Friday, June 27, 2008

Four Whom the Bell Tolls", POTC's Four Scenarios

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We see four scenarios related to crude oil and the unfolding economic data. It's not too late to sell your holdings before the massive sell off, as we see the S&P at 1,190 and Nasdaq at 2,150 before the indexes settle some time next week. Even good earnings this quarter won't matter as most businesses' variable costs have risen substantially. So how the market wants to discount $140/barrel oil is anyone's guess. Do not let the next few closing bells blow up your portfolio. Barring a $10 drop in oil Friday, we are very pessimistic after Thursday's parabolic move. Forecasting crude oil has become an unwelcome financial conundrum and this will exacerbate the sell off. The analyst/firm that says crude is going higher continues to make money as the majority of consumers/investors suffer. Meanwhile the analyst/firm that says crude is going lower continues to lose money and the majority still suffers. Valuations will be questioned in every sector as crude fails to back off. We witnessed every sector in the S&P down Thursday, an extremely rare event. Fasten your seat belts, as we present the four scenarios sprinkled with some psychology.

Our readers should imagine "bad economic data" as a rise in unemployment or fall in retail sales, and "good economic data" as a fall in unemployment or rise in retail sales. Be aware the unemployment data is scheduled for release next Thursday, July 3rd, as the markets are closed for the 4th of July Independence Day celebration… another conundrum.

1) Crude oil does not break down with bad economic data: Very negative for stocks. A deep recession imminent barring more government stimulation/intervention. Even IF the government acts again, isn't investor psychology near the tipping point? We certainly think so. POTC believes in "laissez faire", but after the Bear Stearns collapse, we understand if you differ.

2) Crude oil does not break down with good economic data:Question mark for stocks. FOMC rate hike imminent as the past rate cuts have kicked in and miraculously jump-started the economy. The $64,000 question is whether the rate hike causes the greenback to strengthen and crude to fall. The strengthening of the greenback must develop into a trend, and the same goes for the sell off in crude, otherwise, we're back to where we started. IF trends take hold, stocks rise, IF not, stocks continue to fall. Therefore, we rated this as neutral/question mark.

3) Crude oil breaks down below $130/barrel with bad economic data: Somewhat positive for stocks, as FOMC remains on hold and the biggest thorn/cost in the consumer and corporate sector is slowly removed. Paradoxically, bad economic data has been historically positive for stocks since the FOMC stayed on hold, but with bad economic data like rising unemployment, the question remains as to whether the rate cuts were enough to eventually kick in and turn the tide of unemployment to more employment? A conundrum again, but we rate it as somewhat positive nonetheless.

4) Crude oil breaks down below $130/barrel with good economic data: Very positive for stocks, as the cost of energy diminishes. The focus though again turns to the credibility of the FOMC to hike rates. Uncertainty is what Wall Street hates most. By how much will they raise rates, and for what duration of time? Yet the hike will be warranted on the back of good economic data, so the benefit of the greenback strengthening and oil breaking down further is a huge benefit IF this scenario unfolds.

We hope you enjoyed our four scenarios. Please print out this page and make marks next to the four scenarios, monitoring oil and all economic data. Quick Financial Psychological Fusion: Today's GDP was "good economic data", but weekly unemployment claims came in as "bad", but crude rose, so it fell between scenarios #1 and # 2, yes? Remember scenario #1 is very negative for stocks, and scenario #2 is only a question mark after the FOMC raises rates. We hope we didn't lose too many, but these markets are very complicated. Could the sole dissenter, Fisher, strong arm Chairman Bernanke to raise rates Monday morning IF crude continues to rise or even stabilizes in the $135-$140 range? The argument for hiking could be made for a stronger greenback. Would you and the rest of the world buy it… the greenback, that is? That's where the $64,000 enigma in scenario #2 lies.

With no economic data scheduled for tomorrow, we will unfortunately be trading on hot oil. We urge our readers to avoid ALL stocks until the shake out is complete and/or oil breaks down below $130/barrel. We did blog that there would be better opportunities after the 4th of July fireworks.

We stand by that prediction and we hope you realise that the Psychology of the Call team will continue to stand by you.

1 comment:

Anonymous said...

I live and teach economics in Botswana Africa. I thank you for all your works. I will inform my pupils to your blog address. I think oil will go beyond $150 on account of unrest everywhere they develop oil. Best to your team.