Agora Financial’s Rude Awakening

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Laguna Beach, California

• Oil climbs, financials fall…and the market RALLIES!
• Traders are calling it a bottom…or at least a branch to cling to,
• The bulls turn bearish – what’s a contrarian to do? And plenty more…   

Eric Fry, offering a few observations and guesses from Laguna Beach, California…

What’s this?!…The stock market did NOT fall yesterday?…Wow, when was the last time THAT happened?

Seems like a long time ago. But of course, that’s not exactly true. The Dow leapt about 150 points on Tuesday. But then it tumbled about 240 points on Wednesday. Therefore, as the number-crunchers here at Rude Awakening headquarters inform us, the Dow lost 90 points over two days.

Yesterday, the beleaguered Dow managed to gain 80 points. This remarkable feat seemed all the more remarkable in light of the fact that many leading financial stocks tumbled AGAIN…and that oil soared more than $5 a barrel AGAIN.

On most days recently, a slumping finance sector OR a rallying oil price would have been sufficient to knock the Dow off its moorings. But yesterday, the Dow withstood a battering from both directions. Therefore, should we terrified investors glean any sliver of hope from yesterday’s trading action?

We examine this question in the column below…

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Bull Flight
By Eric J. Fry

Oil soared yesterday, while financial stocks tanked. And yet the Dow Jones Industrial Average managed to post an 81-point gain? Was this “gutsy” performance a mere fluke, or the start of something wonderful? Should we anxious investors be celebrating the fact that the stock market “ignored bad news?” Should we be casting aside the sackcloth of gloom and donning the party threads of renewed hope?

Your editors here at the Rude Awakening do not have the answers to these questions. We are as confused and terrified as every other confused and terrified investor.

Nevertheless, we say to ourselves, “Gosh, stocks sure have been falling a lot lately. Isn’t it about time for them to go up? At least for a week or two?” And we also say to ourselves, “Gosh, oil sure has been going up a lot lately. Isn’t it about time for oil fall, at least for a week or two?”

“Everyone is waiting for the top in the oil market,” Bill Bonner, issuer of your editor’s paychecks, observed recently. “We don’t know where it is, anymore than anyone else. Our only advantage is that we know it is there somewhere. Oil is a useful commodity. It responds to the laws of supply and demand. Every roughneck with a rig is now drilling down and trying to get more oil to sell. And every motorist, industrialist and householder is looking for ways to not buy it. Somehow, somewhere they’ll bring the price down.

“Wait…oil also responds to money,” Bonner reminds us. “We saw an estimate somewhere that 25% of oil’s price increase since 2003 was because of the dollar falling against foreign currencies. What about the other 75%? That too, is probably largely a feature of a dollar that is losing its purchasing power against consumer goods and raw materials. All paper currencies are going down; prices rise. For the last 100 years, the oil price has tracked - more or less - changes in money supply growth. As M3 increased, so did the price of oil. Currently, the money supply - as measured by M3 - is increasing
at an annual rate of about 18%. Oil is going up - on a 10-year moving average basis - about 23% per year…

“What does this mean? Please don’t get us mixed up with someone who knows, dear investor. We’re just guessing. But our rough guess is that oil is a bit overpriced anyway you look at it. And as it responds to normal market signals, it is bound to be beaten down.”

We’re inclined to agree with Bonner’s guess. And we’d add our guess to his: If oil prices retreat, stocks will likely rally.

As we ponder these various guesses and scenarios, we sometimes examine charts like the one below, which tracks the sentiment – bullish or bearish – of newsletter writers across the country.

As the yellow line in the bottom half of the chart clearly shows, newsletter writers (as polled by Investors Intelligence) are as bearish as they have ever been in the last 10 years. From a contrarian perspective, this extreme bearish reading indicates that share prices might soon rally. The folks at Sentimentrader.com provide a few additional details:

“The latest results of the Investor’s Intelligence sentiment survey are truly remarkable…The current reading on the “Bull Ratio” is the lowest one on the chart - lower than the last financial panic in 1998, lower than after the 9/11 tragedy, lower than what we saw after the Enron (et al) scandal…
 
“One reason we haven’t seen very many excessively bearish readings in this survey is because it looks at newsletter writers.  Newsletter writers are well aware that bullishness is what keeps subscribers.  Even if they’re bullish and wrong, it’s often better than being bearish and right (go figure).  And if they’re bearish and wrong, then heaven help them as their subscriber base will shrink rapidly, except in a few cases where the writer has made a name for him or herself.
 
“So it’s very rare to see these writers so pessimistic on the market’s prospects, and I think it’s notable.  Combined with…a multitude of economic surveys on the broader public, we’re seeing a level of pessimism towards the economy in general and the stock market in particular that we have not seen in 30 years. During those 30 years, this has been an infallible - and I do mean infallible - buy signal on an intermediate- to long-term time frame.
 
“The question, of course, is whether this is anything like the past 30 years.  If so, then we should be buying on every dip and holding for several months at least.  We should not see the stock indices fall much further, if at all, beyond the lows they established earlier this week.”

On the other hand, the current situation may contain financial toxins that are far more debilitating than anything our economy has ingested in the last 30 years. So even if a trading rally is close at hand, the economy may continue to stall. No one should expect the economy to begin dancing in flowers, sunshine and happy feelings.

A short-term bounce would feel good. But it wouldn’t remove the considerable obstacles to resurgent prosperity on Main Street and jubilation on Wall Street. Even if the Dow were to tack on 1,000 points over the next few weeks, for example, many homeowners would still lose the roofs over their heads, many banks would still suffer billion-dollar losses and many consumers would still reign in their heretofore unbridled spending habits.

In short, a recession is already baked in the cake…and the oil market has slammed the oven door shut. Even if oil retreats, it has already soared high enough to put the breaks on economic growth.

 

As the chart above clearly shows, every major recession in recent times has coincided with a sharp jump in oil prices. The highly leverage American economy is unlikely to escape a similar fate this time around.

So to summarize our analyses and conclusions:

1) Stocks might bounce before falling again;
2) Oil might drop before rising again;
3) The economy might slump, no matter what happens to the price of stocks or oil;
4) If none of the above scenarios materializes, something else might happen.

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[Rude Endnote: On this, the final day of a wild week in the markets, the Dow kicks off trading from 11,229.02 points after surging 81 points yesterday in the face of rising oil and falling financials.

Oil tacked on $5 and trades right now around $145. Gold too is up. The yellow metal raced past $950. This morning an ounce will cost you 952 crisp American dollars. 

Meanwhile, a pint of the spectacular, Viennese-brewed Ottakringer will set you back about three euros ($4.50) in any of the local beer halls. Back here in Dubai a pint of imported larger (usually Fosters or something equally unpalatable) pours for around 25 dirhams ($6.80). We miss Europe already.

Until next time…

Cheers,

Joel Bowman
Rude Awakening

aussiejoel@the-rude-awakening.com