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Equities Continue "Melt Up" to New Highs, But Risk Appetite Wanes

This morning.  Equity futures are slightly lower after fair value adjustment, but improving despite an overnight increase in Chinese bank reserve ratio requirements and lower European equity markets. This is the final trading day for February options. Asian equity markets closed mixed. The SPX opens at 1340.43, at yet another 2011 and multi-year high. Markets are in a confirmed uptrend. March SPX futures are at 1338.00, -0.74 points after fair value adjustment.  Next SPX resistance is at 1344.29.  Next support is at 1333.79.
 
Yesterday, U.S. equity markets reversed early losses, built on Tuesday’s gains, and closed at new multi-year highs, but volume was lower and well below 50-day moving average volume. Described at some trading desks as a “melt up” rally, most recent themes remain in place. If there’s not much profit taking, or short positioning against the market, investors are not reaching for risk either. The NYSE composite led yesterday’s advance with a +0.52% gain, followed. Led by an +0.84% gain on the NYSE composite, all the major indexes closed at new yearly and multi-year highs.  The SPX closed up 0.63% at 1336.32, moving easily through key resistance at 1333.  Market breadth was very positive.  Though markets were more constructive than on Tuesday, volumes were sluggish, only slightly improved from Monday’s levels and still below 50-day moving averages.   Volatility rose after 1:00, when the Israelis threatened to respond to an Iranian naval provocation.
 
The distribution day count is unchanged at 4 on the NYSE and Nasdaq, 3 on the SPX, and one on the DJI.  Distribution days infer institutional selling by tracking declines of more than -0.25% on increased volume, in the past 25 trading days.  Market uptrends come under pressure as the frequency of distribution days increases.  On the SPX, the most recent distributions were on February 15th and 9th. Both were mild losses on unimpressive volume.  The January 28th distribution grows stale in another 10 trading days. The current market uptrend has persisted since last September.
 
In Asia, equity markets closed mixed. The Nikkei, Hang Seng, and Shanghai composite ended +0.06%, +1.26%, and -0.93%, respectively.  Economic growth in Taiwan accelerated. Financial shares were particularly strong, attributed to attractive valuations after the recent correction. The SHCOMP fell for the 1st time in the past 7 trading days, though volume fell -12.38.  Traders expected the bank reserve ratio increase, and attributed pockets of market weakness to other factors. In Europe, the Eurostoxx50, FTSE, and DAX are mixed -0.11%, -0.46%, and +0.17%, respectively.  Traders cite the Chinese bank reserve ratio increase to explain today’s equity market weaknesses. Sovereign debt spreads are stable again today.  On the EuroStoxx, financials are the worst performing market segment, down -0.82%.
 
LIBOR trends remain unremarkable.  For the 2nd consecutive day, overnight USD LIBOR declined, edging lower to 0.22950% from 0.23100% Thursday and compares to 0.25188% at year-end.  USD 3-month LIBOR is also lower at 0.31250, from 0.31350% and compares to 0.30281% at year-end.  In early trading, the dollar is slightly better against the euro and yen, but worse against the pound.  The euro trades at US$1.3608, compared to 1.3609 Thursday and US$1.3569 the prior day.  The euro trades above its 50-, 100-, and 200-day moving averages.  The dollar trades at ¥83.40, compared to ¥83.31 Thursday and ¥83.68 the prior day.  Treasury yields are lower, with 2- and 10-year maturities yielding 0.796% and 3.599%, respectively, compared to 0.762% and 3.573% Wednesday.  The yield curve spread narrowed to +2.803% compared to +2.811% 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 +2.91% on February 3, 2011.  Commodities prices are generally lower, with lower petroleum and natural gas, mixed precious metals and aluminum and copper, and lower agricultural prices.
 
U.S. news and economic reporting.  Economic reporting is light today. Markets may focus on G-20 speeches by Bernanke and Geithner, in Paris
 
Overseas news.  Today, China announced it will increase bank reserve requirements next week by half a percent, marking the second increase this year.  For the second day in a row, overnight borrowing at the European Central Bank remained elevated, raising concerns of bank and monetary market’s health.  Today, Moody’s downgraded German banks’ subordinated debt on less likely government support.  In February, France’s business sentiment fell, disappointing expectations of no change. 
 
Company news/research:
 
·         TCB – cut to hold at Stifel Nicolaus, price target remains at $17
 
4Q2010 Earnings.  The fourth quarter’s earnings results have so far exceeded EPS and revenue expectations.  Of the 391 S&P500 companies that reported earnings to date, 72% (282 of the 391) beat operating EPS estimates, versus the historical average of 62%.  Companies beat by an average of +5.6% (versus a historical average of +2%).  EPS is up +34.6% over the prior year.  Though challenged in the current operating environment, 308 companies (78%) reported increased revenues and 272 companies (70%) beat revenue estimates. 
 
With all 24 BKX members reporting, 75% (18 out of 24) beat operating EPS estimates.  Bank revenues disappointed slightly, missing estimates by -0.59% on average.  Fifteen banks (63%) reported increased revenues over the prior year’s quarter and 17 banks (71%) beat revenue estimates.
 
Thursday’s equity markets. The major indexes closed at new multi-year highs, on lighter volume. The SPX continued its advance through various technical resistance levels, through 1333 and then 1340, closing up +.31%.  The DJI, NYA, and Nasdaq closed up +.0.24%, +0.52%, and +0.21% respectively.  Activity levels were low. 
 
As in recent days, trading began with a sell-off that couldn’t gain traction. After 10:00, buying picked up after a solid February Philadelphia Fed report, markets crossed into positive territory by 11:30, and traded higher through the day’s remainder to end near the intraday highs. Trading desks report little in the way of profit-taking or short-positioning, but volume levels also imply little in the way of much additional risk appetite.
 
Technical indicators are generally positive. All of the major indexes closed above their respective 200-week, and 20-, 50-, 100-, and 200-day moving averages. Markets are in a bullish configuration, with the 50-day moving averages above their respective 200-day moving averages. New 52-week highs were +313, higher than its 10-day moving average of 240.40.  Market sentiment is positive and elevated. The most recent AAII bullish sentiment index (February 17th) fell again to 46.58 from its last reading of 49.40 on February 10th and below the December high of 63.60. Sentiment indexes are highly variable and often best regarded from a contrarian perspective.
 
Market segments closed mixed. Oil and gas, consumer goods, and basic materials, were the best performers, closing at least +0.66% higher. Consumer services, technology, and financials were the worst performers.  
 
Financials were the only market segment that closed lower. HBAN lead the index down, off -2.52% after a downgrade to neutral by a large brokerage house.  STI and FITB also closed about -1.50% lower on the day. The XLF, BKX, and KRX all closed lower, off -0.12, -0.72%, and -0.29% respectively.  While the broader indices have recovered their post-September 2008 losses, bank stocks have not, with the BKX closing -4.85% below its April 2010 highs and -33.2% below its best level of 82.55 in September 2008.
 
NYSE Indicators.  Volume fell -5.04% to 882.14 million shares, from 928.97 million shares Wednesday, but just 90.7% of the 972.35 million share 50-day moving average.  Market breadth was positive, and up volume led down volume.  Advancing stocks led decliners by +751 (compared to +2196 Wednesday), or 1.66:1.  Up volume lagged down volume by 2.21:1.
 
Valuation.  The SPX trades at 13.9x estimated 2011 earnings ($96.16) and 12.3x estimated 2012 earnings ($109.07), compared to 13.9x and 12.3x 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 +4.0%, and +4.8%, respectively.  Analysts expect 2011 and 2012 earnings to exceed 2010 earnings ($83.81) by +14.7% and +30.1%, respectively.
 
Large-cap banks trade at a median 1.58x tangible book value and 14.3x 2011 consensus earnings, compared to 1.62 tangible book value and 14.6x 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 and 2012 BKX earnings to exceed 2010 operating earnings by +27.1% and 70.6%, respectively.  In 4Q2010, large-cap banks earned $17.92 (the sum of 31 banks’ operating EPS), compared to $16.21 in 3Q2010.  In 4Q2010, the BKX earned $2.99 per share, compared to $1.42 per share in 3Q2010. 
 
SPX.  On lower volume, the SPX rose +4.11 points, or +0.31%, to 1340.43.  The index set a new multi-year high.  Volume fell -8.8% to 698.06 million shares, down from 765.30 million shares Wednesday and below the 760.97 million share 50-day moving average.  For the 84th consecutive day, its 50-day moving average closed above its 200-day moving average (1280.98 versus 1164.41, respectively).  The SPX closed above its 200-week moving average (1180.43). 
 
The SPX gapped lower at the open and dropped to its intra-day low at 9:36 of 1331.00, a support level.  Rallying through the morning from that level, the index re-took its 1336 break-even level at 11:15, and climbed to 1338 by 11:30.  The SPX traded sideways at 1338 through 1:00, when another rally lifted the index past 1339 resistance and to 1340 by 1:30.  The SPX traded sideways into the close, and finished north of 1340.  The index closed +4.64% above its 50-day moving average, closing above that average for the 115th consecutive day, and +15.12% above its 200-day moving average.  The 20-, 50-, 100-, and 200-day moving averages rose.
 
Technical indicators are positive.  The SPX closed at a new multi-year high, above 1333 (double the March 2009 low) for the second consecutive day, above 1300 for the 13th consecutive day, and above its April highs for the 54th straight session.  The directional momentum indicator is positive, with an increasing trend.  Relative strength rose to 73.12 from 71.70, the lower end of an overbought range.  Next resistance is at 1344.29; next support is at 1333.79. 
 
BKX.  On lower volume, the KBW bank index closed at 55.14, down -0.40 points or -0.72%.  The index closed +29.22% above its August 30 closing low of 42.98, the trough of the recent prior correction, but -4.16% below its April 23rd closing high. 
 
Financials were the worst performing sector in the market, and large-cap banks underperformed regionals.  The BKX gapped lower at the open, through first support at 55.31 and to 55.10 by 9:45.  The index set its intra-day low of 55.02 at 10:20 and traded between 55.05 and 55.18 through 1:30.  A small rally lifted financials to the 55.30 level at 2:20, but momentum reversed and the index declined into the close, finishing at 55.14.  Volume fell -8.3% to 89.30 million shares, down from 97.40 million shares, below the 145.52 million share 50-day average, and to the lowest level since Christmas week. 
 
Technical indicators are positive.  The index closed above 50 for the 42nd straight day.  The BKX closed above its 20-, 50-, 100-, and 200-day moving averages (54.23, 52.92, 49.71, and 48.93, respectively), closing above the 200-day average for the 49th straight session.  All moving averages increased.  The 50-day moving average closed (by +3.99 points) above the 200-day moving average, closing above it for the 26th straight day.  The 100-day moving average closed (by +0.78 points) above the 200-day moving average, closing above it for the ninth straight day.  The directional movement indicator is positive with a stable trend.  Relative strength fell to 59.37 from 63.34, a neutral range.  Next resistance is 55.43; next support at 54.93.


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