Dollar Rebound Scotches Early Gains, Equity Markets End Mixed on Lower Volume

Includes: DIA, QQQ, SPY
by: Gary Townsend

This morning. Equity markets are in a confirmed uptrend, but have moved little in recent weeks. It’s election day, Congress seems likely to swing Republican, and the Federal Open Market Committee meets to approve a new round of quantitative easing. Yesterday, closed narrowly mixed on lower volume, as the NYSE composite closed -4.14 points or -0.06%, while the DJI, SPX, and NASDAQ all posted fractional gains. Recent distribution days number four (on September 30th, October 15th, 19th, and 27th), with four for the DJI and NYSE, three for the SPX, and 1 for the NASDAQ. December SPX futures are at 1189.60, up +8.92 points after fair value adjustment. Next resistance is at 1194.24; next support is at 1176.08.

Reflecting recent indecisive trading activity, technical indicators are mixed. All major indexes closed above their 20-, 50-, 100-, and 200-day moving averages, and their respective 50-day are above their 200-day moving averages. The NYSE composite index stands +12.7% above its August 26th closing low, but stands -0.82% below its recent October 18th high. Directional movement indicators are positive, but trends are weak. Relative strength indices show that markets are at the top of a neutral range.

Asian equity markets closed higher, with the Nikkei and Hang Seng +0.06% and +0.08%, respectively. European equity markets are also higher, with the Eurostoxx50 +0.66%, FTSE +1.12%, and DAX +0.71%. On the EuroStoxx, financials are up +0.12%, but are the worst performing market segment. Eurozone sovereign CDS spreads are wider, with Ireland at record levels, and Greece, Spain, and Portugal retesting recent highs.

Despite unfavorable sovereign CDS trends, LIBOR trends remain unremarkable. Overnight USD LIBOR is 0.22563%, essentially unchanged from +0.22625% on September 30th. USD 3-month LIBOR is 0.28594%, down from 0.29000% on the same date. In currency markets, the euro is stronger, while the dollar, yen, and pound are weaker. The euro trades at US$1.3972, compared to US$1.3893 the prior day. The dollar trades at ¥80.89 compared to ¥80.51 yesterday. U.S. Treasuries are mixed, with the 2- and 10-year maturities yielding 0.343% and 2.612%, respectively, compared to 0.344% and 2.623% yesterday. The yield curve spread narrowed to +2.269% from +2.279% 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. With the weaker dollar, commodities are generally higher, with higher oil, precious metals, aluminum and copper, and generally higher agriculture prices.

3Q2010 Earnings. Earnings results have generally exceeded EPS and revenue expectations. Of the 340 S&P500 companies that reported earnings to date, 79% (269 of 340) beat operating EPS estimates, versus the historical average of 62%. Companies beat by an average of +7.54% (versus a historical average of +2%). EPS is up +37.7% over the prior year. Though challenged in the current operating environment, 273 companies (80%) reported increased revenues and 205 companies (60%) 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 have disappointed slightly, missing expectations by -0.30% on average.

U.S. news. Elections, earnings, and monetary policy continue to dominate. Economic releases are light today. GM will file its IPO today. Tomorrow’s focus turns back to employment with the release of the October ADP employment report. The Fed meets today and Wednesday, with a report at 2:15 tomorrow that is expected to detail its quantitative easing plans. The September employment report is released Friday.

Overseas news. In October, the Euro-zone purchaser managers index rose to 54.6, compared to estimates for 54.1. Moody’s said a Euro-zone sovereign default is unlikely. China told its banks to request faster repayment of local government infrastructure loans over worries the current terms leave banks overly exposed to risk.

Monday’s equity markets. Strong early action gave way to mid-day profit taking, a sharp mid-afternoon sell-off, and a late rally. Earnings continued to surprise positively. Macro-economic news flows were favorable, but after a strong open, a better than expected ISM report (56.9 versus 54.0 survey) at 10:00 supported the dollar, and equity prices drifted lower. At 2:00, stocks sold off on a news report that the SEC was investigating JPM regarding a 2007 vintage CDO, but rebounded in the final half hour when comparisons to Goldman failed. The late rally allowed indexes to close mixed, with fractional DJI, SPX, and NASDAQ gains.

As on Friday, market breadth was slightly positive, while down volume slightly exceeded up volume. Market segments closed mixed, with technology, telecommunications, and basic materials the best performers, while financials, consumer goods, and utilities fared worst.

Market sentiment remains variable, as there have been several failed uptrends in recent months. The sustainability of the current uptrend has its skeptics, but the uptrend remains resilient. All major index 50-day moving averages are above their respective 200-day moving averages. The September-October rally brought all major indexes back above their early August and then September highs, to levels last seen in late April, before the euro-crisis and flash crash. All indexes are at least +4.51% higher in 2010. Despite the broader market’s recovery, financial stocks are -22.0% below their April highs. Probabilities that congressional control will swing to Republicans is viewed as a near-term positive, but may prove a sell on the news market reaction. The latest week’s (October 28st) AAII Investor Bullish Sentiment index stood at 51.23, up from 49.62 on October 21st, and at its highest levels since August 2009. This is probably better read as a bearish indicator.

Technical indicators are mixed, but improving. Major indices are above their respective 20-, 50-, and 100-, and 200-day moving averages. With 50-day moving averages back above respective 200-day moving averages, markets are in a generally bullish configuration. Directional movement indicators are positive with a stable trend. Short-term relative strength indicators have moved back to the upper end of a neutral range. Market volatility is elevated, and moved higher last week. The VIX closed up +2.97% to 21.83 from 21.20 at Friday’s close, above 20 for the 5th straight session.

Financials underperformed the broader markets, with regional and small cap names faring much worse than other financials. The XLF, BKX, and KRX closed mixed, +0.01%, -0.59%, and -2.65%, respectively.

NYSE Indicators. Volume fell -0.06% to 959.57 million shares, from 1.036 billion shares the prior day, and compares to the 1.030 billion share 50-day moving average. Market breadth was positive, but up volume lagged down volume. Advancing stocks led decliners by +146 (compared to +556 Friday), or 1.10:1. Up volume trailed down volume by 0.91:1.

SPX. On lower volume, the SPX rose fractionally, closing up +1.12 points or +009% to end at 1184.38. Volume declined -17.1% to 715.37 million shares, from 862.54 million shares the prior day. For the 7th consecutive day, its 50-day moving average closed above its 200-day moving average (1134.72 versus 1122.79, respectively).

Action was more pronounced than in recent days, gapping higher and advancing impressively in early trading, but giving ground over the next hours, selling-off, and finally rallying into the close to end with a fractional gain. The intraday 1195.81 high came just after 10:00 and was the best level since April. Profit taking ensued, and the SPX reduced gains through 2:00, but sold off with news that the SEC was investigating a 2007 vintage JPM CDO. When comparisons to Goldman’s CDO failed, markets rallied into the close.

The SPX closed +5.49% above its August 9th close of 1127.79 (the highest close prior to that month’s correction) and +3.20% above last month’s closing high of 1147.70 on September 28th. The SPX closed +4.38% above its 50-day moving average (1134.72), closing above that average for the 41st consecutive day, and +5.49% above its 200-day moving average (1122.79), which trended higher on the day. The SPX closed +11.3% above the 1064.59 close on the August 27th positive reversal, and +9.64% above the September 1st follow-through close of 1080.29. The SPX closed -2.70% below its April 23rd closing high of 1217.28. The 20-, 50-, 100-, and 200-day moving averages rose.

Technical indicators are mixed, as the SPX closed above its 20-, 50-, 100-, and 200-day moving averages, above its monthly August 7th and September 28th highs, and above 1180, a principal recent resistance point, after trading below that level intraday for the 3rd session in a row. For the 7th consecutive day, the SPX’s 50-day moving average closed above its 200-day moving average. The directional momentum indicator is positive, with a weakening trend. Relative strength rose to 64.03 from 63.89 the prior day, in a short-term overbought range. Next resistance is at 1194.24; next support is at 1176.08.

BKX. On lower volume, financial stocks closed at 45.22, down -0.27 points or -0.59%. The index closed +5.21% above its August 30 closing low of 42.98, the trough of the recent correction.

The BKX never participated in the broader markets’ morning rally, opening modestly higher and barely maintaining gains into the afternoon session. Unsurprisingly, the JPM news whacked financials more than most other stocks, taking the BKX to an intraday low of 44.66 at 3:15 before rallying into the close. Volume fell -2.36% to 97.9 million shares, from 100.28 million shares and below the 144.6 million share 50-day average. The BKX closed -22.0% below its 57.95 April 23rd closing high.

Technical indicators are generally negative. The BKX closed below its 20-, 50-, 100-, and 200-day moving averages (46.42, 46.08, 47.07, and 48.83, respectively). The 20-, 50-, 100-, and 200-day moving averages trended lower. The 50-day moving average closed (by -2.75 points) below the 200-day moving average, as it has since August 16. The directional movement indicator is negative, with a stable trend. Relative strength fell to 41.64 from 43.60, in the lower end of a neutral range. Next resistance is 45.75; next support at 44.68.

Valuation. The SPX trades at 14.0x estimated 2010 earnings (revised up to $84.86 from $84.58) and 12.3x estimated 2011 earnings ($96.14), compared to 14.0x and 12.3x respective 2010-11 earnings yesterday. 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 +10.9%, +4.0%, and +4.7%, respectively. Analysts expect 2011 and 2012 earnings to exceed 2010 earnings by +13.7% and +28.9%, respectively.

Large-cap banks trade at a median 1.39x tangible book value and 11.8x 2011 earnings, compared to 1.39x tangible book value and 12.0x 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 +34.9%. 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.

Company news & research:

  • MA – reports operating EPS of $3.94, beating estimates of $3.54 on higher-than-forecast revenue.
  • PFG – reports operating EPS of $0.64, beating estimates of $0.63.
  • Moody's Investors Service announced after Monday’s close it has downgraded the ratings of 10 large U.S. regional banks after reducing its government support assumptions for these entities (BBT, COF, FITB, KEY, PNC, BPOP, RF, STI, USB, ZION).
  • JPM research reduces bank industry cost estimate of mortgage putbacks to a $40 billion base case from $55 billion.

Disclosure: Long JPM, BBT, COF, PNC, USB

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