Assessing the Calm
By Frank Barbera CMT. July 29, 2008
The last few weeks have been quite interesting, as corrections always reveal a great deal about the character of a market. In the case of the US Stock Market, since mid-July prices have generally been on the rebound with the deeply oversold financials finding some short covering price support. Of course, this has hardly been a one-way street, as in just the last few days, stock prices have gyrated wildly, selling off and then rebounding once again today. Yet, for the stock market, we have encountered a period of stability, which has allowed other markets to find some price support.
In the case of the US Dollar, which was recently threatening a break down to new multi-year lows, a price bounce has taken shape lifting the index back up toward $73.00 near the high end of its recent range. At the same time, a strong Dollar has helped pressure Oil and commodity prices to the downside, with the Oil price selling off from a high of $145.18 on July 14th (the same day as the stock market low), to a recent value closer to $120 for a total decline so far of 17.36% in just 12 days. While several more bullish interpretations are possible, the very conservative approach to Crude Oil suggests that the recent high seen on July 14th could have been the peak of a Primary Third Wave. In this event, a ‘normal’ retracement would take back approximately .236% of the prior advance, which in the case of Crude Oil implies a bottoming range in the $110 to $116 zone is possible.
Above: Crude Oil with updated “conservative” Elliott count and potential downside corrective target.
Once Oil prices conclude the current downside leg, another rally back up across the range should follow with prices ultimately moving into a routine consolidation. This type of high-level consolidation would normally entail prices creating a large and extended trading range, with prices see-sawing back and forth in a sideways motion for some time. Of course, any major global disruption, such as the outbreak of more war in the Middle East, or a major banking collapse in the US or the UK, could easily bring on a Dollar Crisis and that would likely push Oil prices to new highs very quickly. In that event, the chances are that any one of several super bullish outcomes would be in force and Crude Oil would very quickly press above $200. For now, it seems likely that the correction in Crude Oil is more than half way over, and that some type of more important low is either at hand, or should be seen within the next few days. Using something of an average of past turning points, roughly 130 days apart, we note that the middle of August -- August 12th -- could be a potential turning point date for Crude. On our hourly charts, USO which tracks Crude Oil has been ‘walking down’ the lower 200 hour Bollinger band for the bulk of the past two weeks. As prices have moved lower, what we call our Super Hourly RSI has moved down to approach oversold values, but to this point, has not yet reached a fully oversold reading. In circumstances like this, dramatic action is possible where prices spike down for a short time (a few hours), become oversold and then reverse higher seemingly as if nothing had ever happened.
The bottom line takeway for Crude Oil is that what we are seeing right now is another correction in this market, and a correction that is entering its final, maturing phases on the downside. One good upside reversal day in Crude Oil, and we get a signal that an important bottom, and the starting point for another important advance, has been seen. For the US Stock Market, a critical question becomes, 'how much gain as the stock market achieved during this period of relative weakness in Oil?' The answer so far is, not much, and that is not a good indication for the S&P and the DJIA going forward. In the charts below, we show that the S&P remains below the key overhead resistance point of 1270 to 1280. Yes, it is true that the big rally last week in the financials briefly lifted the S&P above this level, but only for a moment. Since then, prices have turned back below this level and so far, despite the big sell off in Energy prices, have been unable to move convincingly above it. This does not mean that stock prices can’t attempt to break above the resistance a second time. However, it does appear that with Oil prices closing in on a potentially important low in the relatively near term, that a prime window of opportunity for equities could be soon drawing to a close.
Above: S&P 500 with overhead resistance points.
Above: DJIA 18 months with overhead resistance points.
Another big event seen in recent weeks has been the continued decline in emerging markets that has come in tandem with the decline in Oil and key commodity indices. In just the last two weeks, Brazil’s Bovespa Index has dropped by 6.5%, with the Mexican IPC down 4.25%, and Russia’s RTS Index down 8.12%. As can be seen in the next chart, over the last few years there has been a striking correlation between the trend in Emerging Market stock markets, and the trend in Commodities, as higher commodity prices have revitalized emerging market economies.
Above: the Brazilian Bovespa and the CRB Index
In our view, there is a good chance that for most commodities, an important peak may have been seen, translating into at least a medium term plateau. This plateau is a reflection, more likely than not of the global economic contraction which is now taking place. In the case of the Base Metals, prices for items like Copper and Aluminum will likely soon follow the path already seen in the depressing metals line Nickel and Zinc. Industrial Metals, such as Steel and Iron Ore could also soon come under substantial selling pressure. Other formerly hot markets, such as the Coal market are also now leveling off. In the chart below, we show the price of nearby Copper which remains near all time highs but is sporting a very bearish divergence on MACD. From here, a decline back toward $2.00 Copper over a period of several months would be no surprise, as unlike Energy, base metals do not typically get a huge boost from a lower US Dollar.
Above: Copper with very bearish divergence showing on daily MACD.
Above: Courtesy Kitco, the spot Aluminum price rolling over from a Double Top.
Thus, a period of transition seems to be taking shape, the backstop of global growth, which in recent years has resided in emerging markets is now starting to fade. With a continued slow down in global growth, it is very likely that some of the cyclical inflation pressures (stemming from supply shortages in various commodities, steel, coal, base metals etc…), which have been driving up inflation rates around the world, are likely to moderate in coming quarters, undercut by weakening demand. In our view, this does not mean that the larger period of Stagflation has come to an end. Instead, after an extended pause, there is a good chance that as the financial crisis deepens in the months ahead, huge quantities of monetary inflation will be injected in order to effect even larger, more broad scale bail outs. In the early stages, monetary inflation will likely take dead aim on the Precious Metals sector which can be expected to move to the fore as a monetary crisis hedge. Later on, when monetary inflation is in full command, other commodities, fresh off corrective lows, will reassert themselves and begin to move higher once again.
In quiet times like these, it is good to look for clues, and to that end, we end this week's update with a view of various interest rate curves. In this chart, we see early signs of a market beginning to factor in more monetary turmoil. In the chart, we plot the FNMA 30 year fixed rate mortgage on the top curve, followed below by the 10 year Bond yield (thick black line), the 2 year Yield (normal black line) and the Fed Funds Rate (bottom-thin line). What we see is that so far, despite a huge rate cutting cycle as reflected by the crash in Fed Funds, other rates are unaffected and have failed to move down. The FNMA Mortgage rate is actually right now fully unchanged, despite a dramatic assault on rates by the Federal Reserve. This is atypical action for any prior Fed easing cycle, with the 2 year rate now climbing back above the Fed Funds Rate. The market seems to be saying that the Fed is going to be monetizing a lot of the bad debt that is still in front of us within the course of this contraction.
Above: Looking at the extreme right side of the chart, from top to bottom the FNMA 30 Year Fixed Rate Mortgage Rate (thin), the 10 Year Bond Yield (Thick), the 2 Year Note Yield (normal) and lowest, the Fed Funds Rate (ultra thin).
At the close, the DJIA rallied sharply as Oil prices tumbled, with the Dow gaining 266.48 index points to close at 11,397.56, the S&P gaining 28.83 to finish at 1263.20, and the NASDAQ gaining 55.40 to finish at 2319.662. For the DJIA, Tuesday produced a gain of 2.39%, for the S&P 500 a gain of 2.34% and for the NASDAQ a gain of 2.45%. The 10 Year Bond Yield ended at 4.044 up 2.6 basis points, while nearby Gold ended lower at $918.91, down 11.71 an ounce.
That’s all for now,
© 2008 Frank Barbera