Welcome to the New Year! I believe it will be another year of excellent trading possibilities for those who are in tune with the markets, whether it be stocks, commodities, or other investment vehicles. In the following paragraphs, I will provide my own insight into what I believe could materialize in 2008 in stocks, metals, oil, the economy and interest rates, and the real estate market.
For 2007, the winner was the tech-laden NASDAQ, which finished the year with a 9.81% gain, marginally ahead of its 9.52% return in 2006. In the broader market, the S&P 500 struggled throughout 2007 and finished the year below the key 1,500-point level, up a mere 3.53% compared to a 13.62% gain in 2006. On the blue-chip side, the DOW returned 6.43% versus 16.29% the year before.
The major disappointment for traders in 2007 was the market action of the small-cap Russell 2000, a barometer of the performance of small-cap companies in the United States. The index started 2007 with momentum and was up 8.58% to a record high in early July before trading erratically for the rest of the year and then closing down at 2.75%. This followed on the heels of a healthy 17% gain in 2006. For small-caps, it represented the worst showing of the Russell 2000 since the bear market years from 2000 to 2002. The Russell 2000 is largely driven by concerns that an economic slowdown would impact small companies because of their smaller capital base to deal with a decline in revenues and earnings that could materialize in a slowdown. Because of this, the current concerns of a potential recession in the United States this year have investors and traders on edge and not wanting to enter new long positions. The current trading is driven by headlines, which makes volatility a major issue. The New Year started on the wrong footing, as stocks across the board fell on the first day of trading. The DOW fell 220.86 points, or 1.67%, to begin the year. Triggering the decline was a strong upward move in the price of oil to over $100.00 a barrel, another record high. For the consumer, the high oil prices mean higher gasoline prices. They could also mean that people may drive less and make fewer trips to the malls, which in turn could impact retail sales and the economy.
Watch how stocks perform in January as an indication to the year. In 2007, stocks edged higher in January and subsequently for the year. According to the “Stock Traders Almanac” in what is referred to as the “January Barometer,” when a positive January occurs, the index finishes higher on the year in about 86% of the time. The year 2007 was largely another up year except for the Russell 2000. The overall accuracy for whatever happens in January has been correct about 75% of the time since 1950.
Now, as we begin 2008, the overall market risk on the long side remains high and appears to be a continuation of the second half of 2007. The credit and mortgage markets remain an extremely problematic area. Earnings growth or the lack of will also be at the forefront. Earnings in 2007 were largely mixed. I believe that 2008 will continue to be characterized by volatility and cautious trading. Stocks could end up higher if the economy does not slow and if earnings growth continues. If these variables do not occur, stocks could head lower this year. As an investor and trader, you need to be careful in this market and protect your capital. Taking big risks could wipe out your capital for trading.
Given the current market conditions, I’m neutral at this time. As always, I advise you to remain prudent in your trading and avoid any unnecessary risk.
Near-term Technical Review:
The new-high/new-low (NHNL) ratio simply measures the number of stocks touching a new 52-week high versus the number of stocks that have declined to new 52-week lows. The theory is that in a bullish market, investors quickly bid up stock and you see a rising NHNL ratio. When investors get nervous, less new highs are made and the NHNL ratio will tend to decline, thereby giving you a warning. At the other end of the spectrum, bear markets have more new lows than new highs.
There is a general guideline that we use to examine the NHNL ratio. When the ratio is above 70%, it is bullish; below 70%, it is a warning; and below 20%, it is bearish. Watch the sentiment to see how the market is feeling.
The NHNL on the NYSE has been weak, as there has not been a bullish 70% reading since October 31, 2007. In fact, nine of the last 13 sessions have been bearish at below 20%, while the other sessions flashed warning signs. The near-term trend is down.
The NHNL on the NASDAQ has also been weak, with the last bullish reading on October 11, 2007. Seven of the last 13 sessions have been bearish. The near-term trend is down.
The near-term technical picture is bearish and the Relative Strength is weak.
Breadth as indicated by the advance-decline line (A/D) is mixed, with five of the last 10 sessions above 1.0.
The NASDAQ is trading just below its 20-day moving average (MA) of 2,659, as well as its 50-day MA of 2,682. Support is at the four-week low of 2,553 with resistance at the four-week high of 2,734.
The CBOE NASDAQ Volatility Index (VXN) — a barometer of near-term market volatility based on NASDAQ 100 index option prices — is generally viewed as a contrarian indicator.
A high VXN indicates maximum fear and a possible market bottom. A low VXN indicates reduced apprehension and a possible market top.
The five-day CBOE VXN to December 31 rose to 22.95 from 22.33 the previous week, and remains above the 200-day MA of 21.44. The recent decline in the VXN could indicate a near-term top.
On the blue-chip side, the near-term technical picture for the DOW is bearish, as the index is threatening to again break below 13,000. The Relative Strength is weak at below neutral. The index is trading below its 20-day MA at 13,394. Downside support is found at 12,855, with resistance at 13,463.
The broadly based S&P 500 is bearish, as is the Relative Strength. The index is below its 20-day MA of 1,479 as well as its 200-day MA at 1,490. Support is at 1,435.
The CBOE Volatility Index (VIX) is a barometer of near-term market volatility based on the S&P 500 index option prices.
The five-day CBOE S&P 500 VIX to December 31 rose to 20.15 from 19.60 the previous week. The lower readings indicate a near- term top.
On the small-cap side, the near-term technical signals for the Russell 2000 — a barometer of small-cap performance and the economy — is bearish, as is the Relative Strength.
The index is below its 20-day MA of 770. Watch for selling at 806 and 816.
Option Strategy for Hedging: Given the uncertainty of the markets, you want to make sure you don’t leave yourself exposed to selling. If you own stocks or index securities that made some decent gains, you might be wondering what to do.
Let’s say you own a basket of technology stocks that have moved in line with or better than the overall markets. A good strategy would be to take some profits. At the same time, you do not want to miss out on any potential gains that may occur as we move into what may be decent earnings in the upcoming quarters. You could also buy some put options to hedge against downside moves.
Another strategy that you may want to consider is to take some profits off the table and then use some of the profits to buy index call options — a bullish play on a stock index.
First, take some profits on your basket of stocks. Second, buy some index calls so that you will continue to partake in any potential upside moves in the markets.
The best thing about options is the leverage involved. For a fraction of the value of the index, you can trade the index and take advantage of the gains. In this way, you can take some profits and sleep well at night. At the same time, you would benefit should stock markets continue to rise. You can also play index call options on the NASDAQ, S&P 500, Russell 2000, or DOW. There are also numerous other index options you can buy depending on what you want to trade.
Should the market continue to rally, you would benefit from the index calls. But if the market falls, you would have realized some profits and only lose the premium you paid for the index call option. In my view, it is a win-win situation for you
The two key metals to look at are copper and gold.
High-grade copper prices continue to hold above $3.00 after trading at the $3.70 level in October 2007. The decline in copper has been driven by the threat of a slowdown in the U.S. and global economies, as well as the weak housing markets where copper is used for many applications including plumbing and wiring.
Global demand could be the key factor to drive copper prices higher. An insatiable appetite for copper in China for its massive infrastructure buildup has helped to drive prices higher. So far, construction in China remains strong but the potential of rising interest rates there could take a bit out of demand.
Taking a look at the chart, the basis March high-grade copper futures contract is currently in a consolidation channel between $2.90 and $3.20. The near-term technical picture is neutral while longer-term indicators are more bearish. The Relative Strength is neutral but needs to rise in order to support an upward move. Watch for support at the 20-day moving average of $3.04. Failure to hold here could see a move to the 13-week low of $2.85.
In my view, the reality is that if the global economies slow, copper can take a major hit. Rising global interest rates could impact growth and ultimately the demand for copper.
Gold continues to trade near record highs driven by concerns towards the economy, stock markets and inflation, and helped by a weak U.S. dollar. As gold is denominated in U.S. dollars, the current downtrend in the U.S. dollar is supportive to gold prices. This could continue if the greenback remains weak.
Also, a fear of inflation and worries towards the stock market attract buying in gold, as the metal is viewed as a safe haven investment in times of uncertainty. The current uncertainties in global economic and political climate will be supportive to gold.
Technically, the near-term picture is bullish as are the mid- and longer-term pictures. Relative Strength is strong, as the March gold is trading above the 20-day MA of $825.00 an ounce as well as the 50-day and 200-day MAs of $817.00 and $735.00 an ounce. The near-term upside target is $883.00 and the 14-day 80% RSI at $918. But watch, as gold is technically overbought given the buying.
Once a strong trend is in place, it is difficult to trade against it. Dow Theory states that a trend stays in place until it is broken. A perfect case of this continues to be the oil market, as the basis light sweet crude February futures contract on the New York Mercantile Exchange broke to another record high of $100.00 in trading on January 2. In 2007, Goldman Sachs shocked the market after suggesting oil would hit $100.00 a barrel, which in hindsight was the correct call.
The core issue driving up price is global supply and geopolitical concerns in the Middle East. In addition, the Organization of Petroleum Exporting Countries (OPEC) failure to increase production is also driving prices higher.
As I have said in countless commentaries, the high oil prices are a real concern because of the negative impact on transportation companies with oil as a major part of their expenses. For the economy, the high oil prices translate into higher corporate costs and could impact earnings. For the consumer, high oil prices translate into high gasoline prices. People will tend to drive less and make fewer trips to the malls, which in turn, impacts retail sales and the economy.
The near-term technical picture for the February oil continues to be bullish at this time with strong Relative Strength but the buying has also created an overbought condition on the chart, an indication of potential near-term selling pressure. The February oil is trading at above its 20-day and 50-day moving averages of $92.79 and $92.16, respectively, as well as the 200-day moving average at $77.37. The upside target is the 14-day 80% RSI at $110.69.
In the upcoming sessions, watch to see if the break at $100.00 will hold and drive oil prices higher. My feeling is that the overbought condition could drive some profit taking in the near term. Fundamentals will continue to drive trading.
ECONOMY AND INTEREST RATES:
The current credit and housing markets issue is pressuring consumer confidence. The recent consumer confidence for November from the Conference Board fell to 87.3, down from 95.2 sequentially. This represented the lowest level since an 85.2 reading years ago in October 2005. The weakening in consumer confidence could translate into weak retail sales. The biggest impact of declining consumer confidence would be on spending, especially on big-ticket items.
According to the Commerce Department, retail sales data in November reported the largest increase in six months, as headline retail sales surged 1.2% in November. This was double the estimate of 0.6% predicted by economists and well ahead of the 0.2% increase in October. The core retail sales number that excludes auto jumped 1.8% in November, well above the 0.6% estimate. The numbers tell us that consumers are ignoring the credit and housing market concerns and heading out to the malls and stores to buy, although we need to see growth in the following months.
The start to the key shopping season does not look encouraging at this time. Results for November have been mixed so far. Bellwether retailer Target Corporation (NYSE/TGT) warned that its fourth quarter earnings would be short of Wall Street estimates should sales not improve. Based on data from Thomson Financial on 43 retailers, about 22 retailers failed to meet estimates for same- store sales, while 19 beat sales estimates and two were inline. Watch for the key December retail data.
The Federal Reserve is pumping cash into the financial sector to try to prevent a possible meltdown and add some stability. After three straight interest-rate cuts by the Fed to drive the key Fed Funds rate down to 4.25%, while positive, there is still concern it may not be sufficient enough to heal the hurting credit markets and economy. My feeling is that the Fed remains concerned about the state of the U.S. economy and financial markets, and this could continue to drive rates lower unless inflation rises. The Fed could cut rates by another 50 basis points this year if the housing market fails to turn around and if the credit market languishes.
An early indication is that a slowdown appears to be in the works, as the key Institute for Supply Management report (ISM) declined to 47.7% in December from 50.8% in November. A reading below 50% suggests economic contraction. There is speculation that the United States may be heading into a slowdown or recession in 2008. Moreover, some pundits are calling for “stagflation” to surface, which is a deadly combination of rising prices, economic slowdown and increased unemployment.
REAL ESTATE: I hate to sound like a broken record, but the housing market continues to be a major risk for the economy going forward, as homeowners face declining capital wealth. The fallout in housing prices is evident. According to the National Association of Realtors, the median price of homes across America was $207,800, down a record 5.1% year-over-year. To put it in another perspective, if you own a home valued at $400,000, your equity in your house would be lower by about $20,000. This decline in your overall net wealth would clearly impact your spending habits especially on larger-ticket items. You may put off that new car or appliance purchase. Even the recent move by the Federal Reserve in cutting the benchmark Fed Funds may not be enough.
In addition, the construction of new homes and apartments in November declined to its lowest level in over 16 years, according to the Commerce Department. The decline of 3.7% in November was highlighted by a 5.5% decline in the construction of single- family homes to its lowest level since April 1991. The report also said that applications for building permits continued to decline and has for sixth straight months.
The soft housing markets are impacting the wealth and consumer spending in what is called the “poverty effect.” When housing prices decline, homeowners believe they are poorer and hence spend less, and this impacts the economy. Lower prices translate into less material wealth and this negatively impacts the way homeowners spend, especially in regards to bigger-ticket items.
The impact of the housing and credit problems on financial companies has been clear. The credit issues will not go away soon; that you can bet on. In spite of tens of billions of dollars of cash infusion by the Federal Reserve into the financial system, the credit market remains a significant concern going forward. Fed Governor Randall Kroszner raised some eyebrows after saying “conditions for subprime borrowers have the potential to get worse before they get better” in a speech at the Consumer Bankers Association Fair Lending Conference. Citigroup, Inc. (NYSE/C) has written off over $11.0 billion in losses related to the housing and subprime problems. Wells Fargo & Company (NYSE/WFC) wrote down $1.4 billion in losses on home equity loans for the fourth quarter.
The weakness in the housing market has also spread to the jobs market. The job loss in the mortgage area has been the worst among financial services companies. Citigroup announced massive job losses that could swell up to 45,000 additional cuts or over 10% of its global workforce in order to pare down expenses.
As we move forward, we expect to hear of more impacts driven by the fragile state of the subprime market and increased credit concerns in the banking system.
My feeling is that the ripple effect from the housing market may continue to spread into 2008 unless we see some stability in the credit and housing markets. For those looking to buy, prices have come down in some of the pricier regions across America. I did a search of properties for sale in the Tampa, Florida, region, and found some attractive pricing at this time; albeit whether it is a bottom is not clear. All I know is that an ocean-front or ocean-view property in Florida is a whole lot cheaper these days.
Clearly, the credit and housing market is not improving and could get worse. Foreclosures are at record highs across the nation and homeowners are beginning to be scared, as evidenced by the declining consumer confidence sentiment.