Take Advantage of a Market Reversal

The China economic boom is for real, sort of. The big Asian country is using 55% of the world's cement as it barrels toward its plan to triple its network of highways by 2008. Despite having four times as many people as the U.S., China currently has a third as many railways and one-fifteenth as many airports, according to researcher Jim Williams of Williams Inference Center.

This sounds like a recipe for a continuation of the first quarter's rise in the shares of companies that produce commodities such as steel, coal and concrete -- and thus higher raw-materials prices and inflation for everyone else. Yet you still have to wonder why, if China is so hot, its stock market is sitting at six-year lows.

Energy prices are skyrocketing, maybe. The price of crude oil is up more than 60% in the past year as investors come to grips with an issue that I pointed out a year ago: That OPEC's ability to pump out excess high-quality petroleum to meet the rising needs of India and China -- not to mention the desire on the part of Japan and the U.S. to boost stockpiles for a rainy day -- is suspect. Oil prices dampen the world economy on a one-year lag as cheaper inventories are gradually drawn down and replaced by the more expensive stuff, so it's about time for the drag line to hit if it's going to.

Yet it's also well-documented that higher prices encourage conservation and sap demand. If oil buyers get a strong whiff of any slackening in end markets, they will almost certainly back away. One experienced oil trader who has made a ton of money long this year told me that he'll sell heavily if crude fails to move through $58. He expects to see it in the mid-$40s by summer.

Interest rates are bound to move higher, perhaps. The conventional wisdom believes that the Federal Reserve will push short-term interest rates a quarter of a percentage point higher at every Federal Open Market Committee meeting from now until Chairman Alan Greenspan presumably leaves his post early next year. That would put the federal funds rate at 4.25%, a level that the central bank has deemed pleasantly "neutral" -- which is to say, neither stimulative to the economy nor a drain.

Yet the Fed has proven itself flexible, if nothing else, and last week at a major economic conference at Princeton University, Fed governors reportedly acknowledged that they are sensitive to short-term economic data and could hold fire if presented with persuasive evidence that tight-money policies were leading to a U.S. slowdown. With companies clearly so fretful about the future that hiring is at an astonishing multiyear low, analysts say another weak employment report could stay the Fed's hand -- a move that could cheer investors.