Since our last market commentary a lot has transpired in the market place. In retrospect the initial downside targets that I had projected for the DJIA (11,750-12,000) were very close to the mark as the DJIA hit an intraday low on January 22, of 11,634.82, and was subsequently tested on March 10th to reach another intraday low of 11,731.60, to form a double bottom. This also coincided with the Federal Reserve and JP Morgan's unprecedented bailout of Bear Stearns. In addition, the numerous rate cuts that have lowered the Fed Funds rate from 5.25% down to 2%, have for the time being put a tourniquet on the hemorrhaging in the credit markets. That set the stage for a nice and much needed oversold rally in all the averages, in which the S & P 500 was up close to 11% from the March lows.
Unfortunately, sometimes we have to be careful of what we wish for! The sector that rallied the most off the bottom in March was crude oil and oil stocks. Until now, the stock market seems to have turned a blind eye to the rise in oil prices. The price of crude oil has virtually gone parabolic from $80 a barrel to a new all-time high of $138 a barrel. With rising demand for oil from emerging market economies, the lack of investment in new productions sources, and the declining value of the dollar created a perfect storm of events to fuel this explosive rally in crude oil.
The equity market however has reached another crossroad. The S & P rally off the March lows hit some key technical resistance areas, most notably the 200 day moving average, and the key 20 month moving average at 1436. Since the market advance was extended we have been expecting a pullback which we are currently in the midst of. The S & P has now broken some support area and has formed an interesting head and shoulders topping pattern. If the S & P should decisively break the 50% Fibonacci support area at 1348.61 the pattern measures down to 1300 in the near term.
In the intermediate term, where the equity market ultimately goes depends on how this economic downturn unfolds. Right now the market seems to have discounted a short and shallow recession, and if so, after some consolidation we could see improvement late in the 3rd quarter. However, if this turns out to be a consumer led recession similar to 1973-75, with continuing high oil and commodities prices as the culprit, then the equity markets could have much lower to fall.