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11-Dec-08

More On Oil; Watchlist

Overseas markets sold off during the night, and US futures look quite weak in the premarket. Let's take a look at the SPY chart to consider possible near term market action.

Yesterday's selling was not particularly heavy, and we have considerable support below the current level. If we gap down to anywhere near the 83.50 level, I will be covering shorts and watching for the next move. I think the market would be inclined to bounce from that level. On the other hand, should SPY sink below 82.10, it would be time to re-enter shorts.

Looking at NYMO, we are still overbought in the short term, although a decent gap down could relieve those conditions:

With respect to sentiment, the Bullish Percent Index for SPX is quite high. The Ticker Sense Poll puts blogger sentiment at 66.67% bullish, also on the high side. I usually take this to be a contrary indicator.

All thing considered, sideways trading appears to be most likely in the near term. I am focused on bullish trades in commodities and emerging markets, and bearish trades in consumer and financial sectors.

If we get a big gap down, my short watchlist will need some adjustment, but here it is for now: HXM, STC, CXW, AKR, EAT, SONC, CEC, CBRL, CPKI, BJRI, DRI, FHN, STT, CTRN, PSS, JNY, SHLD, RSH, BBY, HD, COH, and DFS. I am currently holding puts in the following: IYR, JCG, GE, MET, NLY, PFCB, JPM, AN, RE, KEY, PSS, JOSB, MTH, PNC, XLF, AXP, and DFS. Again, I will take some profits on a gap down this morning, but plan to keep most of them in anticipation of a big drop before the end of January. I think most of these stocks have seen their highs for the foreseeable future.

On the long side, USO is coming off the lows with very high volume, and has broken its downtrend line. While oil gave up some of its early gains toward the end of the day, it remained reasonably strong in the face of a general market selloff. If we see a rally, I would expect oil to lead.

Also note that the US dollar ETF made a very bearish move yesterday:

In related articles, energy economist Philip Verleger says that OPEC will need to reduce production by 7.7 million barrels a day, or reduced demand will continue to drive the price down.

"The implication, then is that OPEC countries need to reduce quotas not by one million or two million barrels per day, but rather by six or seven million barrels," Verleger says in his report. "Since cuts of such magnitude are out of the question, one should expect prices to come under further downward pressure."

This type of cut is not going to happen. At the same time, market speculation can drive prices considerably higher in the short term. A large number of people believe oil is oversold, and should see higher prices, regardless of fundamentals. Bespoke Investment Group cites a Bloomberg poll of oil analysts, and makes note of the following:

As shown, the median estimate for the end of this quarter remains at $66, which is more than $20 above the current price of oil. Good luck with that one! For the end of the first quarter, analysts are collectively looking for a price of $64. By the end of Q3 '09, analysts expect oil to be at $71.5. Expectations are for $83 by the end of 2010, $100 by the end of 2011, and $95 by the end of 2012. Based on these estimates, analysts aren't expecting the speculative high of $145 to be reached at any time over the next four years, but they are expecting a considerable rebound.

In summary, I will be looking for a decent bounce in oil prices here, but will not necessarily expect prices to continue higher indefinitely.

Looking at emerging markets charts, the ETFs for China, Russia, and Brazil all look intresting.

- FXI has support in the 28.00 area.

- RSX: The Russian market will benefit from higher oil prices, and P/E ratios for Russian stocks are relatively low. I will start buying over 15.85.

- EWZ: Brazil will benefit from the rally in commodity stocks, and PBR is a large component of EWZ. The chart looks like it is putting in a low here.