Oil was first, commodities next

Equities plummeted last week and the Dow Jones Industrial Average closed below the 11,000 mark on Wednesday amid growing investor concern about inflation and the direction of interest rates. There are a couple of serious issues playing on the global financial markets, some technical like interest rates and inflation and some other influences like the distraction associated with the World Cup.

There were twice as many decliners as advancers last week. The equity markets fell 4.3% on average globally, 3.8% in the USA. Bearishness is high, which can be a good thing, especially when looking for a market bottom in a world where economic expansion is definitely happening. Remember everyone needs to get on the same page for things to change, but with inflation the only real concern at this time, we remain optimistic on the future based on the economic fundamentals that are driving growth.

On the technical side, the truth is with 30 days of downward trend from the market’s recent high, investors and traders are looking for the market bottom. Even though there have been two trading days in the last 30 where more than 90% of the stocks traded actually went down (a very rare occurrence), most analysts believe that we are in a correction, not a bear market.

With the distraction by the World Cup, distance to the US Federal reserve’s next meeting at the end of the month, and finally the triple witching (see term of the week definition) coming at the end of this week, it seems likely the markets will stay uncertain, perhaps for as long as the end of summer.

One of the more important things to consider in looking forward, is interest rates and why they are moving now. Interest rate moves are now principally based in controlling inflation. Previously, interest rate hikes were based in stimulating economic growth and then progressed to simply controlling economic growth. We note that earnings are expected to decline, albeit from above normal to normal levels, but there is still the negative effect that people see in “going down”. That said, the equity markets have been building this expectation for the past year or so, that is why the S&P P/E ratio remains in the 17 range. Oil was the hot topic last year, then commodities in general, especially metals, took off. Now maybe it will be food. Pricing in many of the food-based commodities has lagged for a long time, just like the industrial feed stocks. Maybe now is the time for the food group to take off getting better prices and margins. Corn will certainly be a major commodity in the grain market, with the price mostly driven by the need for the product in ethyl alcohol production for gasohol (fuel consisting of a blend of ethyl alcohol and unleaded gasoline). Even small increases in consumption of gasohol will bring large demands to corn production.

THE UNITED STATES

On Monday, remarks by the Federal Reserve chairman, Ben Bernanke, at the International Monetary Conference prompted a sell-off as he highlighted his concern about core inflation as the US Fed’s primary concern and the need for further interest-rate increases to control it. Bernanke stated developments, such as the core inflation as measured by the consumer price index excluding food and energy prices being at 3.2% over the past three months and 2.8% over the past six months, were unwelcome.