Are Stock Traders Watching The Wrong Signals?

After ten losing weeks since early May, the Financials (XLF +10.2% W/W) reversed the pattern this week. What does that mean for the general market?

As I see it, there was a lot of short-covering and attempts at bottom-picking by day traders, but not much serious action by long-term oriented traders. I say that because the weakest companies had the shares that gained the most this week. Fannie and Freddie, for example, gained +30.7% and +18.5% W/W. Among the banks I follow, Bank of America (BAC +26.9%), JP Morgan (JPM +20.7%) and Citi (C +19.5%) had the biggest gains, and among the broker-dealers, it was Lehman Brothers (LEH +32.4%) at the top.

Although I’m not among them (at least not in all cases), there are professional analysts who think most of these Financial operators are toast. Arguably, Fannie and Freddie would be if they had no support in Congress, and how Lehman and JP Morgan would go if their CEO’s didn’t take 2 of the 9 seats on the Board of directors of the important NY Fed is questionable.

It strikes me that traders are watching the wrong signals; they ought to be watching the stock performance of the strongest companies in each sector. Trying to assess the going-concern prospects of a woeful financial services company when you do not understand and cannot evaluate their liabilities and potential losses is a mug’s game.

But, what else can traders do, so they play the market like a ping-pong board. How else could the market cap of LEH grow by one-third in five days?

The Chinese authorities must have a big laugh when after Treasury Secretary Paulson admonishes them for not adopting a market driven model they observe the market cap of five of America’s biggest financial corporations (BAC, JPM, C, LEH and FNM) is up over +26% in a single week.

I wrote some time ago that the market has lost its ability to price value, which is a different issue than the subject of Bear market volatility. The fact is we don’t have the information at hand to price value. The regulators (as in the case of the Fed dropping M3 for example or the SEC allowing offending broker-dealers to abuse the short sale rules) and the banks (not coming clean on losses and write-downs) are hiding information, and apparently they expect us to sit back and accept the crumbs they give us.

When was the last time a banker received a prison sentence for more serious crimes against the public than “our” Martha for example?

Yes, Mr. Moral Hazard, when all this stuff ceases, there could be a free market. Then, and only then, should the Treasury Secretary advocate the unconditional support of international capital markets. That’s an ideal to which we all aspire, but seasoned traders, fortunately, know better. And the Chinese, in case the US authorities doubt this, happen to be pretty fair traders as well as business people.

But, let’s not get hung up on stuff we already know. Let’s pay more attention to the future. What I mean is: are we starting to zero in on prospects for our portfolios for the next Bull market?—you know, the time when our decisions are made with a longer than day-to-day or week-to-week orientation… Yes, decisions based on fundamental, quantitative and economic reasons as well as the technical analysis that we seem just to be focused on these days.

Maybe not at these price levels, but not far off in some situations, I think a Bull case can be made for the likes of IBM (IBM), Intel (INTC), General Electric (GE), Exxon (XOM), Wal-Mart (WMT), Procter & Gamble (PG), Toyota Motor (TM), Research In Motion (RIMM), Google (GOOG) and a few smaller ones like Silver Wheaton (SLW) and Suncor (SU) and even a value play like Tata Motors (TTM). There are many European companies like Nokia (NOK), ABB (ABB) and Diageo (DEO) and Brazilian companies (several) I like as well.

My point is that if you are not watching these stocks, at least week to week, you will not be ready to execute trades somewhere near the cycle bottom. In a couple months there could be a massive sell-off that scares the daylights out of you, and if you are not prepared to let the falling prices come to you at that point, you will be too busy running with the crowd, and settling for smaller Total Returns in the future.

Trading is about preparation. Managing a securities portfolio is, like Charles Dow wrote over 100 years ago, much like running any business based on strategies and tactics. Effective trading that is based on a plan helps you accomplish your goals.

Global Economics Review

The macro-economic data continues to worsen, both in America and abroad.

Weekly International Economic Report .

Please check to see if the date of the report is current.

Here are the key US economic reports and the Econoday analysis from last week.

US Producer Price Index for June. Econoday reported: “PPI in June accelerated dramatically at the headline level but remained moderate at the core level. The overall rate remained red hot with a 1.8 percent jump, following a 1.4 percent spike the month before. The June increase was well above the market projection for a 1.4 percent jump. The core PPI rate, however, held steady at a 0.2 percent rise and fell short of market expectations for a 0.3 percent gain. The headline number was led by a monthly 6.0 percent surge in energy costs and a 1.5 percent gain in food prices. Within energy, gasoline spiked 9.0 percent for the month and is up 39.7 percent for the year.”I believe that if, as and when energy costs fall, as appears likely, both inflation numbers will fall for the next few months, which will serve to push the $USD level higher, setting the stage for a broad market bottom and a final move down in the precious metals prices.

This scenario is not a given because the speculators behind oil and precious metals will make a concerted effort to hold the line on prices.

US Retail Sales for June. As I opined a week ago, “US Retailers ($RLX) continues to get hammered, so the data is not likely to come out looking good for June.” After the data was released, Econoday reported: “Retail sales for June were disappointing with income tax rebate checks apparently going mostly into drivers’ gasoline tanks. Overall retail sales posted a modest 0.1 percent in gain in June, following a 0.8 percent boost the month before. The headline number was considerably softer than the market forecast for a 0.5 percent increase. Excluding motor vehicles, retail sales increased a strong 0.8 percent in June, after advancing 1.2 percent the month before. The consensus expectations for ex-auto sales were for a 1.0 percent increase. However, strength was mostly due to higher gasoline prices. When excluding both motor vehicles and gasoline, sales advanced 0.2 percent, after rising 0.8 percent in May.”

The rebate program was an unmitigated disaster, serving only to help speculators keep the price of oil high, and more downward pressure on the $USD. Without the funds in hand, the public was forced to drive less, and the lower demand sank the price of oil. As long as the US economy remains weak, and there is no US military escalation, there will be significant downward pressure on the oil price. What we knew two and three months ago about “peak oil” is what we know today, which is not helping to hold the line on prices. Hence, the argument, while to an extent valid, is not a major factor in having the oil price above say 80 to 90.

I still believe we are in a secular Bull market for oil and precious metals that will last for many years, but for now I believe the speculators are being taken out of the market by central banks and other regulators, and by tighter credit in the banking system. This is a typical late-cycle action.

US Consumer Price Index report for June. Before the data was released, I opined: “This report is not expected to improve.” Afterwards, Econoday noted: “Consumer price inflation got even hotter in June. The headline CPI soared 1.1 percent, following a 0.6 percent surge the month before. June’s boost was above the consensus forecast for a 0.8 percent jump. The core rate firmed to a 0.3 percent increase after a 0.2 percent rise in May. The market had forecast a 0.2 percent increase. Once again, energy led the surge in overall inflation with a monthly 6.6 percent increase, following a 4.4 percent gain in May. Gasoline was up a monthly 10.1 percent after rising 5.7 percent in May. Food inflation accelerated sharply with a 0.8 percent jump in June, following 0.3 percent increase the month before.”

Don’t underestimate the lagging pressure on demand or the impact on all costs that high oil prices have had, which goes to say that as oil prices fall, I think demand will stay weak for a while longer but prices will come down more quickly. The result ought to be that traders are not so concerned about inflation, and will shift their focus elsewhere in the next couple months.

US Industrial Production report for June. After the data was released, Econoday noted: “Overall industrial production rebounded 0.5 percent in June, following a 0.2 percent decline in May. The June gain was above the market forecast for no change. The manufacturing component made a 0.2 percent comeback, after slipping 0.1 percent in May. Utilities output increased 2.1 percent in June while mining output rose 1.1 percent.” It’s because of improvements here that economists are looking for a GDP growth of +1.8% for 2008 for the US vs say +1.0% for Canada, +1.8% for UK, and +1.2% for Japan.

Traders on the other hand are questioning the ability of banks to finance much if any growth when they are in need of write-downs and much more capital raises. So, while these IP numbers are looking better, I don’t know if in fact traders are yet convinced that it will be translated into higher broad earnings. Still, it is encouraging and supports my view that the Bear is beginning its final phase.

US Housing Starts report for June. Before the release of the data, I opined, “It may take a year or more for this industry to turn around. Interest rates staying down, oil prices falling, and personal incomes growing will be the keys.” Afterwards, Econoday noted: “Housing starts in June posted an unexpected rebound and provide welcome news in tandem with today’s better-than-expected earnings news and jobless claims. However, strength was lopsided - mainly in NYC and based on a one-time change in regulations. Starts rebounded 9.1 percent, following a 2.7 percent decline in May. The June pace of 1.066 million units annualized was down 26.9 percent year-on-year and was above than the market forecast for a 0.960 million units. However, the June rebound was led by a 42.5 percent monthly surge in multifamily starts as single-family starts fell 5.3 percent. The surge in multifamily starts reflected the enactment of more restrictive building codes in NYC effective July 1, 2008 which created a rush to get permits before that date which in turn boosted starts. The single-family starts pace of 0.647 million was down from 0.683 million in May and was down 43.0 percent on a year-ago basis.”

The details show that the industry issues are unresolved. One impact of higher oil prices is the demand for inner-city housing, which of course is multi-family units. People are rejecting their suburban lifestyle, including their gas-guzzling SUV’s and trucks. They discovered that in the semi-rural areas, the demand for houses crunched prices whereas the prices in the inner-city held up much better. Traders are people too; they follow the money.

How is next week’s calendar looking?

US Economic Calendar.

US Existing Home Sales for June. This is a bigger market than new home sales, and the health of the market affects people much more. US New Home Sales for June. Obviously this data impacts the home-builders and the employment situation more.

In today’s Toronto Star, the outstanding columnist David Olive writes something about how new housing has impacted the richer economies, “The current economic slowdown may look global, but it might turn out to be the first in history that hits rich countries harder than developing ones. The contagion of weak U.S. growth has spread to Europe and Japan, the world’s second- and third-largest economies, respectively. Prolonged economic booms in Australia, Ireland and Canada finally have faded; no one’s talking these days about the “Irish miracle” now that Irish job growth and housing values are in decline.

Jobless construction workers now queue up at 5 a.m. outside the Águeda Diez unemployment benefits office in the Carabanchel district of Madrid. Until 2006, Spain was building more houses – about 700,000 a year – than Britain, France and Germany combined. But the Spanish housing market now is in a deep slump, and construction giant Martinsa-Fadesa SA, with debts of 5.2 billion euros, last Tuesday made Spain’s largest-ever bankruptcy filing.”

People’s excesses in 2005-2006 led directly to wealth destruction. I warned of it at the time, and said that the problem was not just US-based.

US Durable Goods Orders for June. After the May report, Econoday noted: “Durable goods orders in May came in largely as expected but despite market relief, indicate at best a flat manufacturing sector. Durable goods orders were unchanged in May, following a 1.0 percent drop in April. May’s overall number matched market forecasts for no change. However, excluding the transportation component, new orders fell back 0.9 percent, following a 1.9 percent surge in April. April was revised down somewhat for both overall orders and ex-transportation. For the latest month, strength was in civilian and defense aircraft orders.” This report is important to those who are trading companies like BA, ERJ, HON, UTX, WHR, BC, etc.

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