US markets fell on back to back weeks for the first time since July; the S&P 500 dropped 1.8% and the NASDAQ shed 2.1%. It was a very pleasing week, not so much because the market fell but because for the first time in a long time it seemed as if the markets obeyed some old rules, especially of the technical analysis kind. James DePorre (“Rev Shark”) over at Realmoney.com said as much Friday afternoon:
This time it is looking like the old-fashioned rules of TA may actually be kicking in. We had a light-volume bounce on Monday that quickly failed, and then another leg down on Thursday.
Technically, this is troubling action. We have been bailed out many times in the last few months just when it looked like we were ready to fall apart. Those crazy dip-buyers would aggressively chase the market straight back up and frustrate those who were trying to apply some basic concepts of chart reading. (emphasis added)
While I cannot figure out the rally on Monday on no news, outside of “mark up the quarter to make our books look better than they should be” by institutions, the rest of the week was quite textbook and unlike many months this year, it actually felt like having many years of experience in the behavior of markets actually helped, rather than hindered. Blindly chasing was not rewarded, that’s also a change. All in all, it was a flashback to times when automated computer orders who live in the world of momentum trading did not dominate everything and it was nice.
Since a week ago Friday we had outlined a short term strategy of pressing down on the market on any break below S&P 1040 with a target of S&P 1020 – while Monday’s rally pushed that to the side, it came to fruition this week. The game plan worked to perfection Thursday and Friday and a large part of this period’s profits (every 4 weeks we measure ourselves in a “period”) will have come from a swift foray into put options on the S&P 500 as per our game plan.
So now what? Well it depends if last week was a one week wonder where old rules applied, or if there is an actual sea change. Obviously we have no idea. If it is the former, we’d expect some more bouncing action after a retrace to a key moving average happened last week. If volume is pathetic (as it has been for months on end) this bounce should peter out in the weeks ahead and that should provide a heck of a great shorting opportunity. If however, nothing matters other than liquidity being thrown in the market to drive up nominal asset values while continuing to crush the dollar – then this was just a pit stop to further “prosperity”. Here are the key charts to consider … it really has all just come down to the dollar as we’ve been saying repeatedly.
Last week, the dollar was able to break over one key resistance, obviously getting over $78 would signify more game changing behavior. On the S&P 500 I’d like to add short exposure either on a more significant bounce OR a break down below the 50 day moving average. We’ve lightened up short exposure significantly at the end of the week as the S&P 500 is down 7 of the last 8 sessions and has given back a quick 5%. This is more of a tactical move as we await to see how the market acts, than any bullish condition. S&P 990 remains a key level for us, as a breakdown below that level would create our first “lower low” in many moons.
Everything above has nothing to do with fundamentals or the economy… because frankly technicals have dominated things for much of the past few months. As we like to say in terms of economic or fundamental news it only matters when it matters. I was struck with the reaction to the economic news this past week – MUCH of it was NO DIFFERENT than the news we’ve been getting the previous 2-4 months. But in those time frames market participants were willing to get giddy over “less bad” or vague talk of “green shoots”. One could apply the same precepts to last week’s data set, but this time they were not enough. So once more – the larger question: pitstop to further ignoring of reality and leaning on government to provide the consumption model of the US or change in character as market participants realize green shoots is all about the government ATM replacing the house ATM.
Unlike last week the coming week is light in economic data. ISM services is Monday and really this report should get much more attention, rather than last week’s ISM manufacturing since services now swamp manufacturing in America. It is also much harder for a government program to turbocharge the service economy as opposed to handing people $4500 to buy cars. Consumer credit comes Wednesday, and trade figures are Friday – normally the former figure is a non starter to the market but last month we saw an enormous (record breaking) contraction. We also begin earnings season with the traditional miss by Alcoa (AA). Ok, they only miss estimates 80% of the time… but the following weeks bring the heart of earnings. Which leads us to the next question:
Can just beating analysts expectations (again) be enough, regardless of valuation? What we saw last quarter was stock after stock bid up furiously after losing only 18 cents rather than 28 cents. As long as you beat the analysts estimates it doesn’t matter if your stock was valued at 50-80x forward estimates, you were bid up. I will assume analysts once again underestimate the golden era for corporations – they cut jobs (or outsource them) which drive down expenses; while government steals from future generations to give to consumers today, which helps maintain revenue at some subdued level. Effectively future generations subsidize the entire economy plus corporations profits. I expect a similar outcome this quarter and with the large banks reporting early, and everyone believing balance sheets no longer matter we can clap like seals when banks tell us how much money they make when the Federal Reserve destroys American savers by driving down rates to nothing; allowing banks to print money as long as they turn on the lights in the morning. All those old loans sitting in the dump on the balance sheet? No problemo; we’re just going to keep rates ultra low until banks can earn enough to make all those problems go away. And for the rest of corporate America – see strategy above; slash workforce, beat analyst estimates, receive money from consumer via government – win, win win.
This game will eventually end when analysts, being burned by being too conservative in estimates finally overreach and push expectations to a level companies cannot reach by slashing and burning even more American employees. I don’t think that will be this quarter but something to ponder by middle of 2010. Unless we see real private demand return a real conundrum shall hit the market at that time. So again, the question will be are we willing to bid stocks now valued at 60,70,80x forward estimates up again just because they beat a headline estimate by analysts. This is all that seems to matter around earnings season, so I don’t know at what point people begin to question paying 40x forward earnings for a retailer or 70x forward earnings for an industrial company. The justification of “they’ll grow into those earnings” becomes harder to justify the farther into the stratosphere valuations go.
The stock market’s strong rally is facing its next test as companies gear up to announce third-quarter earnings that, while still weak, will very possibly be better than investors expect.
Earnings in the first two quarters of the year that beat expectations helped propel the market’s recovery, and the prospect of a repeat has even some bears wondering if they have been too pessimistic.
One big reason for the market’s continued strength is that expectations were so low for the economy and corporate earnings that the market was able to rise even on modestly good news.
“If you are expecting to lose a dime and you lost a nickel, you are a winner,” says senior analyst Howard Silverblatt at Standard & Poor’s.
The parade of better-than-expected news began in this year’s first quarter when S&P 500 profits fell 36%. Analysts had expected worse, so 65% of companies exceeded forecasts, according to Thomson Reuters.
In the second quarter, although profits fell by almost a third, 73% of companies produced results that were less bad than expected. That tied the first quarter of 2004 for the highest percentage of companies beating estimates since Thomson Reuters started tracking such numbers 15 years ago, and it helped propel stocks still higher.
Expectations remain low. Analysts forecast a 25% decline in third-quarter profits for companies in the S&P 500 compared with a year ago, not counting charges and special items, according to Thomson Reuters. When the quarter began, analysts had been forecasting a drop of 21%.
For makers of industrial materials, analysts now forecast a 68% third-quarter profit drop. The expected profit decline for energy companies is 64%, for industrial companies, 45%, and for technology companies, 15%, Thomson Reuters says. (emphasis added)
So in the first quarter earnings fell by 36%, and in the second quarter by almost 33%, yet we bid up stocks on “beat the analysts estimate at least!” We’ll see how many more quarters this can continue – due to the continued elevated status of weekly jobless claims it is probable the slashing of jobs will lead to more “surprises” this quarter to the positive for profits. I expect a litany of bad revenue numbers as was the case last quarter, but as a weaker currency helps exports some multinationals should also benefit from that situation.
As always the importance will not necessarily be the news, but the reaction to the news – that is what I’ll be studying in the next 4-5 weeks as we swig Kool Aid and tickle ourselves with green shoots.