Weekly Recap & Outlook – 07.16.10

Tower Private Advisors

Prior posts

Below

  • Lousy week for the first week of earnings season.  Good earnings = stocks down
  • More ammunition for double-dippers

Capital Markets Recap

(as of 2:27)

Please note the spike in Implied Volatility.  Also known as the Fear Index, what used to go by the ticker VIX (now VXO) measures the expected volatility based on option prices.  Option prices are a function of the following factors:

D – dividends

I – interest rates

V – volatility

U – underlying stock price

T – time

S – strike price (the price at which the option can be exercise)

Those initials made a great mnemonic aid in one of the CFA exams, and five of the six factors in the acronym are easily known . . . all but volatility.  From algebra you’ll recall that with just one unknown, it’s easily solved for.  While options can be used for both speculation and protection it seems that their prices move most violently when they’re bought for protection.   When put options are bought for protection their prices rise, while all of the factors remain fixed or at least known.   Therefore, what changes is their implied volatility.  It goes up.  Thus, the Fear Index.

The VIX is a contrary indicator.  As it rises it should push one closer to being bullish.

Here’s a simple technical look at the S & P 500.  With this week’s action we’ve made the third lower high (labeled LH on the chart).  Coupled with two lower lows (labeled LL on the chart), that makes for a downtrend.  The horizontal lines are previous areas where either buyers (red) or sellers (dashed white) have stepped in with enough force to overwhelm the selling or buying (circled areas).

Admittedly simple, the chart does present us with a straightforward lens through which to view the action:

  • A decline that drops through1043 is likely headed to 1011.
  • A decline that drops through 1011 confirms the downtrend and likely heads points us toward 900 – time to sell some stocks.
  • A reversal–like this week’s–that stops short of 1011 is an alert that the trend is reversing upward.  Ideally, we would want to see some basing action above 1011, rather than a V-shaped bounce.  It’ll set us up for a bullish, inverted head-and-shoulders pattern.  If it plays out, it’ll target 1200.
  • A more aggressive strategy might include making some buys with the S & P 500 around 1011 and making some sells around 1100.  In effect, taking advantage of the apparent summer range.

Top stories

If you hadn’t heard, the second quarter earnings reporting season started in earnest this week, kicked off by Alcoa.  So far just 23 of the companies in the S & P 500 have reported.  It’s been overwhelmingly positive (20 positive surprises, 3 negative) but from a really small sample.  129 of the companies will report next week.

  • Alcoa‘s earnings were better than expected
  • Intel reported blowout earnings, its best quarter in a decade.  Analysts looked for revenues of $10.3 billion; the company reported $10.8. 
  • GE reported earnings that beat estimates, helped by better results in its finance unit, but its sales came up short.
  • Bank of America beat the GAAP earnings estimate but came up short on the adjusted number.  The stock is down (-)9.5% from last night’s close.
  • Citigroup knocked the ball out of the park, beating the GAAP and adjusted numbers by 63% and 83%, respectively.  Stock down 5.5%.
  • Goldman Sachs came to a settlement with the SEC . . . cool $500 million.  Stock up 7.3% from the announcement.
  • Apple says its “working our butts off” to address the iPhone4′s antennae problem.  It might want to spend some time listening to engineers who point out these problems before they arise.  Buyers of the three million phones will get a free case that addresses the problem.

Bloomberg reported that “Consumer Confidence in U.S. Slides, Heightening Risk of Economic Slowdown.”  Sorry, folks, that should have read “Consumer Confidence in U.S. Slides, Reflecting Risk of Economic Slowdown.”  At best, consumer confidence is a coincidental–occuring at the same time–indicator, not a leading indicator.

The much-ballyhooed Financial Regulation bill passed through Congress, and the President is expected to sign it next week.  Despite at least one poll that said 4 of 5 don’t think it’ll prevent another financial crisis or protect them (what do those four know, anyway), and despite misgivings by the solons in Congress (“well, it’s not perfect, but . . . “), those faithful stewards of our nation insist it’s good enough to sign.

Ever hear of “technical correction bills?”  Neither had I, but our Strategas service had this to say this morning about them.

Financial Regulation: The Senate passed the final financial regulation bill yesterday and President Obama is expected to sign the measure next week. The details will be filled in over the next few years through regulatory rulemaking and through “technical corrections” bills that could potentially make substantive changes to key provisions. Think Reg Reform Is Done? Just Wait for the ‘Corrections’ Bill: Top lawmakers have acknowledged another bill will be needed to clean up their bill to overhaul the financial system, in which many complicated provisions were decided near the end of a marathon 20-hour session…But how far the corrections bill could go remains a question. Some said it may be confined to technical changes to better reflect congressional intent; others see an opportunity to make more substantive alterations… Even a change as simple as inserting or striking a word could have a big impact and once any corrections bill delves into making substantive changes, every interested lobbying group will be going to the mat for its issues. (American Banker, 7/16).  (Underlining is mine.)

 And this to say about Goldman Sachs:

GS/SEC Bookends: You’ll read a lot about the timing of the Goldman Sachs settlement today. We will leave the conspiracy theories to others. Goldman Settles SEC Suit for $550 Million: It’s interesting to note the timing of both the beginning and now the end of this case. Goldman was formally charged right around the time when the public was beginning to take interest in financial reform. The case made for the perfect narrative of an evil Wall Street firm that needed to be reined in with thoughtful regulation from Washington. And when did the case end? The settlement was announced a few hours after Congress passed the financial reform bill, sealing the legislation’s fate. So there’s no longer any reason to make an example of Goldman. (The Atlantic, 7/15).

So Tiger Woods’ wife gets $750 million, the SEC gets $500 million.  Is that right?  I mean right?

This week

Folks looking for evidence of a double dip in the economy–the feared second V in W–found it this week in the Empire State Manufacturing and Philly Fed indexes.  The former dropped from 19.57 to 5.08; the latter fell from 8.0 to 5.0.  Both were significantly below estimates.  As the chart below attests, however, neither index has much predictive ability–about as much as a broken clock.  Say 2:00 long enough and soon you’ll be right.

All of this is beginning to wear on the consumer.  University of Michigan Consumer Confidence fell sharply, from 76.0 to 66.5, far below economists’ expectations of 74.0. 

NFIB Small Business Optimism didn’t do much to counter the message from the regional indicators, falling, as it did from a recent near-term high.  There’s no question that the economy has run into a soft spot, only that some of the indicators don’t have a very good track record.

That housing is in for a double dip seems more of a certainty, both from anecdotes and from solid data, such as the recent mortgage activity.  Despite record low 30-year mortgage rates (green line), Mortgage Applications for refinances (orange) and purchases (white) fell again this week.  This is a mini-version of what John Meynard Keynes called a liquidity trap.  Rates can be pushed ever lower with no resulting spurt in economic or mortgage activity.  While probably overused, no cliche works as well to describe the phenomenon as “pushing on a string.”

Those watching for lurking inflation will need to look around the next corner because it didn’t come this week.  The Producer Price Index fell to a 2.8% annual rate and just 1.1% when looking at Core PPI.  Prices at the consumer level were similarly subdued in June.  The headline Consumer Price Index slowed to a 1.1% annual rate and, net of food and energy prices, stayed at a 0.9% annual rate.

Next week

Housing, housing, housing

Key indicators to watch

  • National Association of Home Builders Housing Market Index (July) – Monday
  • Housing Starts (June) – Tuesday
  • Building Permits (June) – Tuesday
  • Initial Jobless Claims (weekly) – Thursday
  • Existing Home Sales (June) – Thursday
  • House Price Index (May) – Thursday
  • Leading Economic Indicators (June) – Thursday

Graig P. Stettner, CFA, CMT

Vice President & Portfolio Manager

Tower Private Advisors

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2 Responses to “Weekly Recap & Outlook – 07.16.10”

  1. Larry Dent says:

    I am holding muni funds. They are scattered among Nuven, Blackrock, Pimco and several others. All are leveraged around 40% or so.

    Any comments on the likely hood of muni’s starting to default?

  2. Although the problems with munis should be pretty isolated–rather than across the entire asset class–now would probably be a pretty good time to get comfortable with what those funds hold. I assume they’re closed-end funds since you mention leverage. Consquently, you can find their holdings on the internet at, among other places, http://www.cefconnect.com. When you jump to a fund there’s a “Portfolio Characteristics” tab where you can see top holdings and characteristics of the fund. Pay especial attention to the Credit Quality graph. If you want to see more you can jump to the SEC Filings and look at the detailed holdings. One fund I looked at had 26.3% in New York and 15.9% in California bonds, so you might be able to spot some potential trouble spots and shift to safer funds.

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