Last week volatility was the name of the game as we saw commodities back down, while the stock market and U.S. dollar gained ground. While there is considerable uncertainty about whether underlying economic fundamentals can support continued stock market gains later this year, traders currently are focusing on the positive aspects of relatively lower crude oil prices and a favorable US dollar that is attracting foreign money to our shores.

There are clear signs that the U.S. economy is slowing. Consumer spending is sluggish now that income tax rebate checks have been spent, credit is still tight, and jobs are less secure. There is also the prospect that export growth will slow due to a weakening in growth abroad, and the rebound in the U.S. dollar. The good news is that headline inflation should be coming down a bit due to a recent drop in crude oil prices. Still, energy costs (including gasoline) remain elevated, and companies are still trying to pass along costs. Core inflation may not ease as quickly as headline inflation, but overall, I see the economy at a turning point for slowing growth and somewhat easing inflation.

S&P 500

Despite a still uncertain economic outlook, the stock market wanted to focus on the positive, and last week the S&P 500 saw its third weekly gain. The index has risen about 6.9 percent after nearing a three-year low on July 15. The stronger dollar made U.S. investments more attractive overseas and lower crude oil prices were seen as likely to boost consumer discretionary dollars. Small-cap stocks in particular were helped by these factors.

There is no question the economy is slowing here, but there are signs of slowing in the rest of the world too. The U.S. was the first in trouble with the subprime lending crisis going back over a year now, and the thinking is, we might be the first out when economic fundamentals start to improve. Across the pond, a report just came out that home prices in the United Kingdom saw the largest annual decline since at least 2002, sinking 4.8 percent in August. In France, manufacturing confidence fell to the lowest in five years in July.

I have to question whether this recent rally in our stock market may be a bit premature, as the signs show we are still in a slowdown. Perhaps the market is looking six months ahead.

From a technical standpoint, September S&P futures closed higher Friday, consolidating above the 38 percent retracement level of the May - July decline at 1292.

Momentum indicators, the Stochastics and Relative Strength Index (RSI), are turning bearish, indicating a short-term top might be in. A close below 1274, the 20-day moving average, could suggest a near-term top. My upside target for bulls is 1321.

For day-traders only of the S&P futures, I see the trend as neutral to bullish, but watch 1297, my daily pivot. Trade underneath that level could trigger a larger selloff, while trade above looks constructive. September S&P futures were last trading slightly lower at 1294.90.

Crude Oil

Last week crude oil paid little heed to geopolitical events, sinking below $112 a barrel last week. A couple months ago, news like the Russian/Georgian conflict would’ve sent crude oil soaring. Not now. The thinking is that demand will be slowing worldwide as global economies slow, and that is taking precedence over any other news that would’ve in the past been deemed bullish.

Other events far outweighed the perceived minor impact of Russia’s military intervention. These included a run up in the value of the dollar on reports last week that the 15-nation euro zone economy had declined by 0.2 percent in the second quarter. All three of the largest economies in the euro zone contracted – those of Germany, France, and Italy. Demand for crude oil is seen as falling as Japan’s economy also contracted in the second quarter and China reported a 7 percent drop in crude oil imports for July. Also, Iran called for further nuclear talks, further soothing the crude oil market. Crude oil has declined 22 percent from its record of $147.27 on July 11. I’ve mentioned some contraction overseas affecting the stock market and crude oil, so let’s turn to the dollar.

U.S. Dollar

Economic slowing in Europe and Asia will make our dollar more attractive, and although it will hurt our exports, that’s a minor thing to worry about in my opinion. For now, the focus seems to be on improvement in the U.S., and the dollar’s strength is aiding a decline in crude oil prices. Traders are also betting that while U.S. interest rates will probably rise, those in Europe and the UK are probably headed downward sooner or later. While our Central Bank was cutting rates over the past year, other nations were raising rates to fight inflation, and that trend might shift.

This week, we only get two market-moving indicators but the first is very important – housing starts on Tuesday, August 19. Federal Reserve officials and many economists say the U.S. economy will not strengthen until housing picks up, so markets may give this data extra prominence. However, technicalities in the data mean markets must carefully pick apart this week’s report. The other market mover is the July producer price index. Some see recent declines in crude oil prices as making the report outdated, but the core numbers will still be important. Also, leading economic indicators come out and the release could boost chatter about recession.

Looking at action in futures, the ICE U.S. Dollar Index contract has seen a streak of gains, with September futures up for 11 straight sessions and for five straight weeks. The Dollar Index contract tracks the dollar against six global currencies. On Friday, the contract closed above the 75 percent retracement level of the 2007-2008 decline.

I’ve been watching 74-75 for weeks as a pivotal point in the contract, and once we got a close above, the market took off. Stochastics and the Relative Strength Index (RSI) are overbought for sure, but still signaling more gains could be coming.

The 10-day moving average at 75.60 is acting as support on a slight pullback this morning, with second support seen at 74.75. If September futures extend the rally, the 87 percent retracement level of the 2007-2008 decline at 78.15 is my next upside target.

Feel free to contact me with any questions you have about these markets or others, and to develop a trading strategy suited to your particular account size and risk tolerance.

Good luck and good trading!

Financial Fundamental Reports: Week of August 18, 2008

Jeff Friedman is a Senior Market Strategist with Lind Plus. He can be reached at 866-231-7811 or via email at jfriedman@lind-waldock.com. Join Jeff for his monthly webinar, Friedman’s Futures Forecast, by visiting Lind-Waldock’s events page.

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