Wednesday, April 15, 2015

Oil Likely to Signal Next Major Market Correction, Eventually

The trading pattern of the major U.S. stock indices (DIA) (SPY) (QQQ) during since the beginning of 2015 is best described as sideways and volatile.


A review of the equity market indices shows the 50 day moving average of DOW and the S&P500 barely maintained a positive slope in the first quarter, while the trading range showed a loss YTD of almost 5% in early February only to recover to a positive 2% by early March, a range of 7%.  The tech heavy NASDAQ was a better performer in the first quarter, providing relative gains of 2% for the 1st quarter, and currently up 3% for the year.  This pattern is indicative of a market in which stock buyers are increasingly wary of the valuations of large capitalization stocks which are expected to suffer earnings hits in the coming quarters because of a strong dollar, while riskier bets on technology that derive benefit from lower overseas cost of goods paid off.

The market dichotomy of technology out-performance while more commodity based industries suffer is not unusual.  There are two instances in recent history where the major market indexes were driving to new highs while commodities, and in particular oil, suffered major corrections - the mid 1980s and the late 1990s.  The actual market characteristics are decidedly different today; for one neither of these last two points in history had a zero-bound interest rate policy at the Fed.  In addition, there is no major technological discontinuity today  such as the analog to digital transformation in the 80’s or the dot.com boom of the late 1990s.  However, the investment pattern is similar.  And the tendency of investors to see relative value in technology over alternatives is evident, not only in the U.S., but also in foreign markets, particularly China (U.S.Dot-Com Bubble Was Nothing Compared to Today’s China Prices – Bloomberg, April7, 2015).

Why are market investors currently bidding up the values of technology firms which are characteristically cash burning bets with a few big hit survivors, versus continuing to plow money into the more conservative stocks?  It is within the context of this market scenario that is beginning to play out in 2015 that investors need to continue to assess the likelihood that the U.S. equity market will “correct” from its lofty relative valuation levels before the new tech bets being placed can pay-off.

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