Q4 2008 Weekly Reports
12/29/08
Utilities, healthcare and services score highest across our 1800+ stock universe. Basics and tech score weakest.
In 2009, focus on monthly trends in industrial production in the U.S. and abroad for evidence of economic recovery and profit expansion. Watch AAR’s weekly railroad freight data for evidence of rising demand.
In 1930, every month posted contracting production and the DJIA fell –33.77%, worse than the –17.17% drop in 1929. In 1974, 10 of 12 months posted contracting production and the market fell –27.57%. In 2001, every month posted contracting production and the market fell –7.1%. In 2008, 7 of 11 have contracted and the market has fallen –35.80%. As industrial production improves, equities will attract money flow from alternate asset classes.
Unemployment will rise in the first half of 09. California has put $4bn in spending on hold due to budget shortfalls. California’s unemployment rate is 8.4%, 3rd highest in the U.S. Own stocks benefiting from rising demand tied to economic hardship and avoid plays reliant on consumer credit. Our scores will adjust as the market shifts, providing you with early insight into leadership. Wait for conviction.
In healthcare, unemployment is straining Medicaid budgets and prompting the Fed to increase aid. Rising Medicaid rolls benefit private Medicaid providers. Cost containment will drive upside at hospital alternatives. Cost pressures, including rising unpaid bills from uninsured patients, will drive hospital closures. In NJ, 47% of hospitals lost money in ’07 while 5 acute-care hospitals closed in 08. Hospitals will continue to outsource everything from laundry, safety/training to ER’s, radiology and anesthesia departments. Own related stocks.
In services, education service providers will enjoy robust enrollment growth in 09 as dislocated workers retrain. Margins will improve alongside capacity as fixed costs are levered. Slower ad spending in early 09 will benefit providers through cheaper rates. Discount retail will win cost-conscious consumers. By year end, specialty retail will outperform as investor pessimism wanes, comps become easy, margins from cost cutting flow through to earnings and consumer balance sheets improve from 08. In the first half of the year, store closings will pressure CMBS as un-leased sq. ft. increases; forcing another wave of write-downs. The ICSC estimates 148k store closings this year, the most since 2001, with another 73k coming in the first 6 months of 09.
Banks and insurers will continue to write-down assets in the first half of 09. CMBS risk will grab headlines in the next quarter. Credit card charge off rates will rise alongside unemployment and pressure issuers. Cracks in the armor of small and mid size banks will become more evident by Q2. Large cap banks will remain volatile in the first half, however, portfolios will have unwound financial positions by the end of Q2, allowing for upside by yearend. Wait for scores to show you which will generate the most alpha.
In consumer, value and generic product portfolios will do best as consumers remain frugal through Spring and investors embrace stability and “above-Treasury” yields.
In technology, EPS risk will rise alongside falling industrial production forcing Street estimates lower again in the Spring. Corporate bankruptcies will increase grey market technology availability, pressuring lackluster demand for equipment in the first half of 09. January's CES will be an afterthought. Folks hoping for a breakthrough product in early 09 will be disappointed. GS estimates U.S./W. Europe and Japanese global spending on computers and software falling 8% in 09. Tech will exert itself alongside industrial production expansion, however, until then remain on the sidelines and focus solely on top scoring names. Avoid the temptation to buy winners from the last expansion and instead allow scores to direct you to the next expansion’s winners.
Basics will endure another wave of selling in the first half of 09 as emerging market financing remains weak. The USO will get 85% off its highs, rally significantly and roll over again. Commodity suppliers will lose price power. Lack of emerging market financing will strain supplier’s ability to provide financed sales to at-risk farmers, forcing EPS erosion at ag suppliers. Dividend paying basics will be forced to cut dividends. The basket will provide position-trading opportunities. Corn, soybeans and wheat have all rallied to multi-week highs. Focus on scores and underlying commodities before committing additional money into the basket. Watch Gaza news-flow for short-term impacts on oil and gold.
The yield curve will flatten further as investors go out in duration. The 2 to 10 year spread will fall below 100bps in the Spring. A bubble in Treasuries will provide risk and reward in alternate asset classes 2010. The drop in yields will drive investors into corporates and muni's during the first half of 09. Corporates have returned 2.3% more than Treasuries this month – the most since April – following dismal underperformance in October and November. Historically, corporate yields peak prior to the economy’s bottom. However, rising corporate default risk will keep investors from at-risk industries early in 09, with high yield attracting more investors in the back half of the year. Utilities, thanks to yields, will perform nicely.
12/22/08
Utilities and healthcare are the strongest scoring sectors across our entire universe. They are the only two sectors with an average score greater than the average score of our entire 1800 stock universe. Consumer and tech score weakest.
Money continues to flow into defensive sectors ahead of yearend. In healthcare, focus on cost containment plays including outsourced solutions, cost recovery and home healthcare. In large cap, cash rich businesses yielding above Treasuries with expanding margins score highest.
Winter weather further crimps retail spending as consumer balance sheet cleansing continues to weigh on spending. Own discount retailers benefiting from price sensitivity. Also, own education service providers benefiting from unemployment inspired enrollment, falling marketing costs and Government support for secondary market student lending.
The 2 to 10 year Treasury spread continues to contract at 138bps, down from 251bps at the start of November. Declining spreads weigh on financials. The 30-year yield has fallen to 2.55% on investor enthusiasm over future quantitative easing and continued economic risk. In Financials, avoid credit card default risk. DFS and COF are closing inactive accounts to avoid future use and risk of default. DFS alone is set to close 5mn unused accounts. Credit card issuers continue to chase rising default risk. COF has above average industry exposure to low credit score consumers while DFS saw charge offs climb to 5.48% from 5.2% last quarter. Currently, 30-year mortgages are only 7bps more expensive than 15-year mortgages. Madoff’s failure increases risk of ongoing redemption activity in the hedge fund industry as impacted investors reclaim investments to boost cash for operations.
Oil is 77% off its high. Historically, investors have success in buying bursting bubbles when losses retreat toward 85%. PBR, DVN, COP and CVX have all delayed investment plans, impacting clarity for energy service companies. Emerging market finance risk weighs on commodity suppliers, including agriculture suppliers. In basics, only own top scoring.
The SPX rose for its second week, the first back to back rise since September. Friday’s market volumes were higher thanks to option expiry. Volumes in related ETF’s, including DIA and SPY remained lackluster. The SPY last traded above average volume on December 4th. The Libor-OIS spread narrowed to the least since September.
12/15/08
Utilities and financials score highest across our universe. Basics and tech score weakest.
The SPX gained 0.4% while the DJIA lost 0.1%. Financials (XLF) have fallen 11.2% since the 8th. Basics are up 2.1% in the same period on hopes for Government infrastructure spending.
Volumes remain below average across indexes. The SPY has fallen 2.2% since its 33 point rally on the 8th.
Strength in financials is driven by non-CMBS and non-credit card dependent stocks. The markets have been digesting negative newsflow, moving up 18.7% since its low on November 21st. Overall, 25 banks have failed this year, more than the combined total of the past 6 years. BB&T picked up Haven Trust ($515mn in deposits) from the FDIC. On the 25th, the FDIC had listed 171 banks as ‘problem’, up 46% from Q2.
The commercial mortgage delinquency rate will rise, increasing writedowns in early 09. Credit card charge offs will rise with unemployment. Avoid banks with related exposure. On Thursday, the Fed is set to adopt new credit card rules restricting issuers from changing credit card interest rates on existing balances. The subprime credit card market may shrink, increasing payday loans. Credit cards would only be allowed to increase rates on new cards and future purchases/advances. The Fed action would require payments above minimums be applied to the highest rate balance rather than the lowest.
The spread between corporate bonds and Treasuries has risen to 885bps from 296bps this year. Corporate’s are yielding 10.8% (Merrill), up from 6.53% in January, despite Treasury’s hitting record low yields. The 2-year is yielding 0.76% and the 2-10 year spread is 181bps, down from 251bps at the start of November. The 30-year got closer to 3% (3.04%).
Emerging markets continue to weaken. Industrial production in India fell 0.4% in October YoY after rising 5.45% in September – the first negative reading in 15 years. Economists were looking for a 2.1% increase. Manufacturing accounts for 80% of India’s output and it fell 1.2%. China will increase money supply 17% next year as it further acts to restart production. Russia has widened the Ruble’s trading band 6 times this year, mostly recently on the 11th. Last Week, the Ruble fell the most against the Euro in 8 years.
FDX fell the most in 2 decades after cutting guidance. U.S. railroad freight carloads fell 10% YoY in November.
Industrial production will continue to fall. The following table shows U.S. industrial production by month from prior significant periods and resulting DJIA returns.
Industrial Production - Historical Prior Significant Periods DJIA
Yellow indicates month to month up change. Red indicates month to month down change. % Return
1928 7.2749 7.335 7.3952 7.3651 7.4553 7.5154 7.6056 7.7559 7.816 7.9663 8.1167 8.267
1929 8.3872 8.3571 8.3872 8.5375 8.6878 8.748 8.8682 8.778 8.7179 8.5676 8.1467 7.786 -17.17%
1930 7.786 7.7559 7.6357 7.5755 7.4553 7.2449 6.9142 6.7639 6.6436 6.4633 6.313 6.1626 -33.77%
1931 6.1326 6.1626 6.2829 6.313 6.2228 6.0725 5.9823 5.7718 5.5013 5.2909 5.2307 5.2007 -52.67%
1973 49.1607 49.9221 49.9085 49.8171 50.168 50.2121 50.4271 50.3357 50.7826 51.13 51.3693 51.2457 -16.58%
1974 50.8909 50.7566 50.7423 50.6271 50.9715 50.932 50.9239 50.4538 50.5021 50.3186 48.6566 46.9378 -27.57%
1975 46.3024 45.2098 44.731 44.7621 44.6709 45.0047 45.4923 45.9195 46.5145 46.7003 46.8201 47.3838 38.32%
1976 48.074 48.5115 48.5547 48.8553 49.0661 49.0693 49.3535 49.6908 49.821 49.8746 50.6214 51.1445 17.86%
1999 97.4849 97.8947 98.0864 98.2949 99.0314 98.8656 99.4962 99.9767 99.6093 100.9459 101.5527 102.395 25.22%
2000 102.465 102.8375 103.2423 103.8999 104.1433 104.2873 104.032 103.8104 104.2642 103.8077 103.8208 103.475 -6.17%
2001 102.748 102.1625 101.8291 101.5704 100.8683 100.2266 99.7613 99.4021 98.9667 98.4163 97.8874 97.8399 -7.10%
2002 98.3224 98.3983 99.1081 99.4718 99.9772 100.9301 100.6212 100.7317 100.7395 100.446 100.8772 100.377 -16.76%
2007 109.779 110.5181 110.4036 110.953 110.9686 111.3551 112.0024 111.9712 112.2598 111.8262 112.2962 112.386 6.43%
2008 112.57 112.2604 112.0235 111.441 111.2179 111.3292 111.4124 110.0712 105.9458 107.2854* -33.83%
* September and October data affected by Hurricanes and BA strike
In healthcare, own home healthcare as Medicaid enrollment increases drive cost containment. Hospitals are suffering from declining elective procedures. Own suppliers focused on training, cost cutting and outsourced lower-cost services.
OPEC meets Wednesday to discuss more production cuts. The CRB was up 8.8% last week. Oil rose 13%. The Dollar had its biggest 1-week fall since 1985 with the UUP dropping 4.5%. Corn rose 21% last week, its biggest weekly gain since at least 1959, yet remains 53% off its June high. Copper also rallied up 4% on hopes for an auto bailout (the average car has 50lbs of copper tubing and wiring), yet remains ~ 50% off its high.
An ice storm on Thursday night cut power to more than 1.2mn utility customers in the Northeast sparking worries over freezing pipes and driving restaurant traffic. As a result our offices are running on limited connectivity and our phone lines remain unavailable. We hope to have full services restored in the coming days and apologize in advance for any inconvenience.
Tech scores remain too low to justify risk. Stay stock-by-stock - high scoring solely
12/8/08
The SPY remains below its November 28th closing high of $90.09. Volumes have remained comparatively light since the intraday low of 741 on the 21st.
There weren’t any high scoring (>80) stocks in large cap again this week. Only 3 mid caps score above 80. The scores will add conviction and point you to the next cycles leaders. Avoid bottom-fishing winners from past bull market cycles.
Friday’s employment report suggests continued pressure on consumer debt repayment. The broadest measure, U-6, has moved from 8.4% to 12.5%. Since December 07, the economy has lost 2.7 million jobs. Overall, the employment-population ratio has fallen to 61.4%. September unemployment was revised from –284k to –403k and October was revised from –240k to 320k.
Since October, the TLT is up 19%. The spread between the 2 and 10 year bond has contracted from 251bps to 178bps. Credit Default Swaps continue to price for record defaults at both non-investment and investment grade companies.
Financials continue to score near the top of our ranking, boosted by small cap regionals. The basket has led since the low on the 21st (see table) with the XLF up more than 3x more than the SPY. Focus on top scoring names and avoid large caps with exposure to credit card debt and CMBS. Delinquent mortgages are at record highs (6.99%). Avoid insurers.
Use down days to buy education service providers. Government intervention supports the secondary student loan market. Enrollment is rising alongside unemployment while advertising rates are shrinking. In retail, own high scoring discounters. Note: the IndexMetrix Specialty Apparel index has rallied 42.46% since November 21st versus the 18.86% return of the RTH. In consumer, own stocks without overseas currency risk and with generic/value product portfolios.
In healthcare, hospitals are caught in a cost squeeze. Rising unemployment is forcing greater enrollment in state Medicaid programs. Medicaid, strained by budget shortfalls, is focusing more on cost containment. Elective surgery is shrinking. Focus on home healthcare providers.
Investment fund flows continue out of emerging markets. Supplier financing for commodity related users has dried up. Pricing power for commodity suppliers is eroding. Avoid basics until the underlying commodities can prove they’ve broken the back of sellers. The Brazilian Real fell~10% last week, sparking intervention.
Technology stocks remain weak. Global economic contraction is weighing on future earnings. Business bankruptcies provide grey market product inventory – chipping away at new product sales. Through June, business bankruptcies are up 42%.
12/1/08
Utilities, financials and services score strongest while healthcare and tech score weakest.
The SPX has risen 20.9% from its low on November 21st. Volumes on the SPY last week were 20% below the November average and 25% below the Q4 average. Use resistance to unwind stocks in weak scoring sectors.
Our scores remain weak. On Tuesday, no large cap stocks scored above 80. Stay stock-by-stock until scores improve and add conviction. Use up days to unwind at-risk positions.
The 30-year fixed mortgage rate dropped to 5.76%, returning to September levels. Watch for narrowing in the 2 to 10 year spread- as long-term yields are coming down quickly and 2-years are already at 1%. This month, the spread between 2 and 10 year Treasuries has compressed from 251bps to 193bps. The 2-year yield is the lowest since November 20th when the SPX closed at 752. The TLT (20 Year) is up 13.8% this month.
Charge-offs of comm’l backed securities remain too low and will rise, straining commercial banks, who hold $1.4trn. Another $761bn is securitized in CDO/CMBS/ABS issues. Life insurers hold $313bn of exposure, equal to ~41% of their equity. Spreads on CDS for CMBS spiked in November on shifts in TARP’s directive. Of the CMBS outstanding, $41bn matures in the next 18 months.
The NRF reports the average shopper this past weekend spent 7.2% more than last year with total spending of $41bn. More than half of the weekend shoppers visited discounters (54.7%). The association continues to project holiday sales will rise 2.2% to $470.4bn. Focus on high scoring discounters.
Education service providers got a boost from last week’s Government intervention as self-financed tuition risk was reduced by a commitment to loan to holders of recently securitized student loans. Unemployment will rise, boosting enrollment while government intervention will support student loan markets. Buy education service providers. The average return of a basket of providers returned nearly 142% from the low of October 2002 to the high of October 2003 (note: unemployment peaked in June 2003).
Unemployment will boost enrollment in State Medicaid programs, straining state budgets and prompting increased Federal aid. Look for low cost healthcare solutions, including cost and payment auditing and IT to benefit as cost containment pressure rises.
11/24/08
Utilities, financials and consumer are the only baskets currently scoring above the average universe. Basics and tech are weakest.
The market has fallen 17% this month. Last week, the market failed to hold the 848 closing low from October 27th, sparking another sell-off as technicians retreated. Friday’s option expiry drove volumes and a 6.3% recovery in the SPX. Thursday’s SPY volume (814mn) equaled 169% of average daily volume. Friday’s SPY volume (623mn) equaled 129% of average daily volume.
The failure to hold prior lows restarts the bottoming process. Expect more volatility. The VIX topped 80 on Thursday for the first time since the low on October 27th. The VXO hit it’s highest since the low on October 10th. The market is at record levels below its 200dma. Use a rally to unwind weak scoring stocks at resistance and reposition into top scoring stocks and sectors on a retest.
Financials were dealt a major blow on the shift of TARP away from illiquid assets. Firms were forced to buy CDS on at-risk securities, spiking costs to insure both investment and non-investment grade debt. CMBS remains a significant overhang on future bank profits as default rates begin to reflect economic contraction. Cheap money and a steep yield curve provide support to bank profitability, however without a system for unlocking illiquid RMBS and CMBS securities, pressure will remain due to demand for related CDS. AAA rated CMBS are trading at 70 cents on the dollar. Insurer book value will shrink (basket has fallen 45% this month).
As a result, big banks are pricing for financial Armageddon again. As we noted Friday, 63% of all C shares are held by institutions, many of which are prohibited from owning sub $5 stocks. JPM, the CDS pioneer and largest holder of CDS outstanding (~20-25% of the $45trn market) fell 33% in three sessions. Stay focused on strong scoring banks and remain on the sidelines in weak players.
Falling commodity input costs benefit consumer stocks. Consumer companies have spent the past 3 years cutting expenses. Shelf prices will contract more slowly than input costs, benefiting margin growth. Own consumer stocks with limited currency risk.
In keeping with their defensive nature, healthcare stocks have outperformed the SPY this month. The PPH has dropped –7.39%. Concerns over reimbursement delays weigh on receivable reliant companies. Rising unemployment reduces elective treatment. Focus on solutions tied to chronic disease.
Service scores are boosted by education providers and discount retail. Unemployment is driving college enrollment. Access to student lending will be supported through Government intervention. Discount retailer’s benefit from greater foot traffic, low cost models and shifts from discretionary products to consumer staples.
Basic will remain under pressure with sellers into rallies until underlying commodities can break downtrends. Drops in global growth are pressuring financing in commodity dependent countries, increasing supplier-financed risk. Use rallies to rotate.
Technology remains pressured by global economic weakness and currency risk. Focus on the highest scoring names, especially those with little debt and large cash positions.
11/17/08
The S&P 500 made a new intraday low on Thursday; reversed and closed above the October 27th 848 closing low. The day marked the first above average volume trading in 10 sessions. The index remains within its range with resistance at 1000-1005. The market will need to close on volume above 1005 to shift itself into a new higher trading range with 1000 as support. An upside breakout above 1005 shifts our upside target to ~1160. Use down days to add to positions. Watch our best list for new stocks climbing higher as they’ll become tomorrow’s leadership.
The Russell 2000 double bottomed, entering Thursday 33.68% below its 200dma. There have been 25 days where the R2k has been more than 25% below its 200dma, 16 of them in 2008. The average return 5 days later is +5.54 and only 2 of the 25 (1 of this years 16) have been down 5 days later.
When the S&P 500 gets more than 25% below its 200dma, the average return 5 days later is +4.60. It entered Thursday –32.48% below. There have been 32 such periods since 1950.
Russell 2000 > 25% below 200dma
Date Open High Low Close Adj Close 200dma % from 200dma 5 Day Return
10/27/2008 468.11 474.33 448.4 448.4 448.4 694.06955 -35.40% 20.09%
11/12/2008 478.71 480.09 452.8 452.8 452.8 682.775 -33.68% ?
10/24/2008 472.63 480.72 461.62 471.12 471.12 695.3508 -32.25% 14.30%
10/28/2008 448.39 482.72 441.92 482.55 482.55 692.9199 -30.36% 13.10%
10/23/2008 503.1 507.56 468.29 489.92 489.92 696.59625 -29.67% 4.95%
11/11/2008 490.76 497.43 480.82 482.29 482.29 683.98845 -29.49% ?
10/9/2008 550.69 558.11 499.2 499.2 499.2 707.5308 -29.44% 7.48%
10/29/2008 483.42 506.03 480.31 490.88 490.88 691.88715 -29.05% 4.84%
10/8/1998 322.23 322.23 303.87 310.28 310.28 435.77515 -28.80% 7.91%
10/15/2008 549.48 551.8 502.07 502.11 502.11 702.7398 -28.55% 0.00%
10/22/2008 525.35 525.35 494.75 501.97 501.97 697.70725 -28.05% -3.87%
11/10/2008 511.71 515.19 490.06 493.1 493.1 685.103 -28.03% ?
11/6/2008 514.46 514.56 495.84 495.84 495.84 687.0635 -27.83% ?
10/9/2002 340.32 340.32 326.88 327.04 327.04 452.5882 -27.74% 7.28%
10/9/1998 310.28 318.57 309.85 318.4 318.4 435.257 -26.85% 7.69%
11/7/2008 499.24 509.06 494.26 505.79 505.79 686.14945 -26.29% ?
10/13/1998 325.62 325.69 320.33 320.33 320.33 434.2741 -26.24% 11.86%
10/7/1998 332.55 332.55 319.82 322.23 322.23 436.33815 -26.15% 0.85%
10/10/2008 490.24 526.39 467.92 522.48 522.48 706.15805 -26.01% 0.76%
10/10/2002 327.04 336.18 324.9 336.18 336.18 451.84005 -25.60% 7.90%
10/30/2008 498.23 514.18 496.44 514.18 514.18 690.9585 -25.58% -3.67%
10/7/2002 347.98 347.98 337.57 338.29 338.29 454.0419 -25.49% 2.44%
11/5/2008 542.16 542.84 513.58 514.64 514.64 688.0479 -25.20% -12.02%
10/12/1998 318.4 327.63 318.4 325.62 325.62 434.7799 -25.11% 8.24%
10/14/1998 320.33 325.87 319.53 324.98 324.98 433.76565 -25.08% 10.76%
AVERAGE 5.54%
Despite bad earnings and weak economic data the market has behaved better than during the first capitulation low on October 10th. The volumes going into Thursday were far below those going into the low of the 10th.
Unemployment peaks well after markets bottom. Instead focus on stocks likely to rise from growing demand from greater unemployment, including education service providers.
Consumer spending tanked with retail sales a record low of –2.8% last month. Yet, the RTH put in a higher than previous (24th) intraday low on Thursday and sell volumes remained very light ahead of Thursday’s reversal. The energy to sell has diminished in the face of an endless stream of negative news.
The regional banks (RKH) held their July low last week despite word Treasury is switching tracks for deploying its TARP. The yield curve remains steep, supporting profits. Cheap Government money and higher demand deposits allow for inexpensive market share growth as weak competitors are folded into strong hands.
We are moving away from the wholesale selling of all stocks to the market differentiating between the strongest and weakest.
The DBC remains in a structural downtrend, boosting profits at consumer companies and reducing pricing power at basics related suppliers. Basics are trades until underlying commodities re-exert.
Technology stocks continue to score poorly as earnings risk tied to global recession weigh on valuations.
11/10/08
Financials, utilities and healthcare score highest across our universe this week. Basics and tech score weakest. The average score in our universe has ticked back above the 4-week moving average score. The Street is looking for 9.7% EPS growth next year on our 380 stock large cap universe, down from 19.8% at the end of September.
The unemployment rate will continue to rise into next year. The number of people collecting unemployment is the highest since 1983. California’s unemployment rate is now 7.7%, 4th worst in the nation. Historically, unemployment rates lag the market recovery. In 03, the unemployment rate peaked 3 months after the retest in March and 8 months after the 02 October low. The unemployment rate peaked at 9% in May 1975, 7 months following the October ’74 low.
The market is moving within its recent range. Bear market bottoms are not “V” bottoms. Instead, they retest lows – providing a lot of back-and-fill action and opportunity to buy without chasing whipsaw market action. The current closing low is 848 on the S&P 500. The market enjoys seasonal tailwinds as we’re now in the most robust period for annual returns. Consider the table to the right. In the 5 days prior to and including the October 10th low, the SPY traded 656.3mn shares. In the 5 days prior to and including the October 27th low, the SPY traded 490.1mn shares, 25% less. Volumes have been light as the market has remained range bound. Despite a continuing barrage of negative economic and earnings news, the market remains 9.7% above the October 27th low. As long as we remain above the 848 closing low, use down days to build positions in our best lists. The market is tilting toward upside reward (see this week’s Technical Commentary for additional remarks).
South Korea has cut its interest rates 3x in the past month. The Fed Fund Futures are predicting the U.S. will move closer to free money in mid December, anticipating another 50bps in cuts. Core inflation is higher than benchmark interest rates for the first time since the ‘80’s. UK interest rates are the lowest since 1955, and likely heading lower. Banks continue to tighten lending standards. The Nikkei is its lowest since ’82. Easy money and a steep yield curve, coupled with cheap market share growth, benefit financials.
Utilities benefit from the unlocking of credit markets and downward pressure on natural gas, crude and coal.
Healthcare stocks focused on services, treatment and margin improvement (IT) offer upside.
Consumer stocks offer margin improvement, as shelf prices remain high as input costs retreat. Services stocks are hit-and-miss. Focus on market leaders where expense controls meet the retailer’s ability to convert traffic to sales per sq. foot.
The Dollar continues to put downward pressure on commodities, remain on the sidelines until underlying commodities confirm upside. Dwindling foreign investment impairs commodity-reliant emerging markets, dampening demand. The correlation of the Dollar to Oil has risen to -0.959 (ytd = -0.768).
Many expect tech to lead us out of recession, however scores continue to favor other baskets, as investors remain concerned over global demand impacts on tech earnings. Wait for the basket to prove itself and only own leaders appearing in our best lists.
11/3/08
The SPX traded higher in 3 of the past 4 days as we ended the fiscal year for many funds. However, volumes were below average with Friday’s marking the weakest for the week.
Utilities, financials and consumer score highest across our universe. Basics and tech score weakest. A score above 1.00 indicates the average score in the sector is larger than the average universe score. Overall, mid cap scores highest.
In the 3 months ending January 31st, Industrials, utilities and basics post the strongest seasonal history of producing profits. Services and technology stocks have below average seasonality for the next 3 months. Seasonality is based on rolling 3-month periods over the past five years.
Barclay’s tapped Middle East investors for $11.8bn, paying an astronomical 14% yield. Gov’t spending and exports helped support GDP; exports are slowing on Dollar strength. LIBOR has fallen for the past 15 days and marked the first monthly decline since May. Global re-inflationary policy supports a steep yield curve, supporting bank profits. Government supported consolidation is driving low cost market share expansion.
Consumer scores are high thanks to retail shelf prices remaining elevated and input costs declining. Retailers have prepared for a year for the consumer recession, cutting inventory and expenses. A leaner industry offers greater profitability post-recession
Healthcare fell less than the market in October yet offers upside potential post-election. Healthcare plans profits have been hit by investment portfolio write-downs. Approach the basket stock-by-stock using our best and “cheap” stocks lists.
Brazilian credit risk creates problems for farming as the lack of lending availability dampens spending on related supplies. With 50% of GDP in debt, Brazil has counted on the commodity boom to support debt levels. As commodities have retreated, so has investment. Watch emerging markets closely for rising default risk and impacts on related U.S. suppliers. At some point, reduced investment supports commodity prices. In the meantime, ag suppliers will lose price power. Cargill and ADM, for example, have halted financing to Brazilian farmers. Brazil is responding by increasing the amount of money available for farm lending. Brazil’s primary surplus fell to 6.2bn reais in September from 10.2bn in August. The tug of war between tight historical supply, population growth and production will intensify. Argentina had its ratings cut again Friday by S&P, spurring rising concern of debt default. Wheat had its worst month in 22 years. Ag supply offers trade opportunities only until scores confirm and underlying grains trend higher.
U.S. sales of grains to oversea buyers are weighed on by the stronger dollar and global halt in shipping, with the Baltic Dry Index 90% off its highs. Rails have propped transports, thanks in part to strength in commodity shipping. Watch for weakening in rails and resulting weakness in the DJ Transports. Last week rail shipments dropped 4.7% YoY. Inter-modal dropped 4.1%, waste and scrap metal shipments fell 22.7%, auto’s fell 28.1%, metals dropped 22.3% (coal actually rose 6.5%). Total rail volume ytd is now trailing ’07. Overall, commodities posted their worst month in 52 years (Bloomberg). The DJ Transports (3885) enter resistance at 4000.
Intel is the latest tech company to indicate the global recession could slow sales and profits. Corporations are increasingly demanding cuts in service costs and discounts from tech equipment and service firms, further hampering profits. Stay stock-by-stock.
10/27/08
The market broke below its recent range, violating the lows established on the gap down rally day of the 10th. The uncertainty of where the new low will occur and the tempered upside into new resistance at the prior low of 899, suggests reducing overnight risk. It is likely we will indeed find another bottom, establishing downside support, this week. Until then, expect sellers to emerge on moves up toward 900. Ideally, the low should mimic the 10th, a steep volume draw down and heavy volume reversal. In short, until the market establishes a new low or recovers resistance at 900, you should return to the sidelines. We are noticing late day volume buying across major indexes suggesting short sellers are covering and value investors are entering the market. Consider this point, the average days-to-cover of short interest in our large cap universe was 3.28 on September 30th. As of last week, it has dropped to 2.26. To be clear, you should wait for either a steep decline volume reversal or a close above 899 resistance to add money to our “cheap stocks” list/wish list.
The majority of clients are mandated to remain invested. Avoid committing new money to favored stocks and groups until the heavy volume sell-off or recapture of resistance occurs. It may very well occur this week. There are plenty of diverging arguments for both bears and bulls. While many are counting on 2002 support, you shouldn’t. Let the market dictate where it stops, be it at ‘08, ’02, ’94 (445) or some other level.
A couple considerations, the DJ Transports bottomed in ‘01 at 1916 and 1908 in ‘03. It stands at 3448. The NASDAQ (1552) bottomed at 1108 in ’02. The Russell 2k (471) bottomed at 325 in ’02. Clearly, all indexes are not equal in regard to how close they are to what many hope to be support.
The Election is quickly approaching; yet another variable into the bottoming equation. We believe Election risk is factored into the market. Consider the Election “event” as the removal of one of several overhangs weighing on market sentiment.
Very few stocks score above 80 in our work. We’re in a market of relative vs. absolute return. Of the major ETF’s we track, only the Dollar (UUP) and the 20-year Treasury (TLT) are positive this month.
Financials, whose scores moved positive in small cap in July and in large cap in mid September, continue to benefit from Gov't intervention. PNC's acquisition of NCC is another example of cheap market share growth. While we’re starting to see a relative weakening in small cap financial scores, large and mid cap remain top rated. Watch this closely, as many investors who cast aside credit crisis risk are now evaluating comm'l and consumer debt risk.
Consumer stocks benefit from late ‘07 through mid ‘08 shelf price increases alongside steep declines in commodity input costs. Retailers will emerge post-recession stronger and more profitable as they’ve spent the past year reducing expenses, re-positioning product mix and re-engineering inventory models.
Basics are intriguing. In mid and small cap, the baskets score has moved back above the average score for a 2nd consecutive week. The last time the basket scored above average was early in Q3. The basket remains under GDP and Dollar pressure, however, pressure of forced liquidation may be easing and investors may be considering the upside impacts of Global re-inflationary policy and the intrinsic value of hard assets.
Healthcare stocks historically produce SPX leading returns through the December following the Election year. In October, the PPH, IYH and IBB have all produced above market declines. Scores in the basket have weakened, however, suggesting investors are using risk money to buy into financials (last month) and basics (most recently). Wait for scores to re-exert and focus buy power on top scoring baskets.
Use our wildly cheap large and mid cap reports to compile your wish list (see final page of today’s report).
10/20/08
The SPX made lows of 839 on the 10th, 865 on the 16th and 918 on Friday. 899, the closing low from Friday the 10th has held. We believe sellers will emerge at 1075 and 1175. In the short term, we would view a close below 899 as bearish for another move lower.
Options expiry influenced end of week trading, putting pressure on the market this week. Watch transports. The DJT (3692) is well above its ‘02 low (1900). A close below 3632 on the DJT is bearish for the DJIA.
In our small cap universe, 93% are more than 5% below their 200dma. The average small cap stock is –34.64% below its 200dma. The average large cap stock is –25.71% below its 200dma with 95% more than 5% below.
In October 1974, the SPX bottomed at 62.28, it retested 46 days later getting 4.2% from the low (65.01). In October 1987, the SPX bottomed at 224.84. It retested on the 27th, 7 days later, getting to 3.7% above the low (233.19). It retested again on December 4th, slightly undercutting by 40bps the October low (223.92). In ’98, it bottomed on August 31 at 957.28 and retested 28 days later on October 8th at 959.44. In ’02, it bottomed on October 9th at 776.76 and retested 105 days later at 800.73, 3.9% above the October low. Bottoms in recessions are re-tested.
The NASDAQ is sitting at 1688. It’s ‘02 low is 1108. The Philly Sox Index (239.13) got to 223 intraday last week, near its ’02 closing low (214.06 on October 9th, 2002). Tech scores remain under pressure and continue to point toward underweight. Semiconductors, however, can be bought. Watch technology scores for improvement and a crossover above the average universe score – we have not gotten that signal yet.
Healthcare, defensive by nature, has crossed back below the average scoring stock. Historically, healthcare outperforms the SPX following Presidential elections. Investors are rotating out of healthcare into too-big-to-fail financials. The rally in Financials kicked off in June with small cap financials crossing above the average small cap score. Large cap financials did the same in mid September. Basics scores are starting to tick higher and are close to crossing back above the average universe score.
10/13/08
The DJIA touched 7888, putting it into a retest of the lows of 2002. The SPX got to 840, 47% off its 2007 peak. The average large cap stock in our universe is 22.9% below its 200dma. Last October 9th, the average large cap stock was trading 20.86x current year EPS. As of this week, the average is 13.09x. Last October 9th, the average large cap stock was trading 1.86x its 5 year PE low on 07 EPS. Currently, the average is 1.25x.
October has a strong history of marking the bottom of bear markets. In ‘02 the bottom occurred on October 9th. In ‘87 it was October 19. The sell-off in ‘98 ended October 8th. In ‘90 it ended October 17th. In 74 it was October 3rd. In ‘66 it was October 7th. Overall, including ‘98 and ‘90, 4 of last 5 bears ended in October and 6 of last 8 ended in October.
The chart below shows the VXO in 1987. The VXO is the “old” VIX calculation, based on the S&P100 it provides us with more relevant data on extreme readings. Intraday, the VXO got above 100 Friday (103.41).
As we move beyond Yom Kippur headwinds will ease. Forced liquidation from the end of Q3 will slow. Treasury yields support asset rotation back to risk. We believe we will see a trading rally, however, this rally will fade into resistance forcing a retest of lows.
Financials remain top scoring. The G7 has stated it will not allow any large systematic bank failure. The global printing press is focused solely on unlocking credit markets. The LEH counterparty risk, which overhang last week’s action, will be digested. Own top scoring financials benefiting from demand deposit growth and inexpensive market share acquisition costs.
Consumer stocks benefit from shrinking input costs while retail prices remain high. Investors will continue to embrace defensive stocks despite short term trading rallies as unemployment spreads.
Healthcare scores have moved below the average score in our universe. Pre-election jitters have returned to the basket. Historically, healthcare outperforms the SPX through the year following the Presidential election.
Basics remain heavy as deleveraging and a strengthening Dollar work against global reinflation efforts. Expect trading rallies in basics back into support, where sellers will re-emerge and drive them back toward lows.
Tech is weakest as investors avoid EPS risk. Bargain hunters will emerge sparking short term trading rallies and short covering. We expect rallies will meet sellers at resistance forcing baskets to retest.
10/6/08
The SPX fell 9.3% last week as the market wrestled over bailouts, GDP risk and a bank bidding war. The Russell 2k put in a new 2008 closing low, as did the NASDAQ and all major market indexes. 1075 is the 61.8% retracement level, roughly ~19% below its 200dma. Volumes were above average yet well below mid September levels. A successful test and close above 1075 sets up a 10% rally.
The number of stocks trading more than 5% below their 200dma is it’s highest since January’s bottom.
Big banks rallied sharply in the past month as investors shifted from “the next bank to fail” to “which banks will succeed”. Embracing under-owned large cap banks is generating significant excess. Money market redemptions are flowing into FDIC insured bank accounts, supporting cash starved balance sheets. Government intervention supports large cap megabanks. Fear of insolvency has become fact of insolvency, allowing investors to speculate on which leaders will thrive post-recession. Buy financials.
Consumer stocks are benefiting from recent price increases and falling commodity input costs. Retailers have had a year to prepare for a lean holiday season. Product mix and inventory levels will separate leaders from laggards in Q4. Own the top scoring only.
Small and mid healthcare stocks score better than large cap healthcare stocks. Big money is rotating away from liquid large cap healthcare. Medical instruments and healthcare plans have the best Q4 seasonality in big cap.
The Dollar hit 2008 highs last week, further pressuring industrials and basics. The USO is challenging its mid September low. Natural gas has been sideways for a month on below average volumes, yet offers positive seasonality on winter inventory builds. Ag supply dropped significantly last week as MOS disappointed, commodity dependent emerging markets questioned future financing and Farmer Mac raised capital to avert a regulator downgrade. The underlying grains do little to add conviction. Remain on the sidelines until they can re-exert.
Technology stocks continue to slide as risk money goes into financials. Semi’s offer short term positive seasonality into late November. Wireless operators also offer upside seasonality. Funding costs are weighing on Telco.
9/29/08
This past week, financials moved into the top spot across our entire universe. The large cap financials, which have scored below the average large cap stock since March, moved above average this week. Small cap financials, which have scored above the average small cap stock since June, remain strong. The next two weeks will test the resiliency and sustainability of the basket. Clearly, have and have-nots are being identified and Darwinistic bets are being made for Q4.
Small regional banks remain disadvantaged by Government regulation. Investors, who sold financials in Q2, are returning to large cap despite continued failures and Government intervention. Volumes were light last week as investors avoided risk ahead of quarter end. Watch early October action closely as short restrictions are lifted and investors return from sidelines.
Despite negative news, financials and homebuilders are performing best in September, suggesting the appetite to sell has abated. Basics have performed poorly, with coal (KOL) and ag supply (MOO) falling –29.77% and -21.60% respectively.
Post election legislation supports larger insured populations, boosting demand for healthcare services, treatment and equipment. Margin pressure drives investment in healthcare IT. Generic sales growth supports biotech M&A as big pharma bolsters pipelines.
Despite EPS contraction and rising job loss, consumer staples and retailers offer upside potential through Q4. In 2002, retail (RTH) rallied 7.2% from the end of September to the end of November. Job loss drives macro risk; forcing inventory and product mix adjustments. Focus on top scoring names in the basket.
Basics remain under pressure as the Dollar finds its footing near support and the global economic slowdown reduces demand. Natural gas offers positive seasonality on winter inventory builds. Ag supply failed to recapture support as underlying grains remain under pressure. Focus on natural gas for basics exposure.
Tech stocks retreated this month as investor’s reduced EPS risk. Semiconductors offer positive seasonality beginning mid October. Use down days to accumulate positions in top scoring names.
posted by Todd Campbell at 3:49 PM
