Was Market Sell-Off Due?

03/23/2009 12:52 pm EST

Focus:

Jim Farrish

Founder and CIO, Jim's Notes

Jim Farrish, editor of SectorExchange.com, says stocks sold off late last week, and there needs to be good news on the bank rescue plan to push the markets higher. 

Ben Bernanke and company decided that some aggressive action was needed to stimulate lending, especially for housing. So, they are throwing $1.1 trillion more at the problem by buying up $300 billion in Treasury bonds, $700 billion of agency debt (Freddie Mac and Fannie Mae), and another $100 billion in agency securities. He wants mortgage rates lower and looking at the response of the yield curve, for now he has just that. 

Investors’ response was to buy commodities such as gold and oil and sell the US dollar. The CRB Commodity index gained over 5% following the news. The “I” word (inflation) showed up in the media almost immediately, and the dollar declined more than 4% on the news. 

The financials lost ground, giving back 11% on Thursday and Friday after digesting the news. This negated the break above the down trend line from November on the Dow Jones Financial Index. Banks fell 14.7%, leading the sector in selling. (Financial stocks were strong early Monday and global markets rallied in response to further details about the Treasury department’s proposed bank-rescue plan—Editor.)

Gold fell to a low of $859 intraday on Wednesday and finished the week at $958, up 8%. The inflation fear from the Fed action pushed the Dow Jones Precious Metals index up more than 12%.

Crude ended the week at $51.06, jumping 7% on the Fed news. Most of the move came on the back of a weaker dollar. Supply data on Wednesday showed excess is still in place. The Organization of Petroleum Exporting Countries (OPEC) chose not to cut production, since its members aren’t completely compliant on the last cuts. That didn’t help the supply side of the equation.

If the dollar stabilizes, so will crude, and maybe even drop. I think you have to watch both supply data as well as the dollar. United States Oil Fund (NYSEArca: USO) was up 11.3% last week, breaking above resistance at $29. Natural gas, coal, heating oil, and gasoline all climbed more than 10% following the announcement.

From the lows of 667 on March 6, the Standard & Poor’s 500 index rallied more than 20%, hitting resistance at 803 last Wednesday; it closed at 768 on Friday. I am questioning if will we hold support near the 742 mark or the 20-day moving average or whether we could retest the March 6 low?

So, what to do we watch this week? Plenty!

Financials and banks: Will they hold the new short-term trend higher or reverse to test the lows? The answer lies in the reaction to the details of Treasury’s plan to buy bad assets. Do we hold support and move higher? Do we start a retest of the previous lows? The early moves will give some indication as to which way investors are leaning.

Energy: Oil, natural gas, heating oil, gasoline, and coal all made moves higher, but will the dollar flatten out and leave the sector to the supply data again? Short-term emotions are involved with plenty of speculation. I would be very cautious with the sector. Let this play out before over-committing capital.

Health care was the biggest loser last week, down 2.4%. There are question marks about the impact of the proposed health care reforms in President Obama’s budget plan. I remain cautious towards the sector; it needs to hold support at the 240 level on the Dow Jones Healthcare Index.

Basic materials were up 5% on the week, but most of the move came from the surge in commodities. There is still resistance at the 136 level for the Dow Jones Basic Materials index. Watch for a break higher on short-term momentum or a retest of the March lows at 112.

Here is my ETF watch list of the major sectors (which also is updated each night on my Web site, SectorExchange.com).

I have tightened stops and taken profits based on the Fed’s announcement. The move changed the short-term psychology of the markets. We went from a rally based on increased confidence in the financial sector to a market focused on inflation and commodities.

An additional concern is the action taken by Congress towards AIG bonuses. The 90% proposed tax could send a negative message to investors and thus temper money flow to stocks, especially financials. All of the red flags are warning signs and should be taken accordingly.

Jim Farrish, founder and editor of Melbourne, Florida-based SectorExchange.com, writes regularly about sectors and speaks widely about investing and money management.

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