MarketView for August 8

 

 

Summary  

 

No, there is no neat or funny way to put it, so without the hyperbole the simple truth is that the stock market went in the tank on Monday. Was it because of the S&P downgrade, who knows? What I do know is that the markets are dramatically oversold.

 

One reason I say this is that fewer than 2 percent of NYSE stocks were positive.  This has not occurred in 70 years and indicates a deeply oversold market. Furthermore, there have only been three times in history that the up ratio was less than 5 percent, while the 10-day average was below 30 percent.  One month later the average gain for stocks was 8.1 percent.

 

Does that mean we are facing a major rally in the near future? Absolutely not -- what it means is just what it says that historically that is what has happened in the past. Is it a time to move into those stocks that heretofore you thought were too expensive? Well, you are going to have to use your own judgment.

 

Meanwhile, here is a synopsis of the day’s events.  Share prices saw the heaviest volume since last year's "flash crash," taking the S&P 500 down more than 6 percent on growing fears of a recession, in the first session after the historic loss of the country's pristine triple-A credit rating.

 

Panicked selling resulted in the S&P 500's worst day since December 2008, with every stock in the benchmark index ending in negative territory. Volume totaled 17.89 billion shares traded on the major exchanges, the heaviest volume since the "flash crash" of May 6, 2010. Monday's volume was more than twice last year's daily average of 8.47 billion.

 

The anxiety about the economy was matched by rising worries about Europe's debt problems, where the latest initiative to buy Italian and Spanish bonds is far from enough to solve the euro zone's debt crisis.

 

The CBOE Volatility Index, Wall Street's "fear gauge," was up 50 percent to end at 48. This marked the first time the VIX has topped 40 since May 2010.

 

The S&P 500 is down 17.9 percent from its 2011 closing high, reached on April 29 -- putting it close to the 20 percent decline from a recent peak that Wall Street defines as bear market territory. Monday's slide also marked the first time since November that the Dow has fallen below 11,000. 

 

While all 10 S&P sectors lost more than 3.5 percent, the groups most sensitive to the economy, such as banking and commodities, were the hardest hit. The S&P financial index fell 10 percent while the S&P energy index shed 8.3 percent. U.S. crude oil futures settled at $81.31 a barrel, down $5.57, and in post-settlement trading fell as low as $80.17 -- a drop of more than 7 percent from Friday's close.

 

Bank of America Corp fell 20.3 percent to $6.51. The Dow component was the most actively traded name on the New York Stock Exchange and the S&P 500's biggest loser.

 

Monday's global stock market sell-off wiped out more than $1.35 trillion in investor wealth worldwide, according to the 5.2 percent drop in the MSCI World Index . The index began the week with a market value of $26.42 trillion. The S&P 500 alone lost $729.3 billion in value with its drop for the day of 6.66 percent.

 

One money manager put it succinctly when he was quoted as saying the sell-off was uniformly blamed by my clients on the government's inability to act rationally.

 

Traders expected redemptions and margin calls for the sharp early afternoon declines.

 

Even the European Central Bank's dramatic intervention in bond markets, which pushed down yields on Spanish and Italian bonds, was not enough to stem selling. However, a number of analysts noted that the mass selling has made some stocks attractive at much lower prices.

 

Barclays Capital, in a note to clients, wrote that the decline created a "time to buy," and that the recent losses "left equity valuations at levels of cheapness not seen since the early 1980s.

 

Price of Crude Oil Also Down Sharply

 

The price of crude oil fell 5 percent on Monday, falling below technical support levels as the markets raised concerns of an economic slowdown. Brent crude broke through its 200-day moving average, extending a correction that has sent prices off more than 18 percent from 2011 peaks hit in April as traders weighed the prospect of a second recession on the already shaky oil demand outlook. Prices are down $13 a barrel since the start of August alone.

 

Brent crude ended the day down $5.63 per barrel to settle at $103.74, substantially below the 200-day moving average of $106.89 and down more than $23 from the 2011 peak over $127 a barrel hit in April.

 

West Texas sweet traded down $5.57 per barrel to settle at $81.31, the lowest close since November 23. It then dropped as low as $80.17 a barrel in post-settlement activity, down $34 from the 2011 peak of $114 a barrel struck on May 2.

 

Domestic crude trading volumes were nearly 40 percent over the 30-day average and Brent volumes were 28 percent over that average in late afternoon activity. Brent's premium to domestic crude was $23.54 per barrel in late activity; just three cents shy of the record hit in July.

 

Weekly oil inventory data would reinforce the bearish picture, with crude stockpiles seen up 1.5 million barrels for the week to August 5, with gasoline and distillate stockpiles also expected to show a build.

 

Oil company shares were slightly weaker than crude futures, with the CBOE Oil Companies Index shedding 6.30 percent, led by declines in EOG Resources, Apache and Chevron.

 

Meanwhile, both Merrill Lynch and Goldman Sachs maintained their 2012 price forecasts. "We believe that WTI crude oil prices could briefly drop to $50 under a recession scenario," Merrill Lynch said in a note to clients, but it maintained its 2012 average forecast for U.S. crude at $102 a barrel and its forecast for Brent next year at $114.

 

Technical indicators also suggested the selling may abate. On the 14-day relative strength index, U.S. oil dropped to 22, the lowest level since the third quarter of 2008 and well below the 30 level often interpreted as a sign a commodity has been oversold. Brent crude also dropped below 30 for the second time this month.

 

Markets Now Look to the Fed

 

The Fed meets on Tuesday and all eyes are going to be on what it says after the meeting. The Fed is in a tough position with investors having lost confidence that Europe and the United States can rein in their budgets quickly and fear spread of a double-dip recession.

 

This despite the fact that the European Central Bank entered into the bond market in a strong way buying up Italian and Spanish debt, thereby placing a safety net under the euro zone's third and fourth largest economies.

 

Although the G7 finance ministers' and central bankers pledged on Sunday to help smooth markets if needed, the words provided little solace. There was realization on both sides of the Atlantic that the political obstacles to quick budgetary reform are so huge and the monetary options so limited that it has deepened the pessimism. Furthermore, there remains continued disagreement in Europe over a longer-term rescue plan.

 

Therefore, the worsening market turmoil puts significant pressure on the Federal Reserve at its regular policy meeting on Tuesday to announce some fresh measures of support for a damaged U.S. economy.

 

The G7 financial policymakers from major industrialized nations said on Sunday they stand ready to provide extra cash if markets seize up, are consulting regularly and could cooperate to smooth volatile FX markets if needed. President Barack Obama called for urgent action on the U.S budget deficit but his proposal on taxes was promptly rebuffed by Republicans.

 

Particularly worrisome was a more than 20 percent plunge in the shares of Bank of America. AIG sued it for $10 billion for allegedly deceiving investors, on top of mounting concerns about the size of its potential losses from mortgages litigation and questions about management. The bank has shed nearly one third of its market value in three days.

 

On the political front, Obama said he hoped that Standard and Poor's stripping the United States of its prized AAA credit rating would add a sense of urgency in Congress to finally agree to sensible budget reductions.

 

Meanwhile, the fact that Standard and Poor's cut the credit ratings of organizations tied to Treasury debt to AA-plus, namely government mortgage agencies, clearing houses and insurers, did not stop the Treasury market from rising sharply on Monday, sending interest rates sharply downward.

 

President Obama also spoke with Italian Prime Minister Silvio Berlusconi and Spanish President Jose Luis Zapatero, welcoming measures by their governments to address the economic turmoil in Europe.

 

Traders estimated the ECB bought about 2 billion euros in Italian and Spanish debt after it agreed on Sunday to broaden its bond-buying program for the first time to halt an attack on the Mediterranean countries.. Italian and Spanish yields declined sharply.

 

One outcome from S&P’s downgrade is that French sovereign credit default swaps hit a record high of 160 basis points as the downgrade raised questions about how long other AAA countries, such as France, could hold onto their top-notch ratings.

 

The ECB move was seen as only a temporary solution however, due to the sheer size of Italy's bond market -- $1.6 trillion. European stocks sank to their lowest in nearly two years, with the German DAX closing down 5 percent as doubt about governments' ability to deal with the euro zone debt crisis and its impact on economic growth emerged.

 

A bailout of Italy would overwhelm Europe's emergency fund. Germany has so far opposed expanding it, a view unchanged on Monday, but French Finance Minister Francois Baroin said: "The allotment is 440 billion (euros) and we've already said if we need to go further we will go further."