CWS Market Review – August 5, 2011

Ugh! There’s not much else to say about Thursday’s stock market except that it was a total disaster. It was the Rocky V of trading days. But unlike Rocky V, we can’t pretend that Thursday never happened. In this issue of CWS Market Review, I’ll review the damage. More importantly, I’ll tell you what’s really going on and what you need to do to protect yourself during a frenetic market like this.

As we all know, Wall Street can be a serious drama queen. When the bears go on a rampage, well…they’re pretty hard to stop. There’s an old saying on Wall Street: “If you can’t sell what you want, sell what you can.” That’s exactly what happened. I mean, AFLAC ($AFL) at $42?? Dear Lord! And Reynolds American ($RAI) yielding 6.3%?? Heavens to Murgatroyd; that’s the equivalent of 718 Dow points!

I can’t predict when all this madness will end but I can say that we’re already well-protected. On Thursday, our Buy List out-performed the S&P 500 by 27 basis points. Of course, that simply means we got shellacked somewhat less than the other guy, but the important point is that investors didn’t massively abandon the high-quality stocks I favor like they did everything else. This is key and I’ll dissect it more in a bit.

Now let’s look at some of the numbers. I’ll warn you: If you have a weak stomach, feel free to skip this section. On Thursday, the S&P 500 plunged 60.27 effing points for a drop of 4.76%. Yuck! That’s the index’s worst loss in 18 months. Plus, this sell-off comes on the heels of an eight-day losing streak which culminated in Tuesday’s 2.56% wipeout. All told, we’ve lost 10.78% in the last nine trading sessions.

Want to see how much the sellers are in control? On Thursday, the Nasdaq’s up volume swamped its down volume by a ratio of 85-to-1. Think about that. Even the Smurfs were no help. Since they rang the opening bell last week, the Dow has dropped 760 points. Short blue bastards.

What’s especially frustrating is that I saw a lot of the larger trends coming but I was wrong in anticipating just how hard they would hit. For example, I’ve repeatedly warned investors to stay away from cyclical stocks, but I didn’t think the Morgan Stanley Cyclical Index (^CYC) would perform quite so poorly. Consider this: The cyclicals have trailed the overall market for 17 of the last 20 trading sessions. That comes to a loss of 18.32% which includes a staggering 6.68% drop on Thursday.

Similarly, I told investors to keep an eye on the S&P’s 200-day moving average. I even cautioned folks that there are often three tests of this key support level. That’s exactly what happened. The S&P 500 bounced off the 200-DMA twice in June but never closed below it. Then on Tuesday of this week, the S&P 500 finally breached the 200-DMA. That gave the bears a huge confidence lift because by the closing bell on Thursday, the S&P 500 stood nearly 7% below its 200-DMA. Once again, I wasn’t surprised by the retest but I didn’t anticipate that rout that followed.

For some background, the 200-day moving average is one of these silly rules that has a surprisingly good track record. The evidence is clear: The S&P 500 has performed much better when it’s above its 200-DMA than when it’s below it. In the short-term, momentum is a key driver of the market and for some reason the 200-day moving average captures this well. If history is our guide, the stock market will likely spin its wheels until we surge above the 200-day moving average.

So is it time to sell? Absolutely not. In fact, this would be a terrible time to sell. The stock market may indeed head lower in the short term, but the best opportunities are in stocks. As I’ve said many times, the earnings outlook for our Buy List stocks continues to be bright. Just this week, both Becton Dickinson ($BDX) and Wright Express ($WXS) not only beat Wall Street’s earnings estimates but also raised guidance. For Wright, it was the second guidance increase this year. If some hedgie needs to raise cash by dumping WXS, that’s his problem, not ours.

I urge investors to be patient. Wall Street likes to shoot first and ask questions later. Remember, we had a 16% sell-off last year due to another “Double Dip” that failed to come. Do not give into the market’s panic.

Here’s what’s happening: Investors are quickly moving out of areas that are seen as risky and into areas that are seen as safe. What we’re witnessing is the unwinding of the QE2 trade. Last November there was an especially brilliant and prescient article at which explained how the Fed’s QE2 policy would cause a shift in favor of riskier instruments. Now that trade is falling apart in a major way. All across the board, investors are dumping risk and hoarding security. Fear is giving greed a major beat-down.

Just look at the two-year Treasury yield which dropped to an all-time low of 0.26%. That means that an investment of $1 million yields you a whopping profit of $7 per day. I honestly think you could find more loose change on a DC metro car. The yield on the one-month Treasury actually become negative for a brief period which means you had to pay the government to borrow your money. The long-end of the curve has been even more popular. The price for the 10-year T-bond jumped by more than 2% on Thursday and the price of the 30-year rallied by 4.66%. Gold just hit a new all-time high this week of $1,681.72 per ounce. Safety is trumping everything. Everything.

In last week’s issue, I discussed the alarming rise of the Volatility Index ($VIX). I noted that the VIX had spiked up from less than 16 to 23.74 in just three weeks. Please; that was nothing. On Thursday, the VIX jumped more than 35% to reach 31.66. That was the biggest jump in more than four years. To give you an idea of what the VIX means, a reading of 30 means the market expects the S&P 500 to swing by an average of 8.66% over the next month. Note that it doesn’t indicate which direction it will move, just that it will move a lot.

The Federal Reserve meets again next week and there’s growing speculation that the Fed will launch another round of quantitative easing, QE3. For now, call me a doubter. So far, the Fed hasn’t given us any indication that it’s looking to buy more bonds. The last time around, the Fed made its intentions very clear to Wall Street. Part of the reason I missed the strength of this sell-off is that earnings for the overall market have been quite good. Of course, earnings results are backwards-looking. What’s troubled the market so much recently has been growing evidence that the economy will soon take a turn for the worse.

Every day we’ve gotten bad news on the economy. Starting last Friday, the second-quarter GDP report came in very soft and the first-quarter report was revised downward. The government revised the GDP numbers for several quarters and it showed that the recession was worse than we original thought and that the recovery was weaker than we thought. In real terms, the economy grew by less than 1% for the first half of this year.

Then on Monday, the ISM Manufacturing Index dropped to 50.9 for July which is the lowest level in two years. Any number above 50 means the economy is expanding, while any number below 50 means the economy is receding. Also, the Commerce Department said that factory orders dropped by 0.9% in June. That’s the first drop for that metric since the recession ended.

On Tuesday, the Commerce Department reported that consumer spending dropped by 0.2% in June. That’s the biggest fall-off since September 2009. This is very important because consumer spending represents 70% of the U.S. economy.

On Wednesday, the ISM Service Index came in at 52.7, its weakest level in 17 months. Since February, the index has dropped by seven points. Also, ADP ($ADP) released its jobs report which showed that the economy created 114,000 jobs last month which is far from a strong number. The government will release its report on Friday morning. (I’m writing this in the wee hours of Friday morning.) Wall Street expects a meager gain of 85,000 jobs.

These negative reports are causing analysts to pare back their growth forecasts. JPMorgan Chase ($JPM) cut its estimate for third-quarter growth (which we’re nearly halfway through) to just 1.5%. As bad as this is, there’s still no hard evidence that we’re in a recession. That may come, and the odds are higher than they were one month ago, but it’s still not here yet. For now, I suspect that the economy is due for a period of slow and disappointing growth but not a full-blown recession. I’m not writing off the possibility of a recession, but I don’t think it’s probable.

The best part of a fearful and panicked market is that you can find good values and that’s what prudent investing is all about. I want to highlight some Buy List stocks that look especially attractive right now. If you can get shares of Nicholas Financial ($NICK) for less than $11.50, you’re getting an amazing deal. As I mentioned before, AFLAC ($AFL) and Reynolds American ($RAI) are both very cheap. How about Oracle ($ORCL) at $28? I strongly doubt that will last. Abbott Labs ($ABT) is a solid buy that now yields 3.9%. I also think JPMorgan Chase ($JPM) is worth a look now that it’s below $38 per share. The yield alone will get you 2.6%.

That’s all for now. The Fed’s meeting and QE3 speculation will dominate headlines next week. Be sure to keep visiting the blog for daily updates. I’ll have more market analysis for you in the next issue of CWS Market Review!


P.S. This Sunday, I’ll be on Kevin Whalen’s radio show on WRKO at 7:30 p.m. to discuss (what’s left of) the market and the economy. I also want to thank everyone who submitted a question for my Q&A. I hope to have that up soon.

Posted by on August 5th, 2011 at 7:09 am

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.