Commodities, China Probably Won’t Break The Market’s Back

After today’s open, it is obvious that the market is retesting its early July lows.  Talk about whiplash!  The market went straight up in eight trading sessions, to an intraday high of 2132.82 (on the S&P 500), above the previous high of 2129.87 set on June 22, but just shy of the all-time high of 2134.72 set on May 20.  That higher high keeps the hope of a resumption of the uptrend intact.  The latest sell-off is scary, but I would be reluctant to bail out now.

From here, traders will be looking to see whether we hold above the July 7 low of 2044.02 and similarly the March 11 low of 2039.69.  If we break below these levels, we will be talking about a correction.  The next level of support will be around the Feb. 2 intraday low of 1980.90.

Today’s sell-off was precipitated by the steep one-day sell-off in China.  The Shanghai Composite declined 8.5% yesterday, its worst one-day decline since 2007.  The Composite essentially gave back all of its July gains in a single-day.  There are fears that the Chinese government’s support of the stock market has ended and that the selling will resume.

Globally, fear that the Chinese economy will slow significantly has contributed to the weakness in all types of commodities.  The declines in oil and related commodities are especially troublesome.  Pricing pressure has become so severe that many companies are starting to show financial strains.  An increasing number of highly leveraged companies in energy-related industries have filed for bankruptcy and many more are on the ropes.  The associated declines in earnings have pulled down earnings expectations for the market as a whole.  Stock price pressure in energy, materials and even industrial companies has been dragging down the rest of the market.  Indeed, market leadership has narrowed significantly.  This morning, the WSJ reported that six companies – AAPL, AMZN, FB, GILD, GOOG and NFLX – account for half of this year’s gains in the Nasdaq Composite.

So continued weakness in commodities could end up cracking the market.  Yet, there has already been a supply response in the energy sector which will lead to higher prices eventually, next year, if not sooner.  If oil keeps plummeting, it is hard to imagine that OPEC, and especially the Saudis, will sit by and let it take down the global economy.  Consequently, there is the potential for an even quicker supply response, if needed.  If commodity prices bottom, stocks will begin to catch a bid.

 I remain cautious about taking new positions at the current moment, but would be inclined to consider adding to positions in the event of further market weakness.  My guess is that if we are in a correction, the best places to hide would be in selected stocks or sectors (e.g. utilities) or possibly in equity markets outside of the developed world.  If we do not remain range-bound, I currently believe that we will see a quick correction.  There are positive factors that should help to underpin the market (i.e. recent U.S. job growth, more spending by U.S. consumers, the recovery of the U.S. housing sector, low cost inflation, Europe still on the mend, etc.).  While the risks that remain are indeed formidable, it is also possible that one or two positive news flashes could reverse the negative sentiment and brighten the outlook  for the equity markets.   

Stephen P. Percoco

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