Leaders languish...
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Leaders languish...

Week Ending May 15, 2009

Rally backs off...
Leaders languish
Earnings continue to weaken
Trade deficit rises, Treasury sales inch higher
Market Yin and Yang
Elliott Wave SPX Perspective

Last Week

Quote of the week
"Even though economics is a very old subject, it has not truly come to grips with the main difficulty, which is the inordinate practical importance of a few extreme events." Benoit Mandelbrot (1983)

Rally backs off...
After nine weeks of gains, the rally finally came to an end this week with all-red across the board for the major indexes. Up 36% from its March 6 low last week, the S&P500 gave back 5% this week but the index is still nearly 6% above its 50-day moving average. And as we see below, earnings continue to decline...

So is this the end of the rally or just a little profit taking?

Technically Speaking
Leaders languish...
Last week Dan's Monday watchlist included 16 stocks of which 13 were breaking out as the group gained 5.4% to end the week. This week only two stocks, namely Ambac Financial (ABK), Hartford Financial (HIG) out of his watchlist of 19 stocks were breaking out and making new short to medium-term highs, a sign perhaps of things to come for the rest of the week.

After steadily dropping from March 20 to April 10 then spiking two weeks ago, weekly volumes for the major indexes were above average for a second week except this time prices fell which is bearish. A rally needs a steady supply of new bulls buying stocks to give it strength but above average volume on falling prices shows net selling. Whether this was some short-term profit taking or marks the return of the bears remains to be seen.

Meanwhile, the Market Volatility Index (VIX) ticked higher as the VIX closed the week at 33.12 from 32.05 last week. Not a lot of fear has yet begun creeping back into the market but this indicator bears watching.

Since rebounding off its December 5 bottom, the 19 commodity NYFE CRB Index has gained ground but the index took a break this week along with equities to close at 393.43 down from 402.37 last week. The seemingly endless supply of cash from governments should continue to have a positive effect on commodities but when it doesn't any longer, look out below. This index us now up more than 23% from its December 5 low after this week's correction.

But gold showed some strength this week. After the surge in gold to $1001.10/oz February 20 then dropping, the precious metal moved higher again this week to close at $931.80/oz up from $917.20 last week and $886.50 two weeks ago. But volume and open interest remain low which is bearish. It is important to point out that gold has a seasonal low in July and then rallies into year-end which may explain why we are seeing some strength in the metal now.

Meanwhile, the US Dollar Index made an attempt to rise this week as it closed at 83.02 up from 82.53 last week but is still below 84.54 two weeks ago. Since its March 6 peak, the U.S. Dollar Index is still down more than 7%.

Crude oil futures joined commodities in slipping this week as a barrel of crude closed at $57.10 from $59.66 last week but up from $54.06 two weeks ago. Oil is still down nearly 60% from its mid-summer high of $147.20 but that gap will be short-lived as long as economic recovery continues.

The Baltic Dry Index, an indicator that tracks the cost of shipping dry goods by sea, surged 15% this week (23% last week) to 2544 from 2214 last week, to a new 2009 high as shipping demand continued to rebound. This is bullish for both the economy and the price of oil but it is important to note that shipping has been quite volatile.

The U.S. bank prime rate and the Fed funds target rate held steady at 3.25% and 0.00% - 0.25% respectively while the effective Fed funds rate slipped again to 0.17% (from 0.19% last week and 0.23% two weeks ago). Meanwhile, the 3-month London Interbank Offered Rate (LIBOR*) slipped again to a new 52-week low of 0.82563% (from 0.9375% last week and 1.00688% two weeks ago). This compares to LIBOR 52-week high of 4.81875% last October.

On the mortgage front, Freddie Mac mortgage rates firmed again this week to 4.86% (from 4.84% last week and 4.78% two weeks ago) for the 30-year fixed mortgage while the one-year adjustable rate mortgage (ARM) eased to 4.71% (from 4.78% last week and 4.77% two weeks ago).

*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.

Earnings - The earnings-deficient recovery continues
Last week we learned that the average Price/Earnings ratio for the 8,011 US stocks of the VectorVest index hit a new all-time high of 130.45. As we see from the next chart, that ratio continued to climb again this week to a new high of 143.5.

Why? Even though stock prices fell, earnings are falling faster on a percentage basis - the VVC fell 4.6% this week while VVC earnings fell from $0.15 to $0.13 per share, a drop of more than 13%.


Figure 1 - The VectorVest Composite (VVC) is an index consisting currently of more than 8000 stocks so provides a more realistic picture of what is going on with the "average" stock as opposed to cherry-picked indexes like the Dow Jones Industrial Average or S&P500. Chart courtesy of VectorVest.com


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At the beginning of the last recovery, April 11, 2003 marked the "golden cross" of the price of the VVC moving above its 40-week moving average and the beginning of a 56-month bull market. As the rally was getting underway in March and April 2003, earning growth (GRT in red) was a much healthier 8% and earnings growth had begun improving nearly a year before after hitting a low of 3%.

This time around as we see from the chart, another golden cross occurred last week but prices failed to penetrate the 40-week MA and dropped lower. If this rally is to survive, two things need to occur. First, the 40-week MA will need to be decisively penetrated. Second, in spite of trillions in stimulus being pumped into markets around the globe, a recovery won't last until earnings begin to recover.

Economic Reports
Trade deficit rises, Treasury sales inch higher
It was a relatively uneventful week for economic reports starting Tuesday with the March U.S. trade deficit that widened to $27.6 billion from $26.1 billion the month before. The rise was due to a 2.4% drop in exports while imports slipped 1%. April export prices fell 0.6% but are down 6.8% year-over-year while import prices rose 1.6% in April but have fallen 16.3% year-over-year.

But the most important report was U.S. Treasury International Capital flows that showed a slight increase of $23.2 billion in foreign investment in March following a revised drop of $91.1 billion in February. As we see from the next chart, international capital flows have declined and are far short of the $200 billion monthly Treasury must sell to pay the current budget deficit (orange dashed line). Until this hole is filled, it will exert upward pressure on interest rates.



Market Yin and Yang
As discussed last week, this is a double-sided market. On one side there are corrective forces at work to bring valuations of numerous asset classes back down to earth after years of ‘bubblenomics' driven by cheap money and highly stimulative monetary policy. On the other side, the tremendous amount of liquidity being that continues to be pumped into economies around the world in attempts to lessen the pain and reflate the bubbles.

One lesson the Presidential Cycle teaches us is the almost unbounded efforts in which governments employ to get re-elected and the subsequent impact those stimulative efforts have had on markets. Bears cannot afford to ignore this undeniable fact - at no time in history has the amount of cash currently being pumped into the economy been greater and the cost of money lower. This is bound to have a stimulative impact on stocks. And based on the latest news out of Washington, the generous programs being offered seem to continue without end (see the latest program outlined in the "Treasury Offers Incentives" article below.) But in spite of this generosity, foreclosures hit another new high last month and the number of U.S. homes with mortgages worth more increased to 20.4 million or 22% of the total residential properties (houses, condos and co-ops) of 93 million homes.

Until earnings begin to recover in earnest and consumers begin to spend with confidence, any rally from here will be difficult at best. The question is, is the government prepared to continue to spend taxpayer dollars until then and if so, how big will the bill get?

Be sure to read the latest ProfitScore IQ that discusses how successful similar methods were during the Great Depression.

On the lighter side...
Good judgment comes from bad experience ... and most of that comes from bad judgment.

Stories of interest this week...

Treasury Offers Incentives for Mortgage Modifications

U.S. Regulators Clash Over Holding Banks Accountable

U.S. Economy: Industrial Production Contracts Less

Global Demand for Long-Term U.S. Assets Rose in March

New York, London Exchanges See Rebound in Listings

Rents Crashing in London to 1991 Prices Le Gavroche Shows Gone

Europe's Economy Contracts 2.5%, the Most Since 1995

Socialist Sanders Taps Anger to Influence Bailouts

Working for your wealth,

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

Posted 05-18-2009 10:55 AM by John M. McClure
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