Wednesday, October 28, 2009

GLOBAL OUTLOOK 10/28 + Why this Correction Could Become a Collapse


- Stocks: Tuesday: Asia down, Europe mixed, US down Wednesday morning Asia down, Europe opening down

- FX: Lower equities, bias to safety currencies [JPY, USD, CHF in order of safety appeal] in favor of risk currencies [AUD, NZD, CAD, EUR, GBP in order of risk appetite appeal], USD gains against most majors(down against Yen)

- Main events today:AUD: CPI q/q NZD: NBNZ Business Conference Rate Statement, USD: Durable goods, New Home Sales earnings: Wednesday 10/28: Aflac (AFL), Coca-Cola Ent. (CCE), ConocoPhillips (CON), Eni (E), General Dynamics (GD), GlaxoSmithKline (GSK), Goodyear Tire & Rubber (GT), SAP (SAP)

- Big Theme: Risk Appetite Becomes Nausea? Excessive valuations, oversold USD, uncertainty ahead of US GDP Friday In addition to earnings, Friday's US Advanced GDP, next Friday's NFP are the big events, though US Treasury bond auctions could create volatility if demand isn't good. So far, it's been fine. SEE FULL VERSION: WHY CORRECTION COULD BECOME A COLLAPSE


US: Two of the three major indexes finished lower as continuing concerns about already high valuations was somewhat moderated by some overall positive earnings news.

The Dow was able to net a modest gain as Exxon Mobil (XOM 74.91, +1.68) and Chevron (CVX 76.59, +1.14) shared in strength stemming from a better-than-expected earnings report from BP PLC (BP 57.82, +2.34). IBM (IBM 120.65, +0.54) also provided leadership to blue chips by announcing that it has authorized $5.0 billion for stock repurchases, which not only help improve earnings per share results by reducing the number of outstanding shares, but also sends a signal to investors that strong companies are now willing to fund buybacks, rather than stash cash into their coffers amid economic tumult.

Despite IBM's strength, many large-cap tech issues traded as laggards following downside guidance from Internet search engine (BIDU 383.66, -49.31). Collective weakness among large-cap tech caused the Nasdaq to underperform the other headline indices.

Shares of consumer discretionary stocks were among the worst performers this session, though. They dropped 1.7% as retailers recoiled following a disappointing Consumer Confidence Index reading of 47.7 for October. The consensus had called for a reading of 53.5. Even shares of Under Armour (UA 29.27, -3.82) slumped, despite better-than-expected quarterly earnings and a raised forecast.

Note that for the past years, falling stocks has generally caused the USD to rise against other currencies as a safe haven. Given the US Government's massive Treasury bond auction this week, it is indeed convenient that the market began pulling back last week. This pleasant coincidence has not gone unnoticed in the blogosphere. Conspiracy theories, anyone?

Reasons Why this Correction Could Become a Collapse

1. Fading LeadersFinancials, real estate, homebuilders led the collapse and March rally, but are fading now:

Throughout the financial meltdown financials, real estate, and homebuilders fell harder and faster than broad market indexes like the S&P 500, Beginning with the March rally the broad market rose while financials, real estate, and homebuilders soared.

Those three sectors led the decline and led the subsequent dubious recovery. So it behooves investors to watch such leading sectors closely.

The S&P 500 recorded a closing high on October 19th at 1,097. The Financial Select Sector SPDRs (XLF) reached their closing high a few days before on October 15th. Since their respective closing highs, the S&P 500 has dropped 2.82%, while XLF has already shed 5.64%.

The home builders sector faired worse. The SPDR S&P Homebuilders ETF (XHB) peaked on September 16th and has fallen 9.97% since. Note that XHB's lackluster performance comes on the heels of the biggest monthly increase in total home sales in ten years.

Even though the inventory of existing homes fell 7.5% month-over month in September (to 3.6 million units), the shadow inventory of 3.5 million foreclosed homes is weighing heavily on home builders. Shadow inventory represents foreclosed homes that are vacant, still included on bank's balance sheets, but have not hit the market yet. 3.5 million homes equal about 1 - 2 years worth of supply.

2. Technology sector still hurting:

Apple reported great earnings and rallied over 10% to new all-time highs. Microsoft reported better than expected numbers and spiked 7.4%. Investors loved Amazon's outlook so much that they bid up the stock by over 33%. Combined, the three companies account for nearly 24% of the Nasdaq, yet the Nasdaq is traded lower today than before earnings season on October 14th. The same is true for the Technology Select Sector SPDRs (XLK).

If 24% of the Nasdaq's components rallied between 7 and 33%, without lifting the index, a lot of tech companies must be hurting. In fact, the Nasdaq's (Nasdaq: QQQQ - News) performance is masking the decline IBM, Intel, and many others.

In addition to the above article excerpts, consider:

3. Consumer Demand Gone

Manufacturing has shown improvement and increased production. However, this appears to be mostly due to restocking inventories that were slowly depleted as cash strapped businesses and consumers cut purchases. How do we know? Look at shipping volumes. Genuine demand should be reflected in increased activity in the shipping and packaging sector. However, the opposite is occurring:

• UPS reported falling shipping volume for the 7th straight quarter, and profits are down 43% over the past 12 months

• Burlington Northern, the largest component of the Dow Transportation Average reported a 27% decrease in freight revenue from Q3 of 08.

5. Demand Gone Until Employment & Personal Incomes Improve:

No one disputes that the US along with much of the developed world is continuing to lose jobs, with predictable downward pressure on wages, hours and incomes from those still working. Because 70% of US GDP is comprised of consumer spending, there can be no sustained meaningful improvement in US growth until the jobs and income picture improves so that US consumers can pick up spending.

6. Weak Consumer Spending Means Weak Banks, Housing: Until then, spending will be weak, which means commercial and residential real estate loan defaults will continue, which means the banks will continue to hold massive and growing debt portfolios, try as they may to hide them with regulator cooperation

7. Grossly Overpriced Stocks: We have repeatedly pointed out cases of stocks that have risen (because they beat lowball estimates) to levels at or higher than they were over a year ago, yet revenues and / or earnings are lower. Per available data from Standard &Poors & Robert Shiller, price to earnings ratios for the S&P are now at an astounding 143. Historically p/e ratios are around 15-20, and per Dr. Nuriel Roubini at market bottoms hit 10-12. Even at the recent March 2009 bottom, p/e ratios never got close to that low level.

In sum, the current rally is an irrational bubble to be shorted, or at least avoided on the long side. How far can it fall? Another 10-20% is a safe minimal guess, assuming Washington comes out with more stimulus to keep the markets from full fledged panic. Because markets often overreact, a test of March or November lows is also perfectly possible.

Asia: Asian stocks were lower for a second day Wednesday amid worries U.S. consumers were continuing to struggle, undermining hopes for a quicker turnaround in an economy that's a major export market for the region.

Europe: Oct. 28 (Bloomberg) -- European stock-indexes hit 3 week low fell and Asian shares declined as SAP AG cut its software sales forecast and Canon Inc. posted a seventh straight quarterly profit drop. U.S. futures were little changed.

COMMODITIES: Down Monday with stocks as risk appetite retreated and the dollar gained. See weekly analysis for more on all of these.

Oil: TOKYO, Oct 28 (Reuters) - Oil was steady around $79.50 a barrel on Wednesday, supported by industry data showing a surprise large drawdown in U.S. crude inventories that blunted the impact of a strengthening dollar and weak Asian equities. As the dollar strengthens, crude becomes more expensive for holders of foreign currencies. Traders also await U.S. gross domestic product (GDP) data, due to be released on Thursday. Analysts expect it to show that the world's largest economy grew 3.3 percent in the third quarter, but a lower growth figure could prompt a sell-off in riskier commodities whose prices have rallied this month.

Gold: Gold prices steadied around $1,040 per ounce on Wednesday, recovering from three-week lows hit the day before when the dollar strengthened against the euro. Although gold price has been in consolidation for 2 weeks, net speculation long positions remained close to all-time high level. It's likely for the correction to take place for some more time and gold may need to correct further to 1026 to remove the positioning risk.

CURRENCIES: Bias to safety currencies with falling stocks. Heavy short positioning on the USD made traders hesitant to continue selling it, and more inclined to unwind existing USD shorts, in the face of falling stocks and risk appetite, which heighten the USD's safe-haven appeal. Most USD crosses lost ground against it.

USD: The U.S. dollar gained 0.2% against a basket of foreign currencies. The Dollar Index has now advanced for four straight sessions.

Dollar performance was modestly positive versus most of the majors as US equities were relatively flat and Treasuries were in demand following a good 2y auction and some disappointing economic data. The S&P CaseShiller Home Price Index was slightly better than expectations at -11.32% but the Conference Board Consumer Confidence reading disappointed at 47.7 versus consensus 53.5. The weak consumer confidence figure likely attracted investors to the safety of Treasuries, especially with 2y yields above 1%. The 2y auction bid-cover was 3.63x, compared to an average cover of 2.69x, and indirect bidders took 44.5%, compared to a 10 auction average of 42.6%. There was also a very significant allocation to direct bidders in the auction at 26.1%, which dwarfed the previous high. 2y yields are 0.9260% at the time of writing and 10y and 30y yields also dropped during the session. Data ahead includes durable goods orders. The next Treasury auction is for the 5y note.

EUR- Down vs. the USD Tuesday to around 1.4800 (-200 pips about 1% in 2 days), steady Wed. above 1.4800. The risk asset trade has run into a wall of serious resistance as key psychological points. With Dow struggling at 10,000 S&P capped at 1100 and EUR/USD battling with 1.5000 the recovery rally looks exhausted as most of the good news appears to have been priced in. Yesterday’s sharp drop in the EUR/USD was classic case of stop tripping in FX as the 1.5000 level failed to hold for the fourth time in a row. With the EZ calendar quiet for Wednesday, the major news is due from the US session during which the main news release will be Consumer confidence at 14:00 GMT. Given the U of Michigan miss and stagnant unemployment data, there's a strong chance of a negative surprise, which could spark further risk aversion in stocks and further drag the EURUSD down to test 1.4800.

JPY - USDJPY fell from over 92 to around 91.24, as falling stocks and yen purchases by Japanese exporters lent support to the JPY.

Large Japanese manufacturers expected the yen to average 94.50 per dollar in the 12 months to March 2010, according to the Bank of Japan’s quarterly Tankan survey released Oct. 1. The forecast in the previous report was for a rate of 94.85.

“There’s talk that exporters are buying the yen,” said Lee Wai Tuck, a currency strategist at Forecast Pte in Singapore. “This is causing the dollar-yen to dip.”

MoF Fujii said that competitive devaluations would ruin the world economy but cautioned that this comment should not be interpreted to mean that he favours a stronger JPY. He added that a weak JPY is helpful for exports, but that policy should not be steered by this consideration alone. On the USD, Fujii said that it is natural for Japan to hold the strongest currency in its FX reserves and that Japan's FX policy may actually be supporting the USD. We remain long USDJPY as a trade recommendation from 90.50.

GBP – Recovering against the EUR and USD in the past 2 sessions in what appears to be a reaction bounce after last week's big drop on poor Q3 GDP

AUD: Down 0.7% against the USD as it the AUD drops with stocks and other risk assets.

For the RBA, the below expectations PPI data showed the sharp AUD rebound is clearly slowing upstream price pressure (that should flow through to CPI over coming quarters) by causing import prices to drop at a record pace over the last two quarters. Further, the core PPI had a 3rd straight fall - sufficiently weak to signal slowing in core CPI over coming quarters (towards 2%). However, for the near term - the weaker than expected PPI may not fully translate through to Q3 CPI given lags, and another strong (+1.2% q/q) rise in house construction costs adds modest upside risk to our economists' Q3 headline inflation forecast of 0.7% q/q. With 100bp of tightening already priced for the next 3 RBA meetings, a topside surprise in CPI is needed to justify AUD at these levels.

NZD: Continuing to fall against the USD as risk aversion driven profit taking continues

CAD: stabilizing with oil after days of decline

CHF: gaining slightly against the EUR and USD in early Wednesday trade after struggling for the past 2 days

CONCLUSIONS: New Trading Ideas: If stocks steady or falling, then continue to watch for USD rallies against the EUR and commodity currencies, GBP/USD for more pullbacks on a sustained break below 1.6300, and crude oil has begun to pull back, no strong support level until about $74 (see daily chart below). We favor going short on crude if it breaks below $78 (fibonaccci 23.6% retracement which has held as support for the past week) look to trade at either extreme long or short depending on stocks. NB If continued pullback in stocks, expect other risk assets and currencies to follow, with biggest move from the most oversold (USD) and overbought (crude, gold, commodity currencies, stocks, in that order).

Trading Opportunities: Near term favors higher yielding and commodity currencies, but that could change fast if equities pull back, no trend continues forever. Thus: 1. be prepared to play a pullback in risk assets and get ready to sell stock indexes, commodities, and risk currencies, buying USD, JPY. 2. Trade the near term horizontal trading ranges that should hold until major news causes a change in risk appetite. 3. Those continuing to take long positions in risk assets should consider tight sell stops, though gold and crude may be approaching new breakouts. Crude oil may be beginning pullback Always use sell stop orders.

Crude Oil

Made its first major move down Friday as it followed stocks lower, after it breached new annual highs around $82. Given the fast recent rise, no strong price support before around the $74 level, though at $77.81 there is a 23.6% Fibonacci retracement level that has held for the past week, and at about $75.50 there is a convergence of a 38.2% Fibonacci retracement and a 1 standard deviation Bollinger Band. See chart.

Daily Chart Crude Oil Oct 28- No strong support until around $74, but have minor support at $77.81 & $75.50) where we get a convergence of an established support/resistance price level, Bollinger Band, and 50% Fibonacci retracement. Until then, nothing but air. However, oil is likely to continue following stocks, so if stocks can hold steady, oil may well do likewise, though it does tend to be more volatile and exaggerate equity market moves, so oil could make some further declines on its own.

01 oct 28


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