Equity Markets Fall on Dollar Strength, QE2 Concerns

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Includes: DIA, QQQ, SPY
by: Gary Townsend

This morning. Continuing their consolidation after the past two month’s strong advance, all major equity indexes ended lower on increased volume, recording the month’s first distribution day. The NYSE composite fared worst, down -79.89 points or -1.07%, and back below its 200-week moving average. Initial strength gave way to steady selling throughout the day.

Eurozone sovereign concerns continue to weigh heavily, with increasing focus on Spain’s ability to remain current on its obligations. But Bernanke’s misbegotten quantitative easing policy has quickly morphed into a fiasco, with negative equity market implications. Arguably a principal support for the market’s recovery after the summer’s sharp correction, doubts abound on the wisdom and efficacy of QE2. Bernanke is now the center of criticism from selected fellow governors, numerous foreign finance ministers, assorted congresspeople, the occasional former vice-presidential candidate, and varied market commentators. No doubt QE2 and Bernanke will be a principal off-the-agenda topic of this week’s G-20 meeting in Seoul.

Though no attacks from family members have been reported, markets question whether QE2 can be fully implemented. Accordingly, the dollar has rallied over the past week, slowing the recent advance of equity markets. Still, markets remain in a confirmed uptrend, but recent distribution days increase to four (on October 15th, 19th, and 27th and November 9th), with four for the DJI, three for the NYSE, two for the SPX, and one for the NASDAQ. This morning, after a better-than-expected initial jobless claims report, December SPX futures are at 1212.20, up +1.20 points after fair value adjustment. Next resistance is at 1223.85; next support is at 1205.95.

Technical indicators are generally positive, but more mixed. After yesterday’s losses, markets appear less short-term overbought than in recent days, but the NYSE composite closed below its 200-week moving average (closing at 7702.31 versus 7736.93). Other major indexes closed above their 200-week moving averages. All major indexes closed above their 20-, 50-, 100-, and 200-day moving averages. Also, their respective 50-day moving averages are above 200-day moving averages. Directional movement indicators are positive, but trend strength moderated with yesterday’s losses. Market volatility rose yesterday, but remains near 6-month lows.

Asian equity markets closed mixed, with the Nikkei and Hang Seng +1.40% and -0.85%, respectively. European equity markets are lower, with the Eurostoxx50 -0.66%, FTSE -0.65%, and DAX -0.45%. On the EuroStoxx, financials are down -1.02%, the 8th worst performing market segment. Eurozone sovereign CDS spreads are narrower today, after several consecutive days of widening. Irish, Spanish, and Portuguese CDS remain near record levels.

Despite recent unfavorable sovereign CDS trends, LIBOR trends remain unremarkable. Overnight USD LIBOR is 0.22563%, unchanged since the end of October. USD 3-month LIBOR is 0.28563%, down slightly from 0.28594% at the end of October. In currency markets, the dollar is flat to the euro and pound, but is stronger against the yen. The euro trades at US$1.3776, compared to US$1.3773 the prior day. The dollar trades at ¥82.33, compared to ¥81.69 yesterday. U.S. Treasuries are weaker, with the 2- and 10-year maturities yielding 0.431% and 2.709%, respectively, compared to 0.439% and 2.656% Friday. The yield curve spread widened to +2.278% compared to +2.217% 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. After a sell-off yesterday, commodities are mixed, with mixed petroleum, higher precious metals, aluminum, and copper, and generally lower agricultural prices.

3Q2010 Earnings. Earnings results have generally exceeded EPS and revenue expectations. Of the 422 S&P500 companies that reported earnings to date, 76% (319 of 422) beat operating EPS estimates, versus the historical average of 62%. Companies beat by an average of +7.0% (versus a historical average of +2%). EPS is up +33.1% over the prior year. Though challenged in the current operating environment, 336 companies (80%) reported increased revenues and 263 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 have disappointed slightly, missing expectations by -0.30% on average.

U.S. news. The latest week’s ABC consumer confidence was unchanged at -46. Mortgage applications rose +5.8%, compared to -5.0% the prior week. The September trade balance was -$44.0 billion, slightly better than survey and the prior month’s -$46.3 billion. Import prices rose +0.9%, better than survey +1.2%. Latest weeks initial and continuing claims improved to 435K from 457K last week, and compares favorably to survey 450K.

Overseas news. China ordered banks to increase their reserve ratios by 50 basis points. China’s October exports rose 22.9% over last year, beating estimates, while commodity imports fell more than expected. Ireland extended its bank guarantee program through June 2011 from December 2010. Irish Prime Minister Cowen warned the country will run out of cash unless his proposed budget is passed. European clearinghouse LCH Clearnet raised margin requirements for customers trading Irish government bonds. A Greek justice minister said the country should renegotiate the terms of its bailout to spread budget cuts over a longer period. The Financial Times reported the G20 has drawn up a “two-tier” bank regulatory plan, whereby global regulators would focus their attentions on large world-spanning institutions instead of more domestic-focused firms.

Company news & research:

  • MS – files to sell nearly 100% (31 million shares) of its IVZ stake in a secondary offering.
  • The Financial Times reported the G20 has drawn up a “two-tier” bank regulatory plan, whereby global regulators would focus their attentions on large world-spanning institutions instead of more domestic-focused firms. The global U.S. firms targeted and mentioned were BAC, JPM, MS, GS, and C.

Tuesday’s equity markets. Early strength gave way to mid-day losses that grew through the afternoon into the close. Responding to a stronger dollar, equity markets moved lower and closed below support levels of 1220 on the SPX and 7750 on the NYSE composite. Market breadth was negative, and up volume lagged down volume. All market segments closed lower. Telecommunications, technology, and oil and gas fared best. Industrials, basic materials, and financials were the worst performers.

Market sentiment is positive, but markets are likely at another critical point. The uptrend that commenced on August 30th has proved resilient, and markets have recovered from the summer’s sharp correction. But equity markets must prove that they can hold above their respective 200-week moving averages, and extend their recover. All indexes are at least +7.15% higher in 2010. The latest week’s (November 4th) AAII Investor Bullish Sentiment index stood at 48.23, down from 51.23 on October 28th and compared to 20.74 on August 26th. This is probably better read as a bearish indicator.

While the broader indices have recovered from the correction, financial stocks have not, closing -18.1% below their April highs.

Technical indicators are positive, but somewhat more mixed than in recent days. 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 bullish configuration. However, the NYSE composite closed below its 200-week moving average, as opposed to the DJI, SPX, and NASDAQ. Directional movement indicators are positive, but the strength of the trend has moderated. Short-term relative strength indicators have retreated into the upper end of a neutral range. Market volatility is elevated. The VIX closed up +4.32% to +19.08 from 18.29 at Monday’s close, and below 20 for the 5th time in the past 11 sessions.

For the 2nd consecutive day, financials underperformed. The XLF, BKX, and KRX closed down -2.20%, -1.86%, and -1.40%, respectively.

NYSE Indicators. Volume rose +22.3% to 1.112 billion shares, from 909.5 million shares the prior day, and compares to the 1.041 billion share 50-day moving average. Market breadth was negative, and up volume lagged down volume. Advancing stocks trailed decliners by -1448 (compared to -238 Monday), or 0.35:1. Up volume lagged down volume by 0.24:1.

Valuation. The SPX trades at 14.4x estimated 2010 earnings ($85.09) and 12.7x estimated 2011 earnings ($96.35), compared to 14.4x and 12.7x 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 +11.6%, +4.2%, and +4.8%, respectively. Analysts expect 2011 and 2012 earnings to exceed 2010 earnings by +13.2% and +28.2%, respectively.

Large-cap banks trade at a median 1.46x tangible book value and 12.8x 2011 earnings, compared to 1.47x tangible book value and 12.7x 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 +34.2%. 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 increased volume, the SPX fell -9.85 points, or -0.81% to end at 1123.25. Volume rose +17.6% to 822.12 million shares, from 699.3 million shares the prior day. For the 13th consecutive day, its 50-day moving average closed above its 200-day moving average (1153.52 versus 1125.74, respectively). For the 6th consecutive day, the SPX closed above its 200-week moving average (1192.22).

The SPX rose modestly at the open, but as the dollar gained strength, a sell off began, gapped lower, falling through support at 1220 after 2:00, and through 1215 after 3:00 to an intraday low of 1208.94 a quarter hour before the close. The SPX added a few points in the final minutes to close off the low. The SPX closed +5.49% above its 50-day moving average (1150.23), closing above that average for the 47th consecutive day, and +7.84% above its 200-day moving average (1192.2), which trended lower on the day. The SPX closed -0.32% below its April 23rd closing high of 1217.28. The 20-, 50-, and 100-day moving averages rose.

Technical indicators are generally positive. After two days above its April 2010 high, the SPX ended below that level. The directional momentum indicator is positive, but trend strength moderated. Relative strength declined to 68.15 from 76.45, retreating to the upper end of a neutral range. Next resistance is at 1223.85; next support is at 1205.95.

BKX. On increased volume, the KBW bank index closed at 47.44, down -0.95 points or -1.96%. The index closed +10.4% above its August 30 closing low of 42.98, the trough of the recent correction, but -18.1% below its April 23rd closing high, out of bear market territory, but still deep in correction.

For the 2nd consecutive day, financial stocks underperformed the broader indexes. Like the broader indexes, the BKX opened higher, lost ground through support at 48 as the dollar advanced, and lost more ground throughout the afternoon. Volume rose +19.0% to 159.2 million, compared to 133.75 million shares the prior day, and above the 150.7 million share 50-day average.

Technical indicators are generally positive. The BKX closed above its 20-, 50-, and 100-day moving averages (46.28, 46.51, and 46.94, respectively), but below its 200-day moving average (48.84). The 20-, 50-, and 200-day moving averages trended higher. The 100-day trended lower. The 50-day moving average closed (by -2.42 points) below the 200-day moving average, as it has since August 16. The directional movement indicator is positive, with a strengthening trend. Relative strength declined to 55.82 from 63.33, again in a neutral range. Next resistance is 48.31; next support at 46.95.

Disclosure: Author is long BAC, C, JPM, MS, GS