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It looks as if the stock market is exhausted. I think you would be well advised to ignore of the "Points Above Closing High" graphics we continue to see on CNBC.
For starters, I am expecting a 5%-10% correction on the major market averages. The market has not had a 10 percent correction in four years, and one is way overdue.
What is odd about the current market cycle is that previous Fed tightenings were often followed by a correction in the stock market. In this cycle, this has not been the case. With the threat of another tightening in the works, the stock market may react negatively to the announcement of another rate hike.
If the news of another Fed hike does not bring the market down, news of a peak in corporate profits will. High energy prices have lead to massive profits in the oil industry which has been the main catalyst for double-digit earnings on the S&P. Now that the energy sector is transitioning from its up-cycle to a plateau (but still a high levels), y/o/y earnings growth will decline for the first time since 2003. This puts the S&P's string of double-digit earnings growth in jeopardy. This alone can cause a re-adjustment in the P/E ratio of the index and in turn trigger a correction.
ENERGY
The Department of Energy announced they were going to resume filling the Strategic Petroleum Reserves at a rate of 100,000 BPD starting in the spring. They went on to say that the oil purchases will not adversely impact the market or raise gas prices. I don't get it. Over the last 5 years, the US government has been adding to the SPR's at a rate of 76K barrels per day. How can an additional 24,000 BPD (100,000-76,000= +24,000) have no impact on oil prices?
President Bush said that the Department of Energy will double the capacity of the strategic petroleum reserve to 1.5 billion barrels by 2027.
A two weeks ago (before oil inventories began rising last week), I reported that oil inventories had declined for 6 straight weeks and no one was saying why. We eventually found out that the Chinese added 12.4 million barrels of crude oil for its storage tanks in December. This was a 50% increase from November. Now we have found that Chinese oil giant Sinopec (CEO) has doubled its tank space at the Zhenhai reserve to 20 million barrels.
Since the market is (supposedly) based on supply and demand, How can greater demand lead to more supply? Last year, China imported 145.2 million metric tons of crude, which is a 14.5% increase from 2005. Given that China's oil imports are projected to grow at a double-digit rate this year, I have got to believe we are being mislead on the supply issue.
GEOPOLITICAL PROBLEMS HEATING UP
The London Times reported that Israel has drawn up plans to bomb Iran's nuclear facilities with tactical nukes. If Israel strikes Iran's nuclear facilities, the United States will be blamed, and the possibility of an oil embargo could follow. As we speak, two US aircraft carrier groups have been deployed to the Persian Gulf, and US missile systems are being sent to oil producing countries in the Middle East.
"Hurricane Hugo" Chavez has already taken steps to circle the wagons with his buddies in South America, as well as with Iranian President Ahmadinejad. On top of this, "Hurricane Hugo" is fueling the flames by telling the American Gringos to "go to hell". You have to admit, the guys got guts.
The wildcard in all of this is the formation of a newly formed agreement between China, Iran and Russia in 2005. This important geopolitical event has not been widely publicized by the press. In October 2004, both China and Russia declared the new Sino-Russian relations agreement where both countries held joint military exercises in 2005. The Sino-Russian relationship has brought China National Petroleum Corporation (CNPC) and Russian oil companies together to form a joint venture to develop energy reserves in Iran. It has been reported that China's largest energy-related investments are based in Iran.
Needless to say, any attack on Iran could cause a firestorm throughout the world. I can't speculate as to where the markets will go if troubles irrupt in the Middle East. Frankly, I don't even want to think about it. We could see a sell-off of up to 20%-25% if an oil embargo occurs, we could see much worse if China and Russia join the otherside.
