OIL OIL OIL

Boy was I wrong. My last post 10/10 the S&P closed at 1186, I expected an oversold bounce, instead we got further selling and didn't bounce until Friday. Here we are at 1186. I was right in pointing out that oil remains the wild card and heavily influences the movement of everything else. Today, another storm and accompaning oil price concerns. Stocks are down, dollar stronger. Oil, however is no longer a one way street. Signs of slower global growth and high prices has raised concerns of what they now call demand destruction. So we will now have tug of war. Economic data showing weakness will exert downward bias while supply disruption news will be positive. Let's not forget the weather which of course can go either way but will have more impact if it's colder than normal.
As I write, we are having an up day thanks to GM and MO which are up on GM's agreement with the UAW re health care costs, and MO's favorable ruling from the Supreme Court on tobacco litigation. Even so, I feel the bears have the upper hand in the intermediate term. As I've outlined before, the things we know augur badly for the market. The Fed will continue to tighten. Inflation continues to march higher as the higher energy prices grind their way through the economy. The budget deficits will continue to grow larger, not only because of the large expenditures lately due to hurricane relief, but now we have to worry that receipts may be lower due to a slowdown, a double whammy. Gas prices will stay high and be a drag on consumer confidence. We just don't have the refining capacity to bring them down. Outside of energy, earning are being squezzed by higher costs. It seems like everyone is blaming higher energy for earnings misses, even some that seem to have no connection. If there is a year-end rally I think we would have to see much lower oil prices for some reason and a friendlier Fed as a catalyst.

I haven't written much about the dollar lately, but we are now at an interesting juncture. The dollar has gained strength this year on higher interest rates. So far it has tested its July highs against the Euro twice at around 119 and held. Today I saw comments from both the ECB and the Bundesbank about higher interest rates down the road. Higher energy is causing inflation targets to be exceeded there also.This would of course be very supportive of the Euro, however, they have the same problem we do. Their think tanks last week lowered economic growth estimates. So the question will be, which economy slows sooner and farther and which central bank blinks first. We will trade back and forth on each data point pro or con. As the Euro is near one year lows and the U.S. capital markets are having problems, the best risk reward trade here is to go long the Euro, at least until support is broken. I like trades where the market doesn't have to move too far to let me know I'm wrong.

BOUNCE

The market was oversold. The payroll data was better then expected. Oil prices were dropping. Rally, rally, rally. The bullish argument to take away from the payroll numbers, where the previous two months were revised significantly higher, is that going into the hurricanes the economy was strong, strong , strong. With hurricane season almost over, and reconstruction money pouring into the gulf, it may have all been just a bump in the road with sunny skies ahead. Only a hawkish Fed and higher inflation are restraining prices.

Bears point out, you don't fight the Fed, much higher heating bills lie ahead, and Mutual Fund cash levels are at record lows.

I believe we are now going to test the upside. How far will this rally carry and with what kind of volume. 1210 seems like the first line of resistance in the S&P. Energy is still the wild card and the market will remain sensitive to it. This week we will have higher inflation readings and retail sales, continuing the worry over interest rates. Cold weather or large drawdowns of distillate inventories this week could halt the slide in energy.

WHAT NOW?

Yesterday the S&P finished down by 2 pts, the first down day in eight trading sessions.

True nothing much has happened in most of the last eight trading sessions, with the exception of the month-end window dressing rally. The bulls are looking for a year-end rally. Their argument is:

• The uptrend from the 03 low is intact.
• The market has absorbed all the bad news and remained resilient.
• Fiscal policy will support the economy and generate corporate profitability on Katrina spending. Yesterday's ISM index, certainly supports this.
  
• The Fed is almost done.
• We've seen the worst on oil prices.
  

The bearish argument is:

• The higher oil prices of the past year are working their way through consumer and corporate pocketbooks and will hurt spending and profits for the rest of the year.
• The Fed will continue tightening until they get mortgage rates up and slow housing. Greenspan is now concerned about inflating asset prices.
• Corporate profits while good, are slowing and are on a downward path. Earnings misses will be blamed on energy and Katrina.
• Inflation is in the pipeline.
• Energy prices will stay high particularly natural gas. This will significantly slow consumer spending which accounts for 70% of GDP. Evidence of stress is starting to show up in the higher percentage of consumers who are charging their gas purchases rather than paying cash. Also the percentage of consumers who are late on their credit cards has been increasing.