Equity Edition
Week of June 8-12, 2009

Capital Market Comment | Equity Trade Idea 1: BCE | Equity Trade Idea 2: General Portfolio Trimming | Last Week’s Trade Review | Subscribe | Disclaimer

CAPITAL MARKETS COMMENT

Global stock markets were mixed the past week with the S & P 500 gaining 2.17% and the TSX 60 closing down 0.3% due to a stronger USD and profit taking in the commodity sector. Crude oil rallied $1.96 on the week and Gold was down $19 for the August futures contract.
On Friday, the US monthly non-farm payroll numbers were out and came in at 345,000 which was less than expected but the overall unemployment number reached a 26 year high of 9.4%. In Canada, 41,800 jobs were lost in the month of May, which was worse than expected and mostly due to auto-workers being laid off in Ontario. Unemployment in Canada reached an eleven year high at 8.4% due to one of the worst recessions to hit since World War II.

The biggest story from last week, and one which I am monitoring very closely, is the rise of interest rates in the US. The Ten year treasury bond yield which stood at 3.16% a month ago has moved to 3.83% on Friday. The 30 year Treasury bond has moved from 4.06% a month ago to 4.6% on Friday The increase in rates is a major factor for US mortgage rates and for the hopeful turnaround in housing values and sales. US mortgage rates have jumped almost 28% during the past few weeks and this continues be a major factor for new homeowners who will need the incentive of low rates to be able to feel confident in buying a home.

This week we will get a good look at the health of the US consumer with May retail numbers on Thursday. Expectations are for an increase in sales of 0.5% versus a decline in April of –0.4%. The treasury is also continuing with some major bond auctions looking to sell $35 billion in 3 year notes on Tuesday, $19 billion in 10 year notes on Wednesday and $11 billion in 30 year notes on Thursday. The outcome of these auctions will be very important to watch for equity markets. Recent auctions have been very well received but traders are worried that the US might be going to the well too many times. The major trend-line for 30 year interest rates will need to be watched at 5.09% since it dates back to 1986 and if broken might signal higher rates for years to come.

The risk of higher rates to the US economic recovery is sure to have a very serious effect on the equity markets. The recovery has been helped by low interest rates, lower mortgage rates and lastly low energy prices such as gasoline. With all of these areas now rising the rate of recovery is sure to slow down or stall. The other factor right now is will China step up to the plate for the longer end of the treasury market. It is being said that China is now focused on shorter term US treasuries and without Chinese demand for the long end of the treasury market rates will to need to rise in order to generate some buying interest. China currently holds $768 billion of US treasuries. Therefore, all eyes will be on the auctions this week and I highly suggest investors keep a close eye for themselves on the yields and quality of bonds they hold in their own portfolio’s since a major shift might be happening with interest rates and the overall bond markets of the world.

This week the focus for the S&P 500 and for the TSX markets will be the dollar. The USD is in the midst of bottoming in the short term and the effects can be felt in several markets. The dollar index, which is a basket of currencies priced against the USD hit 78.44 right below the December 18, 2008 price of 79.00 before closing the week above 80 at 80.75. The dollar index (DX) has been a very good tell for the equity markets in terms of willingness of investors to take on risk. When the DX is falling equities tend to be rallying and when the DX is rallying equities seem to be selling off. This past week was important for market participants since the DX put in a key reversal and began to rally from the lows seen a few days earlier.

The other two direct currency pairs that we are watching are the Euro and the Canadian dollar. Both of these currencies have been a very good indicator of risk and of equity direction. The Euro hit a high of 143.44 on the week and then ended up closing below the key 141.50 area at 139.60. The fact that the Euro broke 140 is quite symbolic of the risk that we may see exit the recent equity rally. As long as we stay below 141.50 it will be hard for funds to remain bullish of stocks and we might start to see some major profit taking or more than that a serious short term sell off down to areas in the market that we will outline shortly for you.

The Canadian dollar is another indicator of overall risk appetite and is more important for gauging the health of the commodity markets that have been a driving force in the equity markets over the past 3 month rally especially. The CD hit a high of 9284 last week and closed at 8948 which again is seen on the charts as a key reversal. We highly recommend investor watch these currencies this week for overall market direction.

The S&P500 Future’s contract is currently trading at 940 as of Friday’s close. I believe because of the reason’s outlined above such as the 10 year yield rising and the fact that the USD is trying to rally and the Euro and CAD dollar are starting to sell off, that the risk is now heavily weighted towards a major turn occurring in the markets. Can the stock market continue to rally like we have seen for the past 6 weeks while being overbought? Yes of course it can, but we must be ready to manage our risk when we are in a bear market rally such as what we are currently witnessing.

The market can push higher but I believe based on our chart analysis that the market will have lots of trouble passing the 942-954 on a closing basis with real strength. This area marks a clear area of congestion and I am expecting a serious correction now that will take stocks down to the 889-900 area on the ES. We believe the market may even go lower than this during this setback and are ready for a pullback towards 809 before we could expect another attempt to rally.

Obviously there are many stops along the way that could offer a nice bounce such as 855-858 but I do think that if you have profits in high beta stocks and in the commodity sector of the market that you should begin to tighten stops and think about your strategy for hedging those gains and/or completely selling the equities in those sectors. Investors should also look to start adding short ETF’s to portfolio’s to take advantage of this downward move in the equity markets that is likely coming. What’s even more interesting is that after the huge rally in stocks this year the Dow Jones is only up 13 points for 2009.

EQUITIES TRADE IDEA 1

Covered calls on BCE-Bell Canada

BCE has a current dividend yield of 6.19% with the stock at $24.86 at Fridays close on the TSX.  The stock is forming a nice sideways channel between $22.80 and $26.90 for the past 4 months that looks like some nice accumulation.  The risk here can be managed easily with stops below the channel at $22.50 a share.  Since BCE is considered a defensive name I believe money should flow to this stock if the markets encounter a sell-off like I am expecting over the next few weeks.  For investors looking to increase their yield one strategy would be to sell November calls above the current channel to bring in some extra income while waiting for the stock to break out of the range.  The yield enhancement should help cushion fluctuations in prices while we wait for the stock to make its move out of this sideways accumulation.  The  breakout should be quite powerful so be ready to either exit the calls and just stay long the shares when it happens.

EQUITY TRADE IDEA 2

For our second idea this week I am recommending investors take some money off the table in financials, technology and commodity sectors in Canada and in the US markets. We are looking to add equities in the consumer staple area in order to take advantage of the flow of funds that we expect to roll towards this sector while the overall stock markets correct the recent rally from March until now. There are many ways to take advantage of this either thru ETF’s or individual names in the sector itself.

PREVIOUS TRADE RECAP

Equities

I am sellers of the trade long MOO – short the S&P 500 initiated in our May 4th edition. As of market open June 8, 2009%. The trade has been very successful and we are taking our profits.

I am holding the trade long Loblaws (L) short the TSX we recommended in our May 11th equity edition.

I am holding the trade long S&P 500 index, short Simon Property Group.

I am holding the long Gold – short Gold producer ETF we recommended 2 weeks ago. Despite gold’s large move to the upside over the past few weeks the miners look to be breaking down on their daily charts.

I am holding the long S&P 500 – short First Solar (FSLR) trade initiated 2 weeks ago with a downturn expected we think high beta stocks like FSLR are vulnerable.

DISCLAIMER

This newsletter is based upon factual information considered to be accurate and reliable but not independently verified or guaranteed by us. Opinions expressed are those of the author, are subject to change without notice, and do not necessarily represent the views of ScotiaMcLeod. This report should not be construed as an investment recommendation to you to engage in any transaction involving the purchase and/or sale of equity securities, futures contract(s) and/or commodity options. Past performance is not indicative of future results. The risk in trading futures contracts or commodity options can be substantial. Investors should carefully consider the risks of investing in light of their investment objectives, risk tolerance and financial circumstances. This report may not be reproduced in whole or in part, or referred to in any manner whatsoever, nor the information, opinions, and conclusions contained in it be referred to without the express written consent of ScotiaMcLeod. TM Trademark used under authorization and control of The Bank of Nova Scotia. ScotiaMcLeod is a division of Scotia Capital Inc., Member CIPF.