This morning, Standard & Poor's warned that global banks could experience a profit collapse, employing language that one CNBC commentator termed "apocryphal." S&P warned that pretax profit for those banks could drop 70 percent in the second half of the year.
The potential impact of any such profit collapse on economic growth became readily apparent when the GDP was released later in the morning. Sixty-four percent of the profits in domestic industries were produced by the financial industries. What happens to profits in domestic industries if profit in financials collapses?
Bad news continued. The CEO of H&R Block (HRB) compared the current dislocation in the mortgage lending market to that seen in the 1930s. The company has been trying to divest itself of its Option One unit, but the management says it may be preferable to see that divestiture collapse rather than the company incurring more losses.
The bombardment of negative news continued. In addition to S&P's and HRB's warnings, Lehman Brothers trimmed its price targets and/or earnings-per-share estimates for investment banks MS, MER, GS and BSC. Investment banks have been busy downgrading each other this week, with MER doing the downgrading a couple of days ago.
Credit Suisse cut its price target for Countrywide Financial (CFC) to $28.00, still well above CFC's current price but also well below the firm's previous $40.00 target and CFC's actual prices above $40.00 back in May. KKR wrangled with banks for the $24 billion it needs for its acquisition of First Data (FDC).
In addition, Freddie Mac (FRE) added more worries when it reported a $320 million loss on new mortgages, leading to a 45-percent drop in earnings. The trouble wasn't confined to the financial sectors, however. Merrill Lynch downgraded Wal-Mart (WMT) to a sell rating. Sears Holdings (SHLD) reported a forty percent drop in profit for the second quarter.
After all that terrible news, market breadth as measured by advancers versus decliners was negative much of the day.
So what happened? Why did markets hold up as well as they did? Some posted gains and some tread water, producing relatively small-bodied candles in the top half of yesterday's ranges.
Thornburg Mortgage's (TMA.N) may have helped. The firm asserted that its sale of convertible bonds would allow it to start making new loans. The company also said that it didn't lose as much on the asset sale it was forced to make earlier this month as had been estimated. In addition, the company lost only $863 million rather than the previously estimated $930 million. As you may remember, Thornburg Mortgage is considered a jumbo mortgage specialist with loans that were considered high quality, but the credit crunch forced it to sell assets and delay its scheduled dividend payment. It has rescheduled its dividend payment to September 17.
Techs performed well, too, despite decliners leading advancers on the Nasdaq into the afternoon. Energy-related stocks represented in the XOI and OIX at least held up, if they didn't provide fuel for a push higher. In addition, the Fed issued repos in the amount of $10.00 billion, almost enough to cover the entire $10.25 billion maturing today, so that no liquidity problems arose from that source. Both the euro and the USD rose against the yen since their 6:00 am CST lows, and the maintaining of support for these currency pairs may have proved reassuring, too.
The day's actions may just have been about positioning ahead of our Fed Chairman's Jackson Hole appearance tomorrow, another theory. My theory? The day's actions were part of the pattern we've seen lately. We've seen big up days and big down days punctuated by days that produce small-bodied candles as investors try to recover from their spinning heads and determine what to do next. It was time for uncertainty, and tomorrow's slate of economic events provided plenty of reason for that uncertainty.
Annotated Daily Chart of the SPX:
If there's a triangle breakout, watch for potentially strong resistance at the 72-ema, of course, and then if 1489-1490 is approached. On a breakdown below the triangle's support, watch for potential support at this week's low and then near 1404-1406.
Annotated Daily Chart of the Dow:
Annotated Daily Chart of the Nasdaq:
Annotated Daily Chart of the SOX:
Annotated Daily Chart of the RUT:
Annotated Daily Chart of the USD/Yen:
I believe, if the calendar I'm studying is correct, that Japan has several reports tonight that could impact the USD/yen and euro/yen action, so what happens on our markets tomorrow might not be and probably won't be predicated entirely on what happens with Fed Chairman Bernanke's address tomorrow. In addition, Germany and the Eurozone also will release important economic reports tomorrow morning that could impact the euro/yen action, at least.
I want to remain aware that intermarket relationships can change. The predictive or corroborative effects of the USD/yen and euro/yen movements on US equity movements might change. I want to move away from total reliance on these movements as indicative of what might happen on equities, but we still can't ignore the impact that's been seen in recent years, on everything from a weekly chart to intraday ones. Watch this as one tool for assessing whether all your ducks are in a row if trading tomorrow.
The day started off with the typical weekly initial and continuing jobless claims, but that release was overshadowed by the second quarter's GDP report.
Initial jobless claims rose 9,000 to 334,000. The four-week average, considered more accurate, rose 6,250 to 324,500, its highest reading in four months. We walk a narrow road with jobless claims. A few weeks ago, claims were trending down toward 300,000, with numbers below that indicating that the job market is strong enough that wage pressures might be adding to other inflation pressures. If initial claims move consistently above about 350,000, the job market might be getting uncomfortably weak, indicating a downturn in the economy. Right now, claims came in at the midpoint, but they've been trending sharply higher over the last few weeks.
Continuing claims rose 13,000 to 2.6 million. The four-week average rose 11,250 to 2.56 million. The insured unemployment rate rose to 2.0 percent, the first time I remember that moving off 1.9 percent in a while.
The consensus for the GDP was a gain of 4.10-4.40 percent, up from the previous 3.38 percent. Growth in investments in commercial buildings and an improved trade balance boosted the revised GDP up to a 4.00-percent gain. That didn't quite meet expectations but certainly was an improvement, with the improved trade balanced contributing 1.4 percentage points to the GDP growth.
The GDP growth gain was the largest in five quarters, but many economists now expect slower growth for the rest of this year. An AP article pointed out that many economists now expect 2 percent growth for the current quarter, for example. Bullet points from the report include several areas of concern as well as some that assuage concerns.
One of the reasons behind that prediction of slowing growth is the worsening impact of the housing market's decline. While business investments in structures rose 27.7 percent, investments in residences fell 11.6 percent. That drop in residential investments subtracted 0.6 percentage points from the GDP. As we all know by now, the damage due to the declining housing market can no longer be considered contained. Financial institutions across the globe are being forced to fess up to exposure to the subprime difficulties in the U.S. When corporate profits are discussed later in this coverage of the GDP, the possible impact will be revealed.
First, let's talk about the good news. The GDP report also provided other insights, particularly into price changes. Although headline inflation soared 4.2 percent in the quarter, and you and I know that we're seeing some of the impact of those rising grocery prices, the FOMC reportedly studies core inflation rates more closely. Core consumer prices were revised lower to 1.3 percent on an annualized basis. This is well below what most perceive to be the Fed's comfort zone below 2.0 percent.
The chain deflator, supposedly a favored measure of inflation, remained at 2.7 percent. That was as forecast.
For the year, inflation-adjusted GDP growth was 1.9 percent, rising to $13.77 trillion. Bullet points from that report included before-tax corporate profits that increased 6.4 percent for the quarter, rising now 4.5 percent for the year. Business investments rose 11.1 percent, including that already mentioned 27.7 percent increase in spending on structures. Business investments in equipment and software also rose, by 4.3 percent.
A troublesome question arises from a look at this report and even a glancing knowledge of what's been going on in the financial sector. One has to wonder how much of a hit those corporate profits will take in future reports. In this report, for example, financial industries' profits rose the most in six quarters, making up $57.6 billion of the $89.8 billion in profits in domestic industries. Non-financial domestic industries produced the remaining $32.2 billion of profits in domestic industries. That means that financial industries produced 64 percent of the profit in domestic industries the second quarter. What happens when we start examining the hit they've received?
Consumer spending rose an annualized 1.4 percent, adding 1 percentage point to the GDP. Consumer spending on durable goods rose 1.7 percent and spending on services, 2.3 percent. Spending on nondurable goods fell 0.3 percent, however, the weakest result in more than a decade.
Government spending rose 4.1 percent. Overall growth in federal spending was 5.9 percent, with federal defense spending increasing 8.6 percent but federal non-defense spending rising only 0.5 percent. State and local governments also beefed up their spending.
The weekly report on natural gas inventories was released at 10:30. Inventories rose 43 billion cubic feet, roughly meeting expectations. Natural gas prices have been dropping over the last week, a result likely tied to both expiration-related and weather-related developments. No storms have threatened production. Natural gas ended higher today, at 5.635.
At 11:00, the Kansas Federal District provided its August survey of conditions in the Kansas District. This report isn't as important as the New York and Philadelphia districts' report. I usually have to go directly to the Kansas Fed District's site to find any information on it at all because news sources don't pick it up or offer any reaction to it.
That survey showed a moderate expansion of manufacturing activity in August. The district manufacturers' expectations for future growth declined slightly. Prices indices eased when compared to the previous survey.
The Office of Federal Housing Enterprise Oversight said that U.S. house prices rose 3.2 percent above their year-ago level in the second quarter and 0.1 percent above the first quarter's growth. The organization's director characterized the quarter's growth as flat, while acknowledging that regions that had previously seen the steepest price appreciation or that were currently experiencing slumping economies were now suffering "significant price declines" that he believed were localized.
Sears Holdings (SHLD) was one of the companies reporting earnings early today. SHLD operates both Kmart and Sears stores. SHLD's $1.13 adjusted earnings-per-share met expectations, a Reuters article noted, but both the EPS and revenue fell from year-ago levels. Gross margins also narrowed. SHLD closed lower but off its day's low and with a gain from the open. WMT did the same.
After the close, Dell (DELL) reported, providing a preliminary report for its second quarter. Earnings of $0.32 a share beat expectations of $0.31 a share and were higher than the $0.22 a share seen in the year-ago level. The company noted that demand for their notebook PC's had been better than expected and sales of servers had been strong. As this report is prepared, the results are just being examined. I'm sure industry experts will be making comparisons between Dell's performance and HPQ's. Dell was last at $28.29, down from the $28.46 close.
Tomorrow's Economic and Earnings Releases
The most important or at least most attention-gathering economic event tomorrow will likely be Fed Chairman Ben Bernanke's Jackson Hole address at 10:00. Since the Fed chairman will be speaking about monetary policy and housing, each word will likely be scrutinized. All week, various experts and pundits have debated the wisdom of the Fed making a sentiment-improving rate cut. Experts have argued over whether such a move is within the Fed's scope or would be effective, if made.
However, the Fed chairman's address will not be the only economic event in a day heavy with economic releases. July's Personal Income will be released at 8:30. That will be followed by the August NAPM-NY at 9:00 and the Chicago district's PMI at 9:45, with both reports likely to garner attention.
I've been trying to project whether I think markets will clamp down ahead of Fed Chairman Ben Bernanke's address, not moving on the earlier releases, or will overreact to each jit and jot of the economic outlook the earliest releases, depending on how they are perceived to impact the FOMC's outlook. I just can't decide which is most likely to happen.
Factory Orders for July will be released concurrently with the beginning of the Fed Chairman's address, at 10:00. Later releases, the ECRI Weekly Leading Index at 10:30 and the August Agricultural Prices at 3:00, will not likely have the same impact as earlier ones. Agricultural prices are important, of course, as anyone who has been grocery shopping lately knows, but right now, the focus remains on what the Fed will or won't do.
What about Tomorrow?
What I want to say and have been saying is "Batten down the hatches." Your job as a trader and/or investor right now is to protect your trading or investing capital. Thornburg's action today may have reassured investors that the globe's financial markets weren't collapsing despite Standard & Poor's warning of a profit collapse, but we don't know what news awaits us.
I can't predict what will happen tomorrow. Too many uncertainties present themselves in the forms of overnight economic releases in Japan, Germany and the Eurozone, added to the uncertainties here in the U.S.
I also can't predict what will happen because the charts visually demonstrate the uncertainty that market participants feel right now. Price action chops around within narrowing formations such as triangles, showing that uncertainty in as clear a form as it's possible to show it.
Price action toward the end of the day produced triangles on some intraday charts, too, such as the SPX's, OEX's, and Dow's. Depending on how you squint at the chart, the Nasdaq produced a roughly formed triangle, too, beginning about 2:45.
My opinion is that as long as markets are within the chop zones--triangles, rectangles, whatever it is on that particular index--on their daily charts, we're likely to see chop. Tomorrow may break those formations, but we're just going to have to wait to see. You can, however, watch the movements of the USD/yen for short-term guidance.
Watch the TRAN, too. Something funky was happening on the TRAN in the afternoon.
It dove off its middle-of-the-day high, with only a late-day bounce preventing
its daily candle from looking worse than it did. The TRAN, sensitive to both
energy costs and economic outlook, often leads the SPX, OEX and Dow, and I don't
like what I saw happening there this afternoon.
Play Editor's Note: The markets didn't move much today because everyone is waiting to hear what Fed chairman Bernanke will say tomorrow morning. The challenge for us is that whatever he says will either cause a big rally or a big sell-off. We've decided to add a couple of strangles to take advantage of any volatility. If you are currently in any bullish positions you will want to re-evaluate your risk and consider adjusting your stop loss before he starts speaking around 10:00 a.m. If we had to bet we'd expect him to disappoint the market.
Diamonds - DIA - cls: 132.57 chg: -0.17 stop: n/a
Why We Like It:
BUY CALL SEP 137 DAZ-IG open interest=17869 current ask $0.80
Picked on August 30 at $132.57
S&P 100 Index - OEX - cls: 680.46 chg: -2.56 stop: n/a
Why We Like It:
BUY CALL SEP 700 OEZ-IT open interest=8859 current ask $5.90
Picked on August 30 at $680.46
Intl. Bus. Mach.- IBM - cls: 115.37 chg: +0.80 stop: 109.85
IBM continues to rally. The stock out performed the broader market with a 0.69% gain on improving but still below average volume. Today's close over the $115.00 level is bullish. We want to warn readers that if Bernanke disappoints the market tomorrow we would expect IBM to follow the major averages lower. Readers may want to adjust their stops on IBM to reduce their risk. We have two targets. Our first target is the $118.00-120.00 range. Our second target is the $124.00-125.00 zone.
Picked on August 26 at $113.24
Transocean - RIG - cls: 102.23 change: -1.62 stop: 99.50
There is no change from our previous comments on RIG. The stock did not see any follow through on yesterday's big rebound. We are still waiting for a breakout over resistance near $105.00 and its 50-dma near $105.50. We're suggesting a trigger to buy calls at $105.75. Our target is the $114.00-115.00 range. FYI: Readers might want to consider an alternative strategy on RIG. The stock traded sideways in a narrow range today. It looks like the stock is going to breakout one direction or the other. You may want to consider a strangle. If you bought the September $105 call and the September $100 put it would cost about $4.35. It might be a better, albeit more speculative, play to buy the September $110 call (around $0.75) and the September $95 put (around $0.90). That way the money at risk is only $1.65.
Picked on August xx at $ xx.xx <-- see TRIGGER
Acuity Brands - AYI - cls: 52.38 change: -0.92 stop: 57.11
AYI did not experience any follow through on yesterday's bounce. That's good news for the bears. Traders sold into the morning rally near $53.66 and AYI continues to trade with a bearish pattern of lower highs. More conservative traders may want to tighten their stops and reduce their exposure. We have two targets. Our first target is the $47.75-47.50 range. Our second target is the $45.25-45.00 zone.
Picked on August 26 at $ 52.80
If you consider this market, at least since about the beginning of summer (what happened to the summer doldrums!?), to be a traders dream, you'd be RIGHT. But, and it's a large BUT, you have to be able to figure out the right entry and exit points. There has been a huge jump in volatility of course and their have been many broad trading swings; not ones where the S&P 500 (SPX) moves 20 or 30 points, but where there are 60 point price swings within a few days to at most 2-3 weeks. An option players dream as we have this remarkable period where some big price swings occur within these shorter time spans. Then another opportunity presents itself.
We all know how we can be right on market DIRECTION only to have a move be so slow that time premiums erode faster than underlying price changes. Of course here, I'm talking about buying options, not selling them; i.e., selling premium. I like the challenge and greater rewards of attempting to 'time' the market and I trade the indexes specifically as those following my weekly Index Trader well know. The technique of using 1-3 month hourly charts and the 21-period RSI is also useful for individual equities however.
One very useful way to chart this kind of (volatile) market we've been in recently is to use hourly charts of 30-60 days duration. This is a problem if you rely on charting sites that only provide 10 days of intraday data. Not a problem on charting applications like Q-charts, MetaStock, etc. Any feedback on this or other applications is appreciated (see my e-mail info at bottom). I've been using TradeStation software, with downloads of eSignal data for so long, that I can't always remember all functionality of other applications. Generally you can get an hourly chart of at least a few weeks duration in your own trading applications; the ones that you pay for mostly.
What I most value in an INDICATOR input on hourly charts is the Relative Strength Index (RSI) with a fibonacci setting of 21 ('length' = 21). Setting length to compute the RSI indicator for 21 periods of 'bars' takes the last 21-hourly closes and makes the RSI computation. RSI is basically a ratio of X number of UP closes versus X number of DOWN closes. X here is whatever the length setting you've chosen; e.g., 21.
Let me back up one second and say that I myself am looking for the occasional trade where I could realize 40-50 SPX points or more and be able realistically to set an exit point (absolutely necessary!) equal to one-third or less of those 40-50 or more points that I think could be realized on the move I'm getting in on. If I buy puts or calls at anything other than so-called overbought or oversold 'extremes' I run the risk of being 'stopped out'. I use the language of 'stops' here to mean exit points, whether my broker will take such an automatic order or not. Since I'm not talking about stocks or futures here, so one can't count on being able to enter an actual GTC (Good Til Canceled) or Day buy or sell stop order. I usually check prices morning, midday and near the end of the day, but sometimes can't do that either.
If a close is above/below my exit point, I'll liquidate the next day. In a period of high volatility this strategy carries the risk of exiting far above/below my exit 'trigger' point, but this is not all that common IF you ONLY enter calls or puts at market EXTREMES. The extremes are the overbought or oversold levels I'm going to discuss relative to an hourly chart using the 21-hour RSI only.
There are some specific levels I tend to use for the index I am looking at. There are slightly different levels that 'work' to show extremes depending on the Index. These work well on most of the major indexes, although not so well on the Russell 2000 (RUT) I've found. And, stocks have different levels that tend to define 'overbought' or 'oversold'. For this reason I like to follow a relatively low number of stocks so I can get to know these levels (the extremes); the ones that also have good-sized trading swings might be only 12-15 stocks in my trading universe.
I'll use 'line' or Close-only charts here; RSI is computed at the close of the hour or day or week anyway, although the last trade is temporarily considered to be the 'final' price for the bar or period we're in as far as an ongoing computation; when the period closes (e.g., hourly), the Close of 22 hours ago is dropped and the latest hourly Close is used in for a 21-bar Relative Strength Index (RSI) indicator.
In the chart below, you'll see that the RSI 'overbought' zone for the S&P 500 (SPX) hourly chart is between 62 and 65 or higher. The 'default' line for overbought is usually 70, but that's too high on the upside in general for the indexes. This is because the major stock indexes are broadly based and because rallies tend to be more gradual and slow than down swings; RSI only once reached a reading as high as 70 in the hourly chart seen below. On the downside, 'oversold' extremes tend to be seen when the 21-hour RSI registers between 27-30 or lower.
As you can see from the down red arrows, the RSI for the period shown (nearly 3 months), got into the overbought zone 5 times and into the oversold zone 3 times, one of which was way early in calling a bottom as noted. The rest of the 'extremes' were remarkably good in highlighting significant trading tops and bottoms. The key seems to be to wait ONLY for these key junctures. Hard to do in practice but this is why we should rely to some degree on technical formulas that take out some of the urge to jump into trades. For the timid of heart and I've certainly had MY moments, using a statistical device or formula like the one I'm describing here, can be the push that gets you off the high diving board.
Two more things:
1.) Sometimes, as was most apparent at the July top, the first RSI extreme is seen early and the index might chop around for some days more before a trend reversal. However, on a closing basis, you can also see that in July prices didn't go higher than the first RSI extreme so that a reasonable exit point over the market would not force you out BEFORE the move got underway. By the way, the sideways trend AND the overbought extreme was a double tip off that a top was forming.
2.) Unless you hope to wait to exit at the NEXT opposite extreme reading in the RSI (not advisable usually), don't rely on this indicator with this setting to tell you when to take profits on a trade. Points where the RSI approach the opposite extreme are helpful guideposts, but better to rely on price action, approaches to prior support or resistance, etc. to help time exits. Exceptions: it was buy puts at the early-August RSI extreme, exit puts and buy calls at the oversold extreme two weeks later! Not a long wait for me. I like trading the 2-3 week price swings rather than the 2-3 day ones; to each his own!
A further note on that oversold extreme indicated as 'early' on the SPX hourly chart above is a good example of why I always use a stop or close by exit point, so that I generally will only take a relatively small loss. I don't such tools as the RSI in a strictly 'mechanical' way but as a tool. A market in a steady and steep decline as was seen when the 21-hour RSI hit its first oversold reading is not necessarily a place that I would necessarily jump into calls.
Even if I had and didn't wait for, for example, signs of a key upside reversal such as was evident on 8/6, I would still be quite profitable in my option account overall; but not as much if I let a loss 'run'. By the way, the 21-hour RSI used with the S&P 100 (OEX) chart as seen next (below) did show an oversold extreme at the final mid-August bottom.
I don't have more to say about the use of the longer-term hourly chart with a 21-period RSI except that, as seen in the OEX hourly chart below, there are some variations even with closely related indexes, as to whether and when an RSI hourly extreme will be seen. The zone where oversold or overbought conditions occur also varies some. The OEX 21-hour RSI won't typically dip below 30, whereas SPX will. OEX can tend to register a bit higher readings, relative to SPX, on the upside however.
The hourly Nasdaq Composite (COMP) is my last chart. I always compare this chart to the Nasdaq 100 (NDX), as the index that I will actually trade, but rely most on the COMP readings in RSI as to input on the timing of trade entry. There were certainly some good opportunities suggested at some of the extremes seen in the chart below.
An interesting case is presented by the RSI extreme seen in COMP on the 8/24 hourly close around 2576. Another extreme has been seen at the 2584 hourly close today (not the daily close however). I wouldn't bet on COMP going a lot higher than seen today at least as suggested by the bearish price/RSI divergence; i.e., the hourly RSI reading today didn't 'confirm' the higher hourly closing relative high in the Composite. Stay tuned on that!
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Today's Newsletter Notes: Market Wrap by Linda Piazza, Trader's Corner by
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