The market has been making a series of higher lows and I believe it is about to stage a short-term rally. Oil prices continue to fall and inflationary concerns have eased for the time being. Yesterday’s PCE index cam in “hot”, but the market is more focused on the current oil decline.
The Fed is likely to maintain its current policy and it will be able to stick by its comments last month. The financial crisis and deteriorating economic conditions are the primary concerns. Based on the recent round of earnings, we know that massive write-downs continue to plague banks. The Fed has to bail out FRE and FNM and they know we are on the verge of a full blown financial crisis. Last week’s Unemployment Report should leave little doubt that economic activity is slowing. The slowdown is spreading and international companies have been reporting slower global activity. Consequently, the ECB and Bank of England are likely to soften their inflation rhetoric on Thursday.
Moderating inflation and stable interest rates will be well received by the market and a short covering rally will ensue. I believe the market will hit resistance at SPY 133. The overall picture is still bleak and this rally should be viewed as nothing more than an oversold bounce.
Oil prices will remain high on a relative basis because the supply is constant and global demand will continue to increase. Ultimately, $100 per barrel oil will still translate into inflation. I believe that the recent decline in oil is short-lived. Energy prices got overextended for a number of reasons. The Iran/Nigeria/hurricane risk premium squeezed shorts in June and when they covered, they fueled the rally. Currently, some of the speculative fluff is being taken out and prices are likely to drop farther than they should. I would not be surprised to hear of a hedge fund blowout. Once oil finds support, it will be a long-term bargain.
This morning, the ISM services index shrank less than expected. It came in at 49.5 compared to June’s 48.2 reading. A number below 50 still represents contraction.
I believe today’s FOMC reaction will be positive. The rally will keep the market above key support at SPY 126 and bullish traders will lean on that level with confidence.
Once this rally plays out, a shorting opportunity will exist. I am playing the rally with one fourth of my normal trading size. I don’t want to get cute when I am going against the grain. My instrument of choice is the SPY. For very short-term moves, I want to stay with a liquid vehicle and I want to make sure that I participate in the move. I will use SPY 126 as a stop on a closing basis.