Markets are struggling, but the trend is still up; rising oil is an economic wild card
Today might be the first official day of summer, but it has felt like summer for investors for a few weeks. The market fluctuations since early May produce a sensation in my stomach that is not unlike that popular summer pastime of riding a roller coaster. Just so you know, I rarely ride roller coasters because I really don’t enjoy that feeling at all.
That chart below provides a pretty good picture of the type of ride we are experiencing. Since early May, the Nasdaq has advanced, but the gains have been meager and there have been several big down days. This increased summer volatility is actually not unusual. Lower trading volume can result in accentuated market movement. In fact, summer is usually the weakest season of the year for stocks. So the fact that the market is still trending up could be considered an anomaly.
The gold line on the chart below is a simple 50-day moving average (MA) of the Nasdaq. Notice that the index has held above that line on all of its recent pullbacks and it is still trending well above that mark. In most cases, I consider 50 days a fairly short-term MA. So when a investment breaks below that mark, it is kind of like an early warning that all might not be well. When considering positions to purchase, I generally look for investments that are trending above a 200-day MA.
The middle portion of the chart below is a relative strength index (RSI). So far the Nasdaq is holding above the 50 level on this indicator as well. When an investment is trending above 50 on its RSI, that is usually an indication that it has enough positive momentum to advance. For now that positive momentum is also confirmed by the moving average convergence divergence (MACD) on the bottom portion of this chart.
Right now none of these indicators are at levels that would lead us to expect a powerful upward surge in stock values. But hey, minimal gains are still better than losses, right?
Rising oil could derail economy
Right now the biggest threat to market stability could well be the rising cost of oil and gas. With the price of crude oil approaching $70 a barrel, continued economic growth is in jeopardy. A few weeks ago the government reported that first quarter GDP growth had slowed to 0.6%. At about the same time, Federal Reserve Chairman Ben Bernanke said he thought economic growth would pick up a little for the rest of 2007.
The reality of the situation is that a GDP growth rate of 0.6% is virtually no growth. Higher oil costs could easily be enough to stall the economy and result in a negative GDP number. Most economists define recession as two consecutive quarters of negative GDP. We are just a week away from finishing the second quarter of 2007. We are about a month away from the preliminary GDP reports for that quarter. It will be interesting to see whether the economy has stayed on the brink of negative growth or whether it moved back to a higher number. Regardless, higher oil prices could doom the economy to recession in the second half of 2007.
Because the cost of oil is integrated into every aspect of our society, higher oil costs impact the economy in much the same way as a tax increase. Of course, rising oil costs also present an opportunity for those who invest in energy funds. The chart below shows the one-year performance of Merrill Lynch Oil Service HOLDRS Dep Receipt (OIH). Since March this sector is on a steady climb that shows no indication of stopping.
Unfortunately, when the energy sector does really well, the rest of the market tends to struggle. So it will pay to keep a close watch on oil prices for the rest of the summer.
F.S.