Yet Another Tough Week

UK (SANEPR.com) June 25, 2008 -- It was yet another tough week for global stock markets, with the Dow Jones & S&P 500 declining 3.78% on the week and the FTSE down 3.37%. With oil rallying $4, renewed trouble in the financial sector, downgrades to monoline insurers and trouble in the Middle East, markets encountered an ugly storm on Friday.

Crude oil prices continued to hold above the $130 handle after competing news flows kept oil prices within a $10 range over the week. Downside pressure came from the Chinese government stating that it would be putting up energy prices. With China behind a large proportion of crude's bull run, there is the potential for demand to drop significantly on the back of this. China is the second largest fuel consumer after the US, pushing sales in SUVs thanks to fuel subsidies. Now, as in the US, prices are starting to bite and demand could soon subside. The biggest factor in the future price of oil will be the outcome of the Saudi conference on oil this weekend.

Elsewhere, US leading economic indicators came in at slightly better than indicated, but the Philadelphia Fed Manufacturing index registered its worst reading for 20 years. On the company front, there were some disappointing earnings from Fedex. The logistics company has been hit hard by the price of oil and is seen as a bellwether for the global economy.

Banks with the highest exposure to the UK property market such as HBOS led the fallers on the FTSE. An RBS note to clients released previously, gained attention for its stark warning about the potential for a crash between now and September. Goldman's added further gloom to the already dark sentiment by warning that a deep recession is very possible. Next week's news flow is dominated by the US interest rate announcement on Wednesday. A no change verdict is expected to be the more likely outcome, but aside from the small potential for surprise next week, it is the prospects for the rest of the year that will cause the most excitement. Chatter that US rate hike speculation is overdone caused some initial excitement last week, but this alone wasn't enough to push markets higher in the face of some difficult head winds.

Thursday sees the release of US existing home sales. US Housing starts were down 3.3% last month, falling to a 17 year low. It is little surprise US builders are unwilling to add to their housing inventories in light of recent data. According to the S&P/ Case-Shiller Home price index of 10 major US cities, house prices are now down 15.1% compared to the same month a year ago. In addition, nearly 18.8% of subprime mortgages were past their due in the first quarter of 2008.

There are mixed prospects for the week ahead especially with a US interest rates decision coming up. An interesting sentiment study was highlighted by Jason Goepfert of SentimenTrader.com. His Smart Money/ Dumb money indicator tracks the positions of market timers that have proven to be good or poor at predicting the market in the past. The logic is to follow the smart money and avoid the dumb money. Last week the dumb money confidence dipped below 29%. The last 163 times this has happened, the S&P 500 was positive three months later 100% of the time, with an average gain of 12.3%. If history is anything to go by, it clearly pays to do the opposite of whatever the dumb money is doing.

However, the case for a rally is certainly not clear cut and Mark Hulbert, who tracks the performance of stock pick newsletters believes there is still not enough panic out there for a true contrarian buy signal. According to Hulbert, “the bearishness that prevails right now almost seems to be a calm and tranquil form of bearishness, as opposed to the gut-wrenching emotions of despair and gloom that typically is seen when the typical adviser throws in the towel, having given up all hope.” When the typical advisor has given up hope, the contrarian investor becomes more interested in the opposite trade.

A Bull bet on the S&P 500 to be higher than Friday's opening value of 1333 in three months time could return 107%. Given recent market trends though, it may be better to wait for signs of further capitulation in the form of a 2.5% daily drop or greater.

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