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Gloom Lifts as Crude Slips

Worries about hedge funds retreat, for one day at least, but they're now the No. 3 owner of Treasuries.
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With rosy glasses on, traders overlooked weak economic indications in the New York region Monday and set aside recent concerns over hedge funds. More mergers and continued weakness in the price of crude oil provided strong support for the major indices.

The

Dow Jones Industrial Average

rose 112.17 points, or 1.1%, to 10,252.29. The

S&P 500

gained 11.64 points, or 1%, to 1165.69. The transportation and airline sectors were boosted by merger news as

UPS

(UPS) - Get Report

agreed to buy

Overnite

(OVNT)

for $1.25 billion. Meanwhile,

US Airways

(UAIRQ)

and

America West

(AWA)

are reportedly near a merger deal.

The

Nasdaq Composite

added 17.65 points, or 0.9%, to 1994.43. The tech-heavy index escaped unscathed from last week's pullback, as it posted its fourth consecutive week of gains.

But even as hedge funds faded from the headlines -- at least for one day -- it appears that their current positions are behind market developments in oil, Treasuries and tech stocks.

Hedge funds are rumored to be behind ongoing weakness in the price of crude oil as they unload long positions in crude to make up for losses related to the trades they placed on

General Motors

(GM) - Get Report

stock and bonds. On Monday, crude oil touched $48 a barrel earlier in the session, before bouncing back and closing down 6 cents at $48.61 in Nymex trading.

Perhaps of more direct interest to investors, hedge funds also could involuntarily push a short-term rally in tech stocks, which are poised to rally "more than investors may expect," according to Merrill Lynch strategists.

Why? Just like the "crowded trade" over General Motors that led to some massive movements in GM stocks and bonds, there is currently another "crowded trade" in tech, says Mary Ann Bartels, global equity trading strategist at Merrill.

The sector, for starters, is smack full of short positions by hedge funds. Recent indications show the net long position in Nasdaq 100 futures by large speculators -- i.e., hedge funds -- are in fact at historical lows.

Yet the Nasdaq 100's April low has held well, and the index has fared better than the S&P 500 over the past four weeks. In addition, Merrill technical strategist Richard McCabe expects the major indices to retest their March highs, heightening the potential for a short-squeeze to boost the tech sector.

Among the technical indications used by McCabe is the five-week bull/bear ratio in the American Association of Individual Investors survey that points to "a degree of pessimism that is on a par with other significant market lows in the past 10 years," he writes.

Overall, the tech sector has been shunned so far this year, as the Nasdaq Composite underperformed the S&P 500. Fears of a decline in tech spending -- exacerbated by a warning from

IBM

TST Recommends

(IBM) - Get Report

in April -- have since eased. There also have been strong earnings reports from tech icons such as

Intel

(INTC) - Get Report

,

Yahoo!

(YHOO)

,

Juniper

(JNPR) - Get Report

,

Motorola

(MOT)

, and

Nokia

(NOK) - Get Report

.

Bartell's strategy, including bullishness over techs, is a short-term one. And Merrill's McCabe says that even if the major indices make new highs for the year -- maybe by early summer, "the market has a high risk of peaking on its post-2002 bull cycle sometime this year."

Energy Blues

Bank of America market strategist Tom McManus, meanwhile, remains long-term bullish on the energy sector. The sector is an "inflation beneficiary" and McManus' long-standing position is that inflation is on the rise and that long-term Treasury yields will rise. (On Monday, the price of the benchmark 10-year note fell 2/32, its yield rising to 4.13%.)

Certainly, iconic oil stocks such as

Exxon Mobil

(XOM) - Get Report

have taken a beating as the price of crude oil slid over the past few weeks. The Amex oil index has lost 8% since April 4, when oil prices reached new highs.

It's hard to pinpoint exactly what's behind the recent weakness in oil, especially as most analysts believe that it was simply overpriced and not reflecting fundamentals as it approached $60 per barrel. High U.S. inventories and slowing global growth have been commonly cited as causing the recent weakness. And of course, after the recent turmoil in credit markets, hedge funds are rumored to be unloading some of their commodity positions to offset losses elsewhere.

The rise of the greenback also has had a dampening effect on the price of dollar-denominated assets, including crude oil. OPEC members, for instance, don't have to charge as much to make the same amount in their home currency.

Last week, the dollar hit a seven-month high against the euro amid new evidence of U.S. economic resilience. After the robust April employment report, strong retail sales and a narrower-than-expected March deficit made economists revise upwards their first- and second-quarter growth estimates. The data boost the case that the

Federal Reserve

will continue raising interest rates to stay on top of inflation. That's a strong positive for the dollar as the currencies in other major economic zones face stagnant rates.

Nevertheless, inflation will continue to depreciate the value of the dollar, says McManus. That would mean that still-decent economic growth, but a weak dollar, should continue to support energy prices and the performance of energy stocks.

The greenback did take a hit Monday after news that the New York Fed's regional survey of economic activity fell to two-year lows in May. In addition, the Treasury International Capital (TIC) report for March revealed a decline in foreign purchases of Treasuries from official sources. Notably, Caribbean banking -- aka hedge funds -- has now topped the U.K. as the third-largest regional holder of U.S. Treasuries.

That means the U.S. trade deficit is now being financed in large part by hedge funds -- not a very reassuring trend, if the recent impact of the GM story is any indication of the destabilizing impact that hedge funds can have on markets.

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 invites you to send

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