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S&P 500 FUTURES – MONTHLY
Chart provided by APEX
BEARISH TECHNICAL INDICATORS
One of the oldest technical indicators is the “Dow Theory,” which was created in 1884 by Charles Dow. It basically states that strength or weakness in the industrials will continue if it is matched by a similar move in the transportation stocks. The stock market gyrations of September 29th flashed a “Dow Theory” sell signal for the broad indices when the transportation stocks gave up their gains that were made since July. While this indicator appears to be a bit of a lagging signal, some of the other more sensitive indicators that we have looked at, that are more leading, have been flashing bearish signals for quite some time.
One technical indicator that has been very useful in all markets and not just in the stock index futures is the “opposite reaction to news indicator. Although this indicator is a little more subjective and a little less scientific than the ”Dow Theory” indicator, it does work very well for short term as well as longer term analysis.
The best and most recent example of this signal took place when futures could not hold the sharp gains on the news of the proposed $700 billion bank bailout package. This was a sign that the fundamentals may have been changing for the worse. It could also have been a sign that one more large traders may have been caught on the long side and may have needed to liquidate or possible there was just possibly be a lot for sale above the market. In this case it was the anticipated news that was changing from bullish to bearish. Late last week and over the weekend there was an almost universal feeling that the Treasury’s bank bailout plan was almost guaranteed to receive Congressional approval. Of course, this proved not to be the case. The lack of lawmaker’s approval of the legislation caused the benchmark S&P 500 to suffer an 8.8% decline on Monday September 29th. This was largest single day decline in 21 years. The Dow Jones Industrials registered their biggest decline in history, falling a full 7%. All of our technical work tells us that we are not close to the bottom of this bear market.
WEAK FUNDAMENTALS
So far the S&P 500 is down over 22% for the year on continuing concerns over write downs at financial firms, along with a slowing world economy and prospects for reduced corporate earnings. Financial institutions worldwide have posted at least $522 billion in losses as a result of the troubled subprime mortgage market since the beginning of last year.
Extreme movements in the interest rate markets go hand in hand with continuing worries over the international banking situation. Banks remain wary of the credit worthiness of each other in the U.S. and overseas as interbank dealing rates continue to increase. Highlighting the problems are the increases in the London interbank offered rate and the euro interbank offered rate, which recorded substantial increases recently. In fact, the three month European interbank dealing rate (Euribor) increased to a record high level. These increases in interbank lending rates show that efforts to inject funds into the international money markets have not succeeded. High lending rates tell us that more banking problems are brewing. In fact, it appears that the rate of individual bank bailouts is accelerating. This last weekend there was a bailout of Belgium’s Fortis and the seizure of U.K. mortgage lender Bradford and Bingley. Germany’s second largest commercial property lender received a 35 billion euro loan guarantee in order to remain solvent. Later in the week, France and Belgium led a government backed rescue plan for Dexia SA, which is the world’s largest lender to local governments.
There is a growing feeling that there will be more problems related to the precarious housing situation within the next one to two years. It was recently reported that house prices in 20 U.S. cities declined in July at the quickest pace on record. The decline was .9% from the June level. In addition, the National Association of Realtors reported that the median price of an existing home dropped by 9.5% in August from the year ago period. This compares to an 8% decline in July. These numbers suggest that the worst housing recession since the 1930’s has a way to go. There are worries that any U.S. bank bailout plan will not jump start lending as potential home buyers continue to remain on the side lines.
Profits at S&P 500 companies were substantially lower than expected in the second quarter, with earnings at financial companies in the S&P 500 dropping 91%. Third quarter corporate earnings are not likely to be any better. We are hearing that analysts are revising lower their estimates for third and fourth quarter corporate earnings.
HELP FROM THE FEDERAL RESERVE AND THE TREASURY
There is mounting pressure on the Federal Reserve to ease credit conditions further. Currently there is a 66% chance that the Fed will lower their fed funds target by 50 basis points on or before the Federal Reserve’s next scheduled meeting on October 29th. The odds of such a move only last week were 32% and zero a month ago. In fact, it was not very long ago that the consensus view called for tighter credit from the Fed. However, now the main focus of attention is on the international banking crisis and the looming recession threats. It was only a month ago that inflation was the primary concern.
The Federal Reserve announced several initiatives to support financial stability and to maintain a stable flow of credit to the economy during this period of significant strain in global markets. Recently the U.S. Federal Reserve said they were expanding their Primary Dealer Credit Facility, which was originally established to alleviate subprime related banking problems. It introduced an 84 day Term Auction Facility (TAF), which it said will be in addition to its existing 28 day loans. Also, the Federal Reserve said they will increase their swap lines with major foreign central banks.
These steps were taken to reduce pressures in the term funding markets both in the U.S. and overseas. Because of the commitment to provide a large quantity of term funding, the Federal Reserve actions should reassure financial market participants that funding will be available, lessening concerns about credit risk. Monetary authorities said “In response to continued strains in short-term funding markets, central banks today are announcing further coordinated actions to expand significantly the capacity to provide U.S. dollar liquidity. Central banks will continue to work together closely and are prepared to take appropriate steps as needed to address funding pressures.” This news suggests that monetary authorities believe that there will be more banking write downs to be revealed later.
While the support from the Federal Reserve and the Treasury are noble, it appears that there is too little and too late.
LONG TERM OUTLOOK
Some analysts are now saying that the market is close to making a major bottom for the move and 20% to 30% returns can be expected over the next 12 months. Our analysis suggests this will not be the case. Our research tells us that corporate earnings will remain weaker than analysts’ estimates at least through the second quarter of next year. Our studies also suggest that the housing market will not bottom until the second or third quarter of 2009, at the earliest. All of our research tells us that major bottoms for stock index futures have not been made and that the recent lows will be taken out later this year. This bear market is likely to continue until well into 2009.
Futures and options trading involve significant risk of loss and may not be suitable for everyone. Therefore, carefully consider whether such trading is suitable for you in light of your financial condition. The views and opinions expressed in this letter are those of the author and do not reflect the views of ADM Investor Services, Inc. or its staff. The information provided is designed to assist in your analysis and evaluation of the futures and options markets. However, any decisions you may make to buy, sell or hold a futures or options position on such research are entirely your own and not in any way deemed to be endorsed by or attributed to ADMIS.
Copyright © ADM Investor Services, Inc.
Alan Bush
Financial Futures Analyst
Archer Financial Services
alan.bush@archerfinancials.com
