Last weekend I had written that the stress test results would not intimidate the market, and it is likely to be a buy the news event. The markets did not disappoint.
They bought every leak about the results, and then bought some more after the results were officially released. Though I am a bit skeptical about the secretive exercise, as an American, I am glad that we have perhaps the world’s best campaign organizer as our President.
This difficult task was handled in an exemplary manner, with administration having total control on when and how to release information; the banks were sternly told to keep mum.
Information, both good and bad, was leaked in a well thought out sequence, with the nation’s talking heads ready to put the right spin on it.
The whole purpose of the exercise was to restore investor confidence in our banking system and improve public sentiment. The administration succeeded in its goals, with banks successfully raising capital from the public markets to satisfy the government requirements. If the increase in risk appetite in the world’s financial market is a good metric of success, the administration gets an A+.
The WSJ is now reporting that banks won concessions from the Fed regarding the tests.Now that the capital has been raised from public markets, we might get to see some more dirty linen being washed in public
Economic News Bolsters Risk Appetite
The administration’s cause was helped along by better than expected economic news on all fronts. Job losses came in at a better than expected rate, as did the critical non-farm payroll report. Even the Canadian job report, an economy closely tied to the US came in better than expected with Canada actually adding jobs last month.
The exuberance was visible across different asset classes.
The US Dollar, the safe-haven currency over the past six months endured a major sell-off.
The Canadian Dollar is now at a six month high, and the Euro moved up by about 3% against the USD this week. Spreads on corporate bonds tightened. The yields on long dated treasuries jumped up to levels seen prior to the Lehman bankruptcy.
The Equity Markets: Divergence and Sector Rotation
The equity markets were mixed today. The S&P500, the Nasdaq, and the Russell2000 finished higher. However the tech-heavy Nasdaq100 finished lower. The Nasdaq100 has been the best performing major index this year and was the first to reach its 200 day moving average. It is now pulling back and showing signs of distribution.
With the dark-cloud of the stress-test results removed, the financials were the best performing sector today. Energy and materials, which are helped by a weaker dollar also performed very well. The sector rotation has been particularly vicious in this market, with volatile sectors like the home-builders or commercial REITs often seeing massive intra-day moves.
Typically this kind of volatility and sector rotation means that the markets are getting a bit tired and are likely to take a pause. However, we are living in extraordinary times, and the normal rules do not apply.
Next Week’s Action: Consolidation and Introspection
This week was full of market-moving headlines and wild swings in sentiment, with gap opens, and big pre-market swings. Now that the headlines have subsided, investors will sit back and review all the information generated and plan their next move.
Not All Rosy under the Hood
Though the headline numbers about the jobs have been very calming, the details do not paint a very pretty picture. Payroll data for March was revised downwards to show a loss of 699K jobs. The gain in jobs in April was primarily attributed to the Federal government hiring a large number of temporary workers to run the census 2010. The unemployment rate rose to 8.9%.
The other big news this week was the break-out in long term yields as investors shunned treasuries for more risky investments.
As I discussed in yesterday’s article, this has serious repercussions on the Fed’s efforts to increase asset prices, help improve the housing market, and manage the debt-servicing load on American tax-payers.
It seems that the sightings of the green-shoots have the investors looking for the fruits, instead
of the need to nurture the shoots into a tree.
Consolidation of Gains
I expect investors to book some profit next week in the better performing sectors this week. Like big-cap tech which suffered distribution this week, the financials especially are ripe for a bout of profit taking. Many financial stocks are now butting into resistance levels and areas of congestion, and some retracement of the massive gains of last week is a likely outcome.
Though energy and materials have also done very well, they may get support from a weaker dollar. Their advance is linked to the global economy and as long as good news continues to roll in, they are likely to outperform other sectors. However, in this market with strong sector rotation tendencies, there are no guarantees that a pullback will not occur.
The big wildcard of course is the long-term yields. The fall in the dollar and rise in yields has prompted the Chinese Ambassador to the US to say that the Dollar will continue to be the reserve currency of the world and any attempts to find alternatives are just a scholarly exploration.
Ashraf Laidi, a popular commentator on currencies, noted that “FED CAN’T allow falling dollar falling treasuries & will have to STEP IN and buy Treasuries.
These Chinese remarks are very unusual”.
I unfortunately have not bought the story of the green-shoots as much as I should have. Though I do a lot of intra-day trades, my portfolio remains primarily in cash with very few swing or position trades. I have a small amount of capital in options: on the bearish side (FIG, COF, IYR), some bullish calls in the energy sector (TSO) and a position in the long bond TLT. The TLT recovered a bit after the non-farm payrolls showed that the exuberance about the recovery needs to be tempered. I continue to hold them in
the hope that Mr. Laidi is correct and the Fed will intervene to rein in
the yields and give the green shoots a chance to grow.
Capital One Financial: Blows through my Bearish Spread
I had opened a bearish put spread on Capital One yesterday, but COF continued its upward march today. The one good thing about spreads is that they give you some leeway even if the trade moves against you since you typically gain from time-decay, and the delta is lower than an outright short or a single sided put position. I used the big rise up in COF to close out the short put legs, and added to the outright put position. Though the position is underwater, it is much less so compared to what the 18.49% gain in COF ($4.89 would suggest).
I decided to hold on to this position because of the reasons I list below. I am optimistic that I will be able to close the position at a break-even level by Tuesday.
1. The stock has had an 80% up move in one week, primarily a result of a massive short squeeze leading up to the release of positive stress test results. It is likely to retrace at least some of last-week’s up-move once the exuberance fades. The 23.6% retracement of last week’s move gives a target of 28.54 which is likely to be made. It has appreciated 150% in three weeks, and has jumped through the highest analyst price target of $27 (from Goldman).
2. The stock has now retraced 50% of its downward move starting last September to its March lows. Though the stock tested the zone around $32 multiple times today, it was constantly repelled. Also note how yesterday’s close was at the previous fib level of (38.2% retracement). This action suggests significant influence of technical trading and the potential for a technical retracement.
3. The stock price is now right in the middle of the congestion zone from Nov-Dec of 2008 which will bring in additional supply and hinder upward movement.
4. On a more fundamental basis, though the capital adequacy of COF was a pleasant surprise, we continue to be in a deep recession and a job-less recovery is unlikely to give COF any break from its losses on its consumer credit portfolio.
5. COF also made a shelf filing after the close of trading on Friday to raise capital from public markets.
Though I do not have all the details if there is an equity issuance, it is likely to result in some hit on share price next week.
I have been alluding to the fact the recent exuberance in financial shares suggest big money support to enable capital raises from public markets, and COF’s price action followed the script very well.
Capital One Financial Corporation from time to time may offer to sell senior, subordinated or junior subordinated debt securities, preferred stock, either separately or represented by depositary shares, common stock, purchase contracts, warrants or units. Capital One Capital V, Capital One Capital VI, Capital One Capital VII, and Capital One Capital VIII from time to time may offer to sell trust securities and use the proceeds of these sales to purchase junior subordinated debt securities from Capital One Financial Corporation.
Jeremy Grantham: Turns Bullish on Equities But not on the Economy
I want to close this article by pointing to readers to an article by Jeremy Grantham of GMO who now believes that the stock market will hit much higher levels as the entire world pumps huge amount of stimulus into the system. He believes that this stimulus will have a much bigger impact on stock prices than it will have on the underlying economic fundamentals.
I will have to review my neutral bias this weekend, and come up with a plan to become more bullish while keeping the risks low. Till I come up with the courage to make longer-term investments, I will continue to trade short-term