Sunday, July 05, 2009

The week ahead for Equities is fraught with downside risks following the July 2 NFP report
The week following NFP weeks are generally light on economic data. Typically these economic-light
weeks garner a lot of speeches from Fed officials and the like. But while Fed Presidents Evans and Duke,
as well as Geithner will speak or testify, remarks from them should not be market moving events.

So, you might think that a quiet week would correspond with a low volatility. That is sensible enough, but
you might be wrong. Investor confidence has been shaken by the July 2 NFP report that showed job losses
in June were not just much worse than expected, but also much worse than the previous month. The July
2nd jobs report effectively discredited the “green shooters” thesis that thing were getting less bad. In other
words, things are suddenly less bullish or more bearish. Oops!

Earnings Bomb
Then Bloomberg dropped an “earnings-bomb” on investors today with the headline that “Earnings Drop
Worldwide as Job Losses Hurt Consumers.” This headline offsets the cushion that was expected to be
provided by the financial sector in the Q2 earnings season who have been given a green light by the
government to manufacture fictitious earnings so as to be able to show that they can earn their way to a
healthy recapitalization and therefore not need to raise capital as mandated by the bank stress-tests. From
Bloomberg:

Consumers in the U.S., the world’s largest economy, remain concerned about jobs after unemployment
reached a 26-year high in June, analysts and investors said. Until Americans start spending again on cars,
cell phones and clothes, most U.S., Asian and European companies may keep squeezing out costs.

Railcar shipments and other U.S. shipping data provide scant hope that manufacturers are gearing up for
increased demand, said Mark Demos, at Fifth Third Asset Management. Railcar shipments are down 19
percent so far this year and 18 percent in the week ended June 20.

“Companies are laying off people and not hiring them back,” said Roger Kubarych, chief U.S. economist
at Unicredit Global Research in New York. “This leaves us with a weak, irregular recovery.”

Roger Kubarych’s comments come on the heels of Janet Yellen’s June 30th comments that unemployment
will “remain painfully high for several more years,” underscoring the fact that in our brave new economy,
no matter how accommodative fiscal and monetary policies are in the US, in an open global economy jobs
are created in emerging markets not developed countries.

And we must not forget that demand for energy remains extremely weak too. Oil companies year-over-
year comparisons are going to look sickly given that oil was climbing to $147 in Q2 08 vs $73 in Q2 09.
The back of the napkin computation suggests oil companies’ net income will fall 50% y-o-y, but analyst
estimates think Exxon’s net income could fall as much as 64%. This could be related to y-o-y demand
contracting. As related to us by Barry James of James Advantage, “there’s a lot of excess production and
not that much demand.”

Similar to the July 2 jobs report indicating that things in the labor market are still ugly and not less bad as
hoped for by the green shooters, Q2 earnings for the financial sector may be worse than Q1 09, according
to Bank Securities analyst Dick Bove. He sees “large banks in general will report lower earnings than the
first quarter. Credit losses will offset gains in trading and underwriting.”

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What does all this mean for market participants? It likely means an increase in volatility and downside
risks for the stock market over the next few weeks as there is little to protect investor confidence from
swooning near term. As you can see from the intraday chart, investor confidence was so badly rattled on
Thursday’s jobs report that it took out the June 24 FOMC meeting low where the Fed confirmed that it
would leave monetary policy accommodative for an very “extended period of time.”

The stock market rallied into the June 5 NFP report showing job losses “less bad” month over month and
the June 11 government granting of TARP buybacks. It then swooned into the June 23rd low and only
rallied after the accommodative Fed statement. The July 2 NFP low was supported by the trendline drawn
under the May 26 and June 23rd consumer confidence lows.

A failure of June 23 consumer confidence low at 884 indicates investors confidence is negatively
diverging with the most recent consumer confidence low. This would be a bearish signal immediately
putting the May 26 consumer confidence low at 873 in jeopardy. That was the low set following the
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duplicitous scheming of the Treasury regarding the bank stress-tests where all the large banks were pre-
determined to pass. It was a “Pass-Pass” sort of test, quite unlike the “Pass-Fail” sort which is more or less
required of any test by definition.

In short, the Treasury deemed all the large banks to be like the kids from Lake Woebegone, where they
were all deemed to be above average. But, should the large bank earning be worse than or “less bullish”
than Q1, then market participants should expect the SP 500 to revisit its April 21st earnings season low at
820 in the coming weeks. Oh, and we best leave room for a test of the April 7 pre-earnings season low at
800 on the Sept e-mini contract.

Remember FY 2009 is all second derivative trading and nothing but. Less bearish equates to an up market,
and less bullish equates to a bearish market. C’est tout un besoin de savoir to figure out market direction.

Key off the May and June Consumer Confidence bull trendline for the next few weeks, Above the
trendline, market volatility should remain relatively low and the market relatively stable. Below it and the
volatility and downside risks could pick up markedly.