Rally now six weeks young...
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Rally now six weeks young...

Week Ending April 17, 2009

Rally six weeks old...
Leaders down... no there back up again...
Earnings, still not real signs of improvement
Treasury sales still falling, so are housing permits & starts


Last Week

Quote of the week
"Anyone who is doing anything sensible right now is either losing money or is out of the market entirely," Quant trader "who is seeing something scary in the capital markets" in article by Tyler Durham.

Rally now six weeks young...
This rally marked its sixth-week birthday this week. Since hitting its low in the first week of March, the S&P500 is up 28% with Financials leading the pack. But that being said, this and most other major indexes are getting really stretched (overbought) and 89% of the stocks in the SPX index are above their 50-day moving averages (DMA), which is the highest level since mid-2006 according to Bespoke. Last week we mentioned that the index was 8% above its 50-DMA and that extended to 9.6% this week. Another challenge that faces stocks this week is that major indexes are getting close to bumping up against key resistance areas that taken together with how overbought stocks are across the board, increases the chances for a correction.

Sectors from Financials to Healthcare have performed very well since the bottom with financials now up nearly 78% with Consumer Discretionary a distant second up 40% over the same period.

Our quote this week comes from a very interesting article entitled The Incredible Shrinking Market Liquidity, Or the Upcoming Black Swan of Black Swans by ZeroHedge's own Tyler Durden. We include a link to the full article on his site in the stories of interest links below.

Technically Speaking
Leaders down, no there back up again...
Last week's Dan Zanger's leaders shot higher which was a good indicator for the overall market. This week Dan's Sunday April 12 portfolio consisted of 14 stocks, 10 of which were leading higher. They are Apple, (AAPL), Bank of America (BAC), Boston Properties (BXP, Goldman Sachs (GS), Intuitive Surgical (ISRG), MasterCard (MA), PNC Financial (PNC), Vornado Realty (VNO) and Wells Fargo (WFC). As you can see from the chart, the led the market lower till Tuesday then took off to the upside passing the Dow Industrials, Emerging Market ETF and Nasdaq Composite. This is mildly bullish for next week except that we are certainly due for a correction from these overbought levels.

Figure 1 - Five-day performance of Zanger's last Sunday pix (green) compared to the S&P500 (SPX), the Dow Jones Industrial Average (DJX), Dow Transports (DTX), Nasdaq Composite (IXIC), Russell 2000 (RUT) and MSCI Emerging Market ETF (EEM). Data courtesy of The Zanger Report, performance chart courtesy of VectorVest.com.

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After steadily dropping for four wee, weekly volumes jumped this week dropped below average for the major indexes as trading volumes on the Dow Jones Industrials and S&P500 Indexes moved back above average. This is somewhat bullish if we see the trend to higher volumes sustained. Rallies require steadily rising volume to keep them going and without it they soon run out of gas.

This week, the Market Volatility Index (VIX) continued to drop. At 33.94 where the VIX ended the week, we are at levels not seen since September 2008. This compares to 36.53 last week and 39.70 two weeks ago. This shows that investors are getting more complacent about stock values and being in the market.

Since rebounding off its December 5 bottom, the 19 commodity NYFE CRB Index continued to hold its own as the index closed at 376.25, off marginally from 376.44 last week. Since hitting a high of 611.51 in July the index is still down 38% from its peak.

After the surge in gold to $1001.10/oz the week of February 20, the precious metal continued to weaken again this week, falling to $869.50/oz, down from $880.50 last week and $894.60 two weeks ago. Volume and open interest continued to fall this week which is also bearish following the second of two tops February 20. Gold still has a long way to drop to confirm the double top so this pattern offers little short-term trading value. From a technical perspective, gold is headed lower.

Meanwhile, after putting in a bottom of sorts five weeks ago, the US Dollar Index continued to firm again closing at 85.98 up from 85.79 last week and 84.16 two weeks ago. Since bottoming in July, the U.S. Dollar Index is up nearly 20%.

Crude oil futures slipped for the first time in seven weeks as a barrel of crude slid to $52.31 from $54.69/bbl last week and $54.68 two weeks ago. Oil is still down nearly 62% from its mid-summer high of $147.20 and the rally remains alive.

However, after falling for the last few weeks, the Baltic Dry Index, an indicator that tracks the cost of shipping dry goods by sea, rose this week to 1682, up 14% from 1478 last week and back above 1678 three weeks ago. This is somewhat bullish both the economy and the price of oil going forward.

The U.S. bank prime rate and the Fed funds target rate held steady following the lasted FOMC meeting at 3.25% and 0.00% - 0.25% respectively while the effective Fed funds rate slipped to 0.14% from 0.16% last week. Meanwhile, the 3-month London Interbank Offered Rate (LIBOR*) slipped again to 1.10188% (from 1.13125% last week and 1.16094% two weeks ago). This compares to LIBOR 52-week high of 4.81875% last October.

On the mortgage front, Freddie Mac mortgage rates slipped this week to 4.82% (from 4.87% last week) for the 30-year fixed mortgage while the one-year adjustable rate mortgage (ARM) firmed again to 4.91% (from 4.83% last week).

*LIBOR is the benchmark for $900 billion in subprime mortgage loans which typically adjust to it every six months. Corporations around the world have the interest rates on roughly $9 trillion in debt pegged to LIBOR and rates on more than $380 trillion in derivative interest rate swaps also are based on LIBOR. About 6 million U.S. mortgages, including the vast majority of subprime home loans as well as 41% of prime ARMs are linked to LIBOR.

Over the last four weeks, analysts have raised earnings estimates for 290 S&P1500 companies while cutting estimates for 772 which works out to a net negative 442 or -32.1%. As we see from the next chart, although this may seem bearish, this trend has been improving (red line) in a positive trend since November according to Bespoke.

Does it mean the worst is over? Unfortunately, Bespoke only presented data going back 18 months so no significant conclusions can be made.

For Q4-08, earnings for roughly 4000 companies were down 280% from Q4-07 so not a lot of hope there. Will earnings tell us when we should start buying again? Problem is, earnings numbers have not provided much in the way of an advance signal that things are getting better or worse in equities markets. This next chart provides a clearer picture.

Chart courtesy of VectorVest.com
As we see from a chart of the 8050 companies that make up the VectorVest Composite Index, improvements in fundamentals did show up before the last rally began in March 2003. Growth to PE (GPE in teal) and Relative Value (RV in blue) both pointed up in advance of the last big rally. However, Earnings per Share (EPS in purple) took a while to recover after the rally had begun. Another metric, Earnings Growth (GRT) not shown on this chart also began to improve in advance of the 2003 rally. Unfortunately as we see from this weekly chart, GPE, RV and EPS have yet to show any positive signs at the far right hand side of the chart. The same holds true for earnings growth. You will notice that for a while after the VVC put in its first bottom in October 2002, the fundamentals continued to worsen. GPE was the first to turn up, followed by RV. Earnings growth (GRT) began to improve in March 2002, well in advance of the March 2003 bottom in stocks.

Although the fundamentals do provide some idea as to whether a rally is sustainable or not, don't expect them to give you advance warning that the worst is over. The same holds true for getting you out before the market tanks.

We will continue to track Relative Value, Growth to PE and earnings growth (GRT) because when the turn up and prices are still heading higher, we will become more bullish. For a more detailed explanation of these and other fundamental metrics, please see http://www.vectorvest.com/definitions/

Economic Reports
Treasury sales drop again and so do housing permits and starts...
After January's record net Treasury international capital outflow of $148.9 billion in short-term securities, the net outflow of $97 billion seemed less serious but still heavy. Foreign demand for short-term securities is watched less closely than demand for long-term securities which was net positive $36.8 billion. However, a continuous drop in the short-term number will indicate that the US is having trouble funding its account deficit with negative implications for the US dollar.

Two important numbers were also released this week - housing permits and housing starts. After a rebound of 6.2% and 17.2% for permits and starts respectively in February, permits fell 9% and starts dropped 10.8% in March. On an annualized basis, that equates to 510,000 started units, down 48.4% from March 2008. Permits have fallen 45% over the same period. Although starts were higher than they were two months ago, indicating the beginning of a possible bottom, permits were lower in March than they were in January. This is bearish for the industry and the housing market in generally given that permits lead starts and new home sales tend to lead existing home sales.

Other metrics we don't follow closely such as the Consumer Price Index declined 0.38% officially even though the unofficial level shows an increase of 7.3% (Shadowstats.com). The official number has a high "fudge factor" and is pretty much useless for investing or trading purposes. It is interesting to note however, that this is the first time the official number has shown deflation in 54 years according to John Williams of ShadowStats.com Meanwhile, core retails sales showed a drop of 1.4% in March.

On the lighter side...
Over the next four weeks, we will be featuring actual answers from a Grade 6 history test. Please watch the spelling... I wonder how many of these students made it into grade 7?

1. Ancient Egypt was inhabited by mummies and they all wrote in hydraulics. They lived in the Sarah Dessert. The climate of the Sarah is such that all the inhabitants have to live elsewhere.

2. Moses led the Hebrew slaves to the Red Sea where they made unleavened bread, which is bread made without any ingredients. Moses went up on Mount Cyanide to get the ten commandments. He died before he ever reached Canada.

3. Solomon had three hundred wives and seven hundred porcupines.

4. The Greeks were a highly sculptured people, and without them we wouldn't have history. The Greeks also had myths. A myth is a female moth.

Stay tuned for the next installment!

Stories of interest this week...

The Incredible Shrinking Market Liquidity, Or the Upcoming Black Swan of Black Swans

S&P 500 Financials Eye First Top Finish Since '93

Goldman Sachs Falls Behind JPMorgan in Debt Race: David Reilly

Percentages S&P500 stocks are above their 50-day moving averages

Working for your wealth,

John M. McClure
John M. McClure, President & CEO
EquiTrend, Inc.

Posted 04-20-2009 8:41 AM by John M. McClure