Futures are pointed decidedly lower early Wednesday following a further 207-point erosion in the Dow industrials Tuesday. It is probably a good time to point out that the S&P 500 index is still 1% higher year-to-date while the Dow and Nasdaq indexes are still higher by around 5%. In the big scheme of things, the recent selling pressure has not really scratched the surface. For sure, the financial sector is nursing losses for the year of 12% while consumer services are now 4% lower at the same time, but it’s not all that bad is it? Investors savvy enough to have stuck with basic materials and energy related stocks are sitting on gains of 12 and 15% respectively.
S&P 500 index futures are trading 9.75 points lower at 8 am.
While the sour tone pervades investor sentiment, fears are building of spillover from financial to consumer sectors. In Tuesday’s session, shares of Wal-Mart snapped lower and rejected the trading pattern that has held for most of the past twelve months. There was little open interest at the August 42.5 strike until trading Tuesday. Some 1,500 puts will likely boost open interest of a mere 4,378 this week. Although the tone from Wal-Mart was stark as they lowered the forecast for the remainder of the year, and the CEO noted that the consumer appears a little stretched towards the end of each month, it is possible that management strategy isn’t effective in attracting customers. Not everyone believes that the consumer is floundering and point to luxury retailers as “the place to be in ’07.”
Ahead of the bell Wednesday traders will have to do battle with data for the consumer price index, which is expected to show a monthly gain of 0.2% for an annualized pace of 2.4%. Excluding volatile food and energy from the index should leave consumer prices 2.2% higher over the year. However, the inflation reading is likely to be a sideshow attraction given the incessant bleeding in the stock market. Already the financial woes have created daily money market pressures causing the cavalry-like charge to the rescue from a variety of central banks. With the yield on the 10-year note already at 4.71%, weak data isn’t likely to cause further demands for monetary easing, while a step-up in price pressures likely will be swept under the carpet until volatility abates. Later in the day industrial production and capacity utilization readings will be published.
After the bell Tuesday came results from bellwether semiconductor-machine manufacturer, Applied Materials (AMAT). We already knew that weakness in chip prices due to a flood of chips on the market had led to a downturn in orders. The company produces 20% of the output of the $40 billion a year chip industry. Shares declined on the news that profits fell 7.5% and revenue growth declined. Heading into the announcement, options traders placed straddle orders at the August 22.5 strike involving simultaneous purchases of calls and puts at a combined premium of 1.65. Implied volatility at 39% stood 40% higher than volatility as displayed by the company’s share price movements. That premium indicated that investors expected shares to rise as high as $24.15 or fall as low as $20.85 after the release. In European trading Applied’s shares are trading down 5%.
Worsening sentiment directly tied to subprime issues hurt Asian markets Wednesday with banking stocks dragging the Nikkei in Tokyo down by 2.2% to 16,475.61. Hong Kong’s Hang Seng index fared worse still, losing 2.87% while Australia’s All Ordinaries index shed 3% to 5,801.50. In Europe, trading was lower yet stable with losses of more than 1% in London, Paris and Madrid.
Overnight news comes in the shape of regulatory filings including fresh holdings of shares at Berkshire Hathaway in Dow Jones and Bank of America. Be careful not to read too much into the appetite of legendary investor Warren Buffet since those filings are as of the end of June and so ahead of the real nasty days of the latest bout of selling pressure. And you have to remember that Mr. Buffet has been doing this for around 50 years. It doesn’t mean his action is any kind of a statement about reentering the stock market today.
German reinsurer, Muenchener Ruekver AG is trading lower today at €218.02 (down €1.02). Its options volume is hectic in Wednesday’s session. The December 125 puts have traded 22,500 times while the deferred December 2008 contract has seen volume of 10,000 lots at the 120 strike. On the call side in the near December contract, there was plenty of buying at the 130 and 140 strikes, whereas today some 2,500 lots have been bought at the 125 strike.
Meanwhile options trading at Deutsche Telekom appear reasonably well balanced. With shares at €13.20, September calls at the 14 strike have traded 15,000 contracts while the lower strike puts have seen volume totaling 6,000 lots between the 12 and 13 strikes.
Farm equipment manufacturer John Deere (DE) reported earnings earlier Wednesday stating earnings per share of $2.37 on revenues of $6.63 billion. Estimates had $1.99 on sales of $6.21 billion. Shares closed easier Tuesday at $117.09 but with some brave August call options buyers at the 125 strike where 3,074 lots traded at around 0.70. The September 120 calls were also well bought on volume of 2,122 lots.
The company pinned rising profits on better farm income, which drove agricultural purchases in both the U.S. and Brazil, where demand for bio-fuels is keeping agricultural production strong. Rising commodity prices for wheat, corn and soybeans raises farmers’ incomes and spurs continued investment, which boosts activity at Deere. The company may benefit from a 20% increase in equipment sales to Latin America this year.
Andrew Wilkinson Rebecca Engmann Darst
Senior Market Analyst Equity Options Analyst
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