The question now is whether the markets will
continue to swoon or is last week’s action just a step back before the
next leap ahead? To find out let’s take a good look at…
WHICH WAY THIS MARKET IS HEADED
No matter how you slice it BOTH indices above look
bearish. For the past several weeks we’ve been outlining the headwinds
this market is facing, watching in amazement that the markets were able
to climb higher.
But given enough load everything eventually reaches
a failure point—even irrational exuberance. Combine rising unemployment
with back-to-back increases in the price of already historically high
crude and even the perma-bulls couldn’t take it any more—on Friday the
SPX was knocked for a 43 point loss while the Nasdaq plunged over 75
points.
Let’s take a look at why it happened to give us an
idea if it is going to continue.
The one factor that has made this downturn far less
severe than others is the amazing resilience of the employment
sector—but a big crack may have shown up in that foundation on Friday.
The Non-Farm Payrolls for May showed the
economy lost 49,000 jobs for the month, which was actually less than the
-60,000 loss analysts expected which in that sense was good
news—unfortunately the component that grabbed the headlines was the
spike in unemployment to 5.5%---the biggest single month jump in 22
years!
The loss of jobs
has now stretched for five consecutive months and May’s dramatic
percentage increase has some analysts concerned that this may be the
upward inflection point indicating an acceleration of job losses in the
months to come. If that is the case benign comparisons to previous
recessions will evaporate faster than a residential construction
worker’s unemployment benefits.
Although employment
is huge going forward the immediate risk on everyone’s mind is the
rising price at the pump—and by the looks of oil prices on Friday
gasoline is going to go a LOT higher.
Oil prices declined
to $121.61 on Wednesday night providing hope that a major pullback had
started—but prices quickly rebounded to $128 on Thursday. The net gain
was $5.50 on Thursday--the largest single day dollar gain on record.
However in spite of tracing a record it was nothing compared to what
happened the next day.
On Friday crude
prices climbed right on top of that Thursday spike with a $10.75
explosion to close at $138.50---another record high and the largest
single day price gain in the history of the Nymex. With prices at these
levels you would expect big dollar gains but even in percentage terms it
was the second largest jump since Iraq invaded Kuwait in 1991.
Several major
factors contributed to last week’s huge rise in crude and unfortunately
most of them aren’t going away—in fact some may get alarmingly worse.
For example one big contributor is an announcement by Shaul Mofaz--
former chief of staff and defense minister of Israel--that an Israeli
attack on Iran would be unavoidable if they did not immediately halt
their nuclear program. His statement is about as plain as it gets--"If
Iran continues its nuclear arms program we will attack it."
Iran's President
Mahmoud Ahmadinejad has more than once called for the elimination of
Israel but Mofaz claimed that Ahmadinejad would disappear long before
Israel does. Iran is the 4th or 5th largest oil exporter depending on
whose numbers you believe so any kind of military action is liable to
seriously constrict the world’s supply of oil.
There is precedent
for an Israeli attack--in 1981 Israel planes destroyed an unfinished
reactor in Iraq to prevent Iraq from gaining nuclear weapons. And more
recently they struck another reactor under construction in Syria. Oil
traders could not ignore Mofaz’s comments—for one thing 25% of the
world's oil goes through the Straits of Hormuz and Iran could block that
passage to cripple the west for supporting Israel in an attack.
Venezuela has also threatened to halt oil shipments to the U.S. if Iran
is attacked.
In addition to
saber rattling out of Israel Morgan Stanley warned Friday morning that
the stage was set for $150 oil BEFORE July 4th because of supply
constraints and increased global demand. July 4th is only 26 days away.
Also fueling the
spike was the third consecutive weekly drop in crude inventories. This
week's drop was -4.8 million barrels and that brings the total three
week decline to -19 million barrels. If there is so much oil in the
world then where is it? Current U.S. crude inventories are 11% below
2007 levels.
In addition to
falling supplies consumption is just not decreasing enough to cover the
shortfall. The weekly EIA report showed that over the last four weeks
total crude consumption has fallen only 1.1% compared to the 3%-4%
numbers being reported in the retail surveys. Gasoline demand had only
declined -1.4% nationwide compared to the MasterCard Spending Pulse
report showing a -4.7% drop for the week. This EIA demand picture shows
a significantly smaller drop in demand and suggests drivers still need
to get where they are going in spite of four dollar gas—the question is
‘how far does fuel have to climb before demand really is significantly
reduced?’ It looks like we are about to find out.
The skyrocketing
price of energy is affecting prices in virtually every market sector and
we’ll get a big look at how much in this coming week’s Consumer Price
Index (CPI). The Fed takes out direct food and energy prices as too
volatile to track monthly but the indirect costs for transportation and
raw materials has got to be pushing inflation higher.
The Fed is now
facing the worst of all scenarios. Oil prices are out of control--the
tax rebate stimulus has been consumed by the increase in the price of
gasoline, unemployment is rising and the economy is bordering on a
recession. This is the return of 1970s style stagflation--no growth and
soaring inflation. And the irony is the Fed caused it.
The Fed has to
raise rates if the CPI shows an inflation spike but raising rates will
smack down the economy even further. They can't move in either direction
without escalating either inflation or recession so chances are they
will do absolutely nothing—at least for the next few months. In fact
James Bullard, President of the St. Louis Fed announced last week that
the Fed could remain neutral for the rest of the year. However, he also
warned that the dominant policy focus was rapidly changing from the
credit crisis to pressing inflationary concerns.
So we’ve got rising
unemployment, skyrocketing energy prices, spiraling inflation and a
hand-wringing Fed—the question is…
HOW DO WE MAKE MONEY ON IT?
We’ve got two plays
this week—and they are both bearish.
Our first play is
on a stock we’ve made money on before—and now it looks like it’s giving
us a second chance. The stock just broke below support Friday on big
volume and it looks like this plunge is just getting started. The stock
is pointing due south and we’re liable to make some VERY quick profits
on the right puts—puts we’ll be buying first thing Monday morning.
Our next play is
also bearish and it’s on a stock that looks ready to crash. The
downtrend began back in May but now traders are getting serious about
unloading shares. The good news is we’re liable to get a perfect bounce
entry early this week for some massive short term profits. Once you see
the set-up you’ll agree—this one’s a money maker!
We’ve got two great
high potential set-ups on a market that is ready to move—so let’s get to
it…
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