Recent trading action indicates that some of the major financials may have gone through a capitulation
From Standard & Poor's Equity ResearchNote: This article was originally published on Standard & Poor's MarketScope on Oct. 26.
A mid-week selling capitulation in financial stocks, prompted by the massive writedown by Merrill Lynch (MER), marked the bottom for the current pullback, in our view. At the same time, financial indexes as well as Treasury bond yields held at or near their recent lows, and then bounced on Friday. Microsoft's (MSFT) strong third quarter helped propel the Nasdaq back towards its recent high. Throw in a slew of third-quarter earnings reports and expectations for action by the Federal Reserve at its Oct. 30-31 policy meeting, and it certainly wasn't a week for those with a fragile heart.
Capitulations, whether buying or selling, many times mark the end of a dramatic intermediate-term move. The slope of the price becomes vertical, and volume swells to enormous levels as investors just pound the buy or sell button. This regurgitation by the market has a way of cleaning out the system, once and for all. We believe some of the major financials may have gone through this kind of action this week.
Merrill Lynch fell almost 12% from Tuesday's close to Thursday's low. The stock fell to its lowest level since 2005, and Wednesday's volume was the highest since at least 1990. In just nine days, since the close on October 12, Merrill was off 19% at Thursday's close. Citigroup (C) also was hit hard and has declined almost 15% since October 11. This was the worst 10-day performance by Citigroup since near the bear market low in September, 2002, and has taken the stock to the lowest level since 2003. Not to be left out, Countrywide Financial (CFC) fell 23% from its close on Monday to its intraday low on Thursday. Since October 12, Countrywide is down 30%, the worst nine-day decline since at least 1992.
Despite these dramatic moves in some of the financial stocks, the financial indexes we talked about last week held at or near their recent lows. This includes the S&P Financial SPDR (XLF) and the KBW Bank Index (BKX). In addition, the 10-year Treasury yield did not break down, and held at its recent low in the 4.3% area. For the continued health of the overall stock market, we think that it is imperative that these indexes and yields hold critical support levels that were created over the past couple of months.
The news was certainly not bad for all stocks this week, as Microsoft reported far better than expected numbers, pleasantly surprising the Street. While we certainly do not think Microsoft is the growth stock it once was, or never will be because of its size, its price action is very important for the overall market. The stock represents more than 6% of the Nasdaq and more than 2.2% of the S&P 500. It is by far the largest stock by market cap on the Nasdaq, and it is the third largest on the S&P 500, trailing only Exxon Mobil (XOM) and General Electric (GE). The 8%+ spurt in the stock on Friday was the largest one-day gain since May, 2002, and propelled the shares to their highest level since July 2000. For such a large stock, single day moves like this are a rarity.
The action in the overall market this week was skittish to say the least. The S&P 500 twice fell to the 1490 area before bouncing. On Wednesday and Thursday, we saw nice upside reversals at the end of the day. The sloppy action may be the market's way of repairing the damage from last Friday's pounding, which sent the "500" down 2.6%. The index seems to have found strong support in the 1490 zone, and this level will be important in the coming days and weeks, in our view. Chart support, from the top of the base created in August and September, sits around 1490. A 50% retracement of the rally sits right below the 1490 level. There are a host of key moving averages in the area including the 50-and 65-day exponential as well as the 80-day simple.
There is very little overhead resistance for the S&P 500, in our view, so if some of this selling pressure subsides, and we start to get some buying as we move into the seasonally strong period of November through January, we don't see any reason that the index could shoot to new highs, on the way to 1600.
Crude oil prices continued their march higher, closing above $90 per barrel for the first time. Earlier in the week, crude oil pulled back and held just above a layer of chart support in the $84 zone. Prices are back above a bullish channel that has been in place since March, and are very extended from a momentum standpoint. However, we believe crude could run up to the $93-$95 area based on Fibonacci extension of the pullback this summer, and the major correction during last year. We have not gotten any glaring signals from the Commitment of Traders data of late, and this suggests that further upside is possible. However, we believe the rally is getting a little long in the tooth. There has been a negative divergence on the 14-day RSI, a first for the advance. In addition, the 14-week RSI is up to 79, the most overbought that this indicator has gotten during the entire bull run that started in 2001.
Fortunately, gasoline prices have not followed crude oil prices higher yet. Regular gasoline prices hit $2.49 per gallon in May, when crude oil was down in the middle $60s. Despite crude's strong price advance, gasoline prices have actually fallen sine May, and are now around $2.16/gallon and have been very steady since the latter part of July. Since gasoline prices are a function of crude oil prices, the two have been closely correlated over the long term. There are of course factors unique to each market, such as separate supply and demand drivers, the dollar (crude is priced in dollars), imports, additives, politics, etc. We are not going to take the leap and suggest that gasoline prices will catch up with crude. However, we think it presents a potential worry.