has been limited. This caused immediate short covering and bargain hunting to commence throughout the financials with a resultant rise of the financial sector (+18.5% the largest one day rise on record) which lifted the S&P-500 to a 6.4% gain.
President-Elect Barack Obama unveiled his economic team, which included the Treasury Secretary nomination of New York Fed President Tim Geithner (leaked at 3:00pm on Friday). In addition, Obama said that a big economic stimulus is needed but didn't supply any details. He said he would await input from his economic team for recommendations about what to do about the expiration of tax cuts implemented by the Bush Administration.
Tuesday, November 25th:
There were four economic reports of interest released:
- Chain Deflator-Preliminary (Q3) came in at 4.2% as expected
- GDP-Preliminary (Q3) came in at -0.5% as expected
- Consumer Confidence (Nov) rose to 44.9 (from 38.0) versus an expected 38.0
- S&P Case-Shiller (20 city) Index dropped -1.8% in September, -17.4% year-over-year
The GDP number was revised lower as expected. The Consumer Confidence figure was releaseda half hour into trading and caused an immediate lift in the major indexes. The 10-City S&P Case-Shiller Index fell -18.6% year-over year and was released an hour into the trading day and added to selling pressure at that time.
The focus of the day was on the Fed's plan to soak up $800B in Asset Backed Securities (ABS). $100B of that $800B will be used to purchase debt from Fannie Mae and Freddie Mac. Another $500B will be used to purchase mortgage backed securities from those two GSEs along with Ginnie Mae, another GSE.
In addition to the GSE focused actions, the Fed created a new facility aimed at reducing the cost and increasing the availability of auto loans, student loans, credit cards, and small business loans. The Federal Reserve will lend up to $200 billion in its Term Asset-Backed Securities Loan Facility to help facilitate the issuance of asset-backed securities. The Treasury will provide $20B in guaranteed protection for the Fed as they purchase the ABS.
Wednesday, November 26th:
There were seven economic reports of interest released:
- Durable Goods Orders (Oct) fell -6.2% versus the expected -2.5%
- Initial Jobless Claims last week came in at 529K versus an expected 537K
- Personal Income (Oct) rose 0.3% versus an expected 0.1%
- Personal Spending (Oct) fell -1.0% versus an expected -0.7%
- Chicago PMI (Nov) came in at 33.8 versus an expected 38.5
- Michigan Consumer Sentiment - Revised (Nov) came in at 55.3 versus an expected 58.0
- New Homes Sales (Oct) came in at 433K versus an expected 450K
The economic reports were mostly worse than expected showing the economy continues to slow. This caused the market to open lower. Consumer sentiment continues to languish and new home sales, as has been the pattern, came in lower than expected. The Chicago PMI notched its largest contraction since 1982.
New Homes sales reached the lowest level on record since 1991. Against this backdrop, the home builders rose 13.6% as the Fed's $600 billion plan to support housing lending spurred a drop in the average 30-year fixed mortgage rate to 5.81% from 5.98%, according to BankRate.com.
Buying interest drove the markets higher as automakers rallied on the prospects of a government bailout. Tech also rallied (4.2%) which led the markets higher.
The 10-year Treasury rallied, with its yield falling to 2.98%, marking the lowest level since records began in 1962. The ETF representing the 20-year bond rallied to over $105 (before closing at $104.43) for the first time that we have data for.
China cut its benchmark lending rate by 1.08 percentage points to 5.58% in an effort to support its economy. China's CSI 300 rose 0.5%.
Market Closed on Thanksgiving, Thursday, November 27th:
Friday, November 28th:
Leadership was absent but financial stocks (+2.9%) outperformed on a relative basis with bellwether Bank of America (BAC $16.25 +$0.82) gaining despite having its target price cut by analysts. Investors seem to sense how oversold some of the financials have become. Citigroup (C $8.29 +$1.24) continued its gains after analysts at Barclay's reported they believe Citi will continue to achieve normalized earnings of more than $20B with a recognition that card services carries risk of default and late payments as card holders face rising unemployment and uncertain economic conditions.
GM (GM $5.24 +$0.43) is considering whether to divest some brands/holdings, such as Saturn, Pontiac, and Saab. This would reduce overlap and save some cash. With a government bailout possible in December, automakers surged 19% in the session.
The yield on the 10-year Note fell to historical lows below 2.96% as investors continue to flee to the safety of U.S. treasuries. The Lehman's 20-year bond (TLT) rose in $1.29 in price to $105.72 as investors continue to flee to fixed income investments.
Let's take a look at liquidity. Recall the TED Spread is the difference between the 3-month LIBOR rate and the 3-month T-Bill rate. The recent high was on Oct 10th at 4.64%.
The TED Spread finished Friday at 2.18 which is three basis points higher than a week ago Friday.
Nothing much has changed over the course of the last week. For credit markets to show signs of continued thawing, the first step is for the TED Spread to drop below 180 basis points at a minimum.
The week saw continued signs of a flight to safety as U.S. Treasuries saw continually higher prices and lower yields (yields move inverse to price) to unprecedented levels.
Last week the near term futures contract for a barrel of oil closed at $54.43, up $4.50 from a week ago. This gave a boost to energy stocks through the week, which helped equity markets rally. OPEC has called for a meeting this weekend which is likely to result in more production cuts in order to prop up the price of crude. OPEC has stated it would like to stabilize the price of oil at a higher level than it is trading at today.
We will take a look at all the daily charts and offer comments on them as a group. First, let's take a look at the QQQQs (NASDAQ:QQQQ), as they are the ETF that mimics the NASDAQ-100.
The QQQQs are ready to make a large move. They may move back down to challenge support or to close the gap up open on Monday. The downtrend resistance line has held the QQQQs in check but may be giving way to a move higher toward the next resistance line and above the 20-day moving average.
As stated last week, the technical damage caused by the break to new lows Friday a week ago must be addressed. The current uptrend is within a trading market and we believe the market will move lower before it breaks above the upper Bollinger Band, which will be in close proximity to the 50-day moving average.
Next, let's take a look at the DIAmonds (Amex:DIA), as they are the ETF that mimics the Dow Jones Industrial Average.
The DIAmonds, as a proxy for the Dow, continue to show the most strength. It is the leadership of the Dow that moved the markets higher. At this time, the DIAmonds are still looking strong, but the volume has dropped off through the week and next week's move on higher volume will be more important than the past week's unbroken winning streak. We believe that the DIAmonds must come back to retest the low (thick black line) but it is a matter of how high they can climb before doing so.
Let's take a look at the chart of SPYders (Amex:SPY) since they mimic the S&P-500.
Similar to the DIAmonds, the SPYders have moved upward in an unbroken 5-day winning streak. The overhead resistance is very similar to that for the DIAmonds and we expect them to behave in a similar fashion.
Until a retest of the lows occurs, we recommend caution on long entries. A cash position is best until an opportunity presents itself for a long entry on a successful retest of the lows. Additionally, shorting bonds at these lofty levels would be a prudent trade, although an entry to trades could prove to be a bit early, so shorting would have to be done with a longer time frame in mind.
At this time, we would suggest shorting in staged positions as the outlined resistance areas are met. The safest short would be one where the level was hit and a reversal was immediately apparent. The most conservative short would be to wait until horizontal resistance is hit coincident with the upper Bollinger Band. This is a path we may take as a trade in the long term portfolio, since we are reticent to add to long positions at this time.
Equities have roared back but on decreasing volume which makes the move suspect. As stated, we expect the markets to retreat once more before a tradable bottom can be put in.
We have been using Bank of America (BAC) as a bellwether for financial stocks. BofA roared back 42% from $11.47 to $16.25. The government bailout of Citigroup was responsible for squelching the shorts as it is now recognized that the government will intervene before allowing any of the behemoth banks to collapse. Still, the TED spread has risen modestly rather than continued to fall indicating that credit markets are still somewhat frozen.
With oil moving up nearly 10% from below $50.00, energy stocks have lifted as have commodity stocks and, in particular gold stocks.
You should have exited partial positions with index call options at the resistance areas we outlined last week and should be looking to exit the remainder of those positions at one of the resistance areas we have outlined this week. We believe you will have an opportunity to enter call option positions again at a lower price in the near future.
If you decide to ride your positions higher, you should certainly use a trailing stop to exit your positions after a rally to ensure that your hard won gains are realized before another retest of the low.
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