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U.S. Equities Edge Back Into Correction

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This morning.  The recent, brief market uptrend ended yesterday, as U.S. equity markets moved back into correction. U.S. equity futures are moderately lower.  On the heels of the ECB’s decision to hold interest rates steady, the dollar is slightly weaker.  Commodity prices are lower.  U.S. Treasury prices are slightly higher.  After a fair value adjustment of +0.72 points, June SPX equity futures are at 1334.70, down -9.02 points.  The SPX opens at 1347.32, -1.19% below the April 29 multi-year high and +2.13% above its 50-day moving average.  Next resistance is at 1354.98.  Next support is at 1340.58.
On Wednesday, U.S. equity markets moved back into correction, closing broadly lower, though off the worst levels of the day. All market segments closed lower, in contrast with Tuesday’s mixed action in which some market rotation was evident. Market breadth was negative.  Economic reports surprised negatively, with the non-manufacturing ISM much weaker than expected at 52.8, compared to survey 57.5. All major indexes closed lower, on higher volume. The DJI, SPX, NYSE, and Nasdaq closed down -0.66%, -0.69%, -0.91%, and -0.47%, respectively.  All added distribution days. The SPX, NYSE, and Nasdaq added distribution days, which now number 5 on the NYSE, 3 on the DJI, and 3 on the Nasdaq and SPX in the past 25 trading days.  Distribution days, which indicate institutional selling, pressure uptrends and push markets back into correction. Volatility rose +2.28%, though the VIX ended at 17.08, well off its 17.72 intraday high at 10:00. 
Earlier today, Asian equity markets closed mixed.  The Nikkei was again closed for holiday.  In China, the Hang Seng and Shanghai composite closed mixed, down -0.23% and up +0.22%, respectively.  On the SHCOMP, volume fell -18.2% from the prior day. Chinese equity markets are correction.  For the 2nd time this week, the index staged a positive reversal, gapping lower, but ending above the previous day’s close at 2872.40, though on unimpressive volume. The index closed -6.05% below its recent April 18th high close 3057.33.  Health care, financials, and telecommunications were the strongest sectors, while basic materials and industrials were the worst performers. European equity markets are lower.  The EuroStoxx 50, FTSE, and DAX, are down -1.10%, -0.67%, and -0.56%, respectively.  On the EuroStoxx, financials are 9th worst performing segment, down -1.48%, reflecting monetary policy and rate concerns. 
Despite sovereign debt and other macro-concerns, LIBOR levels are well below those seen prior to last year’s sovereign debt crisis; moreover, LIBOR continues to drift lower.  Overnight USD LIBOR declined to 0.13150%, compared to 0.13350%, Wednesday and 0.25188% at year-end.  USD 3-month LIBOR is 0.26825%, compared to 0.27025% Wednesday and 0.30950% at year-end.  In early trading, the dollar is slightly weaker against the euro and pound, but much weaker against the yen.  The dollar has trended lower since last June and now trades well below its 50-, 100-, and 200-day moving averages.  The euro trades at US$1.4830, compared to US$1.4827 Wednesday and US$1.4825 the prior day.  The Euro trades well above its 50-, 100-, and 200-day moving averages.  The dollar trades at ¥79.78, compared to ¥80.61 Wednesday and ¥80.94 the prior day.  The yen trades better than its 200-day moving average ¥82.21, which is trending lower.  U.S. Treasury yields are lower, with 2- and 10-year maturities yielding 0.577% and 3.201%, respectively, compared to 0.585% and 3.216% Wednesday.  The yield curve narrowed to +2.624%, from +2.631% 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 +2.889% on February 3, 2011.  Commodities prices are lower, with lower petroleum, natural gas, precious metals, aluminum and copper, and agricultural prices.
U.S. news and economic reporting.  Economic releases focus on the latest week’s initial and continuing jobless claims, 1Q2011 nonfarm productivity and unit labor costs. Initial jobless claims disappointed, rising to 474k from 429k the prior week, and much worse than survey 410k. Unit labor costs rose +1.0%, compared to survey +0.8%. Productivity rose +1.6%, better than survey +1.1%.
Overseas news.  Today, the Bank of England left unchanged its benchmark interest rate and asset purchase program, matching forecasts.   Also, the European Central Bank left unchanged its benchmark interest rate, matching estimates.  In April, the U.K. services purchaser managers index fell more than estimated.  In April, German industrial orders fell -4.0% from the prior month, missing expectations for a gain of +0.4%.  Today, the Syrian army began a gradual withdrawal from the southern city of Daraa, the focal point of recent anti-regime protests.
Company news/research:
·         NLY – reports 1Q11 GAAP and operating EPS $0.89 and $0.70, compared to estimates of $0.59. 
·         CIM – reports 1Q11 GAAP and operating EPS $0.16 and $0.15, compared to estimates of $0.15. 
1Q2011 Earnings.  The first quarter’s earnings results have so far exceeded EPS and revenue expectations.  Of the 376 S&P500 companies that reported earnings to date, 73% (274 of the 376) beat operating EPS estimates, versus the historical average of 62%.  In aggregate, companies have beat by an average of +6.8% (versus a historical average of +2%).  EPS is up +21.0% over the prior year.  Though challenged in the current operating environment, 285 companies (76%) reported increased revenues and 258 companies (69%) beat revenue estimates.  In the first quarter of 2011, analysts estimate the SPX will earn $24.32 per share, compared to $22.47 and $19.49 per share in 4Q10 and 1Q10, a +8.2% and +24.8% increase, respectively.  
With all 24 BKX members reporting, 75% (18 out of 24) beat operating EPS estimates.  Bank revenues disappointed slightly(by -0.78% on average), with 58% of BKX members missing estimates.  Eleven banks (46%) reported increased revenues over the prior year’s quarter.  In the first quarter of 2011, the BKX earned $0.95 per share, a +4.4% increase over 4Q10 EPS of $0.91 and 180% above 1Q10 EPS of $0.34. 
Valuation.  The SPX trades at 13.6x estimated 2011 earnings ($98.77) and 12.0x estimated 2012 earnings ($111.86), compared to 13.7x and 12.1x 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 +4.4%, and +4.2%, respectively.  Analysts expect 2011 and 2012 earnings to exceed 2010 earnings ($84.78) by +16.5% and +31.9%, respectively.
Large-cap banks trade at a median 1.53x tangible book value and 12.9x 2011 consensus earnings, compared to 1.54x tangible book value and 13.0x 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 and 2012 BKX earnings to exceed 2010 operating earnings by +32.7% and 71.6%, respectively. 
Wednesday’s equity markets. On higher volume, U.S. the equity markets closed broadly lower. The NYSE, SPX, DJI and Nasdaq finished down -0.91%, -0.69%, -0.66%, and -0.47%, respectively.  The markets saw their highs for the day at the open, but weakened significantly after the 10:00 release of disappointing March non-manufacturing ISM. Markets found support around noon, and recovered somewhat through the afternoon to finish well off their intraday lows.  Commodities, primarily silver (-3.57%), oil (-2.14%) and cotton (-3.6%) were equally weak, and contributed to equities’ poor performance. Silver has been under pressure since a second increase in the margin requirements.  Earnings announcements were mixed.  Mergers continued as well, with AMAT bidding for VSEA ($4.9b). CAG bid $4.9 billion for RAH, only to be rejected by mid-afternoon.
Investors are de-risking portfolios.  Trading desks report that sellers and short sellers have returned.  Buyers seem fatigued and are not chasing prices as they were last week. We are seeing some of the previously favored sectors such as industrial, basic materials and oil and gas give back some of their double-digit year-to-date gains.  We are also seeing some rotation into the names that had not participated in the recent run-up, primarily financials, though that was not as evident on Wednesday.  The VIX rose as volatility rose, finishing at 17.08, up +2.28%.
Technical indicators are negative. The noon time intraday lows broke through multiple support levels. The SPX broke through two support levels (1350, 1344), but bounced robustly off 1341.  After testing this level 3 times, it rallied and rose through most of the afternoon. Technical strategists expect a retest of 1337 on the SPX.  The major indices finished above their 50-, 100-, 200-day and 200-week moving averages.  Domestic equity funds saw outflows of -$726mm  during the week ended 4/27 according to the Investment Company Institute. The Bloomberg NYSE new net highs were +87 versus Tuesday’s +308 and below all the moving averages. The relative strength indicator is in the neutral range, at 52.75 compared with 59.31 at Tuesday’s close.  The AAII investor sentiment index declined to 35.46 (May 5) from 37.90 the prior week.
All market segments ended lower. Health care, consumer goods, and technology were off at least -0.21%.  Industrials, oil and gas, and basic materials were off the most.
Financials declined, with the BKX, XLF, and KRX down -0.97%, -0.85%, and -0.72%, respectively. The BKX and XLF followed the larger indices lower, but never rebounded as did the broader market indexes. The KRX fell off early, but rebounded twice during the day, before moving lower in the last hour. The BKX had 2 names finish up, 21 end down and 1 end unchanged.  The KRX had 9 names up, 40 down and 1 unchanged. Among the larger financials, AIG and UNM were the leaders, up +1.64% and +1.45%.  Large cap banks were led by PBCT and CFR, up at least +0.07%.  Smaller regional banks were led by PVTB (+2.33%) and BXS (+1.19%). The laggards among banks were led by PRSP (-3.29%), WFC (-2.47%), and KEY (-2.15%). The BKX and XLF finished below their 20-, 50-, and 100-day moving averages. The KRX finished below its 20-, and 100-day average, but above the 50-day moving average. While the broader indices have recovered their post-September 2008 losses, bank stocks have not, with the BKX closing -11.5% below its April 2010 high and -37.8% below its best level of 82.55 in September 2008.
NYSE Indicators.  Volume rose +6.62% to 1.070 billion shares, from 1.003 billion shares the prior day, 1.08x the 50-day moving average.  Market breadth was negative, and up volume lagged down volume.  Advancing stocks trailed decliners by -1138 (compared to -911 Tuesday), or 0.45:1.  Up volume lagged down volume by 0.32:1.
SPX.  On higher volume, the SPX fell -9.30 points, or -0.69%, to 1347.32.  Volume rose +5.1% to 831.79 million shares, up from 791.60 million shares Tuesday and above the 783.97 million share 50-day moving average.  For the 135th consecutive day, the SPX’s 50-day moving average closed above its 200-day moving average (1319.18 vs. 1224.17, respectively).  The SPX closed above its 200-week moving average (1169.99).
The SPX opened lower but at its intra-day high of 1355.90.  Through 9:55, the index fell to the 1353-54 level before a sharp sell-off at 10:00 crossed first resistance at 1350 and sent the index to 1345.  The ISM non-manufacturing report’s disappointing data drove the selling.  Stocks attempted tepid rallies through the morning, but each move higher was sold to a lower low.  By 11:15, the index crossed through second-level support at 1344.  By 12:30, the index had reached 1342 and set its intra-day low of 1341.50 at 12:50.  From then until 3:00, the SPX made a stronger move higher.  At 2:30, the index retook 1350 and reached 1351 near 3:00.  The rally was again sold, and by 3:15, stocks retreated to 1346.  The index held that level into the close.
Technical indicators are mixed to positive, but the index’s failure at 1370 and its subsequent fall from that level have placed the markets in correction.  The index closed above 1300 for the 29th straight session.  The index closed above its April 2010 highs for the 105th straight session.  The SPX closed (by +0.93%) above its 20-day moving average (1334.87) for the 10th consecutive session.  The index closed (by +2.13%) above its 50-day moving average for the 10th straight session.  The index closed (by +3.48%) above its 100-day moving average (1302.05) for the 33rd straight session.  The SPX closed +10.06% above its 200-day moving average.  All moving day averages increased, but the market’s stall has halted the 50-day moving average’s positive momentum.  The directional momentum indicator is positive for the ninth straight session, but the gap has narrowed considerably and the trend is stable.  Relative strength fell to 57.61 from 63.95, a neutral range.  Next resistance is at 1354.98; next support is at 1340.58. 
BKX.  On lower volume, the KBW bank index fell -0.50 points, or -0.97%, to 51.31.  Volume fell -20.3% to 96.64 million shares, down from 121.31 million shares Tuesday and below the 120.38 million share 50-day average.  The index closed +19.38% above its August 30 closing low of 42.98, the trough of the recent prior correction, but -11.46% and -7.77% below its April  23,  2010, and February 14, 2011 closing highs, respectively. 
Financials underperformed the market, and large-caps underperformed regionals.  The BKX opened flat, immediately setting the intra-day high of 51.82.  Through 10:00, the index fell to the 51.50 level and dropped sharply at 10:00 to the intra-day low of 51.17 at 10:05.  By 11:15, the index had rallied back to 51.50.  Financials attempted to hold that level through noon, but a sell-off at 12:00 dropped the BKX back to the 51.20-level at 12:45.  A 1:00 rally lifted the index back to the 51.30 range.  Through the close, the index fluctuated slightly above and below that level and finished just above it.   
Technical indicators are negative.  Weakness in the broader markets could remove the recent and important support for the BKX.  The index has remained bound on the upside by the 50-day moving average (now at 51.87 and falling), has broken through 100-day moving average support, but has held above the 200-day moving average (49.64).  The 20-day moving average (51.34) has remained below the 50-day moving average since March 11th  and crossed below the 100-day moving (52.55) average on April 15th.  The 50-day moving average crossed below the 100-day moving average on April 21st.  The index closed below the 20-, 50-, and 100-day moving averages for the first, 19th, and 15th consecutive sessions, respectively.  The index closed above 50 for the 93rd straight day.  The BKX closed above its 200-day moving average for the 99th straight session.  The 20- and 50-day moving averages fell.  The 20-day closed (by -0.54 points) below the 50-day for the 36th straight day, and the negative divergence expanded.  The 50-day moving average closed (by +2.24 points) above the 200-day moving average for the 77th straight session, but the positive divergence contracted.  The 100-day moving average closed (by +2.92 points) above the 200-day moving average for the 60th straight session, but the positive divergence contracted.  The directional movement indicator is positive, narrowly, for the fifth consecutive session, and the trend is declining.  Relative strength fell to 47.56 from 53.60, a neutral range.  Next resistance is 51.70; next support at 51.03.

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