Insights & Advice

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Black Gold Causes Slippery Week for Stocks

The markets spent the week trading in a tight range with only one day recording more than a one percent swing in prices and that day was down. After the bull run of the last few weeks a period of consolidation is not surprising. It is actually encouraging since a lot of stocks and sectors were getting “over bought” as traders would say.

The price of oil or “black gold” as some in my father’s generation once called it, gave investors the excuse they needed to sell. All week the markets struggled as oil raced up and ever upwards. Dire predictions of higher inflation and the ruinous impact that higher energy prices will wreak on the consumer kept the talking heads in business and you glued to the business TV channels.

Continued earnings disappointments from the financial sector gave investors another excuse to take some profits. American International Group, the mega insurer, joined the dubious group of record, loss-making companies Thursday evening. It announced a first quarter earnings loss of almost $8 billion blaming the credit crisis, mortgages and the financial markets for the disaster. That followed several days in which one regional bank after another reported a litany of huge losses while announcing their intent to raise capital. Friday, Citibank said it planned to sell some half a trillion (yes, I said trillion) in assets in order to return to profitability sometime in the dim future.

Readers may have noticed that I have not recommended the financial or housing sectors in my columns despite their substantial gains off the bottom over the last few weeks. I believe that housing stocks, given their tiny weighting in the S&P 500, are not worth worrying about but financials, representing 17% of that index, are a different story. Financials like the Tech sector in ’03 and the energy stocks back in 1982 are, in my opinion, a broken sector. I mean “broken” in the sense that the credit crisis and sub-prime issues have done an enormous amount of internal damage to these companies. As a result, it will take years before they are fully recovered. If history is any guide, financials should lag the market for some time.

Think of a star quarterback who sustains serious injuries in a play. No coach worth his salt would put such a player back into the game. He would know that after the broken bones are set and begin to mend, the athlete would still face months of physical therapy and rehabilitation before he is ready to play again. Even then, it may take a season or two before the QB is back to his playing peak.

My point is simple– broken sectors, like broken quarterbacks; do not lead markets out of corrections. It took oil stocks twenty years to recover. The technology sector, as represented by NASDAQ, is still only half the value it achieved at the end of the Dot Com Boom while both the Dow and S&P have reached new highs. I believe that any rally led by the financial sector is ultimately going to fail, no matter how high it may lead us. That is one of the reasons I believe this market is still in a trading range.

So where does that leave us? The market’s present consolidation is good. The S& P closed above support at 1385 which is also good. The high price of oil is bad, however. I expect oil will pull back once it reaches the $128/BBL.-$130/bbl. level. How far? I’m guessing to $100-$105/BBL. and the markets will rally in relief.

Stay invested, expect higher markets and have a happy Mother’s Day.

Posted in A Few Dollars More, At the Market