What can energize the markets to new highs or cause them to slip down to painfully low levels? Oil! Yes, oil is a commodity that can move markets, causing some to soar while others plummet. It’s the “black gold” that sweeps across continents, affecting everything from the price of airline tickets to the price of gold. It is shrouded in geopolitical mystery and power struggles. As we realize that our long-held belief that oil is a virtually unlimited source of energy is false, the need for oil increases and our fear of life without oil grows. And this makes the market move. On Monday, October 15, 2007, the rising tensions between Turkey and Iraq sparked oil prices to rise to record high levels on the NYMEX. The record high price pushed down the Dow. Yet the all-time high price continued to rise on Tuesday, October 16th as the price of oil reached $87.17 per barrel before returning to the still-high $86-plus level. Rising along with the price of oil is the price of gold, which can serve as a hedge or “safe haven” in the event that inflation runs rampant, currencies deflate, or the price of gold gushes higher in the sky. Let’s make a quick review of the global markets.
Asian markets were mixed, but closed mostly in the negative. China’s Shanghai index hit a record high on Monday, October 15th. The raging index hit another high on Tuesday, October 16th, gaining more than 2 percent. And this happened despite the Peoples’ Bank of China raising interest rates and its reserve requirement for the seventh time this year. The index—and the economy—seem to be unstoppable. However, the Shanghai index was not the biggest winner in the region. India’s BSE index closed 3.47 percent higher. In other parts of region, the Hang Seng hit a record on Monday, October 15th but fell more than 2 percent on Tuesday, October 16th. Japan’s Nikkei fell 1.27 percent on Tuesday and the broader-based Topix lost 1.94 percent. The Bank of Japan had voted, on Thursday, October 11th, to keep interest rates steady at 0.5 percent.
In Europe, the Big Four group closed strongly in the negative. Switzerland’s SMI index was the biggest loser in the region, closing down more than 2 percent by the close. France ran a close second. The FTSE and DAX closed slightly downward by the market close. Swedish telecom giant, Ericcson AB (ERIC), was part of the reason for the strong downward movement on Tuesday, October 16th. Citing a fall in mobile upgrades, the company issued a third quarter earnings warning, which rippled across the continent. Ericcson fell an incredible 26 percent. German electronics company, Siemens AG (SI), also participated in Tuesday’s downward trend. Siemens fell 2.6 percent. Litigation and a Department of Justice indictment caused Lloyds TSB to fall 2.1 percent. Of course, record high oil prices are also responsible for downward pressure on European stocks.
Back in the United States, the Dow ($INDU) hit a record high on Thursday, October 11, 2007, spurred by the release of the Fed minutes on Tuesday, October 9th. The new week has presented new challenges to the index. You guessed it; the problem was the price of oil. On Monday, October 15th, the price of oil topped $86 per barrel, which was an all-time high level. The run does not seem to be over just yet. In early trading on Tuesday, October 16th, oil hit an even higher level of $87.17 per barrel on the NYMEX. The next challenge was presented by Mr. Bernanke’s comments on the market whose outlook he described as “cloudy.” He added that the Fed was prepared to take whatever action was required to help the economy. Most analysts believe this hints that another rate cut is imminent at the end of October. On Monday, October 15th, the Dow lost 108 points and it made people nervous. With higher oil prices on the horizon, how much will the market bear? Tuesday, October 16th will be a decisive day to show the market’s strength against a threat that hits at the core of the struggling economy. Speaking of the economy, let’s move on the economic reports that are coming this week, then discuss the news on everyone’s lips (talking about, that is!) and in everyone’s cars (literally): oil.
Economic Reports
Yes, the economic reports do still move markets! But each week shows the power of a different market mover and, this week, the mover is oil. I want to mention just a few economic reports because they continue to give us the context of how the market is moving. On Tuesday, October 16th, we had the release of the twin reports of Industrial Production and Capacity Utilization. Industrial Production was expected to rise to 0.1 percent while Capacity Utilization was expected to fall slightly. As noted in previous Market Moves articles, the Industrial Production report is the more important and market-moving of the two reports. The bond market could be slightly affected by the increased production figure, particularly at this time when other downward pressures are present from rising oil prices. The figures are just out: Industrial Production for the third quarter is the best figure in a year! For September, Industrial Production met analysts’ expectations of 0.1 percent. In short, industrial output is 4 percent, but was slowest in September. The 10-year bond traded slightly downward following the news.
On Wednesday, October 17th, we get our first peak into the housing market with the Housing Starts and Building Permits reports. Not surprisingly (despite the interest rate cut), the Housing Starts report is expected to show a decline from 1.33 million houses started to 1.28 million in September. The bond market should have a bullish reaction to this news while the stock market could view this information (with good reason) as bearish. Those are the major reports coming this week. Next week (beginning October 22nd), the real market-moving housing data will be released with the Existing Home Sales report on Wednesday, October 24th followed by the New Home Sales report on Thursday, October 25th. Finally, we have the very market-moving Durable Goods Orders report on Thursday, October 25th. The bond, stock, and currency markets are very sensitive to this information so traders will need to keep a strong vigil during the latter part of next week. (That’s okay, since Monday and Tuesday will be free of economic reports next week!) Let’s take a quick look at the stock market on Tuesday, October 16th.
Market Summary
The Dow opened lower and remained down 41 points in the first thirty minutes of trading on Tuesday, October 16th. In the second half of the trading day, the Dow hovered around an 80-odd-point loss. This is a big day for earnings—indeed, it is a big week for earnings—as we have Johnson & Johnson (JNJ) who just reported and three tech companies reporting later in the week. Johnson & Johnson reported good news and bad news. The pharmaceutical giant reported 13 percent lower profits on higher sales. However, the company revised its earnings outlook upward for a full year. That is a classic good news-bad news pattern. Johnson & Johnson is trading flat in the opening minutes of the trading day, but hovered around a .53 percent loss during the second half of the trading day.
Wells Fargo & Company (WFC) did not fare as well—at least, not the stock price. The bank’s third quarter profits rose 4.1 percent though it suffered massive losses from the credit crunch. Yet the country’s fourth largest bank had $490 million in mortgage-related write-downs and reserve increases. These figures were factored into the third quarter earnings report. On Tuesday, October 16th, Wells Fargo shares plummeted more than 3 percent in early trading and remained at that level throughout the trading day.
Figure 1: Wells Fargo & Company Daily Chart. Here is a portrait of a volatile stock! The long candlesticks show how the company experiences a wide price range on a daily basis. For traders on the hour or minute charts, many quick trades are possible. But trends do not appear reliable. Wells Fargo is trading down more than 3 percent in the early trading hours of Tuesday, October 16th. Where will it close?!
Although we have already discussed Ericcson, I want to mention it again briefly because a 24 percent (or $9.88) share price loss doesn’t happen every day—hopefully. The Swedish company’s decline is weighing on the tech sector, but is overall cushioned by the surge among the oil majors. Let’s talk oil.
Special Focus: Oil
Oil is a non-renewable energy source whose demand is increasing while its supply is sharply decreasing. Those facts turn oil into a very sensitive subject. Another fact that increases oil’s sensitivity is that the world’s largest oil reserves are located in Saudi Arabia, Iran, Iraq, Kuwait, and the United Arab Emirates. We are friends with a few members of this select group while we are definitely not friendly with others. Yet the world’s top oil producers are: Saudi Arabia, Russia, United States, Russia, and Mexico.
And the largest consumers can probably be guessed but I will list them here: United States, China, Japan, Germany, and Russia. Because the largest oil reserves are located in politically (and culturally) sensitive areas and because of its finite supply, oil is the world’s most volatile commodity. It is also the most traded. Events can trigger massive demand for oil as well as lower prices when, for example, OPEC increases output. But, in general, the price of oil is increasing. Most analysts agree that there is a positive correlation between the price of oil and the performance of the stock market. So, when the price of oil goes up, the stock market usually goes up. (Note that there is negative correlation between the price of oil and the value of bonds.) This positive correlation between the stock market and the price of oil is driven by consumption in emerging markets.
Did you notice that China and Japan are two of the top oil consuming countries? That consumption is expected to grow, particularly in China. As the Asian nations become more affluent, more cars will be hitting the roads, which will increase company prices and the demand for oil. India has not been factored into this discussion but, as one in nine people are from India, you can expect that the demand in this country will soar to never-before-witnessed levels.
On Monday, October 15th, tensions between Turkey and Iraq over the fate of the Kurdish people dramatically increased. With this rise in geo-political (and human rights) turmoil, the price of oil hit a new high level, topping $86 per barrel. But the positive correlation between oil and the stock market did not surface. Instead, the stock market slipped more than 100 points. Opening the second hour of trading on Tuesday, October 16th, the Dow is trading down nearly 100 points. The bond is trading in the negative. Even gold is trading down though it hit a 28-year high on Monday, October 15th. What about the dollar? The U.S. dollar is trading down against the majors (euro, pound sterling, Swiss franc, and Canadian dollar).
The oil future is not all bleak. Yes, it appears that oil prices could rise without resistance. There is nothing to stop the right in oil prices, right? Wrong! Most analysts believe that oil will succumb to basic economic principles of supply and demand. The demand will naturally decrease if the price hits a certain level. So, the real important question is how elastic is the consumer? Time will tell. Also, many Asian and European countries are frantically searching for alternative energy sources, which will drive down the price of oil, but more importantly, will reduce our dependence on this sensitive commodity. Finally, let’s take a quick look at NYMEX crude oil chart.
Figure 2: NYMEX Crude Oil Daily Chart. Notice that crude has shown a sharp and steady increase over the past year. The price has, at times, made dramatic increases within a month. Usually, it retreats back a portion of its bullish run. However, the resistance level is quite undefined at the present time, which is common in the face of rising political tensions. The Bollinger Bands (pink) show increased volatility. It appears that we are in the midst of an interesting trend in the precious commodity. But how does this affect the stock market? Look below:
Figure 3: Dow Daily Chart. The positive correlation between the stock market and oil is very clear when examining the two charts. But even the best of friends can argue! Oil’s all-time high price pushed the Dow below the 14,000 level. It remains around 13,920 at this time. As the prices of oil (and gold) are increasing, the value of the stock market and dollar is weakening. Perhaps it’s time for our superhero Fed to step in and restore peace and order!
The Market Moves column focuses on the factors that can move the market. Oil is undoubtedly a major market-moving factor. But oil is not the only player in the game right now. Fed speeches have been moving the market. Earnings season has moved the market. The price of gold has moved the market. And the industrial output report has moved the market. It’s a wild world of allies, enemies, commodities, and markets. Get ready for a busy week of market-moving activity. Happy trading!
Market Moves Wisdom of the Week
Think gold, diamonds, cocoa, or even wheat! This article has discussed the impact of oil on the market. There are many other commodities that influence the market from energy (heating oil, natural gas, etc.) to metals (e.g., gold, platinum, copper) to tropical commodities (e.g., cocoa, sugar, cotton) to grains (e.g., wheat). Commodities can be interesting and profitable to trade, but they can also provide additional information about the performance of individual companies and currencies as well as the market. The Market Moves Wisdom of the Week is to consider trading the commodities. They can be an exciting and profitable trading alternative to stocks. Or they can make your stock trading more profitable and your account golden!
Robin Lofton
Staff Writer and Trading Strategist
ProfitStrategies.com
