With all eyes on the Fed for a potential change in monetary policy, many so called experts have prematurely predicted a pause or an end to the rise in short term interest rates. What has become clear is the Fed will not reverse course until there are signs that higher interest rates have reined in credit and demand growth.
It is also clear that the Fed has the speculators in the housing market clearly in its crosshairs. The same problems that with existed with past rate increases, still exists today. There has always been a lag between Fed policy changes and their eventual impact. As in the past, the Fed will over tighten, profits will decline, and growth rates will decelerate.
Oil Prices Will Come Down
Everyone is well aware of the long term supply and demand issues, and refining problems surrounding oil. Obviously, the enormous demand from the emerging Asian nations will reap havoc in the years ahead.
In the short term however, the recent spike in oil prices has lead to a demand response that is setting the stage for an over supply correction in oil prices.
In recent posts, I have alerted you to some key technical points in the price of oil. IE- September 28th post:
The price of crude has been stuck in a trading range of roughly $71 to $63. Within this range the price of oil continues to narrow. A break above $68 will signal higher prices, while a break below $63 could mark the beginning of a bearish pattern. Our first target on a break below $63 would bring the price of crude down to $55.
Our first target for oil is $55/bbl, and sometime in 2006 I would not be surprised to see prices drop to $50, and an occasional drop below that level.
As you have probably noticed, oil related stocks have a hair trigger response when oil prices decline, and a rather muted response when oil prices rise. This leads us to the conclusion that a drop in oil prices will have a greater negative impact on oil shares than we previously thought.
A fall to the $50/bbl mark would probably cause a 10-15% price correction in most oil related shares. This price correction would also present us with a major buying opportunity. We will be looking to take a few profits next week.
Natural Gas:
I am not as cautious on Natural Gas as I am on the price of oil. In the short run, a mild price correction cannot be ruled out, but I do not think we will see a sizeable pullback until spring.
CRB- Raw Materials
A slowdown in US growth will not have a meaningful impact on China. In fact, as the price of oil declines, China's economic expansion will accelerate. This is bullish for Raw Materials, and adds to my opinion that the momentum in Raw Materials will be sustained. This is one reason we are increasingly optimistic on Cemex (CX).
Market Sector Shifts: Sector Rotation
With the expectations of lower growth, one needs to examine their portfolio's to prudently reduce risk. The Small Cap and Value sectors have performed well over the past 24 months, and with growth slowing, these sectors seem to be at most risk.
The Small Cap sector has been a huge beneficiary of the housing boom. As the housing sector cools, so will the performance of the Small cap Indexes. Investors in real estate have been fearless, while the most recent survey of homebuilders showed that their sales expectations for the future have turned cautious.
We are moving are focus a long the natural progression of the Market & Economic Cycle. It looks as if the Energy Sector will begin to go out of favor in the months ahead, and the Consumer Staples and Healthcare Sectors will take their place. This being said,I am not looking for the same performance out of the Healthcare & Staples sectors that we saw out of Energy.
Financials will continue to underperform until the Fed is finished raising rates. I would rather be early on Financials since they are the next sector to benefit in the progression of the Market & Economic Cycle. To view the Sector Rotation Model for yourself, go to :http://stockcharts.com/charts/performance/SPSectors.html
