Eurozone Equities Reverse on Rate Decision, Dragging U.S. Equity Futures Lower

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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.  U.S. equity markets remain in a confirmed uptrend.  Overall trading patterns suggest a slightly positive equity outlook, but the strength and durability of the current uptrend have been in doubt since the uptrend was confirmed on August 22nd.  Equity options markets suggest a bearish short-term outlook.  Asian markets closed mixed, with losses in China on concerns that monetary authorities will raise interest rates over the weekend.  Eurozone equities were higher, but turned lower after interest rates were left unchanged and Trichet’s press conference.  Markets may have been disappointed in the absence of any change in the ECB’s inflation “balanced” language.  Also, a possible rate cut in November appears to have been taken of the table.  The U.S. dollar is mixed.  Commodities markets are mixed.  U.S. Treasury prices are higher.  LIBOR markets suggest heightened interbank lending credit concerns.  Euribor-OIS spreads are trending higher.  After a fair value adjustment of -1.13 points, September SPX equity futures are at 1189.00, down -9.37 points.  The SPX opens at 1198.62, -12.1% below its recent April 29 multi-year closing high, and +1.96% above its 20-day moving average, but -4.01% below its 50-day moving average.  The SPX is -4.69% below its 1257.64 year-end close.  Next resistance is at 1209.54; next support is at 1176.77.

Markets more than erased their Tuesday losses, gapping higher, trending higher through the day, and closing at their intraday highs.  Volume was disappointing, well below the 50-day moving average.  The Nasdaq led with a +3.04% gain, followed by the NYSE composite, SPX, and DJI, which rose +2.90%, +2.86%, and 2.47%, respectively.  Volatility generally fell through the day from a mid-morning intraday high of 34.70, to a 33.38 intraday closing low, off -9.78%.  While health care gained +0.29%, all other market segments closed off at least -0.24%.  All markets segments closed at least +1.06% higher, led by financials, oil and gas, and industrials.  Financials led with a +4.75% gain.  Consumer goods, telecommunications, and utilities were the laggards.

Yesterday’s gains came on unimpressive volume.  Total distribution days were unchanged, numbering 1 on the Nasdaq and SPX, and 2 on the DJI, NYSE, and BKX.  Distribution days signal institutional selling in the prior 25 trading days, or since the commencement of the most recent uptrend.  An accumulation of distribution days signal a weakening of an uptrend and increased probability that an uptrend will come under pressure or that a correction will ensue.

In Asia, Japanese equities rose, while Chinese equity markets closed lower.  In Japan, volume was lower.  In China, volume was mixed.  Traders cited several cross currents, including job cuts in Australia, a report that China will raise interest rates further, and U.S. stimulus expectations.

In Japan, the Nikkei closed at 8793.12, up 0.34% on a -19.2% decrease in volume.  The index gapped immediately higher to the 8876.49 intraday high, but quickly lost momentum and traded back to a small loss just before midday.  The afternoon trade was quiet, but recovered mildly in the final hour to end with a modest, but still disappointing gain.  Most segments gained.  Leaders were oil and gas, health care, and consumer services, which rose at least +1.22%.  Financials, telecommunications, and industrials closed lower, with financials off -0.03%.  The NKY closed below its 50-, 100-, and 200-day moving averages, -14.0% below its 2010 close.

In China, the Hang Seng and Shanghai composite closed down -0.67% and -0.68%, respectively.  HSI volume rose +10.5%, while SHCOMP volume fell -9.21%.  In Hong Kong, the HSI gapped moderately higher, but immediately traded to a loss and never rallied through the day’s remainder.  All market segments closed lower.  Basic materials, financials, and utilities were the leaders, but closed at least -0.31% lower.  Financials lost -0.46%.  Telecommunications, industrials, and consumer goods were the laggards, off at least -0.92%.  The HSI closed -13.6% below its 2010 close, but +2.64% above its 19.399.92 August 19th most recent closing low.  In Shanghai, the SHCOMP fell -0.68%, to close at 2498.94.  The index opened higher, but traded above and below the prior day’s closed through most of the day, before losing ground to close just above the 2498.11 intraday low.  Only health care closed higher.  Other leaders were oil and gas and utilities, which lost at least -0.27%.  Financials closed off -0.42%.  The laggards were technology, consumer services, and industrials, which lost at least -1.01%.  The SHCOMP ended -18.3% below its April 18th 3057.33 high, -11.0% below its 2010 close, and -6.18% below its 2663.68 50-day moving average. 

In Europe, equities markets are up small, after the prior day’s exceptional gains.  The Eurostoxx50, FTSE, and DAX are +0.39%, +0.04%, and +0.13%, respectively.  On the EuroStoxx50, most market segments are mixed.  Leaders are financials, oil and gas, and telecommunications, which are up at least +0.80%.  Financials are up +1.61%.  Laggards are consumer goods, consumer services, and health care, which are at least -0.74% lower.

Libor, LOIS, Currencies, Treasuries, Commodities:

·         Interbank lending rates continue to reflect increased stress, as concerns heighten regarding the health of Eurozone banks in a stressed economic environment. Overnight USD LIBOR rose to 0.14444% compared to 0.14333% Wednesday, but down from 0.25188% at year-end. USD 3-month LIBOR is 0.33683%, unchanged from Wednesday, and above the 0.30950% year-end rate.

·         The US Libor-OIS (LOIS) spread rose to 26.2 bps, compared to 25.6 bps the prior day and 12.0 bps at the end of 2010. Euribor-OIS fell slightly to 76.6 bps, from 77.1 bps Wednesday, and compares to 40.6 bps at the end of 2010.  A rise in the LOIS indicates an increased intra-bank lending risk premium.

·         The U.S. government overnight repo rate is 7 bps, compared to 7 bps Wednesday, and well off from a recent high of 33 bps on August 2nd.

·         The U.S. dollar is slightly stronger against the euro, but weaker against the yen and pound. The dollar trades at US$75.572, compared to US$75.467 the prior day, and higher than its US$74.565 50-day and US$74.618 100-day moving average, but below its US$76.210 200-day average. The euro trades at US$1.4053, compared to US$1.4098 Wednesday and US$1.3998 the prior day.  The euro trades below its US$1.4294 50-day and US$1.4349 100-day. In Japan, the dollar trades at ¥77.19, compared to ¥77.26 Wednesday and ¥77.66 the prior day.  The yen trades better than its 50-day moving average ¥77.987.

·         U.S. Treasury yields are higher, with 2- and 10-year maturities yielding 0.192% and 1.991%, respectively, compared to 0.200% and 2.043% Wednesday.  The yield curve widened to +1.799% from +1.843% the prior day.  In the past year, the 2- and 10-year spread has varied from a low of +1.787% on September 6, 2011 to a high of +2.910% on February 4, 2011.

·         Commodities prices are mixed, with lower petroleum, higher metals prices, and lower agriculture.

U.S. news and economic reporting.   Thursday’s focus turns to initial and continuing jobless claims for the latest week as well as the July trade balance.  Actual initial claims were K, compared to 405K survey and 409K prior.

Overseas news:  Today, the European Central Bank and the Bank of England both left their benchmark interest rates unchanged.  Today, the Bank of France trimmed its growth forecast for the third quarter to a +0.1% growth rate.  Today, Finland’s finance minister said the country will not participate in any future bailouts unless collateral is provided by the aid recipients.  In July, Spain’s industrial output fell -2.8% over the prior year, the fastest drop in more than a year.  Today, Fitch warned it may downgrade China’s credit rating within two years based on risk to banks’ balance sheets.  

Company news/ratings changes:

·         None.


2Q2011 Earnings.  The second quarter’s earnings results exceeded revenue and earnings expectations.  Of the 472 S&P500 companies that reported earnings to date, 76% (358 out of 472) beat operating EPS estimates, versus the historical average of 62%.  In aggregate, companies beat EPS expectations by an average of +5.0% (versus a historical average of +2%).  EPS is up +16.5% over the prior year.  Though challenged in the current operating environment, 84% of companies reported increased revenues over the prior year and 71% beat revenue estimates.  In the third quarter of 2011, analysts estimate the SPX will earn $24.98 per share, compared to $24.84 and $21.49 per share in 2Q11 and 3Q10, a +0.6% and +16.2% increase, respectively.

With all 24 BKX members reporting earnings, 88% (21 of 24) beat earnings estimates on an operating basis.  Revenues also exceeded expectations, with 79% of BKX members beating estimates.  For the second quarter of 2011, the BKX earned $1.12 per share, beating $0.97 estimates and compared to $0.96 and $0.61 per share in 1Q11 and 2Q10 (a +17% and +84% increase, respectively)

Valuation.  The SPX trades at 12.0x estimated 2011 earnings ($99.90) and 10.7x estimated 2012 earnings ($112.22), compared to 11.7x and 10.4x 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 +5.6%, and +4.6%, respectively.  Analysts expect 2011 and 2012 earnings to exceed 2010 earnings ($84.78) by +17.8% and +32.4%, respectively. 

Large-cap banks trade at a median 1.13x tangible book value, and 9.8x and 8.5x 2011 and 2012 consensus earnings, respectively, compared to 1.06x tangible book value and 9.4x/8.0x 2011/2012 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 +36.7% and +65.2%, respectively.

Options.  Options markets are bearish.  Composite options markets are neutral to bearish, equity options markets bearish, and index options markets are bearish.  The composite put/call ratio closed at 0.89, below its 5- and 10-period moving averages of 1.18 and 1.16, respectively.  The index put/call ratio closed at 1.07, above the 5- and 10-period moving averages of 1.51 and 1.55, respectively.  The equity put/call ratio closed the day at 0.60, below its 5- and 10-period moving averages of 0.71 and 0.70, respectively.

Wednesday’s equity markets.  On light volume, equity markets posted substantial gains.  The Nasdaq, NYSE, SPX, and DJI all finished higher, up +3.04%, +2.90%, +2.86%, and +2.47%, respectively.  After opening the month of September with 3 straight losing sessions, futures indicated a strong rebound from an oversold condition. The DJI had lost -4.1%, marking one of the worst September starts since 2002 and the 4th worst for the DJI since 1896.  In the three September starts that were worse, 1931, 1946, and 2002, the index posted full year losses of at least -8.1%.  Prior to the opening, mortgage applications fell for the 3rd consecutive week as fewer Americans refinanced and purchases stayed close to a 14-year low.  Markets opened higher and gained steadily through the day.  Management shake ups at BAC and YHOO helped to fuel the market, but in general, news was light, and investors spent the day speculating on the president’s Thursday night speech on jobs and economic stimulus.  Markets climbed through the afternoon, and moved higher after the 2:00 release of the Fed’s Beige book, which seemed to confirm that the economy is growing at a slower pace than expected and consumers and firms are spending less.  Markets corrected slightly just after 3:00, but reversed course and finished on the highs.  The VIX finished the day at 33.38, down -9.78%.

Trading desks reported light volumes.  Traders discussed that the upward move was helped as sellers seemed to disappear.  Several desks reported that shorts didn’t press their positions on this up day, but didn’t cover positions either.  Technically, the bounce off of 1136 was consistent with a Fibonacci retracement from last April's SPX highs.  The light volume places that conclusion in some doubt, as volumes were anemic.  The AAII Bullish Investor Sentiment index for September 8th was 30.2, lower than the previous reading of 38.62. The relative strength indicator rose to 47.74 from the previous day’s reading of 41.27, still in a neutral range.

All market segments were positive. Financials, oil and gas, and industrials were the leaders, while consumer goods, telecommunications, and utilities were the laggards.

Financials outperformed the broader indexes. The KRX, BKX, and XLF were all higher, up +5.93%, +5.88%, and +4.79%, respectively.  News of a management shake-up at BAC helped propel BAC higher by +7%.  There was relatively light news flow from the financials, and investors seemed to see a bottom in this oversold group. The BKX finished the day with all 24 names higher.  RF, HBAN, and KEY were the leaders, up at least +8.67%.  Laggards were CFR, CBSH, and NYB, up at least +2.59%.  The KRX finished the day with all 50 names higher. Leaders were SNV, PVTB, and SUSQ, up at least +8.13%. Laggards were BRKL, FFBC, and CHCO.  Among the broader financials, RF, CBG, and AIG were the leaders, though banks dominated the top 10 gainers.  Within the banks, however, the regional banks had a better day than did the money centers, as investors remain cautious about those names.  The BKX, KRX, and XLF all finished below their 50-, 100-, and 200-day moving averages.  While the broader indexes have recovered their post-September 2008 losses, bank stocks have not, with the BKX closing -33.5% below its April 2010 high and -53.3% below its best level of 82.55 in September 2008.

NYSE Indicators.  Volume fell -1.51% to 954.50 billion shares, down from 1.124 billion shares Tuesday, 0.82x the 1.164 billion share 50-day moving average.  Market breadth was positive, and up volume led down volume.  Advancing stocks led decliners by +2420 (compared to -1402 the prior day), or 8.66:1.  Up volume led down volume by 20.6:1.

SPX.  On lower volume, the SPX rose +33.38 points, or +2.86%, to 1198.64.  Volume fell -10.47% to 770.89 million shares, down from 861.07 million shares and below the 898.14 million share 50-day moving average.  For the 17th straight session, the SPX’s 50-day moving average closed below its 200-day moving average (1248.65 vs. 1283.84 respectively)The SPX closed above its 200-week moving average (1149.26).

The SPX gapped higher at the open to 1179, setting the intra-day low.  The index melted up through 3:00 with evenly spaced 5 points rallies and never more than a 3 point retracement.  By 10:00, the index reached 1185, but retraced to 1183 at 10:30.  At 11:30, the index rallied to 1189, then traded sideways within a 2 point range through 12:30.  From 12:30 through 1:25, the index slowly reached the 1194 level, but retraced to 1192 by 1:45.  Through 2:45, the index rallied 5 more points to the 1198 level.  Profit taking took hold from 2:45 through 3:35, and the index retraced to 1193.  A rally in the final five minutes lifted the index to its intra-day high at the bell. 

Technical indicators are neutral to negative.  Markets, in correction since July 27th, resumed an uptrend with August 23rd’s gains in higher volume.  The SPX closed below 1300 for the 28th straight session and below 1200 for the third straight session.  The index closed below its April 2010 highs for the 23rd time in the last 24 sessions.  The 50-day moving average has been below the 100-day moving average since July 11thThe SPX closed (by +1.96%) above its 20-day moving average (1175.58) for the fifth time in six sessions.  The index closed (by -4.01%) below its 50-day moving average for the 30th straight session.  The index closed (by -6.58%) below its 100-day moving average (1283.00) for the 29th straight session.  The SPX closed -6.64% below its 200-day moving average, closing below that average for the 25th straight session.  The 20-day moving average rose.  The directional momentum indicator is negative for the 29th straight session, and the trend is moderate and stable.  Relative strength rose to 49.54 from 42.91, a neutral range.  Next resistance is at 1209.54; next support is at 1176.77.

BKX.  On lower volume, the KBW bank index rose +2.14 points, or +5.88%, to end at 38.52, its 25th close below the prior 52-week low of 42.70 from August 25, 2010 and its 22nd straight sub-40 close.  Volume fell -17.80% to 93.85 million shares, down from 108.71 million shares, below the 107.13 million share 50-day average, and the lowest since August 17thThe BKX closed -10.38% below its August 30, 2010 closing low of 42.98, the trough of the last year’s correction, and -33.53% and -30.76% below its April 23, 2010, and February 14, 2011 respective closes.

Financials were the market’s best performing segment, and large-cap banks performed in-line with regional banks.  The BKX gapped higher at the open to the 36.91 level, immediately setting the intra-day low.  Through 10:25, the index added another 0.85 points and reached the 37.75 level.  Gains consolidated back to the 37.50 level by 10:30 and the index traded relatively sideways through 11:00.  From 11:00 to 11:30, the index rallied 0.40 points and reached 37.95.  Momentum paused, and the index traded just below 38.00 through 12:30.  A quick 10 minute rally at 12:30 took the index to 38.20 at 12:40, and momentum again paused through 1:45.  From 1:45 through 2:45, the index gain 0.45 points to the 38.60 level, setting the intra-day high.  Profit taking at 2:45 retraces gains nearly back to 38.00 by 3:35, but a closing bell rally lifted the index back over 38.50 at the bell.   

Technical indicators are negativeBank stocks significantly underperformed the broader market during the May-June correction and the late July-mid August sovereign debt crisis sell-off.  Recent gains on higher volume, and bank outperformance, returned markets to an uptrend on August 23rd.  Since the BKX crossed below its 50-day moving average on February 23rd, the 50-day average has provided meaningful resistance to any positive momentum.  Moving averages align bearishly.  The shortest duration averages are below the longer duration averages, the gaps are widening, and all major averages are falling.  The 50-day average (42.81) crossed below the 100- and 200-day moving averages (45.98 and 49.04, respectively) on April 25th and June 16th.  The 20-day closed (by –5.00 points) below the 50-day for the 123rd straight day, but the gap narrowed.  The 50-day moving average closed (by -6.23 points) below the 200-day moving average for the 60th straight session, and the gap expanded.  The 100-day moving average closed (by –3.06 points) below the 200-day moving average for the 38th straight session, and the gap expanded.  The index closed above its 20-day moving average for the first time in three sessions.  The index closed below its 50-, 100-, and 200-day moving average for the 42nd, 43rd and 68th consecutive sessions, respectively.  The index closed below 50.00 for the 68th straight session and below 40.00 for the 22nd straight session.  The directional movement indicator is negative for the 31st straight session, and the trend is strong but declining.  Relative strength rose to 46.57 from 38.21, a neutral range.  Next resistance is 39.16; next support at 37.30.

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