Financial Market Commentary
For days we’ve had the “calm before the storm” as traders waited for the Fed’s decision. On Wednesday a decent durable goods number and an unexpected build in oil inventories helped spark a short covering rally. The “dogs were barking” and stocks that had been hit hard were leading the charge–but it couldn’t last. Last week we mentioned that the Fed was likely to keep rates unchanged and that it would lead to a short term rally–and we went on to advise taking advantage of that rally to play the short side. That advice paid off big-time by Friday’s close.
The big problem is the Fed pointing toward higher rates in the not-too-distant future–in fact a .25% rate hike has already been factored into September bond prices. Raising interest rates at this point is a delicate operation and they’ll likely want to see the impact of all those mortgage resets before tightening. 30-year mortgage rates have gone up 33 basis points in the last two weeks and a rate hike right now would force even more homeowners into foreclosure as they try to negotiate fixed-rate mortgages. The Fed just got done throwing the kitchen sink at the financial crisis and they are reluctant to change course because one false move right now and the whole house of cards comes tumbling down.
But the truth is they have no choice in the long run–inflation is everywhere and it is just a matter of time until it creeps into the core. On a producer level, the PPI has been “hot” for months. Traders took comfort when the CPI did not move up correspondingly. High food and oil prices have a ripple affect and manufactures are raising prices even if it means selling less product. Both FedEx and UPS said that fuel surcharges are responsible for higher shipping prices and demand is softening. Consequently, they both lowered earnings forecasts for the rest of the year. Dow Chemical announced that they are raising prices by 25% and they are cutting production. Customers are cutting back on their consumption as prices increase.
Meanwhile there is probably no sector that has taken a bigger hit than the airlines–Continental grounded 62 jets and it is laying off 3000 employees. United Air grounded 100 jets and it is laying off 1000 pilots now and 1400 more could be laid off soon. Imagine what this will do to ticket prices and think of the impact on the tourism industry.
In another inflationary development China just re-negotiated iron ore prices with Rio Tinto. Ore prices have doubled since the last negotiation while iron and metallurgical coal prices have skyrocketed leading to astronomical steel prices. Outside of the oil industry there are few if any sectors able to justify new construction. Oil prices dipped temporarily, but they have snapped right back and now look poised for new highs. Global demand outstrips global production while uncertainty in Iran/Nigeria and a hurricane-producing La Nina weather pattern will keep oil prices high.
Central banks around the world are raising interest rates and their economies are feeling the pressure. Global markets are rolling over and its hard to imagine where the strength will come from to avoid a deepening recession. Traders are gradually beginning to lose faith in the theory that global expansion will provide a soft landing for our economy.
The financial sector is getting pounded. MBIA and Ambac are toast now that Moody’s has lowered its rating. These mortgage insurers provided protection to other financial institutions and now that safety net is gone. This morning, Fortis (insurance company) said that they will need to secure additional financing. Last week, Fifth Third Bank said it needs to raise $2 billion. Today, Goldman Sachs said that it believes Citi will take another $9 billion a down and Merrill will take another $4 billion write-down. As the financial sector goes so goes the markets–we are in confirmed bear market until the financials turn around and that could be quite awhile.
The only thing holding this economy above water has been a decent employment picture–but that is changing fast. Jobless claims came in higher than expected and the four-week average sits at 378,000. Continuing unemployment claims rose to 3.14 million–a four-year high. If the unemployment rate continues to climb, our high debt levels will quickly push the country into a much deeper recession. Next week, we will get the Unemployment Report. Last month’s number was very weak and a repeat could push this market down to the double bottom support level established in March. Due to the holiday, the number will be released on Thursday. Traders will brace themselves for a worst-case scenario and the market is likely to drift lower ahead of the number.
Major technical damage has been done. The market broke below support at SPY 138 and it continued to drop, taking out a horizontal support at SPY 132. That was a key support level for two reasons: SPY 132 was the capitulation low from March 2007/August 2007 and in April, we saw two large up gaps from that level as buyers stepped in with confidence. This time around, we only saw a brief bounce from that level and now the “bid” is gone. On a five year chart, a head and shoulders pattern has formed and the neckline has been breached–when major technical patterns form on a five year chart, they need to be respected.
The good news is no matter how dire the economic situation you can make some serious money as the market falls–Trade well and lock up your put positions.