Market Gains Reconfirm Equity Uptrend, Earnings Continue Upside Surprises

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Long/Short Equity, Short-Term Horizon, Medium-Term Horizon

Contributor Since 2008

Gary Townsend - Founding member and Chairman, GBT Capital Management, LLC, a macro long/short fund based in Chevy Chase, Maryland. Also, 2007-2013, a founding partner, CEO and Portfolio Manager of Hill-Townsend Capital LLC, a long/short equity financial sector fund. Mr. Townsend has 35 years banking, regulatory, and investment experience. He started his business career in 1978, as a consultant and advisor on anti-dumping trade issues primarily to foreign manufacturers based in Asia. In 1982, he began a 15 year career as a U.S. government banking regulator. In 1990, he was recruited to build out a new, independent federal regulatory agency, the Federal Housing Finance Board, regulator of the Federal Home Loan Bank System. As Chief Examiner and Director of Supervision and Examination, Mr. Townsend organized and implemented supervisory examinations of the 12 FHLBanks and Office of Finance with particular emphasis on their funding activities, use of derivatives, safety and soundness and regulatory compliance. In 1998, Townsend joined FBR Capital Markets as a sell-side analyst, applying his banking and regulatory experience to the investment analysis of commercial banks of all market capitalizations. In 2007, named him as "Best Brokerage Analyst" for commercial banks; also Starmine ranked him the #2 earnings estimator (out of 109 analysts) and in the top 10% of analysts for stock picking and earnings accuracy. Townsend left FBR in November 2007 to launch Hill-Townsend Capital LLC. He holds a CPA designation (1999) and a MBA from George Washington University (1979).
This morning.  The U.S. equity market uptrend has resumed. In Asia, equity markets closed mixed on mixed volume.  European equity indexes are higher, extending yesterday's gains.  U.S. equity futures are moderately higher, and strengthening on generally robust earnings reports.  U.S. Treasury prices are lower.  The dollar is slightly weaker.  Commodities markets are mixed.   After a fair value adjustment of +1.38 points, September SPX equity futures are at 1328.20, up +5.22 points.  The SPX opens at 1326.73, -2.70% below its recent April 29 multi-year closing high, and +1.04% and +1.11% above its respective 20- and 50-day moving averages.  The SPX is +3.80% above its 1257.64 year-end close.  Next resistance is at 1334.22.  Next support is at 1313.15.
Tuesday, U.S. equity markets closed significantly higher, at intraday highs, on a slight volume decrease.  Markets gapped higher on generally strong earnings reports, strong equity gains in Europe, and optimism that the U.S. debt ceiling negotiations would be soon resolved. Market internals reversed from Monday’s extreme negativity.  The Nasdaq had the strongest gains, closing up +2.22%, followed by the DJI, and SPX, up +1.63%, and NYSE composite, up +1.46%. NYSE volume fell -0.41% or 0.91x the 50-day moving average.  All markets segments closed at least +0.80% higher, with technology, consumer services, and oil and gas the best performers, while health care, utilities, and telecommunications lagged.  Financials gained +1.36%.  Volatility fell -8.31% to end at 19.21, compared to 20.95 at the prior day’s close.  Once again, the VIX moved within a wide range, to an mid-day intraday high of 20.43, before falling sharply after the president’s 2:00 announcement of debt ceiling negotiation progress. Trading desks reported a busy morning, but that market overhangs keep long-only investors on the sidelines.
Yesterday’s strong gains reconfirmed the market uptrend that began on June 21st.  Notwithstanding that confirmation, action has been choppy with substantial distribution days.  The distribution day count is 6 on the NYSE composite, 5 on the SPX and DJI, and 4 on Nasdaq.  The BKX count was unchanged at 7 distribution days.  Distribution days signal institutional selling in the prior 25 trading days, or since the commencement of the most recent uptrend.
In Asia, market uptrends in Japan and China remain under pressure.  Japanese markets closed moderately higher, with trading desks citing optimism that U.S. debt ceiling issues will be timely resolved.  The Nikkei closed up +1.17% on a -4.59% decrease in volume.  Telecommunications, industrials, and utilities led market segments with gains of at least +1.54%.  Financials gained +1.26%. Health care, consumer goods, and basic materials lagged, but gained at least +0.45%. Chinese equity markets closed mixed, with Hang Seng up +0.46% and the Shanghai composite down -0.10%.  Action followed losses in the U.S. and Europe, and traders cited European and U.S. debt concerns.  In Hong Kong, volume rose +5.63%.  Most market segments closed higher.  Telecommunications, basic materials, industrials were the best performers.  Financials, technology, and oil and gas were the laggards. Financials rose +0.33%.  The SHCOMP closed at 2794.21, +6.60% above its June 20th correction low.  The index gapped higher, but reversed to an intraday low of 2779.38 by early afternoon, but rallied in the final hours to close with a small loss. Volume rose +5.63%.  Market segments were mixed, with best performance from consumer goods, health care, and technology, while industrials, telecommunications, and basic materials lagged. Financials rose +0.03%. The SHCOMP ended -8.61% below its recent April 18th 3057.33 high, -0.49% below its 2010 close, and +1.07% above the 2766.15 50-day moving average.
In Europe, equity markets continued to rebound, with trading desks citing strong 2Q2011 earnings reports and U.S. debt ceiling prospects.  The EuroStoxx50, FTSE, and DAX are up +1.61%, +0.94%, and +0.33%, respectively.  Equity markets gapped higher and, after some mid-morning profit taking, has trended higher through the morning session.  The EuroStoxx50 is at 2701.95, compared to its 2665.86 intraday low.  Most market segments are higher.  Financials, utilities, and telecommunications are the leaders.  Consumer goods, industrials, and basic materials are the laggards. Financials are up +3.85%, extending the large prior day gains.
Despite sovereign debt and other macro-concerns, LIBOR levels are near their lowest since early 2009, well below those seen prior to the onset last year of the Eurozone sovereign debt crisis.  Overnight USD LIBOR is unchanged at 0.12225%, compared to 0.12225% the prior day and down from 0.25188% at year-end.  USD 3-month LIBOR rose to +0.25300%, from 0.25200% the prior day, but down from 0.30950% at year-end.  The U.S. dollar is weaker against the euro, pound, and yen.  The dollar trades at US$74.860, below its US$75.01 50-day, US$75.13 100-day, and US$76.90 200-day moving averages.  The euro trades at US$1.4208,  compared to US$1.4156 Tuesday and US$1.4112 the prior day.  The Euro trades below its US$1.4301 50-day and US$1.4301 100-day moving averages.  The dollar trades at ¥78.87, compared to ¥79.18 Tuesday and ¥79.04 the prior day.  The yen trades better than its 50-day moving average ¥80.58.  U.S. Treasury yields are lower, with 2- and 10-year maturities yielding 0.383% and 2.928%, respectively, compared to 0.371% and 2.880% Tuesday.  The yield curve narrowed to +2.545%, from +2.509% 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 mixed, with higher energy, lower precious metals, higher aluminum and copper, and higher agriculture.
U.S. news and economic reporting.  Today’s economic reports focus on the latest week’s mortgage applications and June existing home sales. Thursday, reporting turns to the latest week’s initial and continuing jobs claims.
Overseas news:  Today, German Chancellor Merkel and French President Sarkozy meet in advance of tomorrow’s European leaders’ summit on the sovereign debt crisis.  In June, Germany’s purchase price index rose +0.1% over the prior month, higher than estimates for no increase. 
Company news/research:
·         PNC – reports GAAP and operating EPS of $1.67 and $1.64, respectively, compared to estimates of $1.47
·         USB – reports GAAP and operating EPS of $0.60 and $0.61, respectively, compared to estimates of $0.53
·         BLK – reports operating EPS of $3.00 compared to estimates of $2.89
·         MTB – reports GAAP and operating EPS of $2.42 and $2.16, respectively, compared to estimates of $1.57
·         BAC – cut to outperform from buy at CLSA, price target cut to $11.00 from $14
·         WFC – raised to outperform from neutral at CLSA, price target raised to $33 from $29
·         WFC – named top large-cap bank pick at JPMorgan
·         KEY – raised to outperform at RBC, price target of $10
·         XL – initiated at neutral at JMP Securities
1Q2011 Earnings.  The second quarter’s earnings results have so far exceed revenue and earnings expectations.  Of the 54 S&P500 companies that reported earnings to date, 85% (46 out of 54) beat operating EPS estimates, versus the historical average of 62%.  In aggregate, companies beat EPS expectations by an average of +9.2% (versus a historical average of +2%).  EPS is up +28.1% over the prior year.  Though challenged in the current operating environment, 81% of companies reported increased revenues over the prior year and 75% beat revenue estimates.  In the second quarter of 2011, analysts estimate the SPX will earn $24.36 per share, compared to $23.06 and $21.17 per share in 1Q11 and 2Q10, a +5.6% and +15.1% increase, respectively.  
Out of the 13 BKX members to have reported earnings thus far, 92% (12 of 13) have beat earnings estimates on an operating basis.  Revenues have also exceeded expectations, with 75% of BKX members beating estimates.  For the second quarter of 2011, analysts estimate the BKX will earn $0.97 per share, compared to $0.96 and $0.61 per share in 1Q11 and 2Q10, a +1.0% and +59% increase, respectively. 
Valuation.  The SPX trades at 13.3x estimated 2011 earnings ($99.39) and 11.8x estimated 2012 earnings ($112.91), compared to 13.1x and 11.6x 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 +5.1%, and +5.2%, respectively.  Analysts expect 2011 and 2012 earnings to exceed 2010 earnings ($84.78) by +17.2% and +33.2%, respectively.
 Large-cap banks trade at a median 1.32x tangible book value and 12.3x 2011 consensus earnings, compared to 1.38x tangible book value and 12.1x 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 +34.2% and +69.2%, respectively.
Tuesday’s equity markets.  On mixed volume, equity markets posted significant gains and ended near intraday highs.  The Nasdaq rose +2.22%, the SPX and DJI both rose by +1.63%, while the NYSE was higher by +1.46%.  Futures indicated a higher open as a slew of earnings, especially in financials, and positive indications from Europe encouraged investors.  Strong earnings from IBM, WYNN and HOG helped to drive market enthusiasm, though GS reported disappointing earnings.  Markets opened higher and consolidated the gains through the morning session.  A 2:00 afternoon press briefing by President Obama on a bipartisan debt reduction deficit plan spurred strong further gains through the afternoon. The SPX had its strongest percentage gain since March 3rd amid the news and earnings that continue to exceed expectations.
Trading desks reported a busy morning primarily around earnings, but that activity had diminished by early afternoon. Traders report  that investors are not chasing prices and that long only accounts continue to show disinterest.  They describe the afternoon lift more as a function of a lack of sellers than buyers with conviction.  Investors are still concerned that significant macro questions linger, primarily the European sovereign debt resolution and the US deficit ceiling approval by the Congress. The Bloomberg NYSE new net highs were +50 versus Monday’s reading of -72.  The relative strength indicator rose to 51.23 from the previous reading of 44.76 and remains in the neutral range. The VIX finished the day lower at 19.21, off -8.31%.
All market segments were positive. Technology, consumer services and oil and gas were the leaders, while health care, utilities, and telecommunications gained the least.
Financials were strong, despite mixed earnings reports. The KRX, BKX and XLF were all higher, up +1.95%, +1.36%, and +1.24%.  Several large financial institutions reported results on Tuesday and continued to show progress and in some cases, growth. Investors responded by rewarding those that improved substantially, WFC (+5.69%) and KEY (+4.14%), while punishing those that continue to have lingering questions, such as BAC, GS, and STT.  Among the broader financials, the asset managers outperformed, and the banks, in general, showed strength. The BKX began the day higher, but began a trend through the morning of swings from positive to negative as investors digested earnings. A bottom formed just after 12:00. This bottom then led to an afternoon of gains, as the BKX drove to new highs and ended near its high for the day. The BKX ended the day with 20 names up and 4 lower. Names that were leaders included WFC, KEY, and HBAN, while ZION, BAC and STT were the laggards. The KRX finished with 47 names higher and 3 lower. Leaders in the KRX included MBFI, PACW, and WBS. Laggards were SNV, FULT, and EWBC. The BKX, KRX, and XLF finished below their respective 50-, 100-, and 200-day moving averages. While the broader indexes recovered their post-September 2008 losses, bank stocks have not, with the BKX closing -20.19% below its April 2010 high and -43.97% below its best level of 82.55 in September 2008.
NYSE Indicators.  Volume fell -0.41% to 870.65 million shares, from 874.26 million shares Monday, 0.91x the 957.16 million share 50-day moving average.  Market breadth was positive, and up volume led down volume, both by large margins.  Advancing stocks led decliners by +1749, compared to -2139 the prior day, or 3.75:1.  Up volume lagged down volume by 5.97:1.
SPX.  On lower volume, the SPX increased +21.29 points, or +1.63%, to 1326.73.  Volume declined -1.41% to 669.43 million shares, down from 679.01 million shares Monday and below the 738.26 million share 50-day moving average.  For the 186th consecutive day, the SPX’s 50-day moving average closed above its 200-day moving average (1312.12 vs. 1278.40, respectively).  The SPX closed above its 200-week moving average (1160.68).
The SPX gapped higher at the open to the 1315 level and by 10:25, climbed to 1320.  By 11:40 the index had declined to 1315, and subsequently traded in a narrow range until 1:15 when the index stood at 1316.  The index rallied sharply to 1325 by 1:45.  The index retraced some of these gains, declining to 1322 by 2:25.  For the balance of the day, the index rallied, reaching its intra-day high of 1328 at 3:15.  The S&P500 closed the day at 1326.73.
Technical indicators are neutral.  The index’s reversal in June’s second half returned markets to an uptrend on June 21st, confirmed on June 30th.  The SPX closed above 1300 for the 14th straight session.  The index closed above its April 2010 highs for the 157th straight session.  The 50-day moving average has been below the 100-day moving average since July 11thThe SPX closed (by +1.04%) above its 20-day moving average (1313.06).  The index closed (by +1.11%) above its 50-day moving average and has fluctuated above and below that level since July 11thThe index closed (by +0.79%) above its 100-day moving average (1316.27).  The SPX closed +3.78% above its 200-day moving average.  The 50-day and 100-day moving averages remained relatively stable.  The directional momentum indicator turned positive after yesterday’s session.  Relative strength increased to 54.89 from 47.46, a neutral range.  Next resistance is at 1334.22; next support is at 1313.15.
BKX.  On higher volume, the KBW bank index rose +0.62 points, or +1.36%, to 46.25.  Volume increased +4.38% to 94.89 million shares, up from90.91 million shares Monday and above the 78.54 million share 50-day average.  The BKX closed +7.61% above its August 30 closing low of 42.98, the trough of the recent prior correction, but -20.19% and -16.86% below its April 23, 2010, and February 14, 2011 closing highs, respectively.
Financials’ gains lagged the market’s advance, but regionals outperformed both the large-cap banks and the broader S&P500 index.  The BKX gapped higher at the open to 45.75 and continued to rally until 9:40 when the bank index reached 45.99.  A sharp but brief sell-off followed the opening push, taking the index down to 45.45 at 9:56, the intra-day low.  The banks rallied sharply, climbing to 45.97 by 10:23 after which point the index traded in a narrow range, reaching 45.91 by 11:07.  After consolidating, the bank index declined until 12:30, reaching 45.50.  After the midday selloff, the banks rallied to 46.01 by 1:44.  A small sell-off took the bank index down to 45.85 by 2:00.  For the balance of the day, the bank index rallied, reaching its intra-day high of 46.33 at 3:15.  The banks finished the day at 46.25.
Technical indicators are mostly negative.  Bank stocks significantly underperformed the broader market during the May-June correction.  Recent outperformance during the market’s July rebound has been short-lived as European sovereign debt concerns and renewed risk aversion punish the sector.  The 20-day moving average (47.39) is below the 50- and 100-day moving averages (48.13 and 49.95, respectively).  The 50-day average is below the 100-day moving average and has been below the 200-day moving average since June 16th.  The index closed below its 20-day moving average for seven straight sessions.  The index closed below its 50-day moving average for the eighth straight session.  The index closed below the 100- and 200-day moving averages for the 68th and 34th consecutive sessions, respectively.  The index closed below the 50.00 level for the 33st straight session.  The 20-day closed (by -0.74 points) below the 50-day for the 88th straight day, but the gap narrowed.  The 50-day moving average closed (by -1.92 points) below the 200-day moving average for the 23rd straight session, and the gap expanded.  The 100-day moving average closed (by -0.09 points) below the 200-day moving average for the second time in 110 sessions.  The directional movement indicator is negative for the seventh straight session, and the trend is moderate and stable.  Relative strength rose to 41.16 from 35.64, a neutral rangeNext resistance is 46.57; next support at 45.69.
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