Like all commodities, patience appears to be a depleting asset. As soaring prices for crude oil and food ripple through the economy, a population who is used to having it pretty darn good – and which for the most part is devoid of any historical perspective – continues to adjust to a “new way of life." Somewhere along the way it appears that many folks somehow got the idea that in this “post modern” era we are immune to the vagaries of the economic cycle. This naïve belief is causing many who adopted unrealistic expectations to suffer even more than they would if they understood that despite the advent of high technology gizmos that make life far easier than it has ever been, bad things can still happen.
Take the weather. Thanks to the advent of cable news and the Internet every thunderstorm that occurs anywhere in this great land of ours is now a potential “news story." For example, every TV station in Chicago has its own variation of “Storm Watch," a “special report” where ashen-faced news anchors and various reporters who for some inexplicable reason are standing outside in torrential downpours and/or high winds talk for hours in serious hushed tones about all of the “human suffering” that is taking place. And a tornado – forget about it. To a wide swath of the population, severe weather is no longer an “act of God," but something annoying that someone in government should “do something about." Welcome to the Age of Enlightenment.
Anyway I mention all of this because the stock market has been in a bit of a funk for about eight months now. Between the “credit crunch," the “mortgage crisis," soaring oil and food prices and a great deal of uncertainty regarding just what tax bracket one might be in the not too distant future, there is a great deal of uncertainty overhanging the stock market. And lots of people have just about “had enough” and are looking for someone to blame. Sorry folks. The best advice I can offer is to peruse a long-term chart of the Dow and take note of the fact that the past 26 years have witnessed virtually unrivaled prosperity. And the bad news is that there is no guarantee that this will continue.
The good news is that we may be nearing the beginning of a surprisingly good time to invest in the stock market. As I have written about in previous articles (The Winner of This Year’s Election is… You?, June 4, 2008 and Did Someone Say Double Bottom?, March 21, 2008), we are presently in the midst of two historically seasonally favorable periods. As a result, as long as the January lows hold for the majority of major stock market indexes, I cling to the hope that more bullish days are ahead.
What to Watch Now
#1. The Major Indexes versus their recent lows
The Dow Jones Industrial Average has retraced the bulk of its January to May advance and is close to a retest of the January low of 11,634.82. A successful test would be a bullish development, a break to lower lows would quite obviously not. Still, it is interesting to note that none of the other major averages (Nasdaq 100, Russell 2000 and MidCap 400) displayed in Chart 1 has retraced more than 50%. Now different people will view this in different ways. Some will say that most stocks are showing greater strength than hinted at by the Dow, others will say that the other averages still have a long way to fall. In truth, no one can say for sure. We will simply have to wait for things to play out. The bottom line though is that as long as the majority of major averages hold above their early 2008 lows, we can still give the bullish case the benefit of the doubt.
Chart 1 – Four Major Averages retracing to different degrees
#2. Crude Oil
As everyone is quite aware, the price of crude oil – and the impact it has on the world and U.S. economy – is the number one uncertainty hanging over the financial markets. As long as crude prices continue to advance – or more accurately, as long as fears of still sharply higher prices – overhangs the markets, the stock market will have a tough time making headway.
In Chart 2 you see that the trend is still up based on the 10-day and 30-day moving averages. Nevertheless, a close look at some of the indicators below the graph suggests that momentum may be waning. How will all of this play out? Only time will tell. Still, the most bullish case for the stock market would be crude oil to experience a sharp decline in price.
Chart 2 – Crude Oil futures (Trend is Up, momentum is questionable)
#3. Commodity Prices
Let’s specifically talk grains here. As you can see in Chart 3, the grains have experienced incredible runups in the past year. World demand for food, a portion of grain grown going to biodiesel and ethanol and now flooding in the Midwest have been something of a “perfect storm” for grain prices. This advance and its impact on the economy is similar to that of crude oil. As long as fears of sharply higher prices persist, this acts as a drag on the stock market. The good news is that we are heading into the seasonally weak period for grain (July and September). A sharp decline in grain prices could serve as a catalyst for higher stock prices as many inflation-related fears would be relieved.
Chart 3 – Grains have run up sharply – where to from here?
#4. The VIX Index
Much has been written about the death of the VIX Index as a market-forecasting tool. Forget about it. This gauge of fear and complacency remains as useful as ever. As you can see in Chart 4, the January and March lows were accompanied by spikes in the VIX Index as fear ran rampant. Conversely, take a look at the month of May. As the stock market moved higher, the VIX Index drifted to sharply lower levels signaling an increase in investor complacency. Since that time the stock market has been in a steady decline.
The bottom line: Keep an eye on the VIX Index and look for the next meaningful stock market low to be accompanied by a spike in the VIX Index. To put it another way, until you see a spike in the VIX, patience is in order.
Chart 4 – SPY versus VIX Index
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Jay Kaeppel
Staff Writer and Trading Strategist
Optionetics.com ~ Your Options Education Site
