Insights & Advice

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Markets fall as Commodities Lose Their Luster

Pick your poison—oil, unemployment, earnings, –the markets suffered through a week of anxiety as investors fretted that we just might revisit the bad old days of 2008. Although I don’t think that is in the cards, I wouldn’t rule out further downside.

Over the past few months I counseled readers to keep some cash on the sidelines, play the market rally defensively, and wait to see if the S&P 500 Index broke above the 940-950 level. We did kiss that level briefly and made several attempts over the last month or so to breach that barrier. Unfortunately, rather than breaking above that level, we now have to worry about breaking below 874 on the S&P.
Friday that level was tested all day. Many believe it will break. For those diviners of financial tea leaves like myself this would be a bad sign. It would mean there is a high probability that markets are going lower. How much lower? I’ll say 800-820 on the S&P. That would equate to roughly a 15% pullback from the highs. Let me hasten to add that this would not be a bad thing.

Readers may recall that throughout our meteoric rise from the March lows, I repeatedly bemoaned our lack of healthy corrections on the way up. We barely stopped to catch our breath through that process until we hit 940 on the S&P. A pull back would not only be healthy but would actually present a buying opportunity for readers who do have available cash to invest.

Fundamentally, I don’t see anything on the horizon that would imply a revisit of the March lows of 666. For sure, commodities, led by oil, took a tumble this week. Some say that decline was based on fears that economic demand for commodities was faltering but I suspect the real reason lay elsewhere. The CFTC (Commodities Futures Trading Corporation), which regulates commodity trading, floated a trial balloon this week that might restrict what they see as speculation in those markets. Given the rapid decline in the price of oil on the news (from over $70/BBL. to under $59/BBL. in less than a week), it suggests to me that there is a lot of “hot” money in oil and other commodities that suddenly cashed out. So I see this decline as a good thing. Lower commodity prices certainly would help, not hinder, an economic recovery and the consumer. Today, for example, while filling up on Route 7, outside of Pittsfield, I could already see the impact of oil’s decline at the pumps.

I’m sure that talk of the necessity for a second stimulus plan spooked investors as well. Traders were quick to jump to the conclusion that another plan would mean that the expected recovery was in trouble. I do not believe a second plan is in the cards (please see my column “What’s up with the Stimulus Plan” for more on this subject).

Second quarter earnings season has begun and so far there is no cause for alarm although investors are jittery. Tuesday, Alcoa, the aluminum producer, kicked off earnings season and came in better than expected although still down considerably from prior years. Next week should give us a better idea of how company management’s view the future prospects for the economy and their particular businesses. That could be the key to the market’s fortunes in the short-term.

The technology sector, in particular, has a lot riding on earnings. It is one of the few sectors that is expected to show an improvement over last quarter when earnings as a group were down 26%. The sector has been the star performer in this rally represented by the tech-heavy NASDAQ index which is up 14% this year. So there is little room for negative surprises.

All in all we are still range bond as we have been for weeks. The only difference is that now we are bumping along the bottom of the range instead of the top. Remember too that it is summertime and that usually means lighter volumes, slow days and not much action. I hope that continues since it is a welcome change from the huge percentage swings we experienced practically every day earlier in the year.

Posted in A Few Dollars More