Monday, July 12, 2010

Morning Note...

Futures ~20bps lower this morning as investors prepare for the kick-off to Q2 earnings season.  News flow remains relatively quiet and Europe is trending sideways on perhaps a “post-World Cup hangover” morning.  Japan was lower overnight on recent elections that are neutral-to-bearish for equities there; the rest of Asia was slightly higher.  In U.S. M&A news, AON to acquire Hewitt Assoc (HEW) for $50/share.  Looking ahead, we’ll get earnings from AA tonight to kick things off for Q2.  INTC reports tomorrow, GOOG & JPM report Thursday, and BAC, C, and GE report Friday.  Additionally, we’ll get Credit Card Master Trust data on Thursday, and the FOMC minutes will be released Wednesday.  Overseas, the first debt offering from Greece post-bailout will be this week and will be closely watched.  Also, China will release GDP, IP, CPI, and PPI Wednesday night for Thursday morning U.S. trading.  In political news, Congress is back in session this week and – depending on who replaces Byrd – will vote on FinReg and the extension of unemployment benefits.  Given the +5% move on very light holiday action last week, it will be interesting to see how stocks react given the World Cup is over and many have returned from long holidays around the July 4th shortened week here in the U.S. 

Check the C section of the WSJ for an interesting article on correlations:

The Herd Instinct Takes Over
Component Stocks' Correlation to S&P 500 at Highest Level Since '87 Crash

Stocks are trading in lock-step more than at any time since the 1987 crash, and the trend has some analysts concerned.

In recent weeks, stocks in the Standard & Poor's 500-stock index have shown an increasing tendency to move in the same direction at the same time. Last week, those stocks' tendency to move in the same direction as the index hit an extreme not seen since October 1987, according to research by investment group Birinyi Associates in Westport, Conn.

The market's flock-like behavior is one more reflection of the growing influence of investors using broad-based strategies to buy and sell large blocks of stocks. Instead of picking individual stocks to hold over a period of time, they trade in and out of the market using broad indexes. Often, these investors use exchange-traded funds, which trade as easily as a single stock but contain many different stocks that may belong to the S&P 500, the Nasdaq 100 or another index.

Heavy trading in exchange-traded funds means more stocks are likely to move in the same direction on any given day. Analysts call that correlation, a mathematical term meaning similarity of behavior. Correlation is on the rise, to the frustration of investors who are trying to analyze stocks based on their underlying strengths and weaknesses.

"It is an indexing market and not a market for stocks. On good days everything goes up, and on bad days everything goes down. Everyone talks about baskets or sectors," says Jeffrey Yale Rubin, research director at Birinyi Associates. "It is harder for individual investors and even for mutual-fund managers to distinguish themselves by doing individual stock picks. They might get the product right and the earnings right, but the market goes down and the stock is going to go down as well."

Barron’s positive WMT.  QCOM added to Conviction Buy List at GSCO but target lowered.  LF upped at NEED.  GLW cut at GSCO.  NOC named Conviction Sell at GSCO.  UBSS ups SNDK.  CITI initiates STP with sell.  CITI raises MON on valuation.  WY declares special dividend and UBSS upgrades. 

Asia higher save for JapanEurope slight higher.  EUR/USD $1.2572.  Oil +13bps.  Gold -26bps. 

S&P 500 PreMarket 8:30am (last/% change prior close/volume): 
WEYERHAEUSER CO       37.80    +5.47% 95022
QLOGIC CORP                18.88    +4.14% 303
AGILENT TECH INC         29.38    +2.55% 943
QUALCOMM INC             34.72    +2.39% 13547
SANDISK CORP              43.82    +2.14% 34162
AETNA INC                    27.04    -2.14%  2400
ANADARKO PETROLE      46.37    +2.11% 6020
CORNING INC                 17.14    -2.11%  16835

Today’s Trivia:  Given yesterday’s final, this will be the last World Cup trivia for some time… By winning yesterday, Spain accomplished a series of firsts in World Cup history.  Name two.   
Yesterday's Answer:  Gregor Mendel performed his famous genetic studies on peas. 

Best Quotes:  From BTIG last Thursday, but worth posting nevertheless (bold is mine)…  

Extreme Dream.
In Monday night’s note we stated that we believed “the S&P 500 is setting up an important intermediate bottom sometime over the next two weeks.”  After seeing today’s AAII Sentiment reading for the past week, it now looks as if that statement is incorrect.  As it turns out, we now believe that intermediate low we were looking for was reached July 1st when the S&P 500 traded at 1010.  Considering that the S&P 500 has already rallied 5+%, that is not necessarily a bold statement.  The important statement we would add is that we believe there is a very high likelihood that the July 1st low will be the 2010 low for the year. 

Most readers of this note are aware that we believe the AAII Sentiment survey is the best sentiment indicator out there.  No indicator is perfect and all indicators have hits and misses, but from our work over the 23 year history of this data, it has far more hits.  This week’s reading of 26.8% Bullish  (Bulls/(Bulls+Bears)) is the lowest reading since March 5th of last year.  The way we apply this indicator is in a typical market environment.  We use 40% as a buy threshold, and in a bear tape we tighten the parameters and use 30%.  We consider the move since the April peak a correction within a bull market.  Therefore, a 26.8% bullish reading is something we believe is worth being excited about.  As the table below illustrates, the forward returns on readings below 30% Bullish healthily outpace typical returns. The caveat as well as potential positive is that the ugly readings registered in 2008 are included and 2008 also posted some very ugly returns.  We were bearish throughout the first 3 quarters of 2008, and mostly saw those readings as opportunities to cover or play for a bounce.

We would note that this does not change our overall Neutral stance on the Equity market.  This sentiment washout does firm up positives on the Behavioral/Volatility front which continue to improve.  We still want to see Initial Jobless Claims resume their downtrend.  To place our view in context, when we went to Neutral on May 3rd we stated we believed upside was capped around the 1200 level.  Here we are noting that we believe downside is limited to the 1000 level.  We are aware that is a large range, but the S&P 500 did hit both bookends in the span of two months.  Barring an all out downturn in economic data (as  opposed to the recent softness), we believe investors should feel confident in buying in the lower end of the range, but also not be afraid to make ticks or incrementally hedge during the  rallies.  In the weekly Jobless data today, Continuing Claims registered a cycle low.  We still believe the final piece of the puzzle for the rally to resume and lift that 1200 cap is a resumption in the downtrend of Initial Claims.