Equities Close at Multi-Year Highs, Financials Lead in 2011

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

This morning. For the 2nd consecutive day, world equity markets are advancing, primarily on positive sovereign debt sales overnight in Italy and Spain. There are also news reports that Germany will support broader EU financial powers that would permit purchases of member debt and direct lending. In the U.S. equity futures have weakened after a somewhat disappointing initial jobless claims report, with March SPX futures at 1280.40, down -1.86 points after fair value adjustment.

Yesterday, the four major indexes closed near their highs, setting new 2011 and post-Lehman bankruptcy highs, moving through previously tough resistance levels on mixed volume. Market breadth was positive. Markets are in a confirmed uptrend. Distribution days (index losses of more than -0.25%, on increased volume in the past 25 trading days) were unchanged. Next SPX resistance is at 1290.00. Next support is at 1278.78.

click to enlarge images

Asian equity markets closed higher, with Chinese equities higher on lower volume, with strength in insurance and commodity producing stocks. The Nikkei, Hang Seng, and Shanghai closed up +0.73%, +0.47%, and +0.23%, respectively. Volume was -5.68% lower on the SHCOMP. Financials were slightly lower after strong gains the prior day. The SHCOMP is in a confirmed uptrend after a sharp -13.5% decline starting November 9th and ending December 28th. European equity markets are higher on better than expected Spanish and Italian debt auctions. The Eurostoxx50, FTSE, and DAX are up +1.22%, -0.09%, and +0.14%, respectively. On the EuroStoxx, financials are again the standout performers, up +3.18%.

LIBOR trends remain unremarkable. Overnight USD LIBOR is 0.24000%, unchanged from Tuesday, and down from 0.25188% at year-end. USD 3-month LIBOR is 0.30313%, unchanged since January 6th and compared to 0.30281% at year-end. In early trading, the dollar is weaker against the euro and pound, but slightly stronger against the yen. The euro trades at US$1.3195, compared to US$1.3131 Wednesday and US$1.2974 the prior day. The euro’s technical breakdown has eased over the past two days, rising back above its 200-day moving average US$1.3071. The dollar trades at ¥82.93, compared to ¥83.00 Wednesday and ¥83.24 the prior day. The yen is much better than its ¥86.37 200-day moving average. Treasury yields are slightly higher, with 2- and 10-year maturities yielding 0.601% and 3.369%, respectively, compared to 0.601% and 3.365% Wednesday. The yield curve spread widened to +2.768% compared to +2.764% the prior day. 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 mixed petroleum and natural gas, lower precious metals, higher aluminum and copper, and generally higher agricultural prices.

U.S. news. The trans-Alaska oil pipeline reopened yesterday, though at a diminished flow. At 8:30, initial jobless claims for the latest week are released, along with December PPI and November trade balance revisions.

Overseas news. This morning, Spain’s €3 billion 5-year bond auction saw strong demand while yields dropped by -12 basis points. Also this morning, yields fell at Italy’s €3 billion 5-year and €3 billion 15-year bond auctions. German Chancellor Merkel said her country will take whatever steps are necessary to stem Europe’s debt crisis. Today, Standard & Poors said there is a 40% chance Greece will need to restructure its debt. In a surprise move last night, the Bank of Korea hiked rates 25 basis points to cool inflation.

Company news/research:

  • BAC – removed from short-term Top Picks list at Citi, maintains buy rating
  • MS – rated new hold at Collins Stewart
  • GS – rated new buy at Collins Stewart
  • NDAQ – downgraded to buy at Goldman Sachs
  • PNC, BBT – recommended as top 2011 picks at Oppenheimer

Wednesday’s equity markets. After several days’ struggle, the major indexes moved decisively through recent resistance to end at fresh multi-year highs. Markets gapped up at the open, moved higher through the morning, and after some brief weakness in the final hour, rallied to close near the intraday highs. The NYSE composite led other indexes, up +1.30%, followed by the SPX, NASDAQ, and DJI, up +0.90%, +0.75%, and +0.72%, respectively. Volume was mixed, higher on the SPX and NYSE, and lower on the NASDAQ and DJI. Financials, oil and gas, and consumer goods were the best performing market segments, up at least +0.96%. Health care, telecommunications, and consumer services were the worst performers, but all closed higher.

Trading desks reported that despite the strong upward move, trading was quiet, with flows weighted toward ETFs rather than individual names and greater participation from hedge funds than mutual funds. Selling pressures remain slight and short-lived. Financials retained their market leadership.

Technical indicators are positive. Markets are in a confirmed uptrend that began in early September, which after consolidating in November, extended robustly through one of the strongest Decembers on record. All major indexes closed above their respective 200-week and 20-, 50-, 100-, and 200-day averages. Markets are in a bullish configuration, with 50-day moving averages above respective 200-day moving averages. New 52-week highs minus new lows rose to +263 from +212 the prior day. The HILO trend is positive, as the 10-day moving average rose to 185.90, above respective 20- and 50-day moving averages (167.55 and 160.68). Directional movement indicators are positive, and the trend is strengthening. Relative strength indicators suggest that the market is overbought, though markets currently trade at large discounts to average price/earnings multiples. Prospective resistance levels are 1290 on the SPX, followed by 1295, and 1305; technical support is at 1278, followed by 1270, and 1260.

Market volatility fell to the lowest levels since April 15th, the day prior to the SEC suit against Goldman Sachs (NYSE:GS). The VIX declined -3.85% to end at 16.24, compared to 16.89 the prior day. Market sentiment is positive, probably excessively so, though off recent highs. The latest week’s (January 6th) AAII Investor Bullish Sentiment index fell -6.34% to an elevated 52.34, from 55.88 on January 6th, but below the 63.30 reading of December 23rd. Sentiment indicators are highly variable and are often best read as contrarian in their aspect. Despite positive sentiment, there are many market skeptics, too, and they have hardly capitulated, based on endless business network interviews and research that passes this desk.

Financial stocks closed higher, as the XLF, BKX, and KRX rose +1.68%, +1.53% and +0.79%, respectively. In an important technical development, the BKX’s 50-day moving average crossed above its 200-day moving average, for the 1st time since August 16. While the broader indices are near two-year highs and have recovered their post-September 2008 losses, bank stocks have not, with the BKX closing -7.06% below its April highs and -34.8% below its best level of 82.55 in September 2008.

NYSE Indicators. Volume rose +2.08% to 963.92 million shares, from 943.92 million shares Tuesday, and compares to a 989.3 million share 50-day moving average. Market breadth was positive, and up volume led down volume. Advancing stocks led decliners by +1274 (compared to +557 Tuesday), or 2.44:1. Up volume led down volume by 4.80:1.

4Q2010 Earnings. The quarter’s first earnings results have so far exceeded EPS expectations and matched revenue estimates. Of the 4 S&P500 companies that reported earnings to date, 75% (3 of 4) beat operating EPS estimates, versus the historical average of 62%. Companies beat by an average of +17.4% (versus a historical average of +2%). EPS is up +45.8% over the prior year. Though challenged in the current operating environment, 2 companies (50%) reported increased revenues and 2 companies (50%) beat revenue estimates.

Valuation. The SPX trades at 13.5x estimated 2011 earnings ($95.04) and 12.0x estimated 2012 earnings (raised to $107.59 from $107.44), compared to 13.4x and 11.9x respective 2011-12 earnings yesterday. The 10-year average median Price/Earnings multiple is 20.0x. Since the beginning of 2010, analysts increased 2011 and 2012 earnings estimates by +2.8%, and +3.4%, respectively. Analysts expect 2011 and 2012 earnings to exceed 2010 earnings by +18.6% and +34.2%, respectively.

Large-cap banks trade at a median 1.59x tangible book value and 14.6x 2011 earnings, compared to 1.57x tangible book value and 14.5x 2011 earnings yesterday. 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 +34.3%. Analysts’ estimates for bank 4Q2010 earnings are 18.9% higher than were estimates for 3Q2010 earnings. In 3Q2010, large-cap banks earned $13.78 (the sum of 31 banks’ operating EPS), compared to $5.32 in 3Q2009. In 3Q2010, the BKX earned $0.71 per share, compared to -$1.24 per share a year earlier.

Quarterly Bank Balance Sheet Analysis. According to the Federal Reserve’s latest weekly H.8 report (data through 12/29/10), the 25 largest domestic banks collectively reported a +1.0% increase in period-end loans over the third quarter, a -6.3% drop in reserves (to 3.81% of total loans, or a -$10.2 billion drop from the prior quarter), and a +3.4% increase in deposits.

Regarding loans, C&I loans increased approximately +2.2% over the third quarter levels, residential real estate climbed +2.0%, and credit card loans increased +1.2%, while home equity loans declined -3.9% and commercial real estate loans declined -3.2%.

SPX. On higher volume, the SPX rose +11.48 points, or +0.90% to 1285.96, setting a new two year high. Volume rose +3.25% to 735.08 million shares from 711.83 million shares Tuesday, below the 777.12 million share 50-day moving average. For the 59th consecutive day, its 50-day moving average closed above its 200-day moving average (1230.00 versus 1150.48, respectively). The SPX closed above its 200-week moving average (1183.88).

Like Tuesday, the SPX gapped 6 points higher at the open, reaching 1282 by 9:40. Strength in Europe, and financials in particular, fueled gains. The index rallied straight through the morning, breached 1286 by 11:20, and set the intra-day high of 1286.87 at 12:30. After trading sideways through the Fed’s 2:00 Beige Book release, the index sold-off slightly at 3:00. Buyers bought, and the index rallied to finish near its intra-day high. The index closed +4.55% above its 50-day moving average, closing above that average for the 91st consecutive day, and +11.78% above its 200-day moving average. The 20-, 50-, 100-, and 200-day moving averages rose.

Technical indicators are positive. The SPX closed above its April highs for the 29th straight session, above 1270 for the fifth time in the previous six sessions, and above 1280 for the first time since August 2008. The directional momentum indicator is positive, with an increasing trend. Relative strength rose to 75.63 from 70.70, an overbought range. Next resistance is at 1290.00; next support is at 1278.78.

BKX. On higher volume, the KBW bank index closed at 53.86, up 0.81 points or +1.53%. The index closed +25.31% above its August 30 closing low of 42.98, the trough of the recent prior correction, but -7.06% below its April 23rd closing high.

Financials performed best in the market, and large-cap banks outperformed regionals. A positive Portuguese debt auction fueled financials’ outperformance in European trading, and U.S. financials rallied in kind. The BKX gapped higher at the open, rising 1.65% in the first five minutes, to an intra-day high of 53.94 at 9:35. Small profit taking followed the opening bell surge, and the index retreated to 53.60 by 10:00. Buyers stepped in and returned the index to the 52.90 level by 11:15. Sideways trading took the index through 3:00, where the broader market sell-off sagged the BKX to 53.70. The 3:30 dip-buying rally lifted the index into the close. The index closed above 50 for the 17th straight day. Volume rose 37.33% to 148.47 million shares, up from 108.10 million shares, and below the 158.58 million share 50-day average.

Technical indicators are positive. The BKX closed above its 20-, 50-, 100-, and 200-day moving averages (52.13, 49.17, 47.62, and 49.10, respectively), closing above the 200-day average for the 25th straight session. The 20-, 50-, 100-, and 200-day averages all increased. The 50-day moving average closed (by +0.07 points) above the 200-day moving average. The 50-day average was last above the 200-day on August 15th 2010. The last “golden” cross (the 50-day crossing the 200-day to the upside) occurred on August 4th, 2009. August 2009 saw the BKX’s best monthly percentage return (+16.86%) since March of 2000 (+17.48%). The directional movement indicator is positive, with a stable trend. Relative strength rose to 68.09 from 64.01, the high end of a neutral range. Next resistance is 54.19; next support at 53.27.

Disclosure: I am long BAC, MS, GS, PNC.