Friedman’s Futures Forecast: October

By Jeff Friedman ISSUE 710 | October 2008

All I can say with some certainty about the market outlook for October is that volatility has exploded—get used to it! We are in historic times. Last month, I thought the stock market might test a bottom, but that we’d largely have a trading affair in most commodity markets. I did not imagine what a rollercoaster ride it would be.

We have faced an emergency government rescue of the financial sector, which will affect not only Wall Street but also Main Street too. I don’t like to call it a bailout, but everyone knows the figure and it’s huge, $700 billion. Bear Stearns, Fannie Mae, Freddie Mac, AIG, Merrill Lynch, Washington Mutual, I’m not sure I can count all the victims of this financial crisis in the past month. We might have more to come. This emergency measure was needed because credit, the ability to borrow, has frozen up. You may say you don’t care, but you should. It affects us all. And it’s affecting world markets, as the events of the past few weeks have proven we are all tied together in the global economy.

We know that when America sneezes, the world can catch a cold. The U.S. might not have the same influence it had previous eras, but if our economy breaks down, other nations will feel the pinch. The initial financial rescue package spearheaded by Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke failed to pass through Congress as September came to a close. Some people say we needed market capitulation, and we got it. The Dow Jones Industrial Average fell more than 770 points, its worst one-day point-decline ever, when the initial package failed to pass on Monday, September 29. The “no” vote sent equities into a freefall, and the CBOE Market Volatility Index (VIX), seen as a measure of “fear” in the equity market, surged to a record above 46. The market had been suffering longstanding subprime mortgage issues, and it all quickly came to a head. It was almost out of control.

Revisions and concessions were made to the initial package to push it through. It gives the Treasury authority to buy bad assets from companies’ books, the FDIC the ability to raise deposit insurance temporarily to $250,000 from $100,000 by borrowing from the Treasury, and includes some tax breaks for both businesses and consumers. The revised package got the stamp of approval from Congress last week, but the stock market was focused on the aftershocks, sinking to multi-year lows.

There is no medicine or magic pill to fix the market. What the people in charge are doing is trying to stabilize the markets. If the S&P needs to go to 750, so be it. If the housing market needs to collapse further in 2009, so be it. The rescue package was passed, but concrete actions haven’t yet been taken by the government in regards to buying bad loans or other measures. It will take time. It’s going to be a long, hard road.

For most of the past year, commodities of nearly all types rallied as stocks dropped. We saw record highs set in markets like crude oil, gold, corn and soybeans. Pension funds, mutual funds and hedge funds were pouring into hard assets as the stock market remained in a prolonged bearish trend. The mother of all bull markets was crude oil—investors were using it as a hedge on stock market declines. But during the big stock plunge in late September and into October, we noticed amid bouts of equity panic selling, there was also general demand destruction for nearly all types of assets. People were getting out of everything, and looking for some sort of safe-haven in case of a recession, or even a depression. They are worried about hitting the soup line. Gold exploded to the upside, and we had a flight to quality paper in the form of Treasury instruments.

Now that the plan has passed through Congress, it’s hard to know what will happen in the markets next. The Savings and Loan crisis of the mid-late 1980s may offer some precedent of what might play out. As the government tries to get out of its bad assets, I think the credit markets will start to ease up. Bernanke said they’ll be buying assets at fire sale prices, getting them off the books of troubled institutions, and slowly start to rebuild value.

Even if credit eases up, that doesn’t mean the return to a healthy bull market in stocks, or that the threat of recession is over. These problems are spreading to Europe, and that’s caused the U.S. dollar to rally.  The euro is down about 13 percent against the dollar after peaking at a record high of nearly $1.61 on July 15. It fell another 4 percent against the dollar in September, and started October off with more losses.

The euro basically fell apart as the bad news spread to Europe, where governments had to take action to save major banks there in the past two weeks. Several banks were bailed out by European governments, and/or nationalized. European policymakers realized they’d have to do something to keep their act together. The European Central Bank met during the first week of October and decided to keep its benchmark short-term lending rate steady at 4.25 percent. However, President Jean-Claude Trichet said there was a discussion of a rate cut amid troubled times and that got the market’s attention. Then on October 8, we saw six global banks cut interest rates, including the ECB and the Fed, as emergency action was seen as needed. The markets were gyrating wildly, spiraling out of control.

“The economic outlook is subject to increasing downside risks” mainly “stemming from ongoing financial-market tensions,” Trichet said. The threat of inflation has ebbed a bit in the Eurozone, causing many to bet a rate cut is inevitable, closing the gap a bit between rates between Europe and the U.S. 

To pay for the U.S. rescue plan, the government would likely issue more Treasuries, and the increased supply should push the dollar lower. However, inflation is likely to be less of a concern in Europe as the contagion spreads, and some are thinking the U.S. is a step ahead of many other nations in terms of pulling out of trouble.

The euro fell to a 13-month low against the dollar after Trichet’s comments following the October 2 ECB meeting, slipping to $1.3748, through support at $1.390. (See the euro FX futures chart below.) Closes under $1.390 - $1.380 strengthened the dollar’s bullish case, and suggest better prospects for the U.S. are ahead. As an economy, the U.S. should be better off than Europe as the U.S. is thought to be farther along at working out its financial problems.

The ICE Dollar Index futures contract has risen above 80, but we need to watch for multiple closes above 81 to energize the bulls. If the dollar continues to rally, that will lean on commodities. Overall, I think the dollar has likely bottomed. That being the case, any gains in commodities will likely be more methodical and selective than in the past year, when everyone was rushing into commodities or any kind with near abandon.

S&P 500  
As far as the S&P futures, the market is likely to remain volatile even though Congress passed the rescue package. Investors have been saying “get me out of everything.”  By no means are we out of the woods yet, and I would be looking for places to sell as I believe we are still in a bear market. The failure of December S&P 500 to hold 1130 on a closing basis is very bearish, and technically, there is no clear sign of a bottom yet even though the market sunk to four-year lows in early October. I see 968 as the next downside target in the December S&P futures. Even though the market is oversold and is trying to form a bottom, that doesn't mean it can't go lower.

On the flip side, a close above 1235 will likely bring 1300 by year-end. The index would still likely see double-digit losses on the year even if we get a more optimistic scenario.  Most people underestimated the extent of this credit problem, how fast it would accelerate, and how it would seep into our economy so quickly.

Crude Oil
People will likely be thinking the U.S. will be coming out of its problems once the details of this package are implemented. While dollar strength usually brings weakness in commodities, as many are priced in dollars, I would think the easing of credit would be good for some commodity markets as the outlook for industrial and consumer demand brightens. Crude oil will react to demand prospects, based on the health of the economy.

I had thought $111 a barrel in crude oil would hold, and it did for a while. But then the rug was pulled out, and we saw unwinding, panic selling. Crude oil broke through support at $90, which could bring more selling down to $85 or $82. Some people think oil could even fall to $60. I think crude oil will rise back above $100, however, once things stabilize. I agree with oilman and investor T. Boone Pickens that fundamentals are not supportive of that big a price drop. Our world still needs oil to run.

Gold
In general I see the dollar as bottomed, which will put a ceiling on many commodities in coming months. Gains will be more methodical.  If the thinking is that the economy will improve into 2009, safe-haven buying in gold will be unwound. Gold has had incredible ranges, incredible volatility.

Some of the flight-to-safety in gold was taken out after the Senate passed the revised rescue plan overnight Wednesday, October 1, then fell further after the House passed the plan on Friday, October 3. December gold futures fell $58 in one week, but buyers have been returning to gold time and again on stock market drops. Technically, I see closes under $860 likely to bring $800 into view. If that doesn’t hold, $740 looks to be the next support point. If the stock market sells off further, gold may gain some renewed strength and a close over $940 in nearby futures should project a run to $1,000.

We’ll see what happens in the coming weeks; this past one has been interesting to say the least. In conclusion, I want to emphasize the importance of money management given the environment we are in, where ranges are out of control. Use stops. Undertrade. Keep some capital on the table—risk only 10 percent or less. There will be plenty of opportunities to come. We have a presidential election coming up, and that’s going to be a close race. And likely another wild ride for the markets!

Please feel free to call me to discuss these or other markets, and to incorporate specific trading strategies for your account size and risk tolerance. Good luck and good trading!

Jeff Friedman is a Senior Market Strategist with Lind Plus. He can be reached at 866-231-7811 or via email at jfriedman@lind-waldock.com. Join Jeff for his monthly webinar, Friedman’s Futures Forecast, by visiting Lind-Waldock’s events page. You can view an archived webinar of this forecast at www.lind-waldock.com/events, where Jeff covers even more detail.

Kristina Zurla Landgraf is editor of Lind eWire. She can be reached by email at editor@lind-waldock.com.

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