FuturesFiles Market Newsletter

Stock Index Futures and Treasuries

August 27, 2010

Name: Alan Bush

Company: Archer Financial Services

Years Trading: 32

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Stock Index Futures and Treasuries
By Alan Bush, Archer Financial Services

Recent weakness in stock index futures can be attributed to weaker than anticipated U.S. economic reports, along with the belief that the global economy is slowing. Much of the pressure in stock index futures took place after the August 10 Federal Open Market Committee's policy statement was released. The central bank said "the pace of economic recovery is likely to be more modest in the near term than had been anticipated." The FOMC's downgrade of the economy added to the already extremely bearish stock index futures market sentiment. A look at the S&P 500 futures monthly continuation chart shows us a less dire situation, however. In fact, this chart suggests that this market is in a correction phase and that the main trend is higher.

S&P 500 Futures - Monthly Continuation

Chart provided by APEX

CORPORATE EARNINGS

Stronger than anticipated second quarter corporate earnings reports supported futures in July through the first week in August, until the relatively weak economic reports were able to dominate. This earnings season, 76% of the companies in the S&P 500 that have reported second quarter earnings have reported numbers that were stronger than the median estimates. Earnings for S&P 500 companies are likely to increase 35% this year, according to a Bloomberg survey. This is the fastest rate of increase since 1988. Our analysis continues to suggest that corporate earnings will be stronger than the analysts' median estimates.

HOUSING

Recently there has been a lot of talk about the possibility of a double dip recession led by a renewed downturn in the housing market. The July new home sales report was very weak at 276,000, when 330,000 were anticipated. Former Federal Reserve Chairman Greenspan recently said the economy could contract again if house prices continue to fall. In spite of all of the negative commentary on the housing industry, it was reported on Wednesday that luxury homebuilder, Toll Brothers Inc., has sung back to profitability. This is their first quarterly profit in almost three years. They also reported an improved outlook. Our analysis continues to tell us there will not be a double dip in the economy.

U.S. TREASURIES AND FEDERAL RESERVE POLICY

The factors that adversely influenced stock index futures have caused the Treasury futures to advance to historical highs for some maturities. There was some temporary selling pressure on Treasuries after it was reported that China recently reduced their holdings of Treasury notes and bonds by a record amount. At the same time that China was cutting their holdings of U.S. Treasuries, studies have shown that investors in the U.S. are moving funds out of equity markets and into Treasuries at a near record pace. Many traders, I believe incorrectly, are positioning for another downturn in the economy by seeking the relative "safety" of U.S.Treasuries, apparently regardless of the current historic low yields.

Another reason for much of the increased pessimism toward the economy and stock index futures is the Federal Reserve itself. The Fed's less optimistic economic outlook was telegraphed several weeks prior to the FOMC meeting through statements made by Federal Reserve Chairman Bernanke. The recent economic downgrade from the Fed should not have been a surprise. Before the central bank's August 10 policy meeting, the market had priced in the possibility of more serious attempts on the part of the Fed to establish additional accommodation measures. Analysts were disappointed, however, with the Fed's gradualism approach to adding new stimulus measures to the economy. The Fed under delivered when they said they will reinvest principle payments on mortgage assets it has on its books into long-term Treasuries. The Fed is scheduled to purchase approximately $18 billion of U.S. debt by mid September using the proceeds from its holdings of agency paper.

Currently, there is only a 56% probability that the FOMC will increase their fed funds target by at least 25 basis points on or before their November 2, 2011 meeting. Prospects of tighter credit conditions from the Fed continue to get pushed farther out into the future. The central bank's benchmark interest rate currently stands at zero to 25 basis points, which is where it has been since December 2008.

Some analysts are calling the current bull market in Treasuries a "bubble market," which I also believe is the case.

YEAREND OUTLOOK

The vast majority of traders and analysts are extremely bearish and short stock index futures and we are hearing more and more talk about the possibility of a double dip recession. This overwhelming bearish sentiment on the economy and for stock index futures remains in spite of the better than anticipated second quarter corporate earnings reports. Recent studies have shown that investors are moving funds out of equity markets and into Treasuries at a near record pace. Contrary to this negative thinking about the economic outlook is a recently released Bloomberg survey that said the U.S. economy will grow 3% this year.

Keep in mind that the midterm elections are only a little over two months away. After several
primary elections were held on Tuesday, more attention is now being paid to the market ramifications of the November elections. One of the internet betting sites is predicting a 76% probability that the Republicans will take control of the House, with the chance of this occurring steadily increasing since March 2009. History has shown that a gridlocked Congress is bullish for stock index futures.

The Republicans to control the House of Representatives after 2010 Congressional Elections

Currently, we believe there is too much bearish sentiment for an extended move on the downside for stock index futures and too much bullish sentiment in the credit markets for an extended move to the upside, at current levels, to take place. The front end of the yield curve becomes steeper in 2011, which suggests that the economic recovery will accelerate next year. This has longer term bullish implications for stock index futures and longer term bearish indications for Treasury futures.

If you have a question for Alan Bush, please send an email to alan.bush@archerfinancials.com or call 1.877.690.7303

Futures and options trading involve significant risk of loss and may not be suitable for everyone. Therefore, carefully consider whether such trading is suitable for you in light of your financial condition. The views and opinions expressed in this letter are those of the author and do not reflect the views of ADM Investor Services, Inc. or its staff. The information provided is designed to assist in your analysis and evaluation of the futures and options markets. However, any decisions you may make to buy, sell or hold a futures or options position on such research are entirely your own and not in any way deemed to be endorsed by or attributed to ADMIS. Copyright © ADM Investor Services, Inc.

The ADMIS Commodity Chart Book – Authored by Alan Bush

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About the Author

Alan Bush has been a commodity analyst since 1976 focusing on the fundamental and technical aspects of stock index, interest rate and foreign currency markets. He has authored several articles for Stocks Futures and Options magazine and produced the “Futures Tech Focus” program, which is a technically based market outlook.

Alan served on the faculty of Oakton College as instructor of a course entitled, “Principles of Technical Analysis.” He has been interviewed on many national television programs, appearing on the Nightly Business Report, CNBC, CNN Moneyline, Reuters Television and Web FN. In addition, he has been frequently quoted in The Wall Street Journal, USA Today, The Bond Buyer and the Chicago Tribune and has been regularly interviewed on Chicago’s WMAQ radio business reports.

Alan can be reached at (312) 242-7911, or via email at alan.bush@archerfinancials.com.