Manic Market (Makes No Money)

Manic Market (Makes No Money)

By Duru

April 4, 2005

Now that the season of complacency is over, we find ourselves in one big rut. The NASDAQ is at lows for the year and right back where it was on election day. It is even dangerously close to a complete breakdown below the 200DMA. Despite my claim that the market would eventually follow technology shares downward, the S&P and Dow Jones continue to outperform their over-valued cousin. Both indices have managed to hold their lows for the year and have not yet given up all the gains from the post-election rally. However, it is quite fitting that the markets have seen fit to wipe out the bulk of the post-election gains. They never made sense in the first place! The rapid rise and subsequent flop that we have witnessed in the past four to five months describes the market's manic behavior perfectly.

The manic market has been full of ups and downs as it has responded to one economic twist after another. One day, oil is up and stocks sell off. The next day oil is down and stocks rally. Heck, the market even took pause when Goldman Sachs dropped an alarmist bomb claiming that oil could soon spike to $105 a barrel! Anyone who does not trade or invest into the oil or energy complex has to be dismayed by the way daily fluctuations in those markets have captivated the rest of the financial market. Today holds a classic example: "Stocks End Higher As Crude Oil Prices Slip" (from AP). It seems that every single day, the financial press looks for a reason in the day's move in the volatile madness of the oil patch. The market has become manic as it remains befuddled over which economic currents will dominate in the near-future. One thing I DO know - oil (and commodities in general) is up and the trend is strong and up. Any stock market move that anticipates a counter-trend in oil is temporary until further notice.

How can I be so sure? President Bush is asking for $80 billion more for wartime operations in Iraq, Afghanistan, and perhaps other hotspots in and around the Middle East. This administration has made it clear to us that this region is a top-priority. Now suppose that we are truly in a new world for oil where production capacity remains tight, new finds remain scarce or politically/environmentally untenable, and world demand outside of the U.S. continues to skyrocket. It would then make sense that the U.S. maintains a heavy presence in and around oil-rich regions to guarantee that American needs do not suffer major disruptions, perhaps even get top priority. In fact, it seems the Chicago Tribune reported last year that the U.S. is building 14 "enduring bases" in Iraq. If this does not say permanent occupation, I do not know what does! Oil gets more precious by the year, and America is through playing footsies around the issue. Besides, there are still a lot of SUVs and Hummers to feed over here! Thus, you can bet that oil, energy, commodities will all be enduring investment themes for quite some time to come. The market's manic behavior around this issue no doubt comes from the conflict between the optimists who think this two-year run in oil is an aberration, and the abundant evidence that says oil can keep going higher still. The sooner the market gets used to the idea that we will not see $30 oil again (or even $40!), the more stable it might get.

In the near-term, the Fed is the biggest wildcard out there right now. On March 22, 2005, the FOMC uttered one sentence that made the markets shiver: "Though longer-term inflation expectations remain well contained, pressures on inflation have picked up in recent months and pricing power is more evident." I have picked apart Greenie's words before ("Greenie Is Still Bubble Blind" and "Forget 'Meanie Greenie': Keep Spending!"), but this time I need no elaborate analysis. While the mainstream pundits are running around screaming bloody inflation now that Greenie has finally given a nod to the possibility that inflation is taking hold, they have ignored the fact that the rest of the statement is as benign (and meaningless?) as ever. The Fed still thinks it is being accommodative (ok, ok - so that means rates will keep rising), and they continue too "ooh and aah" at the economy's overall strength in the face of higher oil prices. The labor markets provide to the Fed its most immediate gauge for inflationary pressures, and they are certainly not alarmed by the "gradual improvement" seen so far. The conflicting mood of the Fed has merely fed into the market's manic behavior. On the day of their latest statement, the rate in the10-year Treasury spiked hard and followed through the next day before fading. Now, in true manic behavior, this rate is again below where it was the day before the Fed spooked the markets! This fallback has allowed the homebuilder stocks to hang in there, but commodities have struggled because the dollar continues to rally. In fact, the dollar is approaching its high of the year. I suspect it will fail this test rather easily (if not, it might be gold that is about to fail a major test at its lows for the year!). Regardless what happens in the coming days and weeks, we can expect to see more manic behavior that frustrates anyone trying to make lasting predictions on the markets.

In the end, it seems the Fed has begun to achieve a softening of the economy without drastically boosting rates. A slow, steady drip of rate hikes combined with some yapping and jawboning are all working their magic right now. Some genius knew just the right words that would put the brakes on….even while the main gist of the Fed's message has not materially changed. Given that the April jobs report was weaker than expected, do not be surprised if the Fed begins to pat itself on the back for a mission accomplished. A significantly weaker stock market would seal the deal.

We are now facing the next earnings season with the market on edge. Growing scandals in financial companies like AIG, Fannie Mae, and MBIA, Inc have the market wondering whether the U.S. financial system is creeping toward some sort of crisis. Major retailers are crumbling: 1) Wal-mart makes reaches back to 2003's lows, and 2) Best Buy continues to warn about weakening business conditions (note how Best Buy has failed to follow through on a potential multi-year break-out). Many cyclical stocks are faltering and are on the edge of major breakdowns: Cummins is struggling underneath its 200DMA, Deere is teetering on the same condition, and Caterpillar only stopped selling off in March after Merrill Lynch and Bear Stearns analysts refuted damaging claims made by an astute Morgan Stanley analyst that the heavy equipment sector had reached a peak. Disastrous warnings by General Motors and Parker Hannifin only add to the general sense of unease engulfing the market.

Most of all, as the Fed continues to raise rates, the market has begun whispering the old adage "don't fight the Fed." Now that we approach the traditionally weak period of May to October, it is time to make more than furtive (and manic!) glances at these warnings. I strongly suspect we will rally for at least two weeks this month: either for the two weeks of earnings or for the two weeks after earnings. Pick your favorite excuse or explanation when it happens. But never lose sight of the fact that the Fed is now fighting against the financial markets. I can guarantee you that we do not have enough hard-earned cash to buy them off. The markets will remain manic until they finally bow down, and you can bet it will be hard to make money the whole way down this stomach-churning trip.

As usual, be careful out there!