Wednesday Review: GDP Pleases but the Fed Disappoints

Posted on April 29, 2009 by BMWFan

As predicted, tod ay w

as a day filled with market moving news, and the market did not disappoint. The day started off with a shocking headline: Economy in U.S. Shrank at 6.1% Rate in First Quarter (Update1) – Bloomberg.com instead of the median consensus of a 4.7% drop. However an analysis of the detailed showed that the drop was due to inventory correction and lower government spending; two factors which will likely push the GDP up this quarter.

Further consumer spending increased at an annual rate of 2.2%, the highest level over

the past two years. After the initial knee-jerk sell-off at

the headline number, the futures rallied big and never looked back.

Small Caps Lead

Small cap stocks (IWM), a measure of risk appetite soared to the highest level of this rally.

They took out the prior highs well before the Fed news.

The other major indices also rallied but not to the same level as the Russell 2000.

The breadth of the market was very strong, and the NYSE Tick indicator did not register a -500 reading till 2:00PM!

Fed Disappoints on Quantitative Easing

The FOMC minutes did not have anything new to add to information about the economy or the Fed’s QE policy. Many market participants were expecting an increase in the QE efforts since treasury yields have been climbing steadily. As expected, treasuries sold off with the 30 year bond yield (TYX) jumping 10 basis points and the 10 year bond yield (TNX) jumping 8 basis points.

The dollar also jumped higher against other currencies.


Equities Sell-Off

As I had written last night, a rise in yields put a damper on equities. After some initial volatility, the equities reversed their day-long strength and sold off into the close.

Though most indices finished with strong gains, they closed well off their intra-day high.

However, the day was still very bullish since the major indices broke through key technical levels. The SPX crashed through the 875 level and traded as high as 882.06, very close to the 23.6% retracement of the 2007 highs and 2009 lows (881.38), before pulling back.

One sign of worry was that leading consumer driven stocks like Amazon and Research In Motion were under pressure all day long, in spite of the positive surprise in consumer spending reported in the GDP report.

It seems that some market participants do not expect the rise in consumer spending to sustain and were using the strength in stock market to distribute their holdings.

What Next?

The market clearly has a bullish bias, and there will be end of month window-dressing as fund managers pad their portfolios with better performing stocks.

The strength of market internals was impressive; however the S&P500 failed to close above the 875 level, and the S&P Futures are down a few points from the closing level.

I continue to be primarily in cash though I have added some calls (CTSH) to my portfolio. I was lucky enough to buy some calls on the TBT right before the Fed announcement, to hedge my TLT holdings. I have closed my TBT calls after the pop, and will be distributing my TLT holdings over the next few days. Though the bond yields have broken through key technical levels, I do expect some pullback going into the weekend as traders who were short book profits and the current high in risk appetite wanes a bit.

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GDP Report Fails to Shake Bulls

Posted on April 29, 2009 by BMWFan

The headline is shocking: Economy in U.S. Shrank at 6.1% Rate in First Quarter (Update1) – Bloomberg.com instead of the median consensus of a 4.7% drop.

However the equity markets are not showing any signs of distress.

A detailed review of the GDP report shows that a significant cause of the lower number was the drop in inventories.

As inventories rebuild, it is likely to help GDP going forward.

Another bright spot was that consumer spending which accounts for about 70% of the economy, climbed at a 2.2% annual pace, the highest level in the past two years.

Even government spending was down; something which is likely to reverse.

The whispers are out that the GDP might actu ally turn positive in the second quarter, defying

all the dire prognostics of bearish pundits.

As I wrote lat night, if the Fed can keep a cap on treasury yields, we might see the big up this week. I am waiting for the move to happen before

I commit more capital.

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DNDN: The risk of using Stop Loss Orders

Posted on April 28, 2009 by BMWFan

The price action in DNDN today must have left a whole lot of sore traders.

Th at is the risk of using stop orders before

a big news.

Close to 3 Million shared traded in those

3 minutes. Perh aps protecting yourself with

a collar would have been a better option here.

Hindsight….

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Previewing the FOMC: A Critical Day for the Markets

Posted on April 28, 2009 by BMWFan

Wednesday, April 29 is likely to be a day of fireworks for the financial markets. Equity indices have been chopping in a range for a few weeks, with the rally refusing to die, confounding market pundits.

However the price range has been contracting and it is likely that the indices will make a big move, either up or down

after the Fed announcement.

While equities have chopped around, yields in the treasury market have crept up and are now at the level seen prior to the Fed’s quantitative easing (QE) announcement last month.

While bulk of the attention has been focused on the equity markets, it is the action in the credit markets which are perhaps more critical to economic recovery.

What to Look for: Renewed focus on Quantitative Easing

The Fed will make observations about the state of the economy and their expectations of future growth. However much of this view has already been telegraphed by Chairman Bernanke over the past few weeks.

There should be no surprises there; it is the market intervention on the credit side which will be the focus of the markets.

The rally in the equity markets has made many market participants confident of shorting

the treasuries which has helped push yields higher.

The added supply of new treasury issuance to fund the spending campaign is also helping their cause.

The 10 year yield is above the 3% mark and the 30 year long bond yield is now approaching the 4% mark.

Ho wever,

this rise in treasury yields is threatening Fed efforts to engineer a turnaround in the US economy. Treasury yields are an important factor in determining interest rates across the credit market, including the all important mortgage rates applied to finance home purchases or refinance existing loans.

If treasury rates continue to creep higher they will have a significant detrimental effect on the home prices and put a damper on the recovery effort.

The market expects much higher yields further out in time. However, the Fed cannot afford to let the market get ahead of itself, and stall the recovery by pushing yields high too soon. That is why I expect the Fed to come out swinging in its efforts to talk yields down. The absence of a strong statement by the Fed will embolden treasury shorts and turbo-charge the rise in yields.

Equity Markets: Key off the Bond Market

Equities are likely to take their cues from the credit market after the FOMC minutes are released. A drop in yields will help strengthen the bullish case, since it will help drive economic recovery. However, if the Fed fails to talk yields down, the equity market might weaken.

Note that typically equity and bonds move in opposite directions as investors rebalance their portfolios by selling one asset class and buying the other. However, we are in a unique period where a significant portion of investment portfolios are in cash. As a result this negative correlation is not a given; there is enough cash sitting on the sidelines to drive equities higher and also support the credit market.

Though cash continues to be the largest holding in my portfolio, I have added some bond exposure by buying the TLT ETF over the past few days, in anticipation of the Fed making renewed efforts to cap the rise in yields. I do have concerns that the Fed may not be effective enough in talking the yields down, which is likely to lead to further selling of bonds, and much higher

yields.

I also hold some puts on the IYR and IWM in my trading portfolio, as a hedge against a drop in equity prices which might result if yields continue to jump higher.

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Scary Movie: April 27, 2009

Posted on April 27, 2009 by BMWFan

April 27 was a news driven trading day with some scary twists.

The world woke up to the news th at the Swine Flu h

ad spread all over the world and WHO was considering it as a potential pandemic. US Equity futures had been trading down since the market opened on Sunday evening and continued with the down trend till the market open.

If the swines were not enough, we had the surreal scene of a Jumbo Jet being chased by USAF fighter jets as it flew low over Southern Manhattan and the lower Hudson. Traders trading on the Nymex floor at the New York Mercantile Exchange took no chances and bolted from the exchange floor. It was run first instead of sell first.

All that was missing was pigs flying low over lower Manhattan to complete the Scary Movie.

Dollar Strong but Gold Weak: Change in Risk Perceptions

?

The Dollar was strong today as the flight

to safety trade continued. The dollar was helped by poor economic news from Europe, with the consensus being that Europe will take much longer than the US to emerge from the current economic crisis.

Surprisingly, Gold did not rally. This is an indication of a change in the nature of the risk perceptions driving Gold prices.

Risk it seems is no longer perceived coming from the financial system, which would have led to a flight to hard assets like Gold.

Gold it seems is now increasingly been seen as the reflation trade, a hedge against the risk of a weak dollar and inflation. This change in the risk perception is likely to show up as a negative correlation with the Dollar.

If this trend continues, it also means that Gold is unlikely to see a strong rally, until it is clear that the Fed’s reflation efforts are bearing fruit.

Of course this situation can change quickly if some event triggers the fears of a systemic financial system risk. But given the coordinated efforts of banks worldwide,

the perception of this risk is gradually decreasing.

Gold and Equity Prices: Risk Appetite Improving?

The fact the gold is no longer been driven by the meltdown risk, also means that overall investor risk-appetite is now growing. This is going to be positive for risky assets like equities going forward. The US stock market though did not show the same behavior today with the riskiest small caps, underperforming the large caps, and especially the tech-heavy Nasdaq-100.

The Bulls can take heart that even the fear of a world-wide pandemic did not cause any serious damage to indices. In fact it is likely that some Bulls took the opening gap as an opportunity to add to their positions, with the assumption that unlike SARS in China, there is enough transparency in the situation in Mexico to allow health regulators world-wide to manage the fallout of the swine-flu.

The Russell 2000 is now forming a tight ascending triangle, which is likely to resolve this week.

With the Fed meeting this week (typically bullish), it is going to be a toss-up on which side it will resolve to.
Many indices and sectors are up against strong trend-line or horizontal resistance levels. If the market does break out it is going to be a strong coordinated move. This market has out-foxed most pundits and I will not be surprised if it breaks out over the 875 level on the S&P500 this week. I myself am positioned primarily in cash, and puts on some indices like the commercial real estate (IYR) and small-caps (IWM).

Update

If the dollar continues to strengthen, we might see Gold and Oil pull back. This will be setting up for a giant trade, when the dollar eventually starts to feel the effect of th Fed’s action. That will probably be when the European and the Japanese economy recover.

Dollar Wins Heads-or-Tails Toss on Growth or Weakness – Bloomberg.com

The 30-day correlation coefficient between the Dollar Index and Morgan Stanley’s MSCI World Index reached negative 0.72 on Feb. 19, the most since July 2006, as the greenback approached a three-year high against its trading partners and global stocks fell. A correlation of minus 1 would mean the dollar gains whenever stocks decline.

Seeking Signs

Now, the dollar is gaining as stocks rally, signaling investors see the economy bottoming and are putting their money in U.S. assets.

The Dollar Index rose as much as 5.1 percent since March 19 as the MSCI World Index rallied 11 percent. The 30-day correlation coefficient narrowed to minus 0.55 in that period.

“If there’re signs that the U.S. is the first out of the recession, it’s beneficial for the dollar,” said Samarjit Shankar, director of global strategy for the Global Markets group in Boston at Bank of New York Mellon, which administers more than $20 trillion in assets.

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Monday Morning: Futures Down on Swine Flu but …

Posted on April 27, 2009 by BMWFan

Equity Stock Futures are showing a 2% down open across the market.

The gap down is being attributed to the swine-flu scare which

is sweeping the world.

Though it is tempting to believe that the long awaited pullback might be starting, I would be careful here, and not go all in on the bearish side, lest this turns out to be another fake-out like last Monday.

Some other items I have been pondering about:

(1) Non-Market Cap Weighted Indices : The Value Line Arithmetic and S&P500 components (arithmetic weight) actually show a nice double bottom pattern.

One reason people feel that the bottom is not in is because the current V shaped bottom is not something which can build new bull markets.

The non-market cap weighted indices seem to weaken that hypothesis.

(2) Earnings: Even if we ignore the banks, the non-bank earnings have been a mixed bag with beat rates will in the middle of historical rates. This perh aps suggests th

at the sentiment became a bit too negative earlier this year, precipitating the collapse.

This rally might just have been a return to the equilibrium state from a state of extreme pessimism.

(3) Psychological Structure: Have markets all over the world already priced in and discounted the coming series of bad news

? Fundamentals matter but if everyone is waiting for a magnitude 10 earthquake, a magnitude 7 is a big relief. Is the talk about continuing real estate collapse etc., kind of getting long in the tooth? It is clear that the Obama administration will keep on pumping 100s of billions of dollars to keep the RE/Banking propped up, whether it mortgage cram-down, refi-assistance, foreclosure moratorium, and of course non-stop cheer-leading.

Americans by nature are optimist, and it does not take that long to get the 85% who have jobs to get back to their old ways. Also thanks to depressed prices and low interest rates, homes are a lot more affordable than they have been for a long time. This will provide some sort of pricing support in most markets.

The nationwide price averages are misleading since most big price drops are concentrated in the worst affected areas and not pandemic as the headlines may suggest. Averages are not the best indicator for estimating the amount of bad debt which will be created.

Today’s breakdown is due to an extraordinary event (the swine flu). How long it will last is yet to be seen? I personally am primarily in cash with some put positions. In spite of all the negative indicators, I have not yet seen the market reflect the convincing bear case.

We have chopped around in this range for a month now and the longer we stay here, the less likely the chance for a big drop.

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Bullish Sentiment Continues: Aided by the Bears

Posted on April 23, 2009 by BMWFan

The stock market shook of marginal economic news with the SPX closing above 1% higher. After the late sell-off yesterday the futures were bid up pre-market. However the Jobs report resulted in a small sell-off.

The job losses were at or near consensus but any hope that the Easter week’s drop would continue faded. Unlike Apple and EBay, UPS reported lower than consensus and also guided down.

To add to the bearish case, home sales and prices fell marginally from February.

However stock market shook off the news with

the ES futures never breaching any major support levels, the low being the S1 level around 831. The stock market had a roller coaster ride, with several spurts and sell-offs, before a strong finish towards the close.


I am amazed at the resilience of the market, and its ability to absorb not so great news.

The last hour’s rally was led by the commercial real estate (IYR), housing (XHB) (which had been under pressure) and of course the financial (XLF) and banking (KBE). The near parabolic finish in IYR suggests that the last hour rally again, may have been driven by short covering.

With the details of the stress test methodology coming out tomorrow, there was ample reason for longs to close out their positions in the banking sectors before close today.

However, the late day rally shows that not only were the longs in no rush to sell ahead of the report, but a lot of trapped bears capitulated and covered before the close. Also note that the leaders like Apple did not participate in the late burst in a significant way.

I feel that one reason we are not seeing a major sell-off is the presence of over-eager bears who have lost their fear of the bulls thanks to the success of the past year.

The bears short rallies aggressively, hoping for a major drop, and when dips are bought, rush to cover. This short, squeeze, repeat cycle, is quite visible in the sectors with the most short interest and the weakest fundamentals (IYR).

Almost all pundits are calling for a pullback to the high 700s where they will buy the market. However the pullback is testing their patience.

Every day without the pullback is sucking more people in from the sidelines.

It is also tempting more bears who continue to get burnt by the wide swings.

The market continues to be treacherous with no clear direction. The XHB sold off initially after the poorer sales numbers, but recovered most

of the losses by the end of the day.

What would normally take a few days (a sell-off on poor news, followed by some dip buying the next few days) happens in the matter of a few hours.

Sit on Hands time continues, unless you can scalp.

Clearly this is not the time to lean strongly in any direction.

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A Day of Four Markets

Posted on April 22, 2009 by BMWFan

Wednesday’s stock market was a complete roller coaster.

Disappointing earnings from Morgan Stanley lead to a gap down open, which was bought heavily sending the SPX up by almost 20 points in the first hour. News about GM not planning to make the payments on $1B in debt maturing soon send the market down to the 848 level during lunch. After the news, which should not have been unexpected, was digested, stocks rallied again into the afternoon making a new intra-day high on all major indexes.

The Nasdaq100 (NQ) made a new multi-month high at 1362.

The Russell 2000 (TF) came within a point (480.7) of the high reached last Friday (481.6). However the market sold off hard in the last half an hour; the highs on on the indexes perhaps the trigger.

The price action today was a strong indicator of the treacherousness of the market. The market seems to be driven by program trading computers trading against each other; there seems to be a lack of any strong buy-side bid or buy-side selling for that matter.

However, by making or getting close to making new highs, the market showed that the bullish sentiment is far from gone, Monday’s sell-off not withstanding.

Bears were trapped again at the open today; very much like Mastercard trapped bears yesterday.

After hours two tech giant Apple and EBay handsomely beat expectations; NQ futures are up almost a percent since the close. This is likely going to put greater emphasis on tomorrow’s new jobless claim numbers.

Unlike unemployment which is a lagging indicator, jobless claims

is a concurrent indicator.

The economy will not improve as long as companies continue to issue pink slips. Last week, the number was better than expected.

If this trend continues and we get another better than expected number, we may be setting up for a big rally.

I do not know how the day will end though.

I am primarily in cash with some hedged longs and shorts.

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Small Ticket Luxury: A Bright Spot

Posted on April 22, 2009 by BMWFan

The economic downturn has forced American consumers to scale back their appetite for big-tickets items. . Large homes, new luxury cars, expensive vacations in exotic locales are no longer in vogue.

This is not only due to a reduce ability

to spend because of significantly lower availability of credit or insecurity about the job situation, but also due to a reluctance to be extravagant when so many others in the community are suffering economically.

However the reluctance to spend on big tickets luxury has one positive side-effect: small ticket luxury items are very much in demand. In spite of all the negative headlines, 90% of Americans still have jobs and are paying their mortgage. While they are no longer seeking gratification with

the big-items, consumers are continuing to spend on relatively more expensive small ticket items. Two standouts this week are Apple and Coach.

Apple’s Sweet Performance
Apple continues to beat estimates with iPhone sales well beyond most estimates, giving a nice push up to AT&T (T). Even Mac Sales are not taking the dip (3% year to year) to the extent which was expected, belying common wisdom that people will rush to the less expensive Windows computers during this period of belt-tightening.

However, consumers will continue to seek gratification in some form, and the well defined, easy to use products from Apple fit the bill very well. When people are skipping vacations and not buying new cars, they not only have the money but also the motivation to buy these relatively small ticket luxury items.

This is not so good news for airlines like Continental but good news

for Apple.

Coach: Delivers the good(ies)

Coach, another purveyor of affordable luxury items also announced better than expected results yesterday while initiating dividend payments.

Coach too benefits to the rush to less expensive goods.

Coach is adjusting its product mix to provide lower priced entry level goods allowing consumers to indulge themselves with a little bit of luxury.

Coach is not Prada; but it still works.

I believe that the affordable luxury segment of consumer discretionary equities will continue to outperform

the rest of the sector.

The target customers of this segment are relatively affluent and not distressed to the same extent as less affluent consumers.

The stock price of both Apple and Coach, have run up quite a bit, and investors should wait for a pullback before buying.

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MasterCard: An example of a Bear Trap

Posted on April 21, 2009 by BMWFan

Mastercard broke a bearish upward sloping wedge yesterday.

After losing the trend line around 158-159, it sold off all the way down to 149 at open today.

However after the first few minutes, it ramped up to never look back hitting a price of $163 before taking a pause.

Mastercard closed strong at 164.37 close to the high of

the day.

It formed what is called a bullish engulfing candle, a very strong reversal pattern.

Intra-day there was very strong support at 160.50.

Yesterday I had talked about how though the SPX had broken the wedge, it was still in an upward channel. Today the SPX recovered most of its losses from yesterday.

Mastercard’ s price-action today wa

s a microcosm of the broader market.

This is a treacherous market with big unexpected moves.

It is not a market where one should lean stronger on either side.

No home runs; certainly no grand slams.

Collect your runs single by single.

PS: As I write this, Capital One (COF) reported rising defaults. It is likely that credit card related equities will be under pressure; but nothing is certain.

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