Will Frightful Markets Return?

Daily State of the Markets 
Monday Morning – October 31, 2011

Good morning. After an historic run from what appeared to be the start of a bear market on October 4 (during which, the S&P has tacked on nearly 17% while the DJIA added 14.8% and the NASDAQ popped 17.1%) the natural question on this Halloween day is: Will the markets become frightful again anytime soon? Although a pullback to test the recent breakout area would be natural, many market participants are suggesting that the bulls will control the game from now until the end of the year.

To be sure, there has been a fair amount of short-covering during the recent joyride to the upside. And most analysts can agree that at least some of the relentless buying can be attributed to traders breathing a sigh of relief over the fact that a European version of the “Lehman-moment” has been taken off of the table by the new debt deal with Greek bondholders. Oh, and the better than expected economic data in the U.S. and China’s hints that it may soon turn the growth spigot back on have certainly lent a hand to the bull case.

Given the spot on the calendar, traders also note that favourable seasonality may come into play soon as just about everyone who has ever heard of the Traders Almanac knows that November through February has been a great time to be invested in stocks. And then there is my personal favourite excuse for traders buying with both hands as the year draws to a close: a little thing called performance anxiety.

According to Hedge Fund Research, the volatility that is often attributed to the hedge funds has not been kind to the industry as a whole. While there are indeed a handful of funds with very expensive and powerful computers that via their HFT activity account for the vast majority of the trading volume on any given day, the average hedge fund is having a tough year. Although hedging risk is supposed to be a key part of the idea behind a hedge fund, HFR tells us that the average fund is off by -8% so far this year.

While I can personally attest to the fact that it has been a dangerous and scary environment for much of the year, the fact that the hedgies are down YTD means their performance fees (yes, the 2 & 20 fee models, or variations thereof, still dominates the hedge fund world) are at risk. As such, it is a safe bet that any trends that materialise between now and the end of the year are likely to be exaggerated by funds jumping in with both feet.

Speaking of jumping on the bull bandwagon, in a note to clients, JPMorgan said that there is a “strong foundation for a rally in equities into year end with a target of 1400-1475.” Should this projection come to pass, that would mean stocks could see gains of 9% – 15% between now and the end of the year.

Then there is the valuation issue. One thing that a multi-month trading range does is squash valuations. And in looking at the valuation metrics of the Value Line composite, we will have to say that while stocks are NOT at secular lows in terms of valuations, the valuations don’t look too bad here at all. So, despite the overhead resistance on the charts, it is important to recognise that the crowd may have an interest in pushing things higher into the end of 2011.

However, what could cause traders to rethink their bullish bent are the unintended consequences of the European plan. The bottom line is the plan that was presented last week is complex and VERY short on details. And while the primary goal of the deal is to “ringfence” Greece’s debt so that contagion doesn’t spread, it looks like the cows are already out of the barn here as Italian and Spanish rates continue to climb this morning. The key here that since hedging instruments such as credit default swaps have been made useless by European officials, bondholders will now do the next best thing in order to reduce their risk of a sovereign default – sell.

So, will the markets become scary again on this Halloween day? It does look like the futures are pointing south at the moment and again, a pullback would be normal right about now. But if the street is leaning bullish, we may want to watch closely to see if the dip buyers come in early and often or sit on their hands for a while. In my humble opinion, this will be “the tell” as to whether Wall Street becomes a frightful place again anytime soon.

Turning to this morning… Japan’s intervention to try and stem the tide of the yen’s rise has put a crimp in the risk-on trade this morning. In addition, the rising rates in Spain and Italy are causing some traders to rethink the EU’s ability to control the crisis. As such, stocks across the pond are lower and the U.S. futures are pointing to a weak open for Wall Street.

On the Economic front… We will get the Chicago PMI at 9:45 am eastern.

Thought for the day… Laughter is great exercise – it’s like jogging for the soul…

Pre-Game Indicators

Here are the Pre-Market indicators we review each morning before the opening bell…

  • Major Foreign Markets: Australia: -1.15% Shanghai: -0.21% Hong Kong: -0.77% Japan: -0.69% France: -1.47% Germany: -1.50% Italy: -2.23% Spain: -1.17% London: -1.25%
  • Australia: -1.15%
  • Shanghai: -0.21%
  • Hong Kong: -0.77%
  • Japan: -0.69%
  • France: -1.47%
  • Germany: -1.50%
  • Italy: -2.23%
  • Spain: -1.17%
  • London: -1.25%
  • Crude Oil Futures: -$0.68 to $92.64
  • Gold: -$26.20 to $1721.00
  • Dollar: lower against the Yen, higher vs. Euro and Pound
  • 10-Year Bond Yield: Currently trading at 2.228%
  • Stock Futures Ahead of Open in U.S. (relative to fair value): S&P 500: -14.14 Dow Jones Industrial Average: -110 NASDAQ Composite: -21.89
  • S&P 500: -14.14
  • Dow Jones Industrial Average: -110
  • NASDAQ Composite: -21.89

Wall Street Research Summary

Upgrades:

  • Omicare (OCR) – Barclays
  • RPC Inc (RES) – Canaccord Genuity
  • Weyerhaeuser (WY) – Deutsche Bank
  • Marsh & McLennan (MMC) – Deutsche Bank
  • Aetna (AET) – Added to Conviction Buy at Goldman
  • Amerigroup (AGP) – Goldman
  • Hess Corporation (HES) – Target raised at Oppenheimer
  • Hansen Natural (HANS) – Added to U.S. Key Call list at UBS

Downgrades:

  • Olin Corp (OLN) – Bank of America Merrill Lynch
  • Chevron (CVX) – Bank of America Merrill Lynch
  • Dentsply (XRAY) – Bank of America Merrill Lynch
  • Complete Production Services (CPX) – Canaccord Genuity
  • SanDisk (SNDK) – Sterne, Agee
  • Health Care REIT (HCN) – Stifel Nicolaus
  • Microsoft (MSFT) – Estimates lowered at UBS
  • Apartment Investment (AIV) – UBS
  • Home Properties (HME) – UBS

Today’s Earnings Before The Bell
Company

Symbol

EPS
Reuters
Estimate
Cooper Tire CTB $0.27 $0.29 HCP HCP $0.67 $0.67 Humana HUM $2.54 $2.02 Loews L $0.40 * $0.66 Shaw Group SHAW $1.25 * $0.57 Sohu.com SOHU $1.17 $1.14 Taser International TASR $0.02 $0.02 Trex Company TREX ($0.03) * ($0.01) UDR Inc UDR $0.32 $0.32 Weingarten Realty WRI $0.47 $0.46* Report includes items that make comparisons to the consensus estimate questionable

Long positions in stocks mentioned: none

For more of Mr. Moenning’s thoughts and research, visit StateoftheMarkets.com

 

The opinions and forecasts expressed herein are those of Mr. David Moenning and may not actually come to pass. Mr. Moenning’s opinions and viewpoints regarding the future of the markets should not be construed as recommendations. The analysis and information in this report and on our website is for informational purposes only. No part of the material presented in this report or on our websites is intended as an investment recommendation or investment advice. Neither the information nor any opinion expressed nor any Portfolio constitutes a solicitation to purchase or sell securities or any investment program. The opinions and forecasts expressed are those of the editors of StateoftheMarkets.com and may not actually come to pass. The opinions and viewpoints regarding the future of the markets should not be construed as recommendations of any specific security nor specific investment advice. Stocks should always consult an investment professional before making any investment.

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