In the past two months, I talked about China getting ready for the Olympics. The Olympics have come and gone, and anyone who viewed the games saw that China went way, way out of its way to be the pretty girl at the prom amid much pomp and circumstance. They shut down their factories in preparation for the games, and at the same time starting in late July and throughout August, we saw corrections in commodities. At some point, I said China would turn back on their machines, so to speak. And I do think commodities will recover too.
Global growth and demand does seem to be slowing overall, and China’s GDP might fall from two years in the double-digits to 7-8 percent this year. That’s still pretty strong. (America wishes it were at 7 percent.) I see China remaining a global player in the years ahead, and I do feel commodities will make a comeback into 2009. Maybe not this month, and maybe not across the board, but don’t count commodities out.
A Dollar Breakout?
In Europe, we are seeing reports of economic slowing, including the spread of the housing woes that struck our shores. That has contributed to the summer commodity sell-off, and the rally in the U.S. dollar. The European Central Bank and the Bank of England both held policy meetings on September 4. There had been talk going into those meetings they might cut rates as a preemptive strike against further economic troubles, but for now, they decided to hold rates steady.
Central bank policy both here and abroad is going to be critical to the direction of many markets going forward. Last month, I was bullish on the dollar and said that if the Dollar Index futures contract could close above 75, it would mark a clear breakout. The market did that, and rallied above 78. It certainly looks from a monthly chart that the dollar has broken out to the upside, but I think there’s likely to be some resistance around 80, which is near old support. The Dollar Index has rallied about 7 percent since the end of July, and probably needs a pullback.
Longer-term, I think the dollar will continue to gain on the euro, as Europe’s economy weakens. I think they will eventually have to lower their interest rates. The key short-term lending rate in the eurozone is at 4.25, and in England, it’s at 5 percent. At the September 4 policy meeting, President Jean-Claude Trichet said even though downside risks to the economy prevail, the focus remained on fighting inflation. “We’re resolute in our determination to keep inflation expectations in line with price stability,” he said. When he talks hawkish, it makes the euro go down and the dollar up, as we saw following the meeting.
In the U.S., the short-term lending rate under the Federal Reserve’s control (known as the Federal funds rate) is at 2 percent, and most analysts expected it go up in 2009, if not sooner. So the spread between European and U.S. rates should narrow. But during September, a clear trend may not yet emerge. The dollar may be volatile, correcting back a bit from this latest rally before resuming higher again.
The direction of the dollar versus the euro will depend on further language coming out of global policymakers. Continued talk about inflation fighting in Europe will dampen ideas of rate cuts there, and likely fuel the dollar. Talk about continued risks to the economic outlook in the U.S. could keep the dollar in check. Our Federal Reserve meets on September 16, so we’ll see what Fed officials have to say.
Commodity Boom Goes Bust
The driving force in the commodity boom of the first half of 2008 has been crude oil. Going back to late March/early April, crude oil was trading around $102, and Barron’s came out with article around that time about the commodity bubble, predicting a 20-30 percent pullback. We have indeed had a correction of that magnitude in crude oil since its peak above $147 a barrel in July. The market was definitely way overbought in my opinion, but I don’t think the bull market in crude oil is necessarily over. Looking at a monthly chart, I can see crude oil hasn’t broken a key trendline. The market could certainly fall back further, even to $90, and still be in a bull market.
Crude oil has been acting as a tax on the consumer. A pullback would be like a rebate, and consumers would have more cash in their pockets to spend elsewhere. But I am not sure the pullback will be sustained, and I expect crude oil to find some support. We have more than 30 days left in hurricane season and if a big storm hits, or threatens to hit oil refining areas, it could see a quick pop higher. I also think OPEC may try to defend $100 oil.
I’ve also included a chart below also of the Reuters/Jefferies CRB Index, which tracks a basket of commodities, so you can see how the corrections have been widespread, and not just confined to energy. The bubbliciousness has been taken out of commodities.
Stocks Still Looking a Bit Bearish
As a whole, this year the stock market has had a lot of problems stemming from the financial sector, and the Federal Reserve has kept interest rates on hold this summer as a result. I think the U.S. has dodged the bullet of recession (defined academically as two quarters of negative GDP), and the U.S. dollar is looking better. Other global economies have been carrying us, and now perhaps the U.S. seems to be coming out of its economic troubles as other nations’ troubles are beginning. However, we aren’t out of the woods just yet.
At the beginning of the year, I saw the S&P falling about 20 percent, but by year-end, the market would show single-digit declines, perhaps ending down about 5-9 percent. We seem to be on track for that result, and the S&P futures seem to be developing support around 1225. The question for stock index traders is: will the big money be afraid of risk? I think the big institutional investors and funds will allocate money back into to equities if they think they can absorb risk, but looking at a weekly chart, the S&P 500 futures look bearish still. There could be one more test lower before a year-end rally ensues, but I don’t think the market will make a new low. We need to figure out if the economic risks are shifting—or not. If market participants feel they need to return to the commodity safe-havens they sought in the first half of 2008, such as crude oil or gold, then the stock market is likely to remain depressed.
We’ve had four years of positive performance in the stock market, and I don’t think we’ll be totally out of the woods in terms of the housing market crisis until later into 2009. If the housing market doesn’t come roaring back, the banking system isn’t going to be all that wonderful, and neither will the stock market. I think we are likely to have a weak holiday season, as consumers are tapped out. This contraction in our economy is rather like the grieving process. First denial; then anger; then depression; then acceptance. I think the closer we get to acceptance, the better. Keep in mind also, September has historically been bearish for the stock market. According to the Stock Traders’ Almanac, September is the worst month in terms of percentage losses for the S&P 500, Dow Jones Industrial Average, and Nasdaq. While you can’t bank on seasonal trends, it’s important to keep that in mind because other market participants are aware of these trends, and they can become self-fulfilling prophesies. A more sustained rally may be on hold for a few more months.
The presidential election is certainly going to be factor for the stock market too. If the stock market doesn’t leap forward, we’ll likely see buying return in commodities as a hedge. At this time as a longer-term strategy, I recommend buy major dips in the dollar, which will be a slow mover to the upside.
Please feel free to call me to discuss these or other markets, and to incorporate specific trading strategies for your account size and risk tolerance. Good luck and good trading!
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. You can view an archived webinar of this forecast at www.lind-waldock.com/events, where Jeff covers even more detail.
Past performance is not necessarily indicative of future trading results. Trading advice is based on information taken from trade and statistical services and other sources which Lind-Waldock believes are reliable. We do not guarantee that such information is accurate or complete and it should not be relied upon as such. Trading advice reflects our good faith judgment at a specific time and is subject to change without notice. There is no guarantee that the advice we give will result in profitable trades. All trading decisions will be made by the account holder.
Futures trading involves substantial risk of loss and is not suitable for all investors. © 2008 MF Global Ltd. All Rights Reserved. Futures Brokers, Commodity Brokers and Online Futures Trading. 141 West Jackson Boulevard, Suite 1400-A, Chicago, IL 60604.
