Momentum Traders Are Between A Rock And A Hard Place

by: David White

Momentum traders like to run the market up. They spout continuous propaganda about how well the economy is doing, how well earnings season is going, or how sure they are that the Fed is going to inflate stock prices with further QE. They always seem to have some excuse for the market to go up. With Dr. Bernanke helping them out since 2009, they have often succeeded in running the market up.

Just now the momentum traders are between a rock and a hard place. They cannot say all is right with the EU-27 economy. It was down -0.3% in Q4 2011, and it will likely in the next couple of weeks again be reported as negative for Q1 2012. This would put the EU-27 economic bloc officially in a recession with two consecutive quarters of negative growth. The U.S. has been better. It reported a +3.0% GDP growth rate for Q4 2011. However, the recent preliminary Q1 2012 report was growth of only +2.2% versus an expectation of +2.5%. On top of that the U.S. Durable Goods Orders for March were down -4.2% versus an expectation of -1.7%. Plus the Initial Claims numbers have been rising in recent weeks. Even the Case-Shiller 20-city Index was down -3.5%. There was some minor good news, but it could not compete with the overall negative tone. Much of the above data came from Yahoo Finance.

Expectations for earnings season were very low. Estimates were set to reflect only 0.93% EPS growth year over year. These estimates were being handily beaten before the week of April 23-27, 2012. However, last week some of the mainstays were big disappointments. A bunch of the big oil companies such as Exxon Mobil (NYSE:XOM), ConocoPhillips (NYSE:COP), Chevron (NYSE:CVX), and Hess (NYSE:HES) either missed or came close. Plus they all seemed to issue disappointing guidance. This was partially due to the extremely low price of natural gas currently. However, there were other reasons. For instance, Hess complained it had to drill some wells in non-optimum locations in order to maintain its leases as many leases are HBP. Hess expects this to make it fall short of its oil production goal per day for the end of 2012. In another light this is also a reason many natural gas companies will have to continue drilling for natural gas, even though there is currently a glut in the market. A huge number of natural gas companies have leases that are HBP. Without any production, the companies will lose the leases. The problems brought about by low natural gas prices are not going to go away. In fact they may worsen. Chesapeake Energy (NYSE:CHK) is one of the companies that have been hit hardest by this. Part of the reason for this is that the CHK CEO has again overextended himself financially, and now people are wondering if it will affect the company's progress going forward. Some are also calling for his replacement and possibly the board's replacement. The US natural gas storage level has continued to rise. The amount in storage is 872 Bcf higher than last year at this time, and it is 908 Bcf higher than the five year average for this time of year. This trend is strongly upward. US natural gas in storage may exceed current US natural gas storage space by sometime this summer. Such an eventually would likely lead to a further drop in the price of US natural gas. On top of this a number of regional banks missed this past week. Zions Bancorp (NASDAQ:ZION) was one of the bad offenders with a -48.10% miss (it still made money). S & T Bancorp (NASDAQ:STBA) is another example with a -41.00% miss. Add some weak technology stocks to this such as Radio Shack (NYSE:RSH), ARM Holdings (NASDAQ:ARMH), etc. and you have a hard time claiming that earnings are going well. The momentum traders can hope for a rebound this coming week. However, last week can only be considered devastating to the momentum traders' propaganda.

The momentum traders did hear Ben Bernanke say last week that he stands ready to come to the aid of the economy if it weakens noticeably. However, the Fed already has operation "Twist" in place. It is unlikely to add anything else until that expires. It is also unlikely to add anything else until the price of oil falls significantly. Bernanke has recently stated that the price of oil is the biggest threat to the U.S. economy. The U.S. runs a huge oil trade deficit. If oil prices go too high, this trade deficit effectively crushes U.S. economic growth. If Bernanke acts to make oil prices increase too much (with too much QE), he will effectively kill U.S. economic growth, which is contrary to what he is trying to do (create jobs and create monetary stability). Bernanke won't just blandly add more QE because the economy is weakening. He can't with still high oil prices. On the other hand if he lets Treasury yields rise too much, the U.S. debt will be more expensive to finance; and the USD will rise. This would tend to make U.S. exports fall. This scenario would also hurt U.S. growth. This puts Bernanke between a rock and a hard place along with the momentum traders.

It would seem the momentum traders now have a choice. They can let oil prices fall, and they do seem over due for a retracement. The overall market will likely fall right along with the oil prices. The S&P500 is heavily oil dependent. Alternatively, they can try to move the market upward or sideways. If they do this they will simply allow it to get far sicker before it falls. Oil prices rise almost invariably with the advent of hurricane season and the summer driving season. Keeping oil prices high now will make a US recession more likely.

Many of these momentum traders are the large brokerage houses and hedge funds. They often use their funds to help create momentum. Their overriding rule is that they like to make money. Their secondary rule is that they like to be able to talk others into investing their money in the markets. If they start having trouble making the market go up further, they most often let it fall (or help it to do so). They may lose some money during such a fall, but they will generally make a lot more as the market eventually moves up again. If Goldman Sachs' Chief Forecaster, David Kostin, sees a three month target of 1275 on the S&P500, this gives me a big clue that at least one of the big momentum traders is expecting a down movement in the overall market soon. When Morgan Stanley's top people voice similar sentiments (David Darst and others), it makes me think that the momentum traders are ready to let the market fall. It is hard to time such a fall perfectly, but it is a good idea to reduce exposure for the near term. It is also a good idea to consider that oil may have to fall to allow for further QE. Oil has to fall to allow for a run up in the summer driving season and hurricane season. Otherwise "too high" oil prices may drive the US economy into recession. There is little time left for this fall to occur. Both hurricane season and the summer driving season start in June. This makes me think such a fall in both oil and the overall market could be upon us soon. It may really be time to "Sell in May, and go away." I do expect the oil fall to be much weaker and much more short-lived than a market fall. However, after the week had by XOM, COP, CHK, CVX, HES, et al last week, now does seem like an opportune time. Most of the maintenance work on the refineries is complete or nearing completion. It's now, or we can expect a lot worse in the months ahead. $130/barrel WTI oil could ensure a U.S. recession (or a much worse U.S. recession). Do the momentum traders want this?

It is time to lighten up on positions, especially oil.

Disclosure: I have no positions in any stocks mentioned, but may initiate a short position in XOM, CVX, COP over the next 72 hours.