08/18/10   What Are Oil And Bonds Telling Us?

Editor’s Corner

What Are Oil And Bonds Telling Us?

Ron Rowland

If timing the market is hard, timing one market based on an entirely different market is even more difficult.  Nonetheless, global finance is a vast interconnected web.  There is no doubt that changes in one place can have an impact in another place.  The challenge is to put the pieces together.  Right now, for instance, crude oil and bonds may be trying to tell us something.

Barely two years ago crude prices were in the $150 neighborhood as pundits worried about “peak oil.”  This was, not coincidentally, just before the banking system almost came apart at the seams.  Just a few months later crude oil was down around $50.  Like all commodities, oil prices are a function of supply and demand.  Both vary seasonally and because of unusual events like hurricanes.  However, the key factor is worldwide economic growth.  Whether your business is building cars or running an internet search engine, you need energy in order to grow.  Today, crude prices fell to a one-month low near $75 and may be entering a new downtrend.  This would probably not be happening if a sharp economic recovery were in the cards.

Meanwhile, bond yields have collapsed even further.  The ten-year Treasury rate, which touched the 4% mark as recently as April, is now below 2.7%.  This is a huge swing in a very short period of time.  Why?  Intuitively, one might think that huge government deficits would push interest rates higher.  Yet economic weakness, persistently high unemployment, and a wounded housing market have combined to crush private credit demand.  People would rather save than borrow.  Hence, the Treasury has been able to borrow all the money it needs at very attractive rates.  This is good in some ways, but low interest rates also suggest that the recession will drag on longer.  Eventually corporations will find they cannot remain profitable just by cutting costs.  At that point stock prices will be vulnerable to a sharp decline.

The S&P 500 index has not been able to regain the 1100 mark since the big slide on August 11, except for a few minutes on Tuesday of this week, where it was promptly turned back.  At the moment, the long-term picture looks quite a bit worse than the immediate prospects for stocks.  We are still in a market where selectivity is crucial.  To the extent one must hold stocks, being in the right sectors and regions is critical.

Sectors

Five market days ago, all ten of our sector categories were trending higher, albeit only slightly in some cases.  A subsequent downdraft changed the picture significantly.  The Materials sector dropped from first place to third despite getting a boost from BHP Billiton’s (BHP) buyout offer of Potash (POT).  This puts Utilities back on top only because it “lost less” than others.  Financials and Technology still occupy the basement and are putting more distance between themselves and the other sectors.

Styles

All the Style categories also flipped to the negative side of the ledger this week.  The top half of the list is a virtual tie, with Mid Caps maybe showing a slight edge based on the fact they have been providing much of the leadership for months now.  Small Caps are at the bottom and the smallest, Micro Caps, are at the very bottom.  The Micro Cap benchmark is now in a fairly steep downtrend from its April peak and is struggling to hold support at its early July low.

International

The U.K., Latin America, and Emerging Markets are now 1, 2, and 3 in our Global rankings.  Europe took a big hit, plunging from the #2 spot last week to #8 now.  Weak equity markets, more sovereign credit worries, and a falling Euro combined to put the whammy on the E.U.  Japan is no longer the world’s second-biggest economy, having been surpassed by China, and remains at the bottom in terms of stock market momentum.  Along with Japan, the U.S., Canada and Europe are all trending downward.

Note:

The charts above depict both the relative strength and absolute strength of various market sectors, styles, and geographic locations on an intermediate-term basis. Each grouping is sorted (top to bottom) by relative strength. The magnitude of the displayed RSM value is a measure of absolute strength, which is our proprietary method of measuring and reporting the intermediate-term strength as an annualized value.



“We’ve got to pay better attention to access to credit.”

Ellen Seidman, executive vice president at ShoreBank Corp.


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