Insights & Advice

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Another Dead Cat Bounce

As the month draws to an end, investors are hoping to notch up at least one positive month of returns for the year, no matter how small. I imagine even a flat month, given the news, would be a Herculean feat. So far I would consider this weeks “rally” off the lows as less than inspiring.

Even on this week’s up days the internals of the market—volume, breath, highs/lows- were anemic. Despite the financial media’s promises that “the bottom had finally been reached” and “financial stocks are a screaming buy”, the evidence does not support it. As I said last week, we are having another dead cat bounce but that’s all.

A dead cat bounce is a quaint Wall Street expression. It states that if you drop a dead cat (the market) off a high enough building (the market’s peak) it will “bounce” at least once before coming to rest on the pavement.

One way to identify whether we are having another dead cat bounce or experiencing something larger and long-lasting is by watching the sectors leading the market higher. Trust me; neither the financial nor housing sectors will lead this market into a significant upswing. Any rally led by this deadly duo (as this one was) is doomed to fail. These sectors, similar to technology after the Dot Com bust, have been badly damaged. Like pro football players who have been severely injured, it will take a good deal of time and a lot of physical therapy before they will be in any condition to rejoin the starting line-up. It took technology stocks, for example, years to recover.

In the commodity corner, one reader asked for my opinion on the future of natural gas currently trading at $9.73/mmbtu. We should see $13/mmbtu.before the end of this year. Some of that price upside is based on real demand but like all commodities these days; part of that price is simply due to speculation by stock market investors who have “found” commodities.

Back in the day before exchange traded funds (ETFs) and notes (ETNs), most stock investors could only play commodities by buying gold mining, energy or copper stocks. Now, investors can buy the real thing—bullion, barrels or pork bellies—by simply buying any number of shares of ETFs or ETNs just like stocks. As a result, there is a large amount of “hot money” in commodities that produce huge price swings in an already highly volatile market.

No one knows how much the price of oil, gold or natural gas is directly due to speculation today. Some energy specialists estimate that $15 or more of the oil price and $1-$1.50 in the case of natural gas is hot money and has nothing to do with underlying energy demand. All year stock investors have been using commodities as inflation hedges and a place of safety while the stock markets declined. Commodities experienced a sharp correction a week ago.

Since then, we have seen a sizable rebound in oil, natural gas, gold, silver, copper and some agricultural commodities. Many investors have jumped back into the market but I hesitate. All I see is extreme volatility right now with no clear trend in the short-term. Gold could drop below $900/oz. right here as easily as it could breach the $1,000 mark again, ditto for most commodities so I’m staying on the sidelines for the time being in commodities.

As for the stock markets, I have been preaching patience for months. This latest bounce in the S&P 500 faces fierce resistance from the bears. It must breach the 1330-1360 area and then 1395 which is the top of the trading range on the S&P 500. It would have to break through 1416 for me to sit up and take notice. But it is looking tired and could roll over at any moment. Once it does expect another re-test of the lows and there is no guarantee the lows will hold until they do. One thing for sure, we are not out of the woods yet.

Posted in A Few Dollars More, At the Market