Oil Trumps ISM Data, M&A Activity

A record close for crude sends stocks lower despite the big UnitedHealth-PacifiCare merger.
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It was an orderly retreat but the market couldn't avoid taking another hit Wednesday, as crude oil prices reached a new all-time high. Another strong economic report and news of the acquisition of

PacifiCare Health Systems



UnitedHealth Group

(UNH) - Get Report

weren't enough to offset worries about both the inflationary and growth implications of oil at new highs.

Crude oil for August delivery finished up $1.69 to $61.28 a barrel on Nymex, its highest close on record, boosted by supply concerns as Tropical Storm Cindy hits the Gulf of Mexico. Officials estimate that about 3% of the Gulf of Mexico's oil and gas production was curtailed by the storm, which is being trailed by another potential hurricane, Dennis.

In reaction, the

Dow Jones Industrial Average

fell 100 points, or 1%, to 10,272 while the

S&P 500

lost 9 points, or 0.8%, to 1195. The

Nasdaq Composite

fell 9 points, or 0.5%, to 2069.

Declining stocks bested advancers 18 to 13 in

Big Board

trading and 17 to 12 in over the counter activity, although trading volume remained modest ahead of Friday's employment report and the coming onslaught of second-quarter earnings results.

Despite oil's surge, even energy stars such as

Exxon Mobil

(XOM) - Get Report

retreated as continued dollar strength reminded traders that profits for U.S. multinationals are likely to take a hit. Concerns about second-quarter earnings were further fueled by

Zoll Medical


cutting its third-quarter EPS forecast. Zoll shares fell more than 10%.

Among other stocks in the news, PacifiCare closed up 6.1% to $77 after hitting $82 prior to its midday trading halt while UnitedHealth gained 0.5% to $53.50. In the fallout from the deal,


(HUM) - Get Report

rose 3.7% on the prospect it may also receive a buyout offer. But potential acquirers such as






dipped while

Medco Health Solutions


dropped 4% on fears that UnitedHealth, Medco's biggest customer for pharmacy benefit management, would switch to using PacifiCare, also a benefits operator.

What Might Have Been

Absent oil topping the key $60-level, the market could have reproduced Tuesday's performance, when it moved up even as crude oil rose, thanks to strong economic data.

The trading session began on a positive note as the market first welcomed news that the nonmanufacturing survey by the Institute for Supply Management showed surprising strength for June. The ISM index jumped to 62.2 from 58.5, flying past expectations for a rise to 58.7.

The report confirmed the trend seen in a series of reports including Tuesday's strong factory orders and last week's upbeat reading from the ISM's manufacturing sector survey. And now market players are starting to anticipate the key employment report on Friday, which is also expected to show a strong rebound after weakness in May.

"Oil may be above $60 but that doesn't seem to be doing much to the economy," says Joel Naroff, president of Naroff Economics.

Yet, at some point, the market will have to decide just how happy it is to see resilient economic growth at this juncture, as it gives only more fodder for the

Federal Reserve

to continue raising interest rates. And if high oil prices are indeed becoming comfortably embedded in the economy, the so-far tame inflation picture can't last for much longer. And the downside of the ISM report was a rise in the prices-paid index for the first time in five months; a rise attributed to higher energy prices.

"It's hard to argue with the Fed's apparent thinking that with energy price pressures increasing and the economy growing, inflation is really job one," says Naroff. "Indeed, it would really be surprising if even the

Fed's artificial measure of inflation, the PCE core index, doesn't start to tick up over the next few months to levels that reflect higher-than-expected price increases."

The bond market, meanwhile, seems to believe that the bite of oil into growth and/or more Fed rate hikes will be enough to contain inflationary pressures. The benchmark 10-year bond rose 8/32 while its yield fell back to 4.08%. There was also news that June layoffs reached a 17-month high, according to Challenger Gray & Christmas.

St. Louis Fed President William Poole, who doesn't vote on rates this year but tends to be hawkish on interest rates, said he believes low bond yields reflect low inflation expectations. He also said the Fed has acted "in timely fashion" in moving rates higher.

That was enough for fresh buying into bonds, which have been on a downtrend since the Fed failed to provide a hint that it planned to end or even pause its year-old rate-tightening campaign last week.

While many market players still hope that such hints may be forthcoming when Fed Chairman Alan Greenspan gives his semiannual testimony to Congress on July 20, the strong economic reports recently and the employment report on Friday may dampen these hopes.

That would especially be true if beyond the headline payroll number there are indications of higher wage pressures, a nascent trend the Fed is no doubt watching closely.

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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