Weekly Recap & Outlook – 01.22.10

Tower Private Advisors


  • Stock markets correcting
  • Companies beating earnings estimates
  • Housing wilting

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Capital Markets Recap


Today’s Action

Today’s sell-off accelerated as the day progressed.  Traders don’t want to take their positions home over the weekend.  This week’s decline has not been met with buyers, which have, in the past, stepped in to prop up markets.  The decline has been largely in line with Beta, where those most volatile sectors have fallen the most.  Here’s a look at a heat map for the S & P 500 from the excellent FinViz (Financial Visualizations) website.  (Click to expand.) The brighter the red, the bigger the loss.   There’s a helpful legend at the bottom, but you won’t need most of it. 


Here are the sector results for today, numerically.  Not surprisingly, the three best performing sectors were the of the defensive variety.  The lone defensive sector in the bottom half was the utilities group.


 This Week’s Action

Well, it was bound to happen.  We’re in the midst of a correction, which is the euphemism for “your stocks are going down.”  Since this–as we term it–bear market rally began in March 2009, we have yet to suffer a 10% correction.  Such corrections are usually healthy, as they shake out marginal holders and work off some speculative froth.  They’re healthy so long as they don’t do too much damage.  The only damage done by the present drop has been a violation of the trendline begun last March, as the picture below shows. 


We’ve also taken out the 55-day moving average decisively, which is precisely where yesterday’s low was stopped.  Foray’s below that moving average have been few since the March bottom, and where the foray was decisive it stopped and reversed at the 200-day moving average.  Trouble is, it’s another 7.4% below.

To get some idea of where we might expect/hope the decline to at least pause I’ve added some other charts below.  The first one shows the level that proved to be support back in November.  For whatever reason, buyers were willing to step in and buy at 1,083.80 on the S & P 500.  That level is another 23 points (2.1%) away.


Here’s a chart the shows the Fibonacci retracements of the advance from March 2009.  This is one of my favorite ways of gauging pullbacks, partly because it engenders such ridicule.  I’ve highlighted three areas below that will surely–at least temporarily–stop the decline in its tracks.  The 23.6% retracement of the advance is the top red rectangle, which is, coincidentally, also a 10% correction.  That combination gives me a high level of confidence that we’ll at least pause there.  The always-important 200-day moving average is the next rectangle lower, and below that is the important reciprocal of the Golden Mean, the 38.2% retracement.


For now, this is the bottom lineFor investors, there is no reason to bail out.  This should be a garden variety correction.  One of our key services, named after its eponymous founder, but which doesn’t care to have client’s mentioning hisits name in a blog, is still advising a maximum overweight stock position.  Our other key service, BCA Research, is similarly overweighted to stocks.  For traders, it’s time to lighten up, but not panic.

Speaking of panic, it’s closely related to fear, and stock market fear is measured by the CBOE’s Volatility Index.  Since last March it has trended downward, dropping below 20 this month.  It has shot up by 31.6% in the last two days, as the chart below shows.  In the process, it blasted through the 200-day moving average, suggesting the trend might begin to be upward.


Top Stories

We’re in the thick of earnings releases for the fourth quarter, and they’ve been nicely positive.  You might recall that analysts massage their earnings forecasts as the quarter progresses, largely in response to management guidance.  Combining all of the analysts produces a consensus estimate of a company’s quarterly earnings.  That’s the number that is compared to the actual release.  Then, if a company’s earnings . . .

  • equal the estimate, it’s called “meeting” the estimate;
  • come up short, it’s called “missing” the estimate; and
  • exceed the estimate, it’s called “beating” the estimate.

The two latter types are called negative and positive earnings surprises, and they tend to produce similar responses in the stock prices.

The companies, of course, are aware of this, and with bonuses for the chieftains often tied to the stock’s performance, there is a decided benefit to beating the estimate.  The easiest way to do that–an obvious one for the cynics among us–is to provide guidance to analysts that is less optimistic than it should be.

So here we are, with 13.4% of S & P 500 companies having reported earnings.  So far, 76.9% of the companies have beaten estimates with an average surprise of 21.09%.  In the third quarter, 84% of the total 500 had beaten earnings by an average of 13.55%.

. . . and stocks are getting creamed.  What’s up with that?

Call it expectations.  A very good quarter has been priced into stocks.  That is, their prices already reflect a good quarter.  To truly surprise investors, the reports have to be near perfection, which means that not only earnings beat, but revenues beat, and, most importantly, the outlook for next quarter is upbeat.  Miss one of those, and your stock is toast.

Goldman Sachs seemed to have done all that, but the stock falls by 8.77%.  That all began to happen yesterday morning, when the President announced plans to resurrect a version of the Glass Steagall act, which separated investment banking from traditional banking.  Goldie, it seems, will be most hurt by losing its Prop (proprietary) Trading desk revenues.  The reaction might have been overdone, as the bill does have to wend its way through Congress, and that august body of solons receives a truckload of campaign funds from the golden geese, which are the investment banks. Still, after the drubbing that one election in Massachusetts seems to have handed to the current bunch in Washington, it might eventually become clear to them that there is just a wee bit of anger among the people.  What better way to appease that anger–well, other than slowing down spending, pulling back on the jam-it-down-your-throat healthcare plan, etc.–than to stick it to those most easily blamed for all that ails the world, the bankers?

Here’s a look at some of the week’s top stories, lifted from the Bloomberg terminal.

  • Kraftis likely to win the bidding war for Cadbury
  • Tyco is purchasing Brink’s Security
  • IBM topped its earnings and revenue estimate; stock gets pounded
  • Ebay‘s profits were higher than expected; every dog has its day, and the stock rises
  • China begins to tighten some lending policies to throttle back some of that country’s growth.  They seem to recognize, until the entire Federal Reserve, that a bubble might be forming there.  Rumor’s of China’s demise are, however, greatly exaggerated.
  • Google missed its earnings estimate, which only accelerated the decline from its January 4 peak.
  • General Electric beat its earnings estimate; shares rise modestly

This Week

Cut to the chase:  economic news is, on balance, pretty good, but it’s already baked into earnings estimates.  Housing data suggest all is not well there.

Both Consumer and Producer Price Indexes showed continue, subdued inflation.  At the consumer level, prices rose by 2.7% year-over-year (1.8% core).  At the producer level, prices rose by 4.4% on a year-over-year basis (0.9% core).  We continue to believe that inflation will be subdued for some time because of the tremendous slack in the economy.  In my recent survey, which you might have (thank you) completed (a pox on your house if you didn’t), 57.1% of respondents thought it was a 2011 problem, and another 34.3% thought it was a problem for beyond 2011.

Housing is beginning to look weak again.  In December, Housing Starts were weaker than expected, although Building Permits rose sharply.  It’s easy to see how Starts can drop, depending on the weather, so maybe we should discount that weakness, and Permits, which don’t require thawed soil, might be the better indicator.  Ask the builders, though, and it got worse in January, according to the National Association of Home Builders survey, whose members, on average, felt worse than in December and worse than economists expected.  The survey has given up fully half of its gains since the depths of 2009.

Broad measures of economic activity improved, generally.  The Empire State Manufacturing survey perked up a bit.  Capacity Utilization improved by a rounding error, and the Leading Economic Indicators improved above expectations and the November level.  The Philly Fed survey, however, did not join in the festivities, and it continued its decline.

We watch sentiment toward stocks quite closely as, at extremes, it’s very painful to ones portfolio to follow the crowd.  Sentiment toward stocks has gotten quite optimistic of late, although the last three days action should reduce the froth a bit.  Where there hasn’t been optimism, however, is with respect to the economy.  The ABC Consumer Comfort survey looks downright depressing, while the University of Michigan Consumer Confidence survey only looks slightly better.

The shocker for the week was the report of Initial Jobless Claims, which rose by 38,000–make that 36,000 from an upwardly-revised number from last week.  As I understand it, there was also a huge increase in the number filing for Emergency benefits, for those who have been sidelined for longer than the usual 26 weeks–up to an additional 20 weeks of benefits.

Next Week

It’s an action-packed week, with a focus on housing.  Combined with a rate decision and announcement from the Federal Open Mouth Committee and heavy company earnings, it’ll be a week with plenty of potholes for stocks to fall into.

MondayExisting Home Sales are released.  Economists look for a 9.8% decline from November to December.

Tuesday – theS & P/Case Shiller Home Price Index is released.  It’s expected to have risen modestly, and the year-over-year decline is expected to have moderated from -7.28% to -5.00%.  This data will, however, only be through November.  Later in the day, the FHA will release its Home Price Index, the widest measure of home prices in the U.S.  It’s expected to have ticked up by 0.1%.

WednesdayNew Home Sales are announced. They’re expected to have risen by 4% in December.  That will be a yawn since at 2:15 in the afternoon the Federal Open Markets Committee will announce its rate decision (i.e. nothing), but, more importantly, release its statement regarding risks to the economy and inflation.  The Fed governors had been getting more vocal in their between-meeting dissent.  In short, some of the inflation hawks are beginning to express concern that the inflation spring is being increasingly compressed.

Thursday – the report of Durable Goods Orders is released.  It comes in headline and excluding-transportation orders forms.  The headline figure is expected to be +2%, while the ex-transports figure is expected to be +0.5%.  Both indexes are, just now, improving to the worst levels of the last ~40 years.  Initial Jobless Claims will be released, and economists increased their estimate for this week by 10,000.  They seem to think, as is often the case, that seasonal factors were to blame for this week’s blowout increase.  Last week’s figure was revised upward slightly, and that’s an important consideration, as well.

Friday – we get the first look at Q4 GDP, and it’s going to be a strong one.  Economists expect economic growth in the fourth quarter was 4.6%.  The range of estimates, however, is HUGE, ranging from 2.5% to 7.5%.  Both the median and mean estimates are 4.6%.  Naturally, there are multiple components to the GDP report, with some of them being of lesser quality; some of higher.  Those aspects of the report will be carefully examined.  A key focus will be the impact of inventory restocking.  It’s been much talked about as the savior of GDP but hasn’t been in evidence in the various inventory reports.  A couple of regional economic reports come out (Chicago and Milwaukee Purchasing Managers indexes) afterward, and the week is wrapped up with the University of Michigan Consumer Confidence report.

Graig Stettner, CFA, CMT – Vice President & Portfolio Manager – Tower Private Advisors


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