Financials Lead in Light Trade, Futures Point Higher

Includes: DIA, KBE, KRE, QQQ, SPY, XLF
by: Gary Townsend

After Monday’s mixed session, equity futures are slightly higher, with March SPX futures at 1255.60, up +2.66 points after fair value adjustment. Markets are in a confirmed uptrend. Distribution days number 2 on the SPX and NYSE and 3 for the NASDAQ. Due to the weekend mid-Atlantic snowfall, volume was the lightest since the post-Thanksgiving curtailed trading day. It is likely that volumes will accelerate only after the New Year. Next SPX resistance is at 1260.15. Next support is at 1253.20.

Asian equity markets closed lower. The Nikkei, Hang Seng, and Shanghai indexes closed -0.61%, -0.93%, and -1.74%, respectively, as rate concerns push regional stocks lower, with the SHCOMP correcting -12.7% below its recent November 8th high. Equity markets are closed in the UK, Australia, and New Zealand for Boxing Day. Other European equity markets are up. The Eurostoxx50, CAC, and DAX are +0.29%, +0.41%, and DAX +0.09%, respectively. On the EuroStoxx, financials are middling performers, up +0.37%.

London interbank lending is closed, leaving overnight USD LIBOR at 0.24438% and USD 3-month LIBOR at 0.30281%. In early trading, the dollar is weaker against the euro and yen, while strengthening slight against the pound. The euro trades at US$1.3239, compared to US$1.3165 yesterday and USD$1.3122 on December 24th. The dollar trades at ¥81.99, compared to ¥82.81 Monday and ¥82.88 on the 24th. U.S. Treasury yields are mixed, with 2- and 10-year maturities yielding 0.680% and 3.320%, respectively, compared to 0.639% and 3.329% Monday. The yield curve spread narrowed to +2.640% from +2.690%. In the past year, the 2- and 10-year spread has varied from a low of +1.959% on August 26, 2010, and a high of +2.90% on January 11, 2010. Commodities are mixed, with higher petroleum and lower natural gas, higher precious metals, lower aluminum, higher copper, and mixed agricultural prices.

U.S. news. Economic reporting was light yesterday, with the 9:00 release of the October Case Shiller home price report, and at 10:00, weekly consumer confidence, and the Richmond Fed manufacturing index.

Overseas news. Tuesday, France revised down its third-quarter GDP growth to 0.3% from an initial 0.4%. The People’s Bank of China set the mid-point for the yuan’s peg at a record high, signaling a fresh round of appreciation. In November, Japan’s industrial production rose 1.0% over the prior month, the first monthly increase since May.

Company news/research:

· Ally Financial – ResCap unit settles outstanding Fannie Mae (OTCQB:FNMA) put-back claims for $462 million on loans totaling $292 billion in original unpaid principal balances or $84 in current unpaid principal balances. The settlement represents 0.015% of the original unpaid principal balance, 0.50% of current unpaid principal balance, roughly in-line with Ally’s specific reserves.

Monday’s equity markets. Equity markets shrugged off negative news and bounced impressively off early lows to close mixed, as the SPX and NASDAQ rose +0.06%, while the DJI and NYSE composite ended -016% and -0.06%, respectively. Holiday light volume was made worse by the weekend’s mid-Atlantic snowstorm. In December, the NASDAQ leads the other major indexes, up +6.77%, compared to the SPX, DJI, and NYSE, up +6.52%, +4.99%, and +6.59, respectively. Financials were the day’s best performing market segment, ending +1.01% on the day. BAC was among the best performers, rebounding +1.61% after Thursday’s sell-off. Most of the segment strength came early in the day. BAC may have benefited modestly from news at 3:00, that Ally Financial Inc., the auto and home lender majority owned by the U.S. government, had reached a $462 million settlement to resolve mortgage repurchase claims by Fannie Mae on $292 billion in home loans, immaterially exceeding associated reserves. This news suggests that BAC, JPM, and WFC mortgage putback costs may be substantially lower than many analysts’ estimates.

After a surprise Chinese rate increase, U.S. equity markets gapped several points lower, but quickly found support and rallied throughout the day to close near the day’s highs. The NASDAQ and SPX moved into positive territory shortly after 1:00, and then traded flat through the close. Trading desks generally cited the same ongoing themes: 1) little in the way of high-conviction trades; 2) bullish and complacent investor sentiment; and 3) a bid on weakness. Financials’ outperformance has allowed other sectors to consolidate earlier gains despite individual earnings disappointments.

Technical indicators are generally positive. All major indexes closed above their respective 200-week and 20-, 50-, 100-, and 200-day averages. Markets are in a generally bullish configuration, with 50-day moving averages above respective 200-day moving averages. Directional movement indicators are positive, and the trend is strengthening. The principal negative is that short-term relative strength indicators are have moved into the lower end of an overbought range. Prospective resistance levels are 1259 on the SPX, followed by 1265 and 1280; technical support is at 1250, followed by 1242, and 1234.

Market volatility spiked early Monday, with the VIX soaring to 18.32 from 16.47 at Thursday’s close, but trailing off throughout the day to end at 17.67, up +7.29%. Market sentiment is positive, probably excessively so. The latest week’s (December 23rd) AAII Investor Bullish Sentiment index is elevated, up +26.0% to 63.30 from 50.23 on December 16th. This is the highest reading since 2004. Sentiment indicators are highly variable and are often best read as contrarian in their aspect.

Financial stocks closed higher, with the XLF, BKX, and KRX ending +0.88%, +0.95%, and +0.85%, respectively. While the broader indices are at or near two-year highs and have recovered their post-September 2008 losses, financial stocks have not, with the BKX closing -9.82% below its April highs and -36.7% below its best level of 82.55 in September 2008.

NYSE Indicators. Volume was snowstorm and holiday light, down another -24.0% to 467.6 million shares, from 615.47 million shares Thursday, and a fraction of the 1.032 billion share 50-day moving average. Market breadth was positive, and up volume led down volume. Advancing stocks outpaced decliners by +439 (compared to -119 Thursday), or 1.24:1. Up volume led down volume by 1.28:1.

3Q2010 Earnings. Earnings results have generally exceeded EPS and revenue expectations. Of the 492 S&P500 companies that reported earnings to date, 76% (373 of 492) beat operating EPS estimates, versus the historical average of 62%. Companies beat by an average of +6.5% (versus a historical average of +2%). EPS is up +30.7% over the prior year. Though challenged in the current operating environment, 394 companies (80%) reported increased revenues and 303 companies (62%) beat revenue estimates. With all 24 BKX members reporting, 79% (19 out of 24) beat operating EPS estimates, with a +25.3% average operating EPS surprise. Bank revenues disappointed slightly, missing expectations by -0.30% on average.

Valuation. The SPX traded at 14.7x estimated 2010 earnings ($85.30) and 12.9x estimated 2011 earnings ($97.18), compared to 14.7x and 12.9x respective 2010-11 earnings Monday. The 10-year average median Price/Earnings multiple is 20.0x. Since the beginning of the year, analysts increased 2010, 2011, and 2012 earnings estimates by +11.9%, +5.1%, and +5.7%, respectively. Analysts expect 2011 and 2012 earnings to exceed 2010 earnings by +13.9% and +28.9%, respectively.

Large-cap banks trade at a median 1.53x tangible book value and 14.3x 2011 earnings, compared to 1.51x tangible book value and 14.2x 2011 earnings Monday. These compare to the 10-year average median multiples of 3.08x tangible book value and 15.9x earnings. Analysts expect 2011 large-cap bank earnings to exceed 2010 earnings by +33.8% and expect 4Q2010 earnings to exceed 3Q2010 earnings by +21.8%. In 3Q2009, large-cap banks earned a combined $5.91 per share while the BKX Index earned -$1.24 per share. In 3Q2010, large-cap banks earned $13.78 and the BKX earned $0.71 per share.

SPX. On post-Christmas week-light volume, the SPX rose +0.77 points, or +0.06% to 1257.54, just shy of the 1258.84 two-year high set last Wednesday. Volume fell -21.1% to 355.47 million shares from 450.75 million shares Thursday, well off the 824.11 million share 50-day moving average. For the 47th consecutive day, its 50-day moving average closed above its 200-day moving average (1208.91 versus 1144.28, respectively). The SPX closed above its 200-week moving average (1185.69).

Perhaps on China’s liquidity tightening, the SPX gapped -5 points lower to 1251.48, the intra-day’s low. Early financial sector strength lifted the market, which recovered most of their losses by 10:30. Sideways trading took the markets through noon, when a brief rally at 1:00 pushed the SPX into positive territory. Testing resistance at 1258 through the afternoon, the index closed at 1257.54, up 0.77 points and just off its 3:45 intra-day high of 1258.43. The SPX closed +4.02% above its 50-day moving average (1208.91), closing above that average for the 79th consecutive day, and +9.90% above its 200-day moving average (1144.28). The SPX closed above its April-high closing level of 1217.28 for the 17th straight session. The 20-, 50-, 100-, and 200-day moving averages rose.

Technical indicators are positive. The SPX closed above its April highs for the 17th straight session. The directional momentum indicator is positive, with a stable trend. Relative strength rose to 70.72 from 70.41, an overbought range. Next resistance is at 1260.15; next support is at 1253.20.

BKX. On lower volume, the KBW bank index closed at 52.26, up 0.49 points, or +0.95%, and retracing Thursday’s losses exactly. The index closed +21.59% above its August 30 closing low of 42.98, the trough of the recent prior correction, but -9.82% below its April 23rd closing high.

Financials were the best performing market segment, and large-cap names outperformed regionals. Like the SPX, the BKX opened lower to 51.50, its intra-day low, but reversed violently and climbed +0.70 points by 10:00 to 52.20 and further to 52.29 by 10:30, the intra-day high. The index consolidated gains through 11:00, dropping back to 52.10 and hugging that level through 2:30. A small rally took the index back above 52.20, where it remained through the close. The BKX finished at 52.26, near its intra-day high and up +0.49 points to overtake its Wednesday close. The index closed above 50 for the 6th consecutive day. Volume fell -39.5% to 67.57 million shares, down from 111.75 million shares Thursday, and below the 166.24 million share 50-day average.

Technical indicators are positive. The BKX closed above its 20-, 50-, 100-, and 200-day moving averages (49.25, 47.43, 46.87, and 49.03, respectively), closing above the 200-day average for the 13th straight session. The 20-, 50-, 100-, and 200-day averages all increased. The 20-day moving average crossed above the 200-day for the first time since August 11th. The 50-day moving average closed (by -1.61 points) below the 200-day moving average, as it has since August 16th. The directional movement indicator is positive, with a strengthening trend. Relative strength rose to 69.67 from 67.81, on the cusp of an overbought range. Next resistance is 52.53; next support at 51.74.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.