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U.S. Futures Drift Lower as Euro Euphoria Wanes, Reality Bites

|Includes:BAC, C, GS, JPM, MET, MF Global Holdings Ltd. (MFGLQ), MS, SBNY
This morning.  The U.S. equity markets are in a confirmed uptrend.  This morning, equity futures are modestly lower, but off their worst levels of the morning. One focus is funding problems at MF Global (MF, assets of $40 billion). Overnight, Moody’s cut the company’s debt to junk, suggesting that a sale of the company may be immediately necessary to avoid failure this weekend. Another is an FT headline that China will “likely” invest $100 billion in the European Financial Stability Facility (EFSF), if it can be suitably collateralized or guaranteed. Otherwise, 3Q2011 earnings reports continue generally better than expected. Equity options markets suggest a neutral short-term outlook.  Asian markets closed higher on increased volume.  Eurozone equities began higher, but reversed lower mid-morning and are currently moderately lower and near the day’s lows. The U.S. dollar is largely unchanged. Commodities prices are mixed.  U.S. Treasury yields are higher.  U.S. repo rates remain at low levels.  Overnight and 3-month LIBOR remain elevated, near the year’s highs.  Euribor-OIS spreads are near 2011 highs.  After a fair value adjustment of -2.06 points, December SPX equity futures are at 1276.30, down -4.24 points.  The SPX opens at 1284.59, -5.79% below its April 29 multi-year closing high, +7.86% above its 20-day and +8.72% above its 50-day moving averages.  The SPX is +2.14% above its 1257.64 year-end close.  Next resistance is at 1303.51; next support is at 1254.82.
Thursday.  The major indexes gapped higher, and after a brief but shallow retracement, rallied strongly through late afternoon, building substantial percentage gains. Equities weakened somewhat in the final hour, but rallied somewhat to a strong close. The NYSE composite led with a +4.10%, followed by the SPX, Nasdaq, and DJI, which posted respective gains of +3.43%, +3.32%, and +2.86%. Some commentators described it as a relief rally coming on the heels of Eurozone sovereign developments before the open, but in-line U.S. 3Q2011 GDP and stronger than expected personal consumption pretty well disposed of views that the U.S. economy would return soon to recession. Market breadth was extremely positive, volume was 1.26x the 50-day moving average, and up volume was 20x down volume. Financials led with a gain of +6.04%. Basic materials and industrials gained at least +4.49%. Laggards were utilities, health care, and consumer goods, which added at least +1.47%.
Trading desks attributed early strength to short covering, but reported that afternoon volumes reflected “real” buying as hedge funds and vanilla investors put cash to work. Among the financials, the investment banks were particularly strong, with GS and MS gaining 9.14% and 16.5%, respectively. Money center banks BAC, C, and JPM added +9.41%, 9.63%, and 8.31%, respectively. Insurers were also strong.

Distribution days number 2 on the SPX and NYSE composite, and 1 on the DJI and Nasdaq, since the uptrend commenced on October 4th.
In Asia, equity markets closed higher, on increased volume.  The Nikkei gained +1.39% on a +17.7% increase in volume.  The Hang Seng and Shanghai composite gained +1.55% and 1.55%, respectively.  Volume rose +19.1% in Hong Kong.  In Shanghai, volume rose +33.2%.  Commentary attributed the strong result to better than expected corporate earnings, the European sovereign debt deal, and improving U.S. economic indicators.
In Japan, the NKY closed at 9,050.47, compared to 8,926.54 the prior day.  The NKY closed +4.01% above its 20-day moving average.  The NKY gapped up to its intraday high of 9,086.43 on early short covering and trended lower to test support at 9,000 in mid-afternoon, but finding support, rallied back to 9,050 at the close. Except for utilities, all market segments closed higher.  Leaders were telecommunications, consumer goods, and health care, which gained at least +1.80%. Financials added +1.24%. Technology, industrials, and utilities were the laggards.
In China, the Hang Seng Index closed at 20,019.24, up from 19,688.70 at the prior day’s close, and its first close above 20,000 since early September.  The index reached an early session intraday high of 20,272.38, but profit taking took the index back to several tests of support at 20,000 through the remainder of the session. The index closed +10.4% and +5.81% above its respective 20-day and 50-day moving averages.  Most market segments closed higher.  Leaders were financials, basic materials, and consumer goods, which gained at least +1.89%. Laggards were consumer services, oil and gas, and telecommunications.
In Shanghai, the SHCOMP closed at 2,473.41, up from 2,435.62 the prior day and rising for a 5th consecutive day.  The index gapped up to 2,462 and traded quickly to the 2,483.76 intraday high, before profit taking took the index back to several tests of new support at 2,460. A late afternoon rally raised the index back to 2,475 minutes before the close. The SHCOMP closed +1.55% above its 20-day moving average, but -0.10% below its 50-day moving average.  All market segments gained at least +0.87%. Basic materials, industrials, and technology led with gains of at least +1.95%. Health care, oil and gas, and financials lagged with gains of at least +0.87%.
In Europe, equities have reversed lower after reasonably strong early gains. Commentary suggests that markets are trying to flesh out details on the Eurozone sovereign debt agreements.  The Euro Stoxx 50, FTSE, and DAX are down +0.56%, -0.33%, and -0.09%, respectively.  On the Euro Stoxx 50, the index traded to an intraday high of 2,506.22, before trading back to support at 2,460. At present, health care, basic materials, and consumer goods are higher. Financials are down -1.14%. Other laggards are oil and gas and utilities, down at least -1.41%.
Libor, LOIS, Currencies, Treasuries, Commodities:
  • Interbank lending rates continue to reflect substantial stress, centered on the health of Eurozone banks in the current economic environment.   Overnight USD LIBOR is 0.14222%, unchanged from Thursday, but below the 0.25188% year-end level.  USD 3-month LIBOR rose to 0.42944%, the highest level of the year, up from 0.42806% the prior day and compared to 0.30281% at year-end 2010.
  • The US Libor-OIS (LOIS) spread rose to 34.9 bps, the highest level of the year, from 34.1 bps the prior day and compares to 12.0 bps at the end of 2010.  Euribor-OIS rose to 77.5 bps, from 76.2 bps the prior day, and compares to 40.6 bps at the end of 2010.  A rise in the LOIS indicates an increased intra-bank lending risk premium.
  • The U.S. government overnight repo rate is 4.0 bps, unchanged from 4.0 bps Thursday and 3.0 bps Wednesday, but well off from a recent high of 33 bps on August 2nd.
  • U.S. Treasury yields are higher, with 2- and 10-year maturities yielding 0.297% and 2.393%, respectively, compared to 0.309% and 2.396% Thursday.  The yield curve widened to +2.096%, compared to +2.087% the prior day.  In the past year, the 2- and 10-year spread has varied from a low of +1.520% on September 22, 2011, to a high of +2.910% on February 4, 2011.
  • The U.S. dollar is mixed, slightly stronger against the euro, but weaker against the pound and yen.  The dollar trades at US$75.082, compared to US$74.879 the prior day, and its US$76.563 50-day, US$75.633 100-day, and US$75.758 200-day averages.  The euro trades at US$1.4173, compared to US$1.4189 Thursday and US$1.3906 the day prior.  The euro trades above its US$1.3848 50-day and US$1.4076 100-day averages.  In Japan, the dollar trades at ¥75.77, compared to ¥75.95 Thursday and ¥76.18 the prior day.  The yen trades better than its 50-day moving average ¥76.755.
  • Commodities prices are mixed, with lower energy, mixed precious metals, higher aluminum and copper, and mostly lower agriculture prices.
Volatility, Skew:
  • The VIX ended at 25.46, down -14.7% from 29.86 at the prior close.  The VIX is -26.3% below its 20-day moving average 34.56.
  • The Euro Stoxx 50 volatility index (V2X) is up +0.43% to 30.47 from 30.34 the prior day.  The V2X index trades -26.3% below its 41.06 20-day moving average, -42.1% below the 52.62 30-day high, and +0.41% above the 30.32 30-day low.
  • The Hang Seng volatility index (VHSI) fell -6.37% to 31.89 from 34.06 the prior day.  The VHSI index trades -15.2% below its 20-day moving average of 37.61.
  • CBOE skew ended at 122.82, up +0.14% from 122.65 at the prior day’s close, but still above a neutral (115-120) range.  The index tracks the cost of buying out-of-the-money, long-dated options.  A rise implies that investors are paying more to buy puts, a bearish signal.
U.S. news and economic reporting.  Today’s scheduled economic reports include the 3Q2011 employment cost index, September personal income and spending, and the PCE deflator, all at 8:30. At 10:00, the University of Michigan releases its final consumer confidence report for October.
Overseas news: Today, Italy sold €3.0 billion of 10-year bonds at 6.06% yields, above the key 6.0% threshold.  Today, Italian Prime Minister Berlusconi reiterated his intention to remain in office through 2013, refuting recent speculation that he will step down.  In the third quarter, Spain’s unemployment rate rose to 21.5%, above estimates for a rise to 20.9%.  In September, French consumer spending contracted by -0.5%, below estimates for no change.  In September, Japanese industrial production fell -4.0% over the prior month, more than the -2.1% drop expected. 
Company news/ratings changes:
·         MET – reports 3Q11 operating EPS of $1.11, above consensus estimates of $1.08.
·         SBNY – cut to hold at Sandler O’Neill, $60 price target
3Q2011 Earnings.  The third quarter’s earnings reports have so far surprised expectations.  Of the 284 S&P500 companies that reported earnings to date, 74% (211 out of 284) beat operating EPS estimates, versus the historical average of 62%.  In aggregate, companies beat EPS expectations by an average of +5.5% (versus a historical average of +2%).  EPS is up +16.4% over the prior year.  Though challenged in the current operating environment, 82% of companies reported increased revenues over the prior year and 60% beat revenue estimates.  In the third quarter of 2011, analysts estimate the SPX will earn $24.98 per share, compared to $24.84 and $21.49 per share in 2Q11 and 3Q10, a +0.6% and +16.2% increase, respectively. 
With all of the 24 BKX members reporting, 75% beat operating estimates with aggregated results surprising by +14.3% and 63% have beat revenue estimates with aggregated surprising by +4.2%.  EPS is up +21.2% over the prior year, while revenue is up +1.5%.  In the third quarter of 2011, analysts estimate the BKX will earn $1.15 per share, compared to $1.12 and $0.71 in 2Q11 and 3Q10, (a +17% and +84% increase, respectively) In the second quarter, 88% (21 of 24) beat earnings estimates on an operating basis.  Revenues also exceeded expectations, with 79% of BKX members beating estimates. 
Valuation.  The SPX trades at 12.9x estimated 2011 earnings ($99.29) and 11.5x estimated 2012 earnings ($111.57), compared to 12.5x and 11.1 respective 2011-12 earnings yesterday.  The 10-year average median Price/Earnings multiple is 20.0x.  Since the beginning of 2011, analysts increased 2011 and 2012 earnings estimates by +5.0%, and +4.0%, respectively.  Analysts expect 2011 and 2012 earnings to exceed 2010 earnings ($84.78) by +17.1% and +31.6%, respectively. 
Large-cap banks trade at a median 1.25x tangible book value, and 11.8x and 9.9x 2011 and 2012 consensus earnings, respectively, compared to 1.20x tangible book value and 10.7x/9.7x 2011/2012 earnings yesterday.  These compare to the 10-year average median multiples of 3.08x tangible book value and 15.9x earnings.  Analysts expect 2011 and 2012 BKX earnings to exceed 2010 operating earnings by +30.1% and +53.8%, respectively.
Options.  Options markets are neutral.  Composite options markets are neutral, index options markets are neutral, and equity options markets are bearish.  The composite put/call ratio closed at 0.90, compared to 1.00 the prior day and below its 5- and 10-period moving averages of 0.95 and 1.04, respectively.  The index put/call ratio closed at 1.28, compared to 1.43 the prior day and below the 5- and 10-period moving averages of 1.34 and 1.45, respectively.  The equity put/call ratio closed the day at 0.52, compared to 0.71 the prior day and above its 5- and 10-period moving averages of 0.61 and 0.64, respectively.   
NYSE Indicators.  Volume rose +29.0% to 1.431 billion shares, from 1.109 billion shares Wednesday, 1.26x the 1.139 billion share 50-day moving average.  Market breadth was overwhelmingly positive, and up volume led down volume by a large margin.  Advancing stocks led decliners by 22,321 (compared to 1,839 the prior day), or 7.11:1.  Up volume led down volume by 20.0:1.
SPX. On the highest volume since October 4th’s reversal from the year’s lows, the SPX rose +42.59, or 3.43%, to end at 1284.59, the highest close since August 1st. Volume rose +18.84% to 1.061 billion shares, up from 893.04 million shares Wednesday and above the 893.07 million share 50-day moving average. For the 54th straight session, the SPX’s 50-day moving average closed below its 200-day moving average (1183.41 vs. 1274.24 respectively)The SPX closed above its 200-week moving average (1139.39) for the 15th straight session. 
From its prior close at 1242.00, the SPX gapped higher at the open to the 1265 level, immediately setting the intra-day low.  The index rallied to 1274 by 9:40 before an hour-long retracement took the index back to 1166 by 10:40.  Through 3:30, the index rose consistently, crossing 1280 at 1:15 and 1290 at 3:20.  The index set its intra-day high of 1292.66 at 3:25.  A late-day sell-off dropped the SPX to 1280 by 3:50, but stocks rallied into the close to finish at the high end of the day’s range. 
Technical indicators are turning neutral.  The market returned to a confirmed uptrend following October 12th’s follow-through confirmation of October 4th’s strong reversal.  The SPX closed below 1300 for the 64th straight session but above 1200 for the 12th straight session.  The index closed above its April 2010 highs for the seventh time in the previous 10 sessions.  The 50-day moving average has been below the 100-day moving average since July 11th.  The 100-day moving average crossed the 200-day average to the downside on September 7thThe SPX closed (by +7.30%) above its 20-day moving average (1197.23) for the 15th time in 16 sessions.  The index closed (by +8.55%) above its 50-day moving average for the 13th straight session.  The index closed (by +4.39%) above its 100-day moving average (1230.52) for the fourth time in the last five sessions.  The SPX closed +0.81%above its 200-day moving average, closing above that average for the first time in 61 sessions.  The 20- and 50-day moving averages rose.  The directional momentum indicator is positive for the 11th straight session, and the trend is weak and increasing.  Relative strength rose to 65.12 from 58.80, a neutral range.  Next resistance is at 1303.51; next support is at 1254.82.
BKX.  On significantlyhigher volume, the KBW bank index rose +2.39 points, or +6.04%, to end at 41.97, recording its 60th close below the prior 52-week low of 42.70 from August 25, 2010 but its first close above 40 since August 5thVolume rose +37.63% to 159.34 million shares, up from 115.78 million shares Wednesday and above the 113.67 million share 50-day average. The BKX closed -2.35% below its August 30, 2010 closing low of 42.98, the trough of the last year’s correction, and -27.580% and -24.56% below its April 23, 2010, and February 14, 2011 respective closes.
Financials were the market’s best performing segment, and large-cap banks outperformed regionals.  From its prior close at 39.58, the BKX gapped higher at the open to 41.27 and quickly rose to the 41.74 level.  Through 10:30, the index retraced back to 40.73, setting the intra-day low.   A rally at 10:30 lasted through 3:30, and the index rose to 42.27 by 3:25, setting the intra-day high.  A -2.0% sell-off at 3:30 dropped the index to 41.65 by 3:50, but banks recouped most of those losses in the day’s final minutes to close near the intra-day high and just below the 42.00 threshold.
Technical indicators are negative, but are improving rapidlyBank stocks are leading the market’s direction, which switched to an uptrend after October 13’s  confirmation of October 4th’s strong reversal.  The BKX has now recorded its 12th close above the 50-day moving average since October 12th, a level which provided meaningful resistance since February 22nd.  Moving averages align bearishly, as the shorter duration averages are below the longer duration averages, although all major gaps are narrowing, and some averages are rising.  The 50-day average (37.38) crossed below the 100- and 200-day moving averages (41.40 and 46.66, respectively) on April 25th and June 16th.  The 20-day closed (by +0.25 points) above the 50-day for the second straight session.  The 50-day moving average closed (by -9.28 points) below the 200-day moving average for the 96th straight session, and the gap narrowed.  The 100-day moving average closed (by -5.26 points) below the 200-day moving average for the 74th straight session, but the gap narrowed.  The BKX closed above its 20-day moving average for the 15th time in the previous 16 sessions, above its 50-day moving average for the 12th time in 13 sessions, and above the 100-day moving average for the first time in 79 sessions.  The BKX closed below its 200-day moving averages for the 104th consecutive session.  The index closed below 50.0 for the 104th straight sessionThe directional movement indicator is positive for the ninth straight session, and the trend is weak and increasing.  Relative strength rose to 62.46 from 56.12, a neutral range.  Next resistance is 42.85; next support at 40.52.