Spooky Treasury auction, financials spark small-cap slide

Kevin Pendley | Dec 09, 2008 4:33pm EST | Comment

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Small-cap stocks reversed course Tuesday, unable to sustain upward momentum from Monday’s surge as weakness in financial and homebuilder stocks and numbing results from the Treasury four-week bill auction overwhelmed support from energy and a surprising upside midday spurt on tech stocks. The Russell 2000 (NYSE:IWM) closed down 15.67, or 3.25%, at 465.71 and is now down 39% for 2008. For the year, the Dow is now down 34%, while the S&P 500 is down 39%.

It appeared that the afternoon trigger point for the sudden influx of selling in equities was tied to the results for the Treasury four-week bills, which not only came in at 0.000% (yes, zero), but saw a bid-to-cover ratio of 4.20. In addition, the three-month T-bill traded with a negative yield at times today. The yield on the long bond is nearing 3% once again, which is basically unheard of, and yields for both bonds and benchmark 10-year notes fell hard today as demand ramped up for Treasury products (which tug money flow away from stocks).

“These events in the Treasury market are causing traders to believe that the market lacks liquidity or buying power,” Nick Kalivas, vice president of financial research with MF Global, said in an email interview. “Institutions like hedge funds, fund of funds, etc. have to stash money in a T-bill for reasons of risk management – like expected redemptions and this is robbing the market of buying power and generating fear,” he said.

Kalivas said it will be important to see how demand goes for three-year and 10-year note auctions, as weaker results could boost equities by suggesting that the demand for liquidity is more short-term than long-term in nature. “It is one thing to buy up a three-month T-bill, but an aggressive bid on a 10-year note auction would signal long-term pessimism toward the economy and rob stocks of buyers,” he said.

Interestingly, technology stocks consistently outperformed other index products today, even though the session started out with gloomy news on the tech front from Texas Instruments Inc. (NYSE:TXN), which cautioned about the outlook and from Japan’s Sony, which announced massive layoffs numbering some 16,000 workers.

“I was surprised by the early strength given the parade of profit warnings,” Kalivas said. “I think that some players probably covered shorts and bought on the positive early price action. This may have left the market void of buying power and led to long liquidation by fast money in the afternoon.”

Even though physical commodity prices were soft today, commodity stocks retained a supportive bent for the overall equity market. Crude oil prices tumbled $1.64 a barrel, or 3.7% to $42.07, but energy stocks were actually up some 1% into the close. The crude oil price was hurt by a report from the U.S. Energy Information Administration, which projected global oil demand to fall by 50,000 barrels a day this year and a whopping 450,000/day in 2009 and even those numbers were seen as optimistic by some energy market watchers. Within the commodity spectrum, copper prices fell in London overnight and dropped as well in U.S. trade, which heightens concern about any quick turnaround in the global economic picture.

In fact, you know the economy is in bad shape when the National Football League announced plans today to slash 14% of its league staff (about 150 employees). NFL Commission Roger Goodell said in a memo to staff that “I would like to be able to report that we are immune to the troubles around us, but we are not.”

Senate hearings on the proposed bailout for U.S. automakers continue to progress, but perhaps not as quick as auto industry executives or some market watchers had hoped. The Senate majority leader said a vote on the proposed rescue plan could come Tuesday, but was “more likely” on Wednesday. General Motors Corp. (NYSE:GM) tumbled 4.6% today, while Ford Motor Co. (NYSE:F) was off 3.8%.

Individual small caps pacing the decline today included Analogic Corp. (Nasdaq:ALOG), which gapped lower and shed 28% after the maker of medical imaging systems missed the profit forecast. Learning Tree International Inc. (Nasdaq:LTRE) also gapped lower and dropped 24% as the education vendor also disappointed investors after releasing quarterly results. Rex Stores Corp. (NYSE:RSC) fell 24% as the consumer electronics retailer also took an earnings-tied lump. Sunstone Hotel Investors Inc. (NYSE:SHO) fell 20% as the hotelier real estate investment trust was one of many REITS taking a downside tumble on the day. On the upside of things, dry bulk carriers remained a hot ticket, with Excel Maritime Carriers Ltd. (NYSE:EXM) up 38%, Eagle Bulk Shipping Inc. (Nasdaq:EGLE) up 37%, DryShips Inc. (Nasdaq:DRYS) up 36% and Safe Bulkers Inc. (NYSE:SB) climbing 22%.

The chart picture shifted back from a positive picture to a top-heavy structure as the market left a bearish reversal on daily studies and faltered right on cue near 491. The pullback off 491 wasn’t really a surprise, but the force of the slide back through 473 was a little disconcerting. Looking ahead to Wednesday’s session, support comes in near 452.50, then at 442. Meanwhile, resistance will once again be back at 473, then at 491.

Looking ahead, Kalivas said that in addition to the Treasury auctions, he will be watching how trading progresses in semiconductor shares as that group absorbed bad news and yet improved the technical picture. In addition, he said that bank shares will be worth watching as FDIC bond sales are aggressive and are helping to rebuild balance sheets. “This should be a positive for profits and reduce the need for capital,” Kalivas said. Bank stocks were clearly a drag on the market today, with the PHLX KBW Banking Index off 5.4%. Another key in this holiday season will be the behavior of retail stocks, which have traded well in recent days. “I think the trade sees easier comps and believes that eventually cheap gasoline prices will be positive,” he said. Johnson Redbook said earlier today that chain store sales were off 0.4% in December to-date vs. November, and were off 0.8% on a year-over-year basis. The S&P Retail Index was down 2.9% today, but was coming in off a string of five consecutive solid daily rallies.