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U.S. Futures Rebound, But Equity Distributions Pressure Uptrend

|Includes: NLY, XL Group plc (XL)
This morning.  After two consecutive distributions, the U.S. equity market uptrend is under pressure. This morning, equity futures are higher after fair value adjustment, but off their best levels. Europe remains a focus, with last week’s debt agreements again in substantial doubt. Italian 10-year debt is at fresh record yields.  Possible adverse ratings actions on French sovereign debt further cloud the outlook. The dollar is somewhat weaker today. Otherwise, 3Q2011 earnings reports continue generally better than expected.  Equity options markets suggest a neutral short-term outlook.  Asian markets closed mixed on mixed volume, with a strong positive reversal in Chinese equity markets based on speculation that monetary policy will ease. Eurozone equities opened higher, reversed lower, and are currently mixed. Commodities prices are mixed. U.S. Treasury yields are higher.  U.S. repo rates remain at low levels.  Overnight and 3-month LIBOR remain elevated, near the year’s highs.  Euribor-OIS spreads are near 2011 highs.  After a fair value adjustment of -10.22 points, December SPX equity futures are at 1232.90, up +17.52 points.  The SPX opens at 1218.28, -10.7% below its April 29 multi-year closing high, +0.08% above its 20-day and +2.31% above its 50-day moving averages.  The SPX is -3.13% below its 1257.64 year-end close.  Next resistance is at 1241.05; next support is at 1205.47.
Tuesday.  Principally on adverse European sovereign concerns, equity markets extended the prior day’s losses. Volumes rose.  The NYSE composite lost -3.01%, followed by losses of -2.89%, -2.79%, and -2.48%, respectively, on the Nasdaq, SPX, and DJI.  The pullback was the 2nd consecutive sizeable loss. As on Monday, the major indexes gapped substantially lower, and then traded in narrow ranges through the rest of the day. News focused on the failure of MF Global (MF) and Eurozone news, which was thoroughly confused and contradictory. Volatility rose sharply at the open, then traded sideways through the day. Market breadth was negative, and up volume lagged down volume, both by large margins. All market segments were lower.  Telecommunications, health care, and consumer services fell at least -1.98%. Oil and gas, industrials, and financials lagged with losses of at least -3.08%. 
Trading desk commentary focused Eurozone sovereign debt markets, which deteriorated substantially, with criticism of the ECB, which allowed Italian bond yields to cross above 6%.  After a turbulent open, U.S. equity markets settled quickly into a relatively quiet trade, with most of the action from hedge funds and quicker traders who had chased last week’s strength. Shorting activity was muted, while long-only investors kept to the sidelines, suggesting possible further selling pressure ahead in the absence of a strong bounce. Financials ended down -4.71%, with slightly greater weakness in the regional bank group.

Volume rose on all the major exchanges, adding a distribution day.  Distribution days number 4 on the SPX and NYSE composite, and 3 on the DJI and Nasdaq, since the uptrend commenced on October 4th.
In Asia, equity markets closed mixed, with greater strength in China, where markets staged strong positive reversals. The Nikkei lost -2.21%, while the Hang Seng and Shanghai composite rebounded +1.88% and +1.38%, respectively. NKE volume rose +24.0%. HSI and SHCOMP volumes rose +12.6% and +22.6%, respectively. Commentary focused Eurozone developments. Chinese stocks reversed on speculation that Chinese monetary policy would be eased.
In Japan, the NKY closed at 8,640.42, its intraday low and down from 8,835.52 at the prior close.  The NKY closed -1.23% below its 20-day moving average.  The NKY gapped lower to about 8,725, and traded down to 8,650 by mid-morning. The index rallied back to 8,700 by mid-day, where it found resistance and bell back to 8,650 by mid-afternoon before ending at its intraday low. All market segments ended lower at least -1.41%. Leaders were health care, technology, and telecommunications. Laggards were financials, consumer goods, and utilities, which closed off at least -2.47%.
In China, the Hang Seng Index closed at 19,733.71, up from 19,369.96 at the prior close.  The index gapped lower to 19,100, but began to a mid-morning rally back to 19,200 at mid-day. The rally accelerated through the afternoon, and closed just short of its 19,745.5 intraday high. The index ended +6.79% and +4.44% above its respective 20-day and 50-day moving averages.  Market segment leaders were technology, basic materials, and industrials, which closed up at least +1.96%. Laggards were consumer goods, consumer services, and utilities, which closed at least +1.61% higher.
In Shanghai, the SHCOMP closed at 2,504.11, up from 2,470.02 at the prior close.  The index gapped lower to open at 2,435, where it traded within a narrow range until mid-day, when speculation that monetary authorities will ease policy started a strong rally. The index turned positive at mid-day, and as in Hong Kong, the rally accelerated through the afternoon. The intraday high of 2,505.12 was set in the final minute.  The SHCOMP closed +4.33% and +1.46% above its respective 20-day and 50-day moving averages.  All market segments ended at least +0.86% higher. Leaders were technology, telecommunications, and consumer services, with gains of at least +2.56%. Financials gained +1.28%. Consumer goods, basic materials, and oil and gas were the day’s laggards. 
In Europe, equities opened higher, but reversed lower at mid-morning, before reversing again to a mostly higher trade. Commentary focuses on Greece, today’s FOMC statement, this weekend’s G-20 agenda, and a strong, prospective U.S. equity open. The Euro Stoxx 50, FTSE, and DAX are mixed, +0.49%, -0.22%, and +0.87%, respectively.  On the Euro Stoxx 50, the index opened at 2,280, traded immediately to 2,299.68, and then sold off to an mid-morning low of 2,240.16. The index subsequently rallied back to 2,275. Market segments are mixed.  Leaders are industrials, financials, and basic materials, up at least +.74%. Telecommunications, oil and gas, and health care are the lagging with losses of at least -0.39%.
Libor, LOIS, Currencies, Treasuries, Commodities:
  • Interbank lending rates continue to reflect substantial stress, centered on the health of Eurozone banks in the current economic environment.   Overnight USD LIBOR is 0.14222%, unchanged since October 25th, and below the 0.25188% year-end level.  USD 3-month LIBOR rose to 0.43167%, the highest level of the year, up from 0.42944% the prior day and compared to 0.30281% at year-end 2010.
  • The US Libor-OIS (LOIS) spread rose to 34.8 bps, the highest level of the year, from 34.6 bps the prior day and compares to 12.0 bps at the end of 2010.  Euribor-OIS rose to 86.8 bps, the year’s highest level, from 85.9 bps the prior day, 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 10.0 bps, unchanged from 10.0 bps Tuesday, and well off from a recent high of 33 bps on August 2nd.
  • U.S. Treasury yields are higher, with 2- and 10-year maturities yielding 0.242% and 2.035%, respectively, compared to 0.236% and 1.989% Tuesday.  The yield curve widened to +1.793%, compared to +1.753% the prior day.  In the past year, the 2- and 10-year spread varied from a low of +1.520% on September 22, 2011, to a high of +2.910% on February 4, 2011.
  • The U.S. dollar is somewhat weaker against the euro, pound, and yen.  The dollar trades at US$77.011, compared to US$77.261 the prior day, and above its US$76.731 50-day, US$75.692 100-day, and US$75.741 200-day averages.  The euro trades at US$1.3779, compared to US$1.3703 Tuesday and US$1.3858 the day prior.  The euro trades worse than its US$1.3810 50-day and US$1.4059 100-day averages.  In Japan, the dollar trades at ¥78.05, compared to ¥78.37 Tuesday and ¥78.112 the prior day.  The yen trades worse than its 50-day moving average ¥76.839.
  • Commodities prices are mixed, with higher energy and precious metals, lower aluminum and copper, and mixed agriculture prices.
Volatility, Skew:
  • The VIX ended at 34.77, up +16.1% from 29.96 at the prior close.  The VIX is +9.01% above its 20-day moving average 31.90.
  • The Euro Stoxx 50 volatility index (V2X) is down -0.65% to 42.64 from 42.96 the prior day.  The V2X index trades +10.6% above its 38.53 20-day moving average, -19.1% below the 52.62 30-day high, and +50.4% above the 28.29 30-day low.
  • The Hang Seng volatility index (VHSI) declined -0.48% to 35.17 from 35.34 the prior day.  The VHSI index trades -1.13% below its 35.57 20-day moving average.
  • CBOE skew rose to 126.65, up from 121.18 at the prior day’s close, and above a neutral (115-120) range.  The index tracks the cost of buying out-of-the-money, long-dated options.  A rise implies that investors are paying more to buy puts, a bearish signal.
U.S. news and economic reporting.  Today’s scheduled economic reports include the ADP employment report for October. Challenger job cuts were up +12.6% compared to the prior year, better than expected. ADP employment rose +110K, better than +100K survey. Prior was revised to +116K from 91K. Overall, the report suggests incremental improvement, but insufficient to materially improve the unemployment rate, currently 9.1%. The 2-day FOMC meeting concludes this afternoon with Bernanke’s press conference. Tomorrow’s focus is the latest weekly initial and continuing jobs claims, followed Friday by U.S. non-farm payrolls report for October.
Overseas news: Today, Greek Prime Minister Papandreou meets with French President Sarkozy and German Chancellor Merkel in Cannes before the G-20 summit.  Yesterday, Greece’s cabinet unanimously backed Papandreou’s call for a Friday no-confidence vote and a national referendum on the latest bailout package’s austerity terms.  Eurozone officials announced the pending Emergency Financial Stability Fund (EFSF) bond sale, which had just been scaled down to €3 billion in 10-year debt from €5 billion in 15-year debt, will now be postponed for at least two more weeks.  Today, Standard & Poor’s announced it does not anticipate immediate ratings changes for sovereign guarantors due to the EFSF ramp-up.  In October, Germany’s purchasing managers index increased to 49.1, ahead of estimates but below the expansionary 50-level.  In October, Germany’s unemployment rate increased, the first increase in two years. 
Company news/ratings changes:
·         XL – reports 3Q11 operating EPS of $0.28, below estimates of $0.35
·         NLY – reports 3Q11 operating EPS of $0.65, matching estimates of $0.65
3Q2011 Earnings.  The third quarter’s earnings reports have so far surprised expectations.  Of the 338 S&P500 companies that reported earnings to date, 74% (251 out of 3338) beat operating EPS estimates, versus the historical average of 62%.  In aggregate, companies beat EPS expectations by an average of +5.9% (versus a historical average of +2%).  EPS is up +19.3% over the prior year.  Though challenged in the current operating environment, 82% of companies reported increased revenues over the prior year and 57% 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 of the 24 BKX members reporting, 75% beat operating estimates with aggregated results surprising by +14.3% and 63% have beat revenue estimates with aggregated surprising by +4.2%.  EPS is up +21.2% over the prior year, while revenue is up +1.5%.  In the third quarter of 2011, the BKX earned $1.24 per share, beating analysts’ estimate of $1.15 per share, and compared to $1.12 and $0.71 in 2Q11 and 3Q10, (an +11% and +48% increase, respectively) In the second quarter, 88% (21 of 24) beat earnings estimates on an operating basis.  Revenues also exceeded expectations, with 79% of BKX members beating estimates. 
Valuation.  The SPX trades at 12.3x estimated 2011 earnings ($99.29) and 10.9x estimated 2012 earnings ($111.57), compared to 12.6x and 11.2 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 +5.0%, and +4.0%, respectively.  Analysts expect 2011 and 2012 earnings to exceed 2010 earnings ($84.78) by +17.2% and +31.6%, respectively. 
Large-cap banks trade at a median 1.18x tangible book value, and 10.4x and 9.2x 2011 and 2012 consensus earnings, respectively, compared to 1.24x tangible book value and 10.8x/9.5x 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 +29.6% and +53.8%, respectively.
Options.  Options markets are neutral.  Composite options markets are neutral, index options markets are neutral, and equity options markets are neutral.  The composite put/call ratio closed at 1.35, compared to 1.26 the prior day and above its 5- and 10-period moving averages of 1.10 and 1.08, respectively.  The index put/call ratio closed at 1.71, compared to 1.80 the prior day and above the 5- and 10-period moving averages of 1.55 and 1.52, respectively.  The equity put/call ratio closed the day at 0.87, compared to 0.75 the prior day and above its 5- and 10-period moving averages of 0.68 and 0.67, respectively.
NYSE Indicators.  Volume rose +16.3% to 1.329 billion shares, from 1.143 billion shares Monday, 1.18x the 1.122 billion share 50-day moving average.  By large margins, market breadth was negative, and up volume outpaced down volume.  Advancing stocks lagged decliners by -2,153 (compared to -1,908 the prior day), or 0.17:1.  Up volume lagged down volume by 0.07:1.
SPX. On higher volume, the SPX fell -35.02 points, or -2.79%, to end at 1218.28.  Volume rose +16.29% to 1.001 billion, up from 860.55 million shares Monday and above the 875.97 million share 50-day moving average. For the 57th straight session, the SPX’s 50-day moving average closed below its 200-day moving average (1190.78 vs. 1273.66 respectively)The SPX closed above its 200-week moving average (1138.43) for the 18th straight session. 
From its prior close at 1253.30, the SPX gapped lower at the open to 1227 and fell to 1218 by 9:35.  Through 10:30, the index rallied to 1232 before retracing that entire move by noon and hitting 1215.  Small rallied through 1:30 were sold, and the index set the intra-day low of 1215.42 at 1:25.  At 1:30, news that Greece reversed course on its referendum announcement sent the index 15 points higher in 20 minutes.  At 2:30, the index reached its intra-day high of 1233.79.  The index fell into the close and finished at the low end of the day’s range. 
Technical indicators are turning neutral.  The market returned to a confirmed uptrend following October 12th’s follow-through confirmation of October 4th’s strong reversal, though the last two days’ declines placed that uptrend under pressure.  The SPX closed below 1300 for the 67th straight session but above 1200 for the 15th straight session.  The index closed above its April 2010 highs for the first time in the previous 7 sessions.  The 50-day moving average has been below the 100-day moving average since July 11th.  The 100-day moving average crossed the 200-day average to the downside on September 7thThe SPX closed (by +0.08%) above its 20-day moving average (1217.33) for the 18th time in 19 sessions.  The index closed (by +2.31%) above its 50-day moving average for the 16th straight session.  The index closed (by -0.93%) below its 100-day moving average (1230.22) for the first time in five sessions.  The SPX closed -4.35% below its 200-day moving average, closing below that average for the second straight sessions.  The 20- and 50-day moving averages rose.  The directional momentum indicator switched to negative for the first time in 15 sessions, and the trend is moderate and stable.  Relative strength fell to 50.54 from 57.56, a neutral range.  Next resistance is at 1241.05; next support is at 1205.47.
BKX.  On higher volume, the KBW bank index fell -1.96 points, or -4.89%, to end at 38.13, recording its 63rd close below the prior 52-week low of 42.70 from August 25, 2010 and returning below 40 for the first time in four sessions.  Volume rose +25.94% to 133.86 million shares, up from 106.29 million shares Monday and above the 111.65 million share 50-day average. The BKX closed -11.28% below its August 30, 2010 closing low of 42.98, the trough of the last year’s correction, and -34.20% and -31.46% below its April 23, 2010, and February 14, 2011 respective closes.
Financials were the market’s worst performing segment, and large-cap banks performed in-line with regional banks.  From its prior close at 40.09, the BKX gapped lower at the open to 38.45 and fell to 38.20 at 9:35.  Momentum reversed, and the index climbed to 39.25 by 10:40, setting the intra-day high.  Through noon, the index retraced back to its 9:35 low at 38.20.  At 1:30, the index rallied on news that Greece would not proceed with a referendum on its latest bailout package austerity terms.  By 2:25, the index reached 39.23.  Through 3:45 the index retreated back to 38.40.  A late headline indicated Greece would in fact go through with its announced referendum sent the index to its intra-day low of 38.07 at 3:53 and the index closed just above that level.   
Technical indicators are negative, but are improvingBank stocks are leading the market’s direction, which switched to an uptrend after October 13’s confirmation of October 4th’s strong reversal.  This week’s sharp losses in the markets, and in banks particularly, have placed that uptrend under pressure, The BKX has now recorded its 15th close above the 50-day moving average since October 12th, a level which provided meaningful resistance since February 22nd.  Moving averages align bearishly, as most shorter duration averages are below the longer duration averages, although all major gaps are narrowing and some averages are rising.  The 50-day average (37.64) crossed below the 100- and 200-day moving averages (41.21 and 46.46, respectively) on April 25th and June 16th.  The 20-day closed (by +0.79 points) above the 50-day for the fifth straight session, and the gap expanded.  The 50-day moving average closed (by -8.82 points) below the 200-day moving average for the 99th straight session, but the gap narrowed.  The 100-day moving average closed (by -5.26 points) below the 200-day moving average for the 77th straight session, and the gap expanded.  The BKX closed below its 20-day moving average for the first time in 17 sessions.  The index closed above its 50-day moving average for the 15th time in 16 sessions.  The index closed below the 100-day moving average for the second straight session and below its 200-day moving averages for the 107th consecutive session.  The index closed below 50.0 for the 107th straight session and crossed back below 40.0 for the first time in three sessions.  The directional movement indicator is positive, narrowly, for the 12th straight session, and the trend is moderate and decreasing.  Relative strength fell to 48.83 from 55.22, a neutral range.  Next resistance is 39.20; next support at 37.57.