A Review of the Range Bound Month & Previous Week for the Major U.S. Indices 

From the opening bell on December 7th until Friday’s close on the 11th, none of the three major U.S. stock indices made a directional move that surpassed even a mere percentage point.  The NASDAQ had the strongest move nearly hitting a 1% move backwards, yet fell short ending the week with a mere .9% decline.  The other two major markets, in opposition, posted positive gains, yet their movements were smaller based upon percentages with the Dow advancing only with a .8% gain followed by an inconsequential budge upward for the S&P of .1%.  The lack of sustainable progressions for better or for worse within the marketplaces solidifies the trading range the investment community has been entrenched in for over a month now. 

In my previous report, I brought forth the fact the S&P 500’s total return from its opening for the beginning of the trading week of November 10th until the close on Friday, December the 4th was a mere 1%.  Last week’s trading session failed to halt the sideways movements of the indices.  From the S&P’s November’ 10th opening of 1,091.86 until the 18th’s close this past Friday ending at 1,106.41, the index maintained a dismal 1% gain.  This now represents a time frame of over a month where the S&P 500’s has sustained its sideways advancements which also could have logically been figured via the fact that the index made a meager gain of .1% last week. 

The trading ranges the indexes have been held within provide merit to the sentiment analysis I provide at the conclusion of all of my stock indices reports.  In three of my last four reports, I concluded that the put/call ratio was near a point of neutrality advocating from the contrarian school of thought that the markets had no clear and immediate bullish or bearish directional bias.  As described above, the contrarian analysis I provided within my last few reports held true.  I further elaborate on the meaning of this reading at the finale of this writing as this sentiment indicator has since come the closest to a neutral standpoint than it has done so for quite some time. 

Citigroup Seeks to Repay TARP Funds to Free Itself from Government Restrictions 

It was slightly more than a week after government regulators agreed to let Bank of America repay its government bailout monies which are funds from the Troubled Assets Relief Program (TARP). The federal officials decided to extend the same allowance on Monday to its competitor Citigroup.  The repayment of TARP capital will end the government’s rules imposed upon banks and other companies that sought assistance from the United States near the beginning of the credit crisis.  

As one would expect, Citigroup sought an exit from TARP for competitive reasons as most of its chief banking rivals have left, or at least began the process, of repaying the money they received in large part via the taxpayers which were, ironically, the victims of Wall Street’s greed.  As long as a banking firm had money as a result of TARP, the government had control of the structuring of the banks as well as the stigma of not being able to survive without federal assistance.  

The biggest government mandate that came from being a part of TARP was the limits that were imposed on key executive of the banks.  The banking establishments that were the quickest to repay all the funds they received from TARP were the first to attract the paramount talent left scattered throughout the industry as a result of Wall Street’s meltdown.  This talent will likely restore their institutions to the prominence they held prior to the credit crisis which their gluttony for money created.  All the prominent banks knew this was the case and began the exiting of TARP as quickly as possible leaving a few highflying banks stuck in their wake – much to the disadvantage of the TARP-strapped banks.  This realization prompted Citigroup to seek a departure from the aid that resulted from the credit crisis so they could continue to be competitive within the challenging bank environment.    

Coincidently, another of the last of the largest banks in the nation to remain reliant on TARP, Wells Fargo, followed suit the following day and began its plan to repay bailout monies after the conclusion of my research and construction of this report.  Wells Fargo, however, has less imposing government restrictions upon it than Citigroup as Wells Fargo only received one round of TARP funds whereas Citigroup received two injections from the program. 

As of the announcement of Citigroup’s plan to exit TARP, the banks of the U.S. that received assistance from the government created relief program will have returned at minimum $136 billion which is more than half of the $245 billion in bailout funds extended during the financial crisis.  This repayment of TARP assets has come at a much quicker pace than previously expected and does not even take into affect the decision on Tuesday by Wells Fargo to become one of the last major banking institutions to repay the government. 

Although strength and confidence is being shown through the banking world by the exodus of TARP by almost every major bank, other large corporations are still instilled within the government’s assistance program.  The most noteworthy are another chief consumer bank, PNC Financial, the massive insurance firm AIG (American International Group), and GM (General Motors) as the carmaker is one of America’s largest automakers of all-time.  The government still has tens of billions of dollars at risk within these three institutions alone.  Smaller community banks were also rescued by TARP, but the amounts they received were in the millions as opposed to the billions that were provided to renowned Wall Street firms and U.S. automakers.    

What Impact Does This Have on the Indices? 

Before analyzing how Citigroup’s exit from TARP will affect the indices, it is prudent to first evaluate how its move will impact its stock price.  The plan for Citigroup to repay the $20 billion from TARP, according to The New York Times, will occur through the mammoth bank raising $17 billion through the issuance of new securities.  It is looking to bring in an additional $4.2 billion by selling tangible equity units and subordinated debt. 

Citigroup’s sale of additional stock will initially dilute the equity of its shareholders bringing its value down.  The stock price may very likely decline to a further degree as Citigroup will be adding additional liabilities to its balance sheet through issuance of subordinated notes.  This would be the short-term affect on the shares of Citigroup stocks. 

The bank, however, realizes this temporary situation and is taking a long-term approach to increasing the value of its equity.  Citigroup is looking to escape TARP for the two reasons mentioned above.  First, the company is vying to improve its image once again by removing the stigma many associate with companies that are reliant on taxpayer money for their survival.  Firms that remain associated with TARP are seen as less credible as they are deemed to need government assistance to remain in business.  

Second, Citigroup is striving to relieve the restrictive elements the government imposes on companies that still have bailout funds from TARP.  In the case of Citigroup, as with other TARP recipients, it is seeking to eliminate the limited compensation and bonuses that keep it from attracting the pinnacles of aptitudes that would allow it to better itself, but also allow it to retain its key executives that would go elsewhere if not compensated adequately by the bank.  As Citigroup is still under TARP, offering competitive compensation packages is essentially impossible.  This is because of the government’s prohibitive measure regarding the offering of lavish payments to executives that other banks not restricted by the stipulations of TARP can offer. 

Additionally, the value of Citigroup’s stock would increase when it rids itself of both the government’s mandates and ownership, as currently the U.S. owns 34% of its common stock, as institutional investment firms would begin to substantially increase their holdings in the currently TARP-backed bank.  Citigroup estimates that these institutions only own approximately 20% of its equity.  Thus, it is one of the least largely held banks by institutional investors such as pension funds and mutual funds.  These institutional entities typically hold a composite of 70%+ of a major firm’s stock.  This notion holds even more worth as, before the markets’ disintegration beginning in late 2008, Citigroup was largely held within equity funds. 

Any indexes that hold Citigroup and other companies that are on TARP, or even on their way off of the alleviatory program, would initially be down as a result of their dependence on the government funds.  Any of these firms seeking a complete exit from TARP would have the value of the index potentially move up.  The move would be minor, however, as the reason individuals and firms invest in an index is to diversify away firm specific risk.  This type of risk is also known as unsystematic risk.  A financial index or ETF, such as XLF, would feel the greatest movements from these situations as 1) the individual company would have an impact on the index or ETF and, more importantly, 2) a positive or negative reaction from an individual company has a generally tendency to move the rest of its sector with it. 

Since the major indices of the U.S. are generally comprised of a conglomerate of companies from varying sectors, with the exception of the technology heavy NASDAQ, expect company announcements, such as Citigroup’s plan to repay the money it received from TARP, to move them in a positive direction for at least the short-term.  As their intentions are actually followed through and the government receives repayment of bailout funds, be cognizant of further short-term progressions in the indices.  These advancements are based primarily on the confidence that a company exhibits to become self-sustaining once more.  However, the positive movements should be rather small in nature, yet potentially can provide for lucrative trades for individuals playing these TARP companies for short-term profits. 

The long-term influence on the indices of Citigroup’s plan to disassociate itself with TARP, in addition to the businesses that continue to repay their bailout funds to the program, is of greater importance for both investors and the economy as a whole.  As the companies continually come off the aid provided to them by the government, investors will see this as an additional sign of confidence that firms are continually moving away from their reliance on the government for their survival.  The investment world will react positively to the reduction of companies linked to TARP and interpret it as a solidification that an economy is moving in a positive direction.  Thus, this would have the affect of propelling the indices in an upward fashion.   

Fundamental Reports 

Week of December 21, 2009 to December 25, 2009

(Source: Econoday.com)

Sentiment Analysis 

The sentiment meter I take a reading on for each of my reports, the put/call ratio, indicates a level of .98 for this writing.  This number is calculated using the December’s S&P 500 E-mini figures provided in the December 14th final report from the CME for volume and open interest.  The CME states that at the close of trading for the 14th, the S&P December E-mini had 17,107 puts outstanding versus 17,445 calls.  This is the closest the contrarian indicator has come to neutrality in several months.  It indicates a bearish outlook for the indices although it is so close to a neutral standpoint that its relevance is practically negligible in relation to the advent of a bull or bear market. 

As you may recall from my previous report, the put/call ratio from the CME’s final report on December the 7th came in at nearly a neutral standpoint also with a reading of .9.  The current ratio increased by only 9% to the bearish side since its reading from the 7th.  These two reports, in addition, to others I have put out recently, have provide put/call readings so close to the absolute neutral standpoint for the indicator, which occurs when it hits the level of one, that it holds little weight on the upward or downward direction of the markets for the contrarian perspective.  Hence, it is providing those that take positions against the majority a signal that the indices are indecisive still on the long-term upward or downward directions they want to move.  The likely scenario, according to the indicator, is a move in a sideways manner until the ratio takes on a stronger position.     

In summary, the nearly impartial readings that have been coming from this widely recognized sentiment gauge indicate the U.S. marketplaces are likely to continue in the trading range we have been experiencing for over a month now.  For the time being, use technical readings within the marketplaces, in additional to key fundamental undertakings, can provide profits on short term moves on the major indices when going either long or short.  However, continue to monitor this key contrarian indicator as once it begins to take on a stronger bias stance, whether it’s bullish or bearish, begin to use it by giving it far much more merit when taking a position on markets directions as it will likely provide nice profits for those that incorporate in within both their trading and investing strategies.  

Weekly Trade Recommendations & A PFG Account

If you don’t already have a full service account here at PFG and would like to use me as your broker, call or e-mail me via my information listed below.  There are no minimum requirements to open an account.  Additionally, for trade recommendations on any of the indices & other commodities or to provide feedback regarding this report, please feel free to contact me. 

James M. Gangloff, MBA
Senior Research Analyst / Stock Market Indices
Trading & Managed Futures Strategist
PFG BEST
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