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Monday, May 19, 2008

The week ahead.

Better than expected could apply to many features of the market last week. Firstly, stock markets themselves have been performing better than one would expect with the constant stream of negative headlines in the media. There's a feeling that the bad news on the credit crunch is out now, and things are not as bad as feared. More than any thing, markets hate uncertainty and whether it is good news or bad, the fact that the surprises are thought to be behind us has a positive impact. Whether the bad news is really behind us is another matter.

Better than expected inflation figures from the US managed to pull the FTSE up by its bootstraps midweek. The UKs leading benchmark index was down 80 points before the US CPI figures came in and managed to push back into the black going into the close. Unfortunately, there were no positive surprises coming from the MPC last week, just more bad news on inflation and growth prospects for the UK economy. With the prospects of further bank boosting rate cuts diminished, there was an unwinding of positions in financial stocks. Barclays, HBOS, Lloyds and RBS were amongst the biggest fallers last week as mortgage rates continue to rise. The MPC looks to be continuing its tough line on inflation and consequently investors may view the upside for the financial sector as severely limited in relation to the downside risk. Traders punished Barclays primarily due to the indecision over a potential rights issue. Banking stocks might be seen as cheap at the moment in relation to their dividend yields, but investors are still mindful of how cheap Northern Rock and Bear Stearns looked before they went to the wall.
Oil stocks led the markets higher last week as oil touched another record high in excess of $127. The Nasdaq also performed well over the week with Blackberry maker Researching In Motion announcing it will be releasing a challenge to the Iphone. Yahoo was also in play on the news of a potential boardroom battle which could put the Microsoft deal back on.
Next week is relatively light on the data front with nothing of real note until Tuesday when we receive German sentiment data and US PPI figure around midday. Wednesday sees the release of the minutes from the last MPC meeting; analysts and home owners alike will be keen to know just how close last weeks decision to not change rates actually was. The release of the minutes from the last FOMC meeting will have an even greater impact as the housing market continues to slide.
The news is still bad from the US housing market with a bottom nowhere in sight. Construction of single family housing in April dropped to its lowest level in 17 years. Jason Goepfert recently highlighted a couple of indicators that point to the potential upside for US equities being limited from here.
One factor may be the unusually low levels of volume on the US markets. Monday the 12th had the lowest volume for 2008 on the New York Stock Exchange. Since 1980, the lowest volume days usually happen in the second half of the year, especially summer as traders take their holidays. In fact, the lowest volume day has occurred between January and June just twice since 1980 and on both occasions the market made no further progress for at least 9 months. Secondly sentiment studies indicate high levels of dumb money buying into this rally. While this alone doesnt signify a crash, it may at least indicate that the upside may not be spectacular from here on a 1-5 month basis.
With this in mind, the following trade may be valuable. Placing a No Touch trade on the S&P 500 not to touch 1580 within the next 120 days could return 14%. This places the no touch level above the high from last year, while providing room for some upside.