Middle East Troubles Mean No Rest for the Market

Yesterday, investors were denied the luxury of easing back from the long holiday weekend because of rising concerns over the rising violence in the Middle East. Returning from an extra-long holiday weekend, I'm facing the same challenge today.

Clearly, the escalating violence in the Middle East and corresponding spike in crude prices is causing unease on Wall Street. The developments in the Middle East threaten to undermine President Bush's war on terrorism, as The Wall Street Journal observed this morning. Since Bush has said battling terrorism is the main focus of his presidency, it's not a stretch to say setbacks on that front could threaten his entire agenda.

On a less political note, energy prices remain a key determinant to both inflation and consumer spending and confidence. At midday, crude futures were up 4% and pushing toward the $28-per-barrel level. In reaction, stock proxies moved solidly lower, although they had rebounded from early weakness by midday.

But "problems in the Middle East have been there for 2,000 years -- [the] hatred is well ingrained," observed Kent Engelke, capital markets strategist at Anderson & Strudwick in Richmond, Va. "The simple fact of the matter is that markets are eventually dictated by present and future economic activity. The bond market is suggesting that the Fed is too complacent. Equities on the other hand are searching for earnings visibility."

Engelke's comments run the risk of being self-evident but are notable for their ability to summarize the current environment. More to the point, his observations are being reflected in the market.

In addition to the latest rise in crude prices, equities were reacting to a spate of negative corporate news, highlighted by PeopleSoft's (PSFT Quote) profit warning. Additionally, market-cap behemoth Microsoft (MSFT Quote) was down after Goldman Sachs cut its earning estimates; Tyco (TYC Quote) was under pressure of multiple analysts' estimate cuts; and Bristol Meyers Squibb (BMY Quote) was lower after warning that its inventories are too high.

U.S. Treasuries, meanwhile, were rallying from their morning lows after a weaker-than-expected factory orders report, rather than from the political unrest between Israelis and Palestinians. The price of the benchmark 10-year note was recently up 12/32 to 96 7/32, its yield falling to 5.37%.

The point being Treasuries haven't benefited from any "flight to safety" trade of late. Conversely, gold and related stocks have benefited from geopolitical distress. Midday, gold futures were up 1.1% to $307.50, while the Philadelphia Stock Exchange Gold & Silver Index was down 0.2% after having hit yet another 52-week high early on in the session.

Timing Is Everything

As if what's described above isn't bad enough (for those long), Stock Trader's Almanac reported this morning that its seasonal sell signal has been triggered and is the earliest signal on record since 1950.

"For those using the 'Best Six Months' trading strategy, this is the indication to get out of the market index vehicles and into cash equivalents," according to an email from the Hirsch Organization, which publishes the Almanac.

The signal is based on a combination of Gerald Appell's MACD (moving average convergence-divergence) technical timing indicator, and the Almanac's own work that shows the best time to invest since 1950 has been from Nov. 1 through April 30. Conversely, May 1 to Oct. 31 has been the worst six months to invest.

The signal actually went negative on March 20 when the Dow closed at 10,501.60, but the publishers decided to wait because of the "seasonal aspect of the signal calls," according to Jeffrey Hirsch of the Hirsch Organization.

For the signal to get back into positive territory today, the Dow would have to rise more than 646 points on the day to close above 11,008. "Clearly, that is not going to happen," Hirsch noted. "Without much in the way of bullish corporate information and rampant investor and consumer complacency, the financial markets continue to be ultra news-sensitive [and] turmoil in the mid-east remains the market's overarching problem."

Today's call reverses a buy signal given by the firm on Oct. 2; heading into today's session, the Dow had gained 15.8%, the S&P 9.1% and the Comp 24.8% since Oct. 2.

Hirsch expects the market to revisit/retest its September lows sometime during the next six months, perhaps by late spring/early summer. But he offered the following "silver-lining" observation: Analysis of presidential election cycles shows the market fares worst in the first two years of most U.S. presidencies. Since 1914, the Dow's average gain from a midterm election-year low is 50.2%.