Bulls Embrace Crude Reprieve

Shares move higher as oil prices retreat, but volume is light and obstacles to higher prices remain.
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Bulls had a go at it again on Monday, taking advantage of a pullback in oil prices from all-time highs to continue pushing major stock proxies higher.

The

Dow Jones Industrial Average

finished up 34.07 points, or 0.3%, at 10,634.38. The

S&P 500 index

was up 3.48 points, or 0.3%, at 1233.87. The

Nasdaq Composite

finished up 10.14 points, or 0.5%, at 2167.04.

Among stocks in focus,

Agilent Technologies

(A) - Get Report

soared nearly 15% after posting better-than-expected estimates and agreeing to sell its semiconductor business for $2.6 billion to Kohlberg Kravis Roberts and Silver Lake Partners. Agilent will also sell its 47% stake in Lumileds Lighting for $950 million to

Philips Electronics

(PHG) - Get Report

.

Apple Computer

(AAPL) - Get Report

gained more than 3% after Piper Jaffray said the company is its top recommended large-cap stock for the rest of the year.

And

Time Warner

(TWX)

climbed 1.4% after billionaire shareholder

Carl Icahn demanded the company take action to help its sluggish stock. Icahn wants the company to separate its cable business from its content business and buy back more of its stock.

But without a doubt, the star of the day remained crude oil. After closing at an all-time high of $66.86 on Friday and briefly trading above $67 early Monday, crude oil fell back 59 cents to $66.27 a barrel.

While there's little evidence that oil prices and the stock market move in tandem on a daily basis, investors seem to react to psychologically significant levels, such as round numbers or new highs, according to Chris Johnson, market strategist at Schaeffer Investment Research.

As the price of oil moved moved up to levels such as $50 or $60 per barrel, he notes, the stock market also was rising. When the levels were hit, stocks pulled back as investors paused for emphasis. "But then oil comes down a bit, and when it goes back up investors have that kind of 'been there, done that' type of reaction," Johnson says.

That's what seems to have happened Monday, and bulls saw no reason to hold back putting money in the market at the start of the week. But if recent action is any indication, buying momentum at the beginning of the week can quickly give way to selling and choppy action.

Together with bullish investor-sentiment surveys, this sideways action and the market's unability to break higher is telling Johnson to "at best remain on alert and to continue trading very cautiously."

That sounds like wise words given all the headwinds now facing an equity market full of positive expectations for economic growth and profits. Both the second-quarter GDP and earnings came in much better than expected and more of the same is expected for the third quarter. But overoptimism can only set up the market for disappointments.

And this is where the impact of the price of oil becomes more than just a catalyst for daily trading moves. A close reading of the latest economic conditions shows that while rising energy and costs have not yet hit bottom lines, the time of reckoning may be closer than currently expected by the market.

Monday morning's news that economic activity in the New York region fared much better than expected in July, for instance, also revealed the inability of businesses to pass on higher prices to consumers, which is not exactly good news for profit margins.

The market, however, may cheer the fact that with businesses largely unable to pass along higher input costs, Tuesday's July consumer price index should be tame, excluding food and energy that is. The headline CPI is expected to have risen 0.4% in July, after being flat in June. But without food and energy, core inflation is expected to have ticked just 0.2% higher, after rising 0.1% the previous month, according to a

Reuters

survey.

Gasoline prices have risen about 14 cents on average from June to July. But core inflation, meanwhile, has been held down by sharp cuts in car prices, thanks to generous incentives from the auto industry.

The market's reaction to the report will depend on whether or not the number is in line with expectations -- not on what the implications of higher gasoline prices may be down the line.

Beyond the market's immediate reaction, there is increasing evidence that consumers are finding it harder to cope with surging gasoline prices. The latest signs being weak department store and retail sales, and a dip in the University of Michigan's survey of consumer sentiment.

"So the moral of the story is that after driving the brand new car off the dealer lot and filling it up -- at $3-plus gallon now in California -- on the way to the mall, the consumer quickly realized that there was no change left to go on a fashion buzz," mused Merrill Lynch economist David Rosenberg.

The bond market seems to have been discounting that much since last week, when the price of the benchmark 10-year bond rallied and its yield fell back 15 basis points. On Monday, however, the stronger-than-expected economic performance of the New York region gave an excuse for some profit-taking ahead of Tuesday's CPI. The bond fell back 10/32 and its yield rose to 4.28%.

And so even if at some point businesses do pass on higher prices, consumers whose confidence already seems to have been hit will bear the brunt. Lower sales, of course, can hardly be better than shrinking margins for profits.

For Schaeffer's Johnson, investors really will wake up to the problem when oil starts hitting bottom lines -- either via rising input costs or declining consumption -- of mainstream companies, and not just those of the most obviously affected ones such as airlines. (On a related note,

Delta Air Lines

(DAL) - Get Report

fell 13.7% after a report in

The New York Times

said the airline is in talks to line up bankruptcy financing.)

"When

Wal-Mart

(WMT) - Get Report

which reaffirmed its August same-store sales forecast Monday,

Target

(TGT) - Get Report

and others start feeling the pinch and then pass on prices to consumers, something will click and the selling pressure will get quite bad," Johnson predicts. "For consumers, not only will it cost more to get to the store, but then they have to pay more to buy products."

Partly for these reasons, the strategist is bearish not just for August, but for the rest of the year.

To view Aaron Task's video take on today's market, click here

.

In keeping with TSC's editorial policy, Godt doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He appreciates your feedback;

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