Tag Archives: stress test

Passing The Stress Test

DJIA

DJIA

SPX

SPX

Nasdaq Composite

Nasdaq Composite

XLF

XLF

 The real stress test has already happened, but these results won’t be publicly recognized. For the last few weeks, the major indices have tested upside resistance multiple times tempting the bears to get back into the game. The remaining uncertainty in the market is significantly less than at the beginning of the year, and the Government’s Stress Test and auto industry turmoil account for a large percentage of the overall market volatility. The results of the Stress Test have been delayed three days, to May 7th. The delay stems from disagreement between the banks and the regulators, and while only delaying the inevitable, is perceived as a positive. There is only one reason the banks would disagree with regulators over the results, because the regulators made a mistake, miscalculated or estimated incorrectly. If the regulators were to overestimate, the banks would never raise attention to it. The disagreement has positive market implications, particularly because most, if not all, negative news has been priced in. This week’s volume was below average, but this is to be expected. Smart money is either already long, or they are awaiting the results of the Stress Test so they can jump into the “healthy” banks. The bears had plenty of opportunities to take this market lower, but failed to succeed, even in the light of a worse than expected GDP.

The first chart is the Dow Jones Industrial Average over the last 20 years, monthly. The Fibonacci retracements suggest important resistance at 8240. Closing above 8240 resistance at the end of May would imply the market has its sights set on the next level, 9650. At the end of May, when the markets have closed above the 8240 level, the uptrend march will  continue. I can see the DJIA testing 10,000 during the summer, but do not expect this to last. Expect the DJIA to retrace all the way back to the 8240 level after touching 10,000. This retracement would be extremely healthy, and would establish a base, or support, on top of current resistance. Establishing support on top of previous resistance has bullish implications, and is exactly what each of the major indices is currently doing.

The second chart is of the S&P 500 over the last 10 years, monthly. The Fibonacci retracements again suggest we are approaching important resistance levels, 880. Closing above 880 for May implies 1014 is next. Again, after touching this level, I expect a retracement to 880. The third chart is of the Nasdaq Composite over the last year, daily. No surprises here, the Nasdaq is also nearing important resistance at 1760. Closing above 1760 for the end of a day would imply 1900. However, I expect the Nasdaq to fill the gap at 1950 before retracing. Depending on the relative strength of the market at this time, I do not necessarily expect the Nasdaq to retrace as significantly as the DJIA or SPX. The fourth chart is the XLF Financial SPDR over the last year, daily. Fibonacci retracements are deliberately not drawn here. Over the last month, the XLF has gapped higher and begun to consolidate. This consolidation is similar to what the indices are doing, except the XLF’s next move is contingent on the results of the Stress Test.

As I mentioned already, these results will eliminate a lot of the uncertainty surrounding the financial sector, and will likely be the necessary catalyst to lift this market higher. It is not a coincidence that the markets appear to be searching for a catalyst, especially since reasons for the market to trade lower have not caused any significant decline. Much of the negative news regarding the banks and any forced capital increases has already been priced in. Citigroup and Bank of America, 2 of the 19 banks preparing to receive results of the Stress Test next week, have been shorted heavily. Rumors turned fact concerning additional capital has hit both Citigroup and Bank of America hard, but most analyst do not expect significantly negative remarks from the Government. Citigroup has already announced the conversion of preferred shares to common at the conversion price of $3.25. The short interest in Citigroup is about 23%, and any relatively good news will cause a huge squeeze. I expect to see Citigroup double before expiration of the June option contracts. The open interest for the June $5 calls is over 1.7 million. The derivative markets are quiet indicators of what’s to come.

Markets do not like uncertainty, and when the banking and auto industry issues have been resolved, expect a continuation of this bull market rally. The three largest contributors to the recent market decline was housing, banking and the auto industry. The housing issues were resolved some time ago when the Government took control of Freddie Mac and Fannie Mae. However, it took until a few weeks ago to empirically support a housing bottom. The recovery of the banking crisis began with the failure of Bear Stearns, showed signs of improvement with the consolidations of Merrill Lynch into Bank of America and Wachovia into Wells Fargo, government intervention with AIG, and the collapse of Lehman Brothers. Thursday’s Stress Test results will conclude the banking industry’s roller coaster ride, and mark the beginning of the financial recovery. The finalization of  the Chrysler/Fiat deal and the restructuring of General Motors will consummate this entire financial crisis. Although it is clear that the auto industry was not initially involved in this crisis, the threat of systemic risk implied by the collapse of the industry exacerbated fear and volatility in the markets. As each of these issues are put further and further in the past, less overall market uncertainty and volatility will exist. This directly implies steady growth, in my opinion, similar to the growth seen in the 90’s. Low volatility and steady growth are characteristic of secular bull markets.

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Sell in May and Go Away?

Friday the major indices ended their impressive six consecutive up week streak[1]. During the streak, the SPX averaged 4.15% return per week with the first week boasting a 10.71% increase. Regardless of what the media or the bears are saying, this rally has substance. A rally of this magnitude should not have lasted as long if the underlying fundamentals were not changing. The real question is whether or not American citizens will pay for this rally in the future. The answer is yes, and they will pay for it in the form of double digit inflation. For the future of this country, let’s hope unemployment begins to decrease before inflation begins to increase.
 
The major indices declined Monday and Tuesday on fears that the Swine Flu would turn into world-wide pandemic. As of Wednesday night, there have been 93 confirmed cases in the United States and one death. The one death in the United States was a 22 month baby in Texas, but the baby was not an American citizen. The baby was a Mexican citizen and was visiting Texas to receive medical attention. Although it is suspected that as many as 160 people have died in Mexico only 8 deaths have been confirmed. Swine Flu is suspected of sickening more than 2,500 people in Mexico, but only 99 cases have been confirmed by the CDC[2]. While this could escalate into a world-wide pandemic if the virus is able to spread to enough people, it is likely to be less serious than the attention it is receiving. Only people from Mexico have died, a fact that scientists cannot explain thus far. It is likely that Swine Flu will pass faster than Bird Flu or SARS[3]. Some of the confirmed cases in the United States did not know they had the virus, which may suggest the virus can be controlled with proper precautions.
 
Last Thursday, jobless claims[4] decreased by less than expected, implying an economic recovery. Although the existing home sales[5] were worse than expected, new home sales[6] exceeded expectations. This mixed housing data supports the notion that the housing market is bottoming. On Tuesday, consumer confidence posted[7] the largest one-month jump in four years. This data sparked an early morning rally, but low volume and Swine Flu concerns caused a late afternoon fade. GDP[8] contracted more than expected for the first quarter of 2009. This news, along with the Federal Reserve meeting, acted as the catalyst for Wednesday’s 2%+ rally.
 
The results of the Stress Test will be announced Monday, May 4th. There have been many rumors surrounding the release of these results, specifically in regards to some of the banks needing additional capital. Citigroup will likely announce the conversion of preferred shares for common shares at the conversion price of $3.25 on Monday following the release of the Stress Test results. The conversion will be an attempt to improve their tangible common equity, one of the main metrics of the Stress Test.
 
Market Fallacy expects the major indices to trade significantly higher over the next seven trading days. Current targets[9] for the SPX and DJIA are 950 and 9000 respectively. Following this explosion to the upside, an ensuing retracement is highly probable. The major indices have established new support above the previous resistant levels, an extremely bullish sign. The markets are preparing for a significant move in either direction, with a slightly higher probability for a move higher. It is not impossible for a retracement over the next two weeks, but unlikely. Market Fallacy now has a blog, which will attempt to provide insight into individual questions concerning the markets. Please visit the blog to receive personal attention regarding the markets. http://www.marketfallacy.wordpress.com
 
[1] SPX, synonymous with S&P 500, closed down 0.39% for the week beginning April 20
[2] Center for Disease Control and Prevention
[3] Severe acute Respiratory Syndrome
[4] Jobless claims consensus 651,000 vs. 646,750 actual
[5] Existing home sales consensus 4.72 million vs. 4.57 million actual
[6] New home sales consensus 330,000 vs. 356,000 actual
[7] Consumer confidence consensus 30.0 vs. 39.2 actual
[8] GDP consensus -5.0% vs. -6.1% actual
[9] S&P 500 target 950 and Dow Jones Industrial Average target 9000

Volatile Outlook

Early market volatility suggests uncertainty surrounding the Stress Test results. Look for the possible release of this information tomorrow to be a major upside catalysts. For the most part, the results should be within expectations, but any negative surprises will cause an equity specific sell off. By the same token, any positive surprise will provide more momentum for the current rally, as it is being led by the finanials. I expect to see a continuation of the intraday volatility, but do not expect a significant breakout either way. If there is a breakout it will be foreshadowed by the Nasdaq and the Russell 2000. If the markets bounce back to near even, and the Nasdaq and the Russell 2000 lead the rally positive, the rally will have substance. If this happens look for a substantial move higher, particularly if it happens during the late day.

Existing home sales fell more than expected last month, but this should come as no surprise. I find this to be a huge positive in regards to forming a bottom, even though the markets disagree. If the existing home sales increased a second month in a row, I’d be concerned with the results. For this to be the “worst real estate decline since the Great Depression,” bouncing back on consecutive months should warrant concern. This reconfirms that the real estate markets have bottomed. Although, next month’s existing home sales need to be better than March, they do not necessarily need to be positive like February. It should also be noted that while real estate prices have declined nationally, a majority of residential real estate is not losing significant value. The areas losing the most are the areas that had the highest growth potential. In regards to academia, higher growth potential comes with higher risk, or higher risk is compensated with higher growth opportunity. The areas hit the hardest are areas where there was extreme speculation, and real estate was being purchased, with debt, and with the intent to make a quick profit.

Since the beginning of this post, the markets have bounced a little. I expect a progressive increase throughout the remainder of the trading session, with a late day rally of about 1%. The markets are subconsciously thinking about the consecutive weekly gain streak on the line. The streak, currently at six weeks, has been the largest percentage gain streak since the Great Depression. SPX 832 is the current support level to consider. Closing below this support level implies further declines.

Support and Resistance Levels for the SPX

SPX

SPX

 Yesterday’s decline was very misleading to a lot people. The market dropped hard and every sector felt the fallout. Because no sector was left unscathed, the effects were magnified. This distortion caused some people to load up on short positions in certain sectors, particularly the financials. However, today’s rally was led by the same financials. Right now the financial sector is the strongest and most influenced by manipulation (term many bears use to describe the government regulation). Please do not fight this trend, the government has made it clear they will do everything in their power, including implementing legislation to benefit the banks. The name of the game is the banks win. On April 24, banks may receive preliminary results from the stress tests and the Federal Reserve is expected to release the methodology for the assessment. Final results are expected May 4.

Today the Treasury Secretary, Timothy Geithner, implied that the stress test results will indicate that most of the 19 biggest U.S. banks will have enough capital. The banks that require further funds are expected to get a mix of converted government preference shares and private money. It is no coincidence that the following this announcement the markets rallied, and were led by the financials. The three largest banks (Citigroup, JP Morgan Chase, Bank of America), by market capitalization, receiving bailout money all advanced at least 9%.

From a technical standpoint, if the SPX can close above the 877 resistance level, the next technical target is 1,008. Closing above 880 and forming a base will be bullish as it will create a new floor about 50 points higher than the previous (830 range). If the markets can consolidate around this level without any significant retracement or without retesting previous levels, we will see SPX 1000 in the near future. Near future here does not mean next week or even next month, but rather implies the SPX will see 1000 before it sees 800. The SPX is still trading within the uptrending channel, and with each passing day, the top of the channel is increasing.

Citigroup (C)

Citigroup (C)

 In a shorter time frame Citigroup is making a bullish flag pattern. According to the technicals, no breakout to confirm this pattern has occurred. In this chart, today’s candle was almost a bullish engulfing candle pattern. I understand that “almost” is worthless, but the price action reveals bullish momentum. Citigroup also bounced off of its 50 day moving average this morning, which is also bullish. If Citigroup closes above the $4.00 resistance level for consecutive days, a breakout to $5.00 would be immanent. I can see Citi reaching the upside resistance of $7.00 around the time the SPX is approaching 1000. I continue to see huge upside potential in the financial sector. I expect today’s trend of the financials leading the market higher. It should be noted that this is not as bad as some (Art Cashin) make it out to be. For many experienced traders, the consensus is that the sector that led into the recession will not lead out. While I will agree with this statement, it is important not to lose sight of the fact that the financial crisis was a direct result of the housing bubble bursting. The financials are perceived as the sector that led the markets lower, but this is only because they are larger and received more media coverage. The financials can and will lead us out of this economic downturn. They will not be the only sector as I expect tech and small caps to excel as well.