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Market Shifts Direction on Commodity Selling

Investors shifted their focus to selling commodities. The energy sector was the highlight of their focus as crude oil declines 5.5% in two days. After hitting a closing peak of $112.73 it closed at $106.60. The selling didn’t stop with oil; agriculture and metals were sold as well along with any related sectors such as industrials and basic materials. We have discussed the parabolic move in crude and soft commodities and the risk associated with such moves. Thus, the selling shouldn’t really surprise anyone as air is let out of the speculation balloon. The question mark is looking forward.

Our view of oil is a decline back to support near the $97 mark short term. Unless there is further supply disruption to stimulate speculation, or demand changes directions abruptly, a pullback is expected. The selling on Tuesday caught the attention of investors, but the selling was not equal among secctors. Financial stocks were down, but not crushed. Retail held the 10 day moving average and remains relatively strong. Technology sold, but bounced back before the close. There is a short term pullback in play and the outcome is yet to be determined. Earnings as we have discussed will be the catalyst for the broad markets. For now we are watching the previous leaders and their relative strength during the selling. Do they hold support and set up for a continuation of the previous uptrend, or break lower and establish and new downtrend short term?

Sectors to watch on the downside are basic materials, industrials, and energy. As stated above they are selling in relation to the commodities. Basic Materials has given up nearly 50% of the move off the March lows and industrials have done likewise. Energy fell 5% over the last two trading days to lead the broad markets lower. 

Sectors to watch on the upside are financials, technology, and consumer services. They have held their ground during the push lower and could offer some upside strength should commodity related selling abate. The retail component of these sectors are the strength near term and could provide a much needed lift for the broad markets.

The volatility index is still not pointing to fear rising from investors. In fact, the index looks unconcerned about the current selling in commodities. The financial networks would have you believe the sky is falling and a mass exodus is in progress for the broad markets. Watch the VIX for indications that investor fear is rising as an indicator towards further broad market selling.  

There is plenty to be concerned about looking forward. Commodity inflation has been tops on my list of potential pitfalls to the consumer and the economic recovery. We have seen evidence of demand destruction from higher food and energy costs. Tuesday, the import prices recorded a 2.7% rise in March, almost double the expectations. Year after year they have risen 9.7%. That is the result of a weaker dollar and higher commodities. Plain and simple, there is inflation whether the Fed calculates it or not. We are not out of the woods yet relative to downside risk. As outlined above the market is at a decision point short term, and if you are focused short term in your portfolio, you need to act accordingly. The longer term outlook is still unfolding, but caution is advised.