Market Recap and Strategies for S&P 500, Interest Rates and Crude Oil

By Jeffrey Friedman   ISSUE 608 | AUG 2007

After a subprime lending-inspired meltdown that began in July, the stock market has found comfort from the Federal Reserve's actions to ease a credit crunch and ended last week on a positive note – especially in the technology sector. I'll take a look at the events of last week, what I see for the markets going forward, and offer some short-term strategies for trading S&P 500 and crude oil futures.

Stock Indexes See Relief

The Fed's August 17 cut in the discount rate boosted bets by the markets that the Fed will be cutting the Fed funds rate by 25 or possibly 50 basis points at its September 18 Federal Open Market Committee meeting, and make additional cuts during the remainder of the year. The stock market's recent gains essentially are showing participants have built in lower short-term rates during the rest of this year and next. Last week, the equity market was also boosted sharply by merger talk. Recent declines had partly been fueled by concern that credit would not be available for mergers and acquisitions, and the ease in the credit crunch has restored some optimism that M&A activity will pick back up – especially if the Fed cuts rates. Stocks got a nice bump up on Friday from positive reports on durable goods and new home sales, but slightly reduced expectations of a Fed rate cut damped the gains. Trading was thin at week end due to departures for vacation ahead of the upcoming Labor Day holiday.

The September S&P 500 index closed higher on Friday, August 24, extending the week's rally above the 20-day moving average near 1460. Monday, August 27 was an inside day, as September S&P traded within the prior session's high and low, a mark of market indecision. Even though the contract closed lower Monday, momentum indicators, the stochastics and the relative strength index (RSI), are bullish right now, signaling that sideways to higher prices are possible near-term. If September extends last week's rally, the next upside target is 1510-1511, near the reaction high. Closes below the low Monday, August 20 low at 1435 could temper the near-term bullish outlook in the market.

Interest Rates

Interest rates ended last week higher, but the near-end of the yield curve was whipsawed early in the week. Even though the Fed's earlier discount rate cut calmed the equity markets this past week, the credit markets remained quite jittery from subprime problems. Flight to quality was strong with demand greater for shorter maturities. At one point during trading on Monday, August 20, the three-month Treasury bill was down nearly 140 basis points and ended the day down 69 basis points at 3.07 percent. A lack of sellers increased the volatility and drop in the three-month T-bill. Also, money market managers were taking in as many short-term Treasuries as possible, partly to avoid risk and partly in anticipation of likely needing cash for redemptions. The Fed and other central banks continued to inject more liquidity in the credit markets. The Fed funds rate traded just above 5 percent and well below the target of 5.25 percent – indicating plenty of available liquidity.

On Tuesday, August 21, credit markets were calmed by an unexpected source – Senate Banking Chairman Christopher Dodd. Dodd met with Fed Chairman Ben Bernanke and Treasury Secretary Henry Paulson to discuss credit market problems. After the meeting and during a long press conference, Sen. Dodd stated that the Fed would use "all tools available" to alleviate the credit squeeze. Many saw this as Congress pushing the Fed to cut the Fed funds target rate. Dodd's comments led to a reduction in fears that the credit crunch will impact the economy, and investors moved out of short-term Treasuries, pushing the three-month T-bill rate back up to 3.64 at the end of the day on Tuesday. With the boost in durables orders on Friday, T-bill and T-note rates jumped significantly. Despite the 69 basis-point drop on Monday, the three-month T-bill ended the week up very sharply. Long-term rates were down during the week, continuing to benefit from flight to quality.

The Treasury yield curve rose last week except on the far end, which declined. Much of the rate gains reflected more confidence by investors that credit crunch problems were easing, resulting in a partial unwinding of flight to quality in Treasuries – especially on the near end.

While the liquidity crunch indeed was complex, it may have been more psychological than real, and more narrowly focused. The cut in the discount rate restored confidence, along with the Fed taking some securities with subprime components as collateral at the discount window. If there really had been a continuing broad credit crunch, we would have seen a jump in borrowing at the discount window by more than the few large banks that supported the Fed's urging to ease the crisis by getting cash (reserves) at the discount window. Problems with subprime lenders continue and uncertainty remains over the worth of securities that have subprime components. But based on the lack of a rush by lending institutions to get cash at the discount window, the liquidity problems of mid-August have faded to a large degree.

Credit and equity markets have calmed somewhat since the Fed's discount rate cut. Now, focus should be on the health of the real economy. What does the economic scoreboard show for the economy bulls and bears since the August 17 cut in the discount rate? Economic news has been limited but does give an indication on the economy's health.

Crude Oil

Crude oil prices eased over the first part of last week, only to firm the last two days of last week. Nonetheless, crude oil prices ended the week down somewhat. Prices fell $2.67 over the Monday-Wednesday period as it became apparent that Hurricane Dean would miss key oil platforms in the Gulf of Mexico. The close Tuesday, August 21, at $69.41 was the first below $70 close since June 28 of this year. Prices began to firm after Wednesday's petroleum report indicated low inventories with upward pressure continuing Thursday and Friday. A strong durable goods report on Friday, August 24, helped boost prices.

From a technical standpoint, October crude oil futures were slightly lower last week, consolidating some of their recent rally, but remain above the 10-day moving average at $70.95 a barrel. Stochastics and the RSI are turning bullish, signaling that sideways to higher prices are possible near-term. Closes above the 20-day moving average at $72.30 are needed to suggest that a low has been posted. If October renews this month's decline, the reaction low at $68 is the next downside target. First resistance is at the August 24 high at $71.34. Second resistance is the 20-day moving average at $72.30. First support is the 38 percent retracement level at $69.40. Second support is last Wednesday's low at $68.65.

Jeffrey Friedman is a Senior Market Strategist with Lind-Plus, Lind-Waldock's broker-assisted division. For questions about this market or others, he can be reached at 866-231-7811 or via email at jfriedman@lind-waldock.com.

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

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